Restrictive Covenants

Indiana Supreme Court Provides Valuable Guidance For Employers

Indiana courts continue to allow employers to protect goodwill, trade secrets and other valuable business interests by using restrictive covenants, including noncompetition and nonsolicitation agreements. In Central Indiana Podiatry, P.C. v. Krueger, 882 N.E.2d 723 (Ind. 2008), the Indiana Supreme Court recently provided valuable guidance for employers utilizing restrictive covenants to protect their businesses. Also, the Indiana Supreme Court addressed for the very first time the use of "no defense" provisions in restrictive covenant agreements as a way to limit an employee's ability to challenge the enforceability of the restrictive covenants.

Facts of Recent Decision

In Krueger, the Indiana Supreme Court analyzed the noncompetition provision in an agreement between Dr. Krueger, a podiatrist, and his previous employer, Central Indiana Podiatry, P.C. (CIP). Pursuant to the agreement, Dr. Krueger was prohibited from practicing podiatry for two years within a geographic area defined as 14 specified central Indiana counties, any other county where CIP maintained an office during the term of his agreement, or any county adjacent to any of the foregoing counties. The total restricted area consisted of 43 counties. In his final year of employment, Dr. Krueger worked at CIP's offices in three of the specified counties. After the termination of his employment, he entered into an employment agreement to practice podiatry in Hamilton County, one of the counties listed in his agreement where he had not performed services during his final two years of employment. CIP filed an action for injunctive relief to enforce the noncompetition provision.

The trial court found the geographic restriction unenforceable and denied CIP's request for a preliminary injunction, but the Court of Appeals reversed. Two of the issues on appeal to the Indiana Supreme Court were (1) whether the geographic scope of the covenant was overly broad, and (2) whether the noncompetition provision was unenforceable because of a prior "material breach" by CIP.

Employers Bear the Burden of Establishing that the Restrictions are Reasonable

The Court reaffirmed Indiana law that employers bear the burden of establishing that restrictive covenants are reasonable in scope as to time, activity, and geographic area. Neither the time period nor the scope of activity were challenged in this case. The key enforceability focus was on geographic scope, and the Supreme Court agreed with the trial court that the geographic restraint was unreasonable.

Although the Court upheld the agreement as reasonable (and enforceable) in the three counties where Dr. Krueger had worked in the year preceding his termination, the Court determined the geographic scope was overly broad. The Court recognized that the noncompetition provision restricted Dr. Krueger's practice in Hamilton County, a county where he had not practiced within two years of his termination. Further, emphasizing that Dr. Krueger did not use his employer's resources to establish relationships throughout all 43 counties the agreement identified, the Court concluded the geographic scope was overly broad.

In discussing its decision, the Court suggested, and the dissent emphasized, that reasonableness of geographic scope may be better gauged by radius, not county. After all, Dr. Krueger left northern Marion County (a county where he performed services for CIP) and set up shop in Hamilton County, just ten minutes from his former main site of practice. That a county line divides the two locations means very little to most patients. What matters more is the distance patients must travel to receive health care. The Court suggested that a radius approach would not only increase the likelihood of enforceability if tied to the practice(s) at which the physician performs services, but would increase the value of restrictive covenants for employer practices, and protect their interests more effectively.

While the discussion in Krueger focused on a health care practice, the case may have broader implications. The Court's geographic scope discussion provides yet further support for employers to focus and draft geographic restrictions using the areas in which employees actually perform services, rather than to focus on the entire area of the employer's business. The case also emphasizes that employers should really look at where their customers are located, and to tie the restriction to the area in which the employee is servicing those customers. This is easy if an employee has an established territory, but can be trickier when the employee's geographic area of service is not as clear.

Employers Should Incorporate a No-Defense Provision in Agreements Containing Restrictive Covenants to Safeguard Against the Potential Impact of a Claim of a Prior Material Breach

In an effort to avoid the enforceability of the noncompetition provision, Dr. Krueger made an argument commonly made by employees when a former employer attempts to enforce restrictive covenants. He argued that his employer "first breached" the employment contract (in this case, by failing to provide a car allowance included in the contract). Based on this alleged first breach, Dr. Krueger argued that the noncompetition provision was unenforceable. Consistent with other Indiana decisions, the Court conceded that a first, material breach by an employer may prevent enforcement of restrictive covenants in certain situations.

However, in this case, the employer included an important provision that saved its right to injunctive relief. The employment agreement contained a “no-defense” provision whereby the parties specifically agreed that “[t]he existence of any claim or cause of action of Employee against Corporation . . . shall not constitute a defense to the enforcement by Corporation of this Restrictive Covenant." The Court stated that while there may be some breaches by an employer that would override such a provision, the relatively minor issues Dr. Krueger raised were not sufficient to deprive CIP of its right under the no-defense provision, and ultimately, of the right to enforce the restrictive covenants. This no-defense provision discussion is significant, as it is the first Indiana case to address the enforceability of a no-defense provision in the restrictive covenant context. Employers should consider incorporating a well-drafted no-defense provision in their restrictive covenants, to more effectively protect the enforceability of their restrictive covenants.

If you would like further information or to discuss how restrictive covenants can protect your business, please contact Melanie Harris or Carly Everett.

This publication is intended for general information purposes only and does not and is not intended to constitute legal advice.  The reader must consult with legal counsel to determine how laws or decisions discussed herein apply to the reader's specific circumstances.