Corporate Formalities Harpoon Non-Compete Enforcement

A new Indiana Court of Appeals decision may send companies scrambling to redraft employment contracts containing non-competes. What happened?

The facts of the case display common elements of non-compete litigation. A disgruntled executive employee brought claims against his former employer seeking to find his non-compete clause unenforceable and seeking damages for tortious interference with business relations, breach of contract and violation of the state "black listing" statute. The employer counter-claimed alleging breach of contract, violation of trade secrets, and seeking enforcement of the non-compete provisions.

The executive worked for the parent corporation which manufactured weather-proofing technologies. The parent company also owned a subsidiary company which installed and provided consulting services on weather-proofing technologies. The executive formed a new company which provided weather-proofing technologies in competition with the subsidiary, but did not engage in any manufacturing activities consistent with those carried out by the parent corporation.

As to the former employer's attempt to enforce the non-compete, the executive raised a novel defense: He only worked for the parent corporation, and never worked for the subsidiary. More importantly, his employment agreement which contained the non-compete only listed the parent corporation as his employer.

The executive argued that the parent corporation possessed no claim against him because he did not compete against the parent corporation, in that his new company did not manufacture roofing or weather-proofing systems. Instead, the executive's new company only provided installing and consulting services which definitely competed with the subsidiary corporation, but not the parent corporation.

The parent corporation argued that the corporate formalities should be ignored and that competition against the wholly-owned subsidiary should constitute competition against the parent. The parent corporation cited several cases from other jurisdictions in support of this concept based on the idea that the two entities were "fundamentally indistinguishable."

The Indiana Court of Appeals rejected the conglomeration argument completely. Instead, it found the parent and the subsidiary to be separate entities as a matter of law. As the executive competed only against the subsidiary and not against the parent, he did not violate the non-compete clause of his employment agreement. Consequently, the Court of Appeals reversed the trial court's entry of summary judgment in favor of the parent corporation and remanded the case for entry of summary judgment in favor of the executive. Rehearing was denied October 8, 2008, and both sides have petitioned for transfer to the Indiana Supreme Court.

Consequently, for now anyway, we know that under Indiana law employers must be very conscious of the entities with the right to pursue enforcement of non-compete obligations. This may require a restructuring of employment contracts, and employment relationships, in order to maximize protection from unwanted competition from former employees. Failure to heed the warning provided by this case could cause employers to be harpooned by the very corporate formalities which normally exist to protect business enterprises, not harm them.

David Carr is a partner in the Labor and Employment Section of Ice Miller LLP, focusing his practice in the areas of personnel policies, employment discrimination, sports law, and employment contracts involving trade secrets, confidential information and covenants against competition.

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.