Employers Beware:
Indiana Court of Appeals Invalidates
Employee's Non-Compete as a
Result of Employer's Remedied First Breach
Employers who seek to enforce restrictive covenants against former employees may have a higher hurdle to overcome thanks to a recent case by the Indiana Court of Appeals. In Millsaps v. Ohio Valley Heartcare, Inc., 863 N.E.2d 1265 (Ind. Ct. App. 2007), a medical practice sought to enforce its non-competition agreements against two resigning physicians. The physicians argued and the court agreed that the non-competition agreements were unenforceable because the medical practice had previously breached their agreements with the physicians.
It has long been held that a defense to a breach of contract action is that the party seeking to enforce the agreement breached it first. This legal theory has come to be known as the first breach defense and one of its first applications by an Indiana court was in the matter of Federal Life Insurance Co. v. Maxam, 117 N.E. 801, 805 (Ind. Ct. App. 1917). In Federal Life, the Indiana Court of Appeals held that “when a contract is not performed the party who is guilty of the first breach is the one upon whom rests all the liability for the nonperformance . . . .”
As the theory has developed over time, Indiana courts have described the first breach defense as follows: “A party first guilty of a material breach of contract may not maintain an action against the other party or seek to enforce the contract against the other party should that party subsequently breach the contract.” Licocci v. Cardinal Associates, Inc., 492 N.E.2d 48 (Ind. Ct. App. 1986) (emphasis supplied). A material breach is defined as “[A] breach of contract that is significant enough to permit the aggrieved party to elect to treat the breach as total (rather than partial), thus excusing that party from further performance and affording it the right to sue for damages.” Black’s Law Dictionary (8th Ed. 2004). In these types of situations, the non-breaching party may treat the breach as a termination of the agreement. The recent Court of Appeals decision in Millsaps, however, has stated a broader application of the defense that may have sweeping ramification on your agreements with your employees.
In Millsaps, the employer medical practice had agreed to provide all billing and collection services to the physicians. The policies of the medical practice, which were incorporated into the physicians’ agreements with the medical practice, emphasized the importance of timely collection of accounts receivable and tied a physician’s timely submission of billing information to the physician’s compensation. Through an error, the medical practice neglected to transfer nearly $2 million of accounts receivable on an old software program to the new software program the practice had recently acquired. As a result, no efforts were taken to collect nearly $2 million in accounts receivable that were recorded on the old system. Although the medical practice took steps to correct the problem as soon as it was discovered and before the physicians resigned – too little, too late according to the Court of Appeals. The court ruled that the medical practice breached the physicians’ agreements first by not collecting accounts receivable in a timely manner. As a result of its first breach, the employer could not enforce the physicians non-competition agreements. The court concluded that “a breach is a breach even if temporary, and even if it is later rectified.”
While the Millsaps decision could have influence in cases that are being
decided under the laws of states other than
In light of this decision, employers need to take greater care not to breach their duties to their employees. Employers need to audit their employee and accounting files to determine if a breach has occurred. Keep in mind that breaches may occur when an employer fails to fulfill any promise to its employees (i.e. promises related to salary, training, or internal support).
Nevertheless, minor breaches of an employment agreement may be inevitable and can be caused by a number of factors in a busy workplace, such as accounting errors. To avoid this rock and hard place, we recommend the following strategies. If you know you have breached your agreement with an employee, remedy the breach immediately. After the breach has been remedied, have your employee re-execute any non-competition agreement. Under Indiana law, sufficient consideration for the “new” agreement will be the employee’s continued employment relationship. Another approach you may consider taking is to draft a non-compete agreement that is supported by consideration other than the employment relationship. For example, in exchange for the employee’s promise not to compete, the employer can promise that the employee will receive a two-week notice or two weeks severance pay at the termination of the employee’s employment relationship. This approach limits the scope of the agreement, and, therefore, limits the potential that the employer will commit the first breach. Of course, it is possible that the employee will still raise a first breach defense and the issue may ultimately be left for a court to decide.
If you believe there is a possibility that you have breached an obligation to your current employee, we recommend that you seek legal advice as soon as possible. The sooner you remedy the problem, the less likely it is that a former employee will be able to raise a first breach defense.
Michael Wukmer is a partner in Ice Miller's Competitive Business Practices Litigation and Private Equity and Venture Services Groups. Eileen Moore and Donald Hostetler are members of the Competitive Business Practices Litigation Group and the Private Equity and Venture Services Group. Please contact Michael, Eileen or Donald if you have any questions regarding your non-competition agreements.
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.