Non-Competition Clause in Employment Contract Invalidated

A pharmacy benefits manager employee who signed a broadly written contract agreed not to move to a competitor is sued by his former employer.

Issue of The Case

When an employee signs an employment contract bearing a covenant not to compete should he leave the firm’s employ, should a court refuse to enforce the contractual agreement upon his departure if that provision is drafted too broadly?

Facts of The Case

A national pharmacy benefits management (PBM) company hired an executive and assigned him to negotiate discounts with pharmaceutical manufacturers as well as policies governing returns. He signed an employment contract bearing a non-competition clause addressing his possible departure from the firm, which specified that he was prevented from “directly or indirectly” engaging in competition with the firm or affiliated companies for 1 year after departing. The clause specifically defined competition as meaning “engaging in any activity for a competitor of the company [in any capacity].” (Emphasis added.)

Five months after starting the position he resigned and initiated a declaratory judgment action in federal court seeking to have the judge declare the noncompetition provision in the employment contract to be invalid. He had accepted a position at a much smaller PBM. In response, the employer filed a counterclaim seeking an injunction prohibiting its former employee from working for another PBM. It also sought an award of financial damages for breach of contract and fiduciary obligations as well as for violations of several statutes relevant to its business activities. This action occurred in federal court because the employer was headquartered out of state.

A temporary restraining order was entered prohibiting him from working for another PBM for 14 days. This period was later extended while a US magistrate judge, a federal court official appointed by the US District Court judges, looked into the matter. The 48-page report from the magistrate judge concluded that the motion by the former employer for a preliminary injunction prohibiting the former employee from working for another PBM should be denied.

The former employer took exception to the report and recommendations made by the magistrate judge, asking that the US District Court judge who had referred to the matter to the magistrate judge overturn the latter official’s conclusions and proposed outcomes.

The Court’s Ruling

The motion by the former employer that the magistrate judge’s rulings be overturned and the injunctive relief be granted was denied. The preliminary injunction sought by the firm was denied.

The Court’s Reasoning

As a general proposition, a non-competition provision in an employment contract has to be specific and limited with regard to time period covered and geographic area within which it applies, as well as what activities of the former employee are restricted by the agreement. Looking at the definitions of “competitor” and “competition” included in the agreement, the court concluded that “the language of the non-compete is unreasonable because of its canyon-like broad coverage.”

The employee’s duties were to be quite different at the new position. In his former role, he negotiated discounts and return policies with pharmaceutical manufacturers. In the new position, he was assigned a variety of tasks related to pharmacy operations, for example, overseeing processing of prescriptions at pharmacies, working to reduce the time required to prepare prescription medication for dispensing, and lowering overhead costs associated with the dispensing process.

His former employer had sufficient size and scope to be in a position to negotiate product prices directly with pharmaceutical manufacturers, whereas his new firm had to aggregate its purchasing power with other PBMs to be in a position to negotiate with drug companies. To illustrate this point, during the prior year the former employer’s revenues totaled $50 billion whereas the new employer’s revenues totaled $1 billion. The court emphasized that if the plain terms of the non-compete were enforced, he would be precluded from “working in a wide variety of jobs which have zero relation to his work” at the first employer.

An additional provision in the employment contract was a broadly worded agreement that the employee would not disclose any information obtained through his employment for any purpose other than his position with the firm. The former employee did confirm that he remembered some of the “pricing and rebate/discount information contained in the contracts he negotiated.”

Such a provision is rather customary for employees in this field with his responsibilities, but the court emphasized that the only information the employee took with him from his former position was in his head; he had taken no documents or computer files. The magistrate judge concluded that the information available to him quickly became stale or out of date.

The employer also argued that he had insights and knowledge about the negotiating strategies it used with manufacturers. The court concluded that his skills as a negotiator are not confidential information to which the former employer can claim ownership. PT

Dr. Fink is professor of pharmacy law and policy at the University of Kentucky College of Pharmacy, Lexington.