The Business Divorce Law Report
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A restrictive covenant that is in force during a vesting period for securities granted as part of an employee incentive program may present an issue for enforcement, if not tied to to the protection of an employer’s legitimate interest.
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A court considering a preliminary injunction request blue-penciled the duration of a covenant not to compete or solicit customers to base the time period on termination, not the vesting period for stocks and options sought by the former employer.
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The duration of a restrictive covenant may not be reasonable if the duration is not tied to the former employer’s protection of a legitimate interest.
Restrictive covenants that were tied to the vesting and exercise schedules pf securities awarded through United Healthcare’s employee incentive programs were not reasonable, a federal court held recently. The court then limited the duration of the time when a former employee would be restricted from competing with or soliciting the company’s customers.
The case involved a former executive, Jeffrey Corzine, who worked in strategic marketing for United in its program offered as an option in Ohio’s Medicare program. Corzine was terminated by United in a corporate reorganization and then went to work for a competitor, Humana, Inc., during the time that both companies were competing under a Request for Applications (RFA) for contracted Medicare services. The case was before a federal district judge on United’s application to secure a preliminary injunction.
Restrictive Covenant Linked to Employee Incentive Program
The restrictive covenants at issue in the case, United Health Care Services, Inc. v. Corzine (opinion here) were tied to either a one- or two-year periods or to time which stock and options grants vested, the longest of which was five years. The trial court, however, held that the vesting periods were not related to the interests that United was seeking to protect and imposed the shorter alternative.
The case was decided under Delaware law (United is a Delaware corporation), which requires that an enforceable restrictive covenant be in a valid contract, be reasonable in scope and duration, advance a legitimate economic interest and survive a balancing of the equities. Delaware permits courts to “blue pencil” a restrictive covenant to permit enforcement to the extent reasonable.
The requirements for an enforceable restrictive covenant are similar in New Jersey, where I principally practice. New Jersey also permits a court to blue pencil a restrictive covenant to impose reasonable restrictions.
Duration of Restrictive Covenant at Issue in Dispute Related to Medicaid Contract
Under Ohio’s Medicare system, a significant portion of its Medicare coverage is contracted to a group of private insurers. The number of patients assigned from a pool to the participating carriers depends on the state’s assessment of performance metrics. The participating companies compete through the RFA process – the last was in 2012 – that the state can invoke at any time.
Both United and Horizon expected a new RFA, based on public statements made by government officials. Corzine at the time was employed by United and took a lead role in the preparations for the new RFA until he was terminated. Following his termination, Corzine was subject to restrictions on competition and solicitation contained in and option and restricted stock award. The relevant provisions:
Covenants in the Option Award
Non-competition. The non-competition provision provides
During the Optionee’s employment and for the greater of one year after termination of the Optionee’s employment for any reason whatsoever or the period of time for which the Option remains exercisable, the Optionee may not …directly or indirectly …:
(i) Engage in or participate in any activity that competes, directly or indirectly, with any Company activity, product or service that Optionee engaged in, participated in, or had Confidential Information about during Optionee’s last 36 months of employment with the Company; or
(ii) Assist anyone in any of the activities listed above.
Non-solicitation. The non-solicitation provision provided:
During the Optionee’s employment and for the greater of two years after the termination of the Optionee’s employment for any reason whatsoever, or the period of time for which the Option remains exercisable, the Optionee may not … directly or indirectly …:
(i) Solicit or conduct business with any business competitive with the Company from any person or entity: (A) who was a Company provider or customer within the 12 months before Optionee’s employment termination and with whom Optionee had contact regarding the Company’s activity, products or services … or about whom the Optionee learned Confidential Information during employment related to the Company’s provision of products or services to such Company provider or customer.
Covenants in the Restricted Stock Unit Award
Non-competition. The non-competition provision of the stock awarded provided:
During Participant’s employment and for one year after the later of (i) the termination of Participant’s employment for any reason whatsoever or (ii) the last scheduled vesting date under Section 4, Participant may not … directly or indirectly …:
(i) Engage in or participate in any activity that competes, directly or indirectly, with any Company activity, product or service that Optionee engaged in, participated in, or had Confidential Information about during Optionee’s last 36 months of employment with the Company; or
(ii) Assist anyone in any of the activities listed above.
Non-solicitation. The non-solicitation provision of the award provided:
During Participant’s employment and for two years after the later of (i) the termination of Participant’s employment for any reason whatsoever or (ii) the last scheduled vesting date under Section 4, Participant may not … directly or indirectly …:
(i) Solicit or conduct business with any business competitive with the Company from any person or entity: (A) who was a Company provider or customer within the 12 months before Optionee’s employment termination and with whom Optionee had contact regarding the Company’s activity, products or services … or about whom the Optionee learned Confidential Information during employment related to the Company’s provision of products or services to such Company provider or customer.
Alternative Calculation of Duration Not Reasonable
The trial court was troubled by the language that tied the duration of the restrictive covenant and non-solicitation provisions to the vest schedule. These alternative durations the court noted were at a minimum one year for competition and two years for non-solicitation. In Corzine’s case, as a former employee eligible for retirement at the time he left United, the restricted stock vesting schedule extended until February 2023 and the options were exercisable until October 2023.
A restrictive covenant is unreasonable in duration if longer than that necessary to protect the employer’s legitimate economic interests, the court reasoned, but there wad no connection between the vesting schedule and protecting those interests.
Corzine argues that tying the duration of his covenants to the vesting of his equity—instead of the date his termination—is arbitrary and does not protect United’s legitimate economic interests. This Court agrees. United has an interest in protecting its confidential information, such as its RFA strategy, and protecting its customer goodwill from misappropriation from competitors. But extending the duration of an employee’s restrictive covenants based on the vesting of equity is not tailored to protect these legitimate interests. The agreements provide two alternative timelines: the first is a post-termination duration; the second is a post-equity-vesting duration. The risk that a former employee will trade on the employer’s goodwill or utilize its confidential information to gain an unfair competitive advantage has everything to do with the former employee’s employment and the information known to the former employee; it has nothing to do with the type of equity the former employee holds and when that equity vests.
This case illustrates the arbitrariness of tying the covenants’ durations to the post-termination equity vesting.
Court Blue Pencils Agreement to Restrict Competition and Prohibit Solicitation
The trial court held that only the duration tied to the date of Corzine’s termination was enforceable, though it was subject to a seven month extension (or tolling) during the time that Corzine had actually competed with United. (The court held that Delaware permitted tolling; something that is not available to former employers under many state’s law unless the tolling is part of the written agreement.)
Subject to the blue-penciling of the agreements, the court went on to grant the preliminary injunction until the RFA process had been completed.
If you have an issue with a restrictive covenant or questions about enforcement, feel free to contact us.