Tortious Interference with Covenants Not to Compete

It’s a common enough occurrence: an employee quits to go work for a competitor in apparent violation of a covenant not to compete. The former employer sues the ex-employee for breach of the covenant and seeks a judgment for damages and a temporary restraining order and injunction enjoining the new employment. But those remedies are not entirely satisfactory because the ex-employee may not be able to pay the damages and the TRO and injunction may come too late, after the competitor has acquired customer contacts and sensitive business information from the employee. What’s an employer to do?

The employer should consider filing suit against not only the ex-employee who has breached the covenant but also against the competitor who hired the employee. There are various causes of action by which a competitor may be held accountable for facilitating a former employee’s breach of a covenant not to compete. One of those causes of action is a claim for tortious interference with contract.

 
This article analyzes the history and development of an employer’s claim against a competitor for tortious interference with a covenant not to compete and reviews the elements necessary to prove such a claim. In particular, the article shows that the competitor who employs someone in violation of another’s covenant not to compete may be held liable for interference with contract even in the absence of conduct that is independently wrongful or tortious.

Origins and Evolution

The roots of a claim for tortious interference with a covenant not to compete are the roots of tortious interference itself. A right of action for interference initially existed only for interference with the employment relationship, specifically the relationship between a master and his servant. The theory was that a master owned a property interest in the work and services to be provided by his servant and, therefore, was allowed to recover from anyone who, by violence against the servant, deprived him of his servant’s labor. This claim expanded in 1351 when Parliament enacted the Statute of Labourers in response to the labor shortage that resulted from the Black Plague. The Statute of Labourers eliminated the violence requirement and provided masters a cause of action against outsiders who enticed servants to leave their masters and come work for them.

Over the course of centuries, the predominant employment relationship transformed from one based upon a party’s status as master or servant to one based upon the mutual agreement of employer and employed. The law adapted to this transformation by extending the cause of action for unlawful enticement of a servant from the master/servant context to the employer/employee context.

The first case to do so was Lumley v. Gye, decided in 1853 by the Queen’s Bench in England. In Lumley, an opera singer agreed to sing in Lumley’s theatre for a certain term and agreed that, for that term, she would not sing elsewhere. When the singer breached her contract and went to perform for a competing theatre owned by Gye, Lumley sued Gye for enticing away the singer and procuring the breach of her employment contract. The majority in Lumley found that enticing an independent contractor to breach her exclusive contract for personal services was “strictly analogous” to enticing a servant to leave her master. The Court, therefore, held Gye liable for interference.

In approving the cause of action for enticement in the context of a contract for personal services, the Lumley court saw itself as doing no more than protecting the same interest that courts for centuries before it had been protecting in the context of master-servant relations, i.e. the employer’s interest in the labor and services of the employed. Inasmuch as that interest was protectable against those outside of the employment relationship, it was in the nature of a property interest, good not only as against the party to the contract but also as against the world. In the master-servant context, that property interest existed by virtue of the employer’s status as master. Reasoning by analogy, the court in Lumley found that, in the context of a contract for personal services, this property interest existed by virtue of the contract.

The rationale for the decision in Lumley allowed the claim of enticement to be pulled loose from its moorings in the relationship between employer and employed and applied more broadly to other types of contracts. The logic behind the expansion of the tort is simple enough. If, as the court held in Lumley, an employer’s rights under a contract for personal services constitute a property interest entitled to protection against interference from outsiders to the contract, then it follows that the rights of parties to other types of contracts likewise constitute property interests entitled to the same protection. Accordingly, Lumley is now generally regarded as the leading modern case for tortious interference with contract.

The decision in Lumley became Missouri law when the Supreme Court of Missouri handed down its decision in Downey v. United Weatherproofing, Inc. In Downey, the Court held the defendants liable for persuading the plaintiff’s customers to cancel and repudiate their home insulation contracts with the plaintiff. Following the rationale of Lumley, the Court stated that “the right of a party to a contract to reap the profits resulting from the performance and the right to performance by the other party [to a contract] have been expressly declared to be property rights entitling each party to the other’s performance.” The Court held that interference with that right is actionable even where the interference occurred by means of otherwise lawful persuasion. The defendants in Downey were liable in spite of the fact that, when they interfered with the plaintiff’s contracts, they were merely competing for customers. Interference with the plaintiff’s rights under a binding contract could not be justified as competition for customers.

Application to Covenants Not to Compete

A covenant not to compete is not much different than the agreements at issue in Lumley and Downey. Just as the singer in Lumley agreed with her employer not to work for a competing theatre for a certain period of time, an employee bound by a covenant not to compete agrees with his or her employer not to work for a competing business for a certain period of time. And like the agreements at issue in Lumley and Downey, a covenant not to compete gives rise to a valuable right of property. Although in the context of a covenant not to compete that right is now circumscribed by the requirement that it be exercised and enforced no more than necessary to protect trade secrets and customer contacts, it is nevertheless an asset of the employer with which no outsider to the covenant may interfere.

Elements and Analysis

The competitor who hires or continues to employ someone knowing that the employment violates a rival’s covenant not to compete facilitates the breach of the covenant and may be held liable to the former employer under a claim of tortious interference with the covenant not to compete.

To recover on such a claim, the employer must plead and prove the following five elements: 1) a valid covenant not to compete; 2) the competitor’s knowledge of the covenant; 3) "intentional interference ... inducing or causing a breach of the [covenant]; 4) absence of justification; and 5) damages."

1) A Valid Covenant. 
To prove interference with the covenant against a competitor, the employer must show that the covenant is valid and enforceable. In this respect, proof of the tortious interference claim against the competitor is no different than proof of the breach-of-contract claim against the former employee. Specifically, the employer must show that its covenant not to compete is reasonable in duration and geographic scope and is no broader than necessary to protect the employer’s trade secrets and customer contacts. If the covenant as written is invalid as an unlawful restraint of trade, the fact that a court in equity might nevertheless enforce it to a more limited extent does not render the covenant valid for purposes of the tortious interference claim against a competitor. A defense based on the invalidity of the covenant, however, is effective only if the court actually finds the covenant to be invalid. If the covenant is upheld as written, the competitor may be held liable for interference regardless of the competitor’s good faith belief that the covenant was invalid.

2) Knowledge of the Covenant.

The plaintiff must prove that the competitor hired or continued to employ its former employee even though the competitor knew or should have known the former employee was bound by a covenant not to compete. A competitor without actual knowledge of the non-compete may nevertheless be liable where it had sufficient knowledge to reasonably assume that the employee was bound by a covenant not to compete. To avoid a factual dispute on this point at trial, the employer who has any concern that a departing or former employee may breach his or her covenant not to compete should identify as soon as possible the employee’s new employer and serve that new employer with notice of the non-compete agreement.

3) Intention and Causation.

A competitor may be liable for interference with a covenant not to compete even though it did not hire the former employee with the specific intent to interfere with the covenant not to compete. Liability may be imposed where “the actor does not act for the purpose of interfering with the contract or desire it but knows that the interference is certain or substantially certain to occur as a result of his action.” A competitor with knowledge of an employee’s covenant not to compete necessarily knows that a violation of that covenant will inevitably result from its employment of that employee. Therefore, where the competitor has the requisite knowledge of the covenant, the competitor also has the requisite intent.

To prove causation, the former employer must show (1) that the competitor “actively and affirmatively took steps” that induced the breach and (2) that, in the absence of the competitor’s conduct, the employee would not have breached the covenant. An offer of employment to someone a competitor knows or should know is bound by a covenant not to compete is an “active and affirmative step” that, once the offer is accepted, will result in a breach of the covenant. Thus, while greater efforts to recruit or entice an employee to leave his or her former employer will demonstrate a greater degree of culpability on the part of the competitor, the mere acts of offering employment and hiring or continuing to employ the employee in spite of the covenant arguably constitute the “affirmative steps” necessary to establish liability against the competitor.

4) Absence of Justification.

A competitor is rarely if ever justified in interfering with another employer’s covenant not to compete. Interference with an existing contract is justified only where the interferer has a superior right or interest created either by a prior existing contract or by a supervening financial interest or public policy. A competitor’s interest in interfering with another employer’s covenant not to compete does not extend beyond the mere prospective interest in hiring or retaining the employee who has breached the covenant. Such a prospective interest is not superior to and does not defeat the existing rights and interests created by a valid covenant not to compete. Therefore, a competitor “would not be justified in engaging the employee to work for him in an activity that would mean violation of the [employee’s] contract not to compete.”

In its defense, a competitor might argue that the interference can be justified as lawful competition. That is, in hiring the employee in spite of his or her covenant not to compete, the competitor might contend that it was doing more than lawfully competing in the labor market to find and employ a skilled and valuable workforce. This contention, even if true, is not a defense. Lawful competition serves as a justification only for "interference with a business expectancy" or with a "contract terminable at will". Lawful competition does not justify interference with an existing contract for a fixed term, such as a covenant not to compete.

5) Damages.

The amount of damages recoverable for a competitor’s interference with a covenant not to compete is not limited to the amount recoverable for the former employee’s breach of the covenant. A competitor who interferes with a covenant not to compete is subject to the full range of potential tort damages, including “the pecuniary loss of the benefits of the contract; consequential losses for which the interference is the legal cause; and, emotional distress or actual harm to reputation if they are reasonably expected to result from the interference.” Recoverable damages include the profits the former employer loses as a result of the employee going to work for a competitor. Damages also include the attorneys’ fees the former employer incurs in enforcing the covenant not to compete against the breaching employee. In a proper case, punitive damages may be awarded.

Thus, the damages awarded against the competitor for interfering with a covenant not to compete could far exceed the damages awarded against the former employee who breached the covenant.

The Employer Need Not Plead or Prove “Improper Means”

The employer need not show that the interference occurred by “improper means”. "'Improper means' [are those] means that are independently wrongful ... [such as] misrepresentation of fact, threats, violence, defamation, trespass, restraint of trade, or other acts [that, notwithstanding the interference, are] wrongful under statute or common law.” A showing of such independently wrongful conduct is not required to prove tortious interference with an existing contract.

The case law on this point has been inconsistent and confusing. The confusion lies mostly with a failure to distinguish interference with a contract from interference with a business expectancy. Regrettably, Missouri case law has joined these two distinct types of interference together into one cause of action, leading some courts and commentators erroneously to conclude that “improper means,” or “independently wrongful" conduct, is an element of claims for both types of interference.

Independently wrongful conduct is an element of the cause of action for interference with a business expectancy, not of the cause of action for interference with contract. Therefore, when pursuing a claim for interference with a covenant not to compete, it is essential to distinguish that claim as a claim for interference with a contract as opposed to a claim for interference with a business expectancy.

The tort of interference with a business expectancy, also referred to as a “prospective advantage,” has a different origin and protects less substantial interests than the cause of action for tortious interference with contract. The tort developed, not in the context of the relationship between employer and employee, but in the context of the relationship between competitors in the marketplace.

As the tort developed, courts recognized that the interests it protected, i.e., a proprietor’s interests in its prospective customers, was not a vested right of property and, therefore, was not as strong as the interest protected by the cause of action for interference with contract, i.e., the right to performance under a binding contract. As a result, business expectancies were not entitled to the same degree of protection as that afforded to binding contracts. In particular, business expectancies were not entitled to protection from lawful competition. Competitors should be allowed to interfere with each other’s business expectancies, but only so long as they do so by lawful means. Claims for interference with business expectancies accordingly have been limited to cases where the interference occurred by means of violence, fraudulent misrepresentations, defamation and other conduct that is independently wrongful, i.e. wrongful whether or not it interferes with a competitor’s business.

A cause of action for interference with a covenant not to compete is a claim for interference with a contract, not a claim for interference with a business expectancy. To recover on such a claim, therefore, the employer need not prove “improper means” or independently wrongful conduct on the part of the competitor.

Conclusion

In the world of commerce and competitive markets, it is not uncommon for businesses to hire away a rival’s employee for a job in which a covenant not to compete prohibits the employee from working. Such a set of circumstances presents a fact pattern that fits neatly into the elements of a cause of action for tortious interference with contract. Given its origins in the employment relationship, this cause of action is particularly well suited to the task of providing a remedy to the employer in whose favor the covenant not to compete was given. By forcing the competitor to pay for the consequences of the employee’s breach of his or her covenant, that remedy not only strengthens the legitimate protections afforded by covenants not to compete but also appropriately recognizes the role that the competitor played in that breach.

For further information about this topic, or for a full text version of the article including footnotes, please contact Henry F Luepke III at (314) 231-2800.