Third parties interfering with contracts - a primer

Recognizing a Litigious Reality serves as a good reminder of things businesses should not do and applies more widely than its original audience of accountants.

Intentional interference with contractual relations is a business tort that is especially prevalent in the field of intellectual property. A third party may be liable for this tort by inducing an employee to breach a contract (restrictive covenant) with an employer and encouraging the use of confidential information, such as customer lists. Since customer lists have been held to be trade secrets in some jurisdictions, the third party could also face liability for misappropriation of trade secrets.

The article proceeds to discuss how hiring employees with non-compete agreements can lead to a claim of tortious interference. While the employee gets sued for violating the non-compete, the new employer finds itself sued for tortious interference.

The writer proceeds to some good advice here:

Accounting firms should study the state laws carefully and narrowly tailor their noncompete clauses to an employee’s activities within their organization. Firms should take several factors into consideration:

* The specific language of the clause is very important, and thus a specialized attorney should draft the contract.
* Restrictions must be reasonable and no broader than necessary to protect legitimate interests of the firm. Be specific as to which clients are covered. In states like New York, make sure the noncompete specifies clients with whom the accountant is given direct, substantive work.
* Require recruitment efforts to be firm-driven and consider implementing a client development plan that includes paying employees’ membership dues in community organizations where business may be developed.
* Consult state law for reasonable limitations in time, geography, clients, and scope of activities, and stay within these limits.
* Practice bans are more onerous than reimbursement provisions. It is appropriate to limit the enforcement of these covenants to very narrowly defined time frames, classes of clients, or activities.
* Reasonable-reimbursement clauses based on formulas related to the anticipated loss have greater public policy support than practice bans. An unbiased objective formula commonly used for practice sales to third parties is advisable.
* The employer should exercise good faith in implementing and enforcing covenants.
* It is advisable with existing employees to tie a noncompetition agreement to a raise or promotion.
* Do not require all employees to sign noncompete clauses. Instead, select only those employees who will have the opportunity or ability to unfairly compete.
* Avoid requiring employees or partners to sign noncompetition agreements without allowing time to review them.

Taken together, these steps will show a court that an employer is attempting to protect only the firm’s legitimate interests, while keeping the burden on the employee and the clients to a minimum.

I am far more blunt about non-compete agreements: get a lawyer to draft the non-compete agreement, discuss fully what information and positions need protection with that lawyer, and be sure to have the employee sign them.

I am a bit leery of the advice to tie a non-compete agreement to a raise but only because it is much better to have had one signed at the outset of the employment relationship. Remember I am writing from the perspective of Indiana law,. Our courts will enforce non-compete agreements, but that enforcement is conservative.

As for employers hiring employees with non-compete agreements, always get a copy of the agreement and have it reviewed by counsel.

Remember, if you want more information about retaining me for a case, please give me a call at 765-641-7906.

Speaking of Defamation - A Georgia Case and Indiana Law

I wrote a bit about Indiana defamation law in Business Defamation/Trade Secrets. Reading the following from Quick Takes -- April 15, 2008 from Workforce.com made me think I should repeat myself:

"You Can’t Say That: Slander allegations made by an ex-employee of Amerisave Mortgage Corp. will be heard in court after all, following a decision by the Supreme Court of Georgia that overturns a lower court’s ruling to dismiss the lawsuit. The case stems from allegations made by Stephen Scouten that Amerisave and its business associates allegedly “defamed him by disseminating false information” to employees that he was terminated for theft, according to court transcripts and published reports."

This certainly sounds like the defenses of May v. Frauhiger (WP format) and Dietz v. Finlay Fine Jewelry Corp. (html format) would not apply. Without knowing more , I would say the best defense would be on the issues of damages and malice. Remember the elements for defamation are a defamatory communication; made with malice; publication of the communication; and damages.

Business Defamation/Trade Secrets

Someone asked me an interesting question about a customer contact/relationship database. With customer relations management (CRM) being touted as so important for businesses of all sorts, could there be action against a company for content of its CRM database?

While CRM might contain or be a trade secret of a company, any content from its clients ought not be trade secrets of any sort. (More on why only "ought not" in a moment).

Could the company be liable for defamation? Only if the information contained in the CRM database satisfies the following elements: a defamatory communication; made with malice; publication of the communication; and damages. See Schrader v. Eli Lilly & Co., 639 N.E.2d 258, 261 (Ind. 1994). A more recent cases having interest here are May v. Frauhiger (WP format) from 1999 and Dietz v. Finlay Fine Jewelry Corp. (html format) from 2001.

In general, if the company keeps information in its CRM database private there is no liability for the company even if the information is false.

I see a couple of interesting trade secret scenarios. First, if an employee leaks the content of a
CRM database does not seem likely to be a defamation case against the company but might give the company's clients a cause of action against the employee. My second scenario involves a client giving trade secrets to the company under a non-disclosure agreement and this information goes into the CRM database (or any other database) and that gets leaked to the world - there I see a free-for-all of litigation.

A Third Party Interference Case In Anderson, Indiana

The Anderson Herald Bulletin's reports on a slightly different sort of third party interference with contract. However, after reading Pepelea wants $75K from city, I am have some major questions.

On the face of it this is a good case of third-party interference with a contract except for one thing. Was there a contract between the city and Anthem which gave Pepelea any rights?

After the contract was approved, it was sent to Anthem officials for them to sign. An unknown city employee contacted Anthem officials and told them to put the contract on hold until Jan. 1, when Ockomon, a Democrat, took office, according to the notice.

That paragraph contributes only massive confusion. I have written about third party interference here. If you read that article, you can see that at least two elements are at the least questionable: a valid, existing contract and who did the interfering.

Not that Pepelea is out of luck entirely. Without a contract, Pepelea would have a case for intentional interference with a business relationship and/or interference with a prospective advantage. If his attorney remembered to add these claims to the tort claims notice.

Indiana Appellate Cases: Third Party Interfering With Contracts

On March 20th, the Indiana Court of Appeals handed down its opinion in Allison v. Union Hospital (PDF format) that dealt with tortious interference with contractual relationship against Union Hospital and Wabash Valley Anesthesia, P.C. (the other appellee) and constructive fraud and breach of the duty of good faith and fair dealing against Union.

Allison (and Safford, the other appellant) lost on both claims at the trial court level and had a split decision with the Court of Appeals. The Court of Appeals reversed the trial court on the tortious interference claim but upheld the other claims.

The opinion contains a refresher on the tort's elements:

A plaintiff alleging tortious interference with a contractual relationship must establish five elements: (I) the existence of a valid and enforceable contract: (2) the defendant's knowledge of the existence of the contract; (3) the defendant's intentional inducement of the breach of the contract; (4) the absence of justification; and (5) damages resulting from the defendant's wrongful inducement of the breach. (citation omitted).

This case focuses on the justification element. The Indiana Supreme Court has set out the following factors for judging whether or not the defendant acted with justification:

(a) the nature of the defendant's conduct;
(b) the defendant's motive;
(c) the interests of the plaintiff with which the defendant's conduct interferes;
(d) the interests sought to be advanced by the defendant;
(e) the social interests in protecting the freedom of action of the defendant and the contractual interests of the plaintiff;
(f) the proximate or remoteness of the defendant's conduct to the interference: and
(g) the relations between the parties.

The Indiana Court of Appeals proceeded to evaluate the facts of the case against these guidelines. It then made the following decision:

In weighing all of these factors, we find this to be a very close call. And as noted above, the ultimate question relating to the justification of the defendant's conduct is whether that conduct has been fair and reasonable under the circurnstances. We find this inquiry to he so highly- fact sensitive that we conclude it is best answered by a factfinder. Although it is possible that under certain circumstances this question may lie answered as a matter of law-and, indeed, we make just such a finding with respect to WVA below- we do not find that to be the case with respect to Union, based primarily on its conduct with respect to the without cause termination provision....

I must say this case has some unusual features - Union Hospital admitted entering into a contract it had no intention of honoring - which probably helped lead to the decision for a remand for trial rather a decision as a matter of law.

Having confronted several of these tortious interference cases, my thought is that the lack of justification element is generally the make or break element. If the case is a good tortious interference case, then the other elements ought to be readily apparent with an appropriate support of the evidence. (For example, last week a client wrote me about what would appear a good tortious interference case except there was no interference - the clients were not impressed by the attempted interference.) With this opinion, Indiana has a very a good explanation of when a third party lacks justification for its interference.

Interesting Tennessee case on third party interference with contracts

Thanks to the Tennessee Business Litigation Law Blog and Day on Torts for the lead to this case on third party interference with contractual rights. I am unaware of any similar reported case in Indiana. However, I think think the reasoning ought to be persuasive here.

First, the Tennessee court established that a difference existed between a parent corporation and a subsidiary:

In a tortious interference claim, a parent corporation and its subsidiary will usually not share an identity of interests when the subsidiary is not wholly-owned because the interests of the majority shareholder are often different from and antagonistic to the interests of the minority shareholders. Because of the competing nature of their interests, Tennessee law protects minority shareholders from majority shareholders. Under Tennessee law, a majority shareholder owes a fiduciary duty to minority shareholders.

Second, the Tennessee court noted that one cannot be liable for interfering with one's own contract.

Then, the court examined the policy underlying that rule:

But when the parent is not the sole shareholder, the interests of the parent and the subsidiary will not always be identical. This distinction is crucial because the whole issue of extending the qualified privilege depends on a complete identity of interest, such that two separate entities are treated as one. When the interests of a parent and subsidiary are not identical, the reason for treating them as the same entity disappears. In that case, the parent should not be considered a
party to the contract so as to protect it from liability for interference with contract.