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Indiana Court of Appeals Narrows the “Blue Pencil” Doctrine as Applied to Employee Non-Compete Agreements

As the result of the Indiana Court of Appeals’ recent decision in Clark’s Sales & Service, Inc. v. John D. Smith and Ferguson Enterprises, Inc., No. 49A02-1306-PL-552 (February 20, 2014), it just became more difficult to enforce employee non-compete agreements in Indiana.

Indiana courts have long held that employment-based restrictive covenants – agreements that prohibit a former employee from competing with a former employer in a defined geographic area for a specified period of time, as well as those that prohibit former employees from contacting, soliciting or servicing the former employer’s customers – are disfavored as restraints on trade. Yet the courts consistently have enforced such covenants if they protect a legitimate business interest of the employer (such as confidential information and trade secrets, customer relationships or business goodwill) and provided they are not overly restrictive on the former employee’s post-employment activities. The breadth of such covenants is evaluated in terms of their geographic scope, the activities that are restricted and the length of time the restrictions apply. See Central Indiana Podiatry, P.C. v. Krueger, 882 N.E.2d 723, 728-29 (Ind. 2008).

When a particular covenant is found to be overly broad, Indiana courts have applied the “blue pencil” doctrine, allowing the trial court discretion to modify the challenged covenant by deleting specific words or phrases in such a way as to narrow the covenant to its enforceable terms. This doctrine has routinely been applied by the courts, as it was in Krueger, to enforce geographic restrictions that are found to be reasonable and by striking those that are not.

The decision in Clark’s represents a troubling departure from this long-standing precedent and jeopardizes the enforceability of many non-compete agreements that were drafted to comply with the law pre-Clark’s. The two-year post-employment covenant in Clark’s set forth a series of Indiana counties in which competition was forbidden, and also prohibited competition within a 50-mile radius of the office where the plaintiff, John Smith, worked.  Although the parties agreed that the 50-mile radius was reasonable, Smith claimed that the overall geographic scope of the covenant was overly broad, and the Court of Appeals agreed.

In so doing, the court declined to apply the blue pencil doctrine to delete those geographic restrictions that were allegedly over broad and struck down the non-compete covenant in its entirety. Thus, the court declined to enforce a covenant that was virtually identical in form to the one upheld by the Indiana Supreme Court in Krueger, and has thereby mired the blue pencil rule in uncertainty.

Besides undermining the blue pencil doctrine, the Clark’s decision further heightens the level of specificity required in identifying an employee’s competitive activities. The court’s opinion holds that a covenant may only prohibit the employee from engaging in the same kind of activity the employee engaged in for the employer, not “competitive” activity in general, even as it relates to the employer’s customers serviced by the former employee.

Clark’s is seeking transfer to the Indiana Supreme Court in an effort to set aside the far-reaching holdings of this case. In the meantime, it is important to bear in mind that the law of restrictive covenants is constantly in flux, and agreements that may have been previously enforceable may be in jeopardy today. Indeed, unless and until it is vacated by the Indiana Supreme Court, Clark’s is law in Indiana, and Indiana employers should take this opportunity to review their existing restrictive covenant agreements to ensure that their business good will, customer relationships and confidential information are adequately protected.