The United States District Court for Maryland recently granted summary judgment in a case upholding a covenant not to compete involving a former Director of Strategic Accounts for TEKsystems, Inc. In doing so, it signaled a willingness on the part of Maryland courts to enforce such covenants even where there was no evidence of lost profits by the employer. TEKsystems, Inc. v. Bolton, 2010 U.S. Dist. LEXIS 9651 (February 4, 2010). Click here.
TEKsystems is a technical staffing and services company. Jonathan Bolton worked in the New York City region. At the time he was hired he entered into an employment agreement containing a restrictive covenant that barred him from "engaging in the business of recruiting or providing on a temporary or permanent basis technical service personnel ... industrial personnel ... or office support personnel ... within a radius of fifty (50) miles of the office in which EMPLOYEE worked at the time his/her employment ended ..." The covenant effectively barred him from competing in the New York City area.
After resigning from TEKsystems, Bolton became employed by another IT-staffing company and operated from his home in New Jersey that was within the 50 mile radius of his former office. He was given the title "Managing Director of New York City." The evidence established that during his first year in the new position Bolton made nine placements, none of which were to companies that had been TEKsystems' clients. TEKsystems sued to enforce the covenant not to compete and sought both injunctive relief and damages.
The employment agreement provided that any dispute arising under the contract would be governed by the law of Maryland. In its opinion, the district court provides a thorough discussion of Maryland's law relating to the enforcement of covenants not to compete. Bolton challenged the covenant on the basis that it was overbroad, failed to protect a legitimate business interest, imposed an undue hardship on him and violated the public's interest.
Under Maryland law, covenants will be enforced "if the restraint is confined within limits which are no wider as to area and duration than are reasonable for the protection of the business of the employer and do not impose undue hardship on the employee or disregard the interests of the public." Id. at *12, quoting Ruhl v. F.A. Bartlett Tree Expert Co., 225 A.2d 288 (Md. 1967). Where the scope is reasonable, courts may also consider other factors, such as: "whether the person sought to be enjoined is an unskilled worker whose services are not unique; whether the covenant is necessary to prevent the solicitation of customers or the use of trade secrets, assigned routes, or private customer lists; whether there is any exploitation of the personal contacts between the employee and customer; and, whether enforcement of the clause would impose an undue hardship on the employee or disregard the interests of the public." Bolton, at *12-13, quoting Budget Rent A Car of Wash., Inc. v. Raab, 302 A.2d 11 (Md. 1973).
The court first upheld the 50 mile radius geographic scope of the covenant, noting that Maryland courts had upheld covenants that had unlimited geographic limitations. It found significant that, while TEKsystems operated nationally and internationally, the covenant only applied to the New York City area. The court also found the 18 month period to be reasonable, as Maryland courts have routinely upheld covenants that spanned two years.
Bolton also charged that the covenant was overbroad in that it barred him from engaging "in any activity which may affect adversely the interests of the Company." The court rejected the argument, noting that Maryland courts have "sanctioned restrictive covenants that prohibit former employees from securing employment with competitors." Bolton at *15.
It also noted that employers have a protective interest in preventing an employee from using customer contacts post employment, especially where the "personal contacts between the employee and the customer are an important element determining the business's success." Id. at 16-17, quoting Intelus Corp. v. Barton, 7 F. Supp.2d 635, 639 (D. Md. 1998). Here, the court found that TEKsystem's business depended overwhelmingly on the personal connections between its employees and its clients, and Bolton was one of TEKsystem's most important employees in the New York City area. In Maryland "[c]ourts are more willing to enforce restrictive covenants when the employee at issue possesses unique or specialized skills." Bolton at *18.
Bolton also claimed that enforcing the covenant would create an undue hardship on him because it barred him from bompeting in the New York City area. Again the court rejected the argument, holding that, while such a claim might be inconvenient, it did not rise to a level of undue hardship.
Finally, the court considered the public interest at stake and noted that "the public benefits from the enforcement of reasonable restrictive covenants. ... Such measures facilitate and protect business growth, especially in technology-related and information-based fields." Id. at *20. And it quoted approvingly from Intelus, supra, regarding Maryland's policy as to such covenants: "As long as employers do not restrict employees from earning a living and do not limit fair competition, they must be given the opportunity to provide a service to their customers without risking a substantial loss of business and good will every time an employee decides to switch employment." Id. quoting Intelus , 7 F. Supp.2d at 642.
Turning to remedies, the court denied compensatory damages finding that there was no proof that any of TEKsystem's customers had paid any fees to Bolton for work with his new employer. It reserved, however, on the issue of whether the parties had a desire to litigate further on the damages issue.
And as for equitable relief, the court awarded a permanent injunction, barring Bolton from operating in the New York City area. It noted, however, that the original 18 month period had expired in December 2009. Given prior Maryland precedent that "if the non-compete period is not enforced through equitable extension, it could 'reward the breach of contract, encourage protracted litigation, and provide an incentive to dilatory tactics,'" Bolton at *28, quoting PADCO Advisors, Inc. v. Omdahl, 179 F. Supp.2d 600, 613 (D. Md. 2002)(quoting Roanoke Engineering Sales Co. v. Rosenbaum, 290 S.E.2d 882 (Va. 1982)) the court prospectively enjoined Bolton from violating the terms of his restrictive covenant for 18 months from the date of the court's order.
This case should be viewed as a cautionary tale to employees who are dismissive of the legal import of covenants not to compete that are governed by Maryland law.
Thursday, March 11, 2010
Thursday, January 28, 2010
Failure to Produce Knowledgeable Corporate Designee for Depositions Results in Sanctions
In unfair business practices cases, as with most civil cases involving companies, partnerships or other organizations, a party frequently wants to take a deposition of someone designated by the organization to speak for it as to certain issues. Unfortunately, it is not unusual for counsel to depose one or more designated individuals only to find that they have not been adequately prepared to testify and possess little useful knowledge. Two recent opinions from the Eastern District of Virginia and the District of Maryland suggest that such gamesmanship violates the requirements of the Rule and is sanctionable.
In the federal system these depositions are authorized by Rule 30(b)(6) of the Federal Rules of Civil Procedure. Under that Rule a party may serve notice on an organization that it will depose a corporate designee and provide a list of topics to be covered in the deposition. The organization is obligated to produce an officer, director, managing agent or some other representative who consents to testify on its behalf regarding the enumerated topics. The term "organization" includes corporations, partnerships, LLCs, associations and governmental agencies or other entities.
In Humanscale Corp. v. Compx International, Inc., 2009 U.S. Dist. LEXIS 120197 (E.D.Va. December 24, 2009), click here, the district court examined the clear requirements of the Rule. "The corporation must make a good-faith effort to designate people with knowledge of the matter sought by the opposing party and to adequately prepare its representatives so that they may give complete, knowledgable, and nonevasive answers in deposition." Given that the individual speaks for the corporation, the duty to prepare goes beyond the actual knowledge of the individual to the knowledge of the company. Therefore, the Rule requires the company to prepare the designee to testify as to all matters known by or reasonably available to the company. That this may be burdensome and time consuming to the company does not excuse its failure to adequately prepare its designee. As the court noted, "... sanctions may be properly imposed against a corporation when its 30(b)(6) designee is unknowledgable of relevant facts and it fails to designate an available, knowledgable, and readily identifiable witness because such an 'appearance is, for all practical purposes, no appearance at all,'" quoting Resolution Trust Co. v. Southern Union Co. , 985 F.2d 196, 197 (5th Cir. 1993).
In Humanscale Corp., the court ordered the defandant to designate properly prepared witnesses to testify as to both financial and non-financial topics. It also directed the plaintiff to submit statements of attorneys' fees and costs incurred so that sanctions could be awarded.
Just last week, the District of Maryland in Weintraub v. Mental Health Authority of St. Mary's, Inc., 2010 U.S. Dist. LEXIS 5131 (D. Md. January 22, 2010), addressed the Rule in the context of a defunct corporation. There the plaintiff had served a Rule 30(b)(6) notice on the defendant who sought a protective order given that the company was no longer in business and had no employees or authorized representatives. Counsel for the defendant conceded that he might be able to find a former director who could be deposed, but noted it was likely the individual would have no information related to the designated topics of interest. Nevertheless, the court ordered that the defendant designate an individual who could testify and cautioned that the company could not "throw up its hands" and designate an individual who was inadequately prepared.
Unfortunately for the defendant, counsel did not produce a fully informed deponent. In fairness, however, in his letter designating the individual, counsel informed opposing counsel that he was designating her "having been left essentially no alternative by the court," but acknowledged that he could not compel her to come to Maryland to be deposed. At her deposition, the designee could not testify meaningfully as to at least ten topics and repeatedly testified that no efforts to obtain such information had been undertaken.
The plaintiff filed a motion for sanctions which the court granted. Finding that the defendant had violated its prior order to produce a knowledgable deponent, the court held that the defendant's actions constituted bad faith. The court refused to give credence to the defendant's lack of control over the witness, finding that under the circumstances "Ms. Zoss was a poor choice to serve as the Rule 30(b)(6) designee." Fortunately for the defendant, the plaintiff also deposed the President of defendant's Board of Directors who was more knowledgable and defense counsel asked to treat his testimony as that of a corporate representative. Thus, the plaintiff was able to obtain much of the desired testimony. Because two depositions were required to obtain the information that should have been forthcoming in one, however, the court imposed modest sanctions. Given the tenor of the opinion, had the Board member not testified, it is proabable that the sanctions would have been more severe.
These cases should be cautionary tales to a litigant. The courts have been clear that an organization must produce knowledgable individuals to testify in response to a Rule 30(b)(6) notice even if the designee has no personal, first-hand knowledge. The law requires that they be well prepared to testify as to all topics for which they have been designated. Difficulties arising out of the organization's status or availability of knowledgable employees according to these cases will not excuse that obligation.
In the federal system these depositions are authorized by Rule 30(b)(6) of the Federal Rules of Civil Procedure. Under that Rule a party may serve notice on an organization that it will depose a corporate designee and provide a list of topics to be covered in the deposition. The organization is obligated to produce an officer, director, managing agent or some other representative who consents to testify on its behalf regarding the enumerated topics. The term "organization" includes corporations, partnerships, LLCs, associations and governmental agencies or other entities.
In Humanscale Corp. v. Compx International, Inc., 2009 U.S. Dist. LEXIS 120197 (E.D.Va. December 24, 2009), click here, the district court examined the clear requirements of the Rule. "The corporation must make a good-faith effort to designate people with knowledge of the matter sought by the opposing party and to adequately prepare its representatives so that they may give complete, knowledgable, and nonevasive answers in deposition." Given that the individual speaks for the corporation, the duty to prepare goes beyond the actual knowledge of the individual to the knowledge of the company. Therefore, the Rule requires the company to prepare the designee to testify as to all matters known by or reasonably available to the company. That this may be burdensome and time consuming to the company does not excuse its failure to adequately prepare its designee. As the court noted, "... sanctions may be properly imposed against a corporation when its 30(b)(6) designee is unknowledgable of relevant facts and it fails to designate an available, knowledgable, and readily identifiable witness because such an 'appearance is, for all practical purposes, no appearance at all,'" quoting Resolution Trust Co. v. Southern Union Co. , 985 F.2d 196, 197 (5th Cir. 1993).
In Humanscale Corp., the court ordered the defandant to designate properly prepared witnesses to testify as to both financial and non-financial topics. It also directed the plaintiff to submit statements of attorneys' fees and costs incurred so that sanctions could be awarded.
Just last week, the District of Maryland in Weintraub v. Mental Health Authority of St. Mary's, Inc., 2010 U.S. Dist. LEXIS 5131 (D. Md. January 22, 2010), addressed the Rule in the context of a defunct corporation. There the plaintiff had served a Rule 30(b)(6) notice on the defendant who sought a protective order given that the company was no longer in business and had no employees or authorized representatives. Counsel for the defendant conceded that he might be able to find a former director who could be deposed, but noted it was likely the individual would have no information related to the designated topics of interest. Nevertheless, the court ordered that the defendant designate an individual who could testify and cautioned that the company could not "throw up its hands" and designate an individual who was inadequately prepared.
Unfortunately for the defendant, counsel did not produce a fully informed deponent. In fairness, however, in his letter designating the individual, counsel informed opposing counsel that he was designating her "having been left essentially no alternative by the court," but acknowledged that he could not compel her to come to Maryland to be deposed. At her deposition, the designee could not testify meaningfully as to at least ten topics and repeatedly testified that no efforts to obtain such information had been undertaken.
The plaintiff filed a motion for sanctions which the court granted. Finding that the defendant had violated its prior order to produce a knowledgable deponent, the court held that the defendant's actions constituted bad faith. The court refused to give credence to the defendant's lack of control over the witness, finding that under the circumstances "Ms. Zoss was a poor choice to serve as the Rule 30(b)(6) designee." Fortunately for the defendant, the plaintiff also deposed the President of defendant's Board of Directors who was more knowledgable and defense counsel asked to treat his testimony as that of a corporate representative. Thus, the plaintiff was able to obtain much of the desired testimony. Because two depositions were required to obtain the information that should have been forthcoming in one, however, the court imposed modest sanctions. Given the tenor of the opinion, had the Board member not testified, it is proabable that the sanctions would have been more severe.
These cases should be cautionary tales to a litigant. The courts have been clear that an organization must produce knowledgable individuals to testify in response to a Rule 30(b)(6) notice even if the designee has no personal, first-hand knowledge. The law requires that they be well prepared to testify as to all topics for which they have been designated. Difficulties arising out of the organization's status or availability of knowledgable employees according to these cases will not excuse that obligation.
Thursday, December 17, 2009
Maryland's Highest Court Allows Direct Action by Shareholders Against Corporate Directors for Breach of Fiduciary Duty
Traditionally, in Maryland, as in many states, the fiduciary obligations of corporate directors run to the corporation and its shareholders as a class, rather than to individual shareholders. A recent opinion of the Maryland Court of Appeals, however, has partially rejected that long-standing rule. In Shenker v. Laureate Education, Inc., 2009 Md. LEXIS 837 (Court of Appeals, November 12, 2009), click here, Maryland's highest court held that, in a cash-out merger situation, where a decision to sell a company has been made by its Board of Directors, those directors owe a common law fiduciary duty to maximize the value to be received from the sale by the shareholders. Moreover, individual shareholders can sue those directors for breach of that duty.
The plaintiffs in Shenker were shareholders in a successful publicly held Maryland company, Laureate Education, Inc. During 2006 and 2007, several of the directors of LEI and some private equity investors purchased LEI through a cash-out merger transaction. In a cash-out transaction, sometimes called a freeze-out, the dominant shareholder(s) generally incorporates a company to gain ownership of the target company through a cash transaction. The inside directors are, thus, able to pressure other shareholders to sell their shares to the acquiring company for cash. Shenker and other shareholders accused the interested directors of failing to maximize the price per share in the offer and misleading the shareholders with regard to the tender offer. The trial court and Court of Special Appeals dismissed the action finding that the shareholders could not maintain a direct action against the directors under Maryland law. Under their reasoning, such a claim could only be maintained derivatively. They also held that the directors owed no fiduciary duty to the shareholders, but only to the company.
The Court of Appeals rejected that analysis. It found that, while Section 2-405.1 of the Corporations and Associations Article of the Maryland Code established the duties of directors while engaged in their managerial duties for the corporation, other common law duties coexisted with those statutory duties. Specifically, it found that the directors owed the shareholders the common law duties of candor and good faith efforts to maximize shareholder value and that a shareholder alleging that directors had breached those duties could maintain a direct suit against those directors.
Relying upon the Delaware Supreme Court's decision in Revlon, Inc. v. MacAndrews & Forber Holding, Inc., 506 A.2d 173, 182 (Del. 1986), the Court of Appeals held that those common law duties are triggered once the Board has determined to sell the corporation. And the common law duties are personal to the shareholders. In a sale situation, the directors act as fiduciaries for the shareholders and owe a duty to maximize the price per share that is realized. In addition, according to the court, the directors owe a duty to make full disclosure to the shareholders of all facts related to the transaction.
The Maryland court's holding is the opposite of the rule in Virginia. In Willard v. Moneta Building Supply, Inc., 515 S.E.2d 277 (Va. 1999), the Virginia Supreme Court expressly rejected the Revlon rule, holding that in a sale situation, a director is not required to maximize the sales price, but is only required to "act in accordance with 'his good faith business judgment of the best interests of the corporation.'" Id. at 284. Moreover, as the court found in Willard, in the absence of fraud or some other disqualification under Section 13.1-747 of the Code of Virginia, the directors, as majority shareholders, maintained the right to control the management of the corporation by voting their shares to approve the sale of the company. Id. at 288. Section 13.1-747, allows for the dissolution of a corporation where the directors are acting in a manner that is illegal, oppressive or fraudulent.
The plaintiffs in Shenker were shareholders in a successful publicly held Maryland company, Laureate Education, Inc. During 2006 and 2007, several of the directors of LEI and some private equity investors purchased LEI through a cash-out merger transaction. In a cash-out transaction, sometimes called a freeze-out, the dominant shareholder(s) generally incorporates a company to gain ownership of the target company through a cash transaction. The inside directors are, thus, able to pressure other shareholders to sell their shares to the acquiring company for cash. Shenker and other shareholders accused the interested directors of failing to maximize the price per share in the offer and misleading the shareholders with regard to the tender offer. The trial court and Court of Special Appeals dismissed the action finding that the shareholders could not maintain a direct action against the directors under Maryland law. Under their reasoning, such a claim could only be maintained derivatively. They also held that the directors owed no fiduciary duty to the shareholders, but only to the company.
The Court of Appeals rejected that analysis. It found that, while Section 2-405.1 of the Corporations and Associations Article of the Maryland Code established the duties of directors while engaged in their managerial duties for the corporation, other common law duties coexisted with those statutory duties. Specifically, it found that the directors owed the shareholders the common law duties of candor and good faith efforts to maximize shareholder value and that a shareholder alleging that directors had breached those duties could maintain a direct suit against those directors.
Relying upon the Delaware Supreme Court's decision in Revlon, Inc. v. MacAndrews & Forber Holding, Inc., 506 A.2d 173, 182 (Del. 1986), the Court of Appeals held that those common law duties are triggered once the Board has determined to sell the corporation. And the common law duties are personal to the shareholders. In a sale situation, the directors act as fiduciaries for the shareholders and owe a duty to maximize the price per share that is realized. In addition, according to the court, the directors owe a duty to make full disclosure to the shareholders of all facts related to the transaction.
The Maryland court's holding is the opposite of the rule in Virginia. In Willard v. Moneta Building Supply, Inc., 515 S.E.2d 277 (Va. 1999), the Virginia Supreme Court expressly rejected the Revlon rule, holding that in a sale situation, a director is not required to maximize the sales price, but is only required to "act in accordance with 'his good faith business judgment of the best interests of the corporation.'" Id. at 284. Moreover, as the court found in Willard, in the absence of fraud or some other disqualification under Section 13.1-747 of the Code of Virginia, the directors, as majority shareholders, maintained the right to control the management of the corporation by voting their shares to approve the sale of the company. Id. at 288. Section 13.1-747, allows for the dissolution of a corporation where the directors are acting in a manner that is illegal, oppressive or fraudulent.
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