Dead or Alive? Territorial Restrictions in Covenants-not-to-compete in Nebraska

• Publication year: 2022

33 Creighton L. Rev. 175. DEAD OR ALIVE? TERRITORIAL RESTRICTIONS IN COVENANTS-NOT-TO-COMPETE IN NEBRASKA

Creighton Law Review

Vol. 33

STEVEN J. RIEKES(fn*)

Covenants-not-to-compete are fairly common in the business world. For example, a purchaser of a business may want assurances that his investment will not be soured by the seller going into competition after the sale. Or an employer might be concerned that a key employee, should he or she ever leave his or her position, may take a substantial part of the employer's business with him. While these concerns are common enough, the counselor who is called upon to assist in negotiating or drafting a covenant-not-to-compete should not assume that an easy task lies ahead. Those who rely on clauses out of a form book or the black letter law in a legal encyclopedia risk disastrous results.

The current state of Nebraska law is uncertain, particularly in regard to restrictions against competition in a geographic area or in regard to the length of time the restriction should exist. The consequence of this uncertainty is that if the legal draftsman has not correctly anticipated the current state of judicial thinking, the covenant will, in all likelihood, be held invalid and unenforceable. Extreme caution must be exercised in this area because the validity of the covenant depends on a judicial determination of whether the covenant is "reasonable." The Nebraska Supreme Court has held a covenant-not-to-compete valid if the restriction is "reasonable," in that the covenant: (1) is "not injurious to the public;" (2) is "not greater than is reasonably necessary to protect the employer in some legitimate interest;" and (3) is "not unduly harsh and oppressive on the employee."(fn1) Although some states have statutes governing this subject, Nebraska relies strictly upon judicial precedent and interpretation.(fn2)

While judicial precedent may be one of the crowning glories of common law, occasionally it is meandering and confusing. In some states, while there may be a certain amount of ambiguity in not knowing whether a particular restriction may be deemed "reasonable," the judicial consequence of finding a covenant unreasonable will be conciliated by equity. Often, a state court will "reform" a covenant so as to sustain the reasonableness of the covenant and, hence its validity.(fn3) For example, a territorial restriction might be reduced in its geographic dimensions if the restriction is deemed too broad.(fn4) However, in Nebraska, if the drafter of the covenant makes a mistake, there will be no remedy in equity. In Nebraska, a covenant that is deemed unreasonable, even to the slightest degree, will be declared invalid and unenforceable. The Nebraska courts will give no comfort to any notion of reforming a covenant. The Nebraska Supreme Court has emphatically stated that "[i]t is not the function of courts to reform unreasonable covenants-not-to-compete solely for the purpose of making them legally enforceable."(fn5) For years the Nebraska Supreme Court has remained firm in this position. This is true even where the parties have otherwise agreed in the contract that a court would have the power to modify an objectionable provision of a covenant so as to make the whole covenant valid, reasonable, and enforceable. But the Nebraska Supreme Court has decided to follow a minority position which provides "that reformation is tantamount to the construction of a private agreement and that the construction of private agreements is not within the power of the courts."(fn6)

The purpose of this article is to highlight the development of the "reasonableness" standard in Nebraska with respect to covenants-not-to-compete and to outline some of the confusing aspects of Nebraska case law on this subject, particularly in regard to the concept of a territorial restriction. By bringing this confusion to the attention of the Bar, a practitioner will be aware of the mine fields that he or she may have to cross in negotiating and drafting these covenants. Furthermore, by bringing this confusion to the attention of the Bench, a future opportunity will undoubtedly occur wherein these matters might be clarified. In my view, the Nebraska Supreme Court has a duty to make the reasonableness standard vis'-a-vis' covenants-not-to compete as clear as possible so that employers, businessmen, and attorneys will have an unmistakable guidepost when drafting covenants-not-to-compete.

A. REASONABLENESS OF TIME AND SPACE REQUIREMENTS

In the early Nebraska case of Mollyneaux v. Wittenberg,(fn7) the Nebraska Supreme Court recognized the validity of a covenant-not-to-compete in conjunction with the sale of a business.(fn8) The covenant prohibited the defendants, as sellers of a hotel, from operating any other hotel on certain lots in the town of Sutton for a period of two years. The plaintiffs argued the covenant was void because it was "in restraint of trade." The court held otherwise, stating:

The contract not to use the premises for hotel purposes was a limitation in itself, necessarily confining it, as to place, to the particular lots and building, and the time was limited to "two years." These limitations clearly relieve the agreement of any objection made to it on the ground that it is obnoxious to the common-law rule governing contracts in restraint of trade, if, coupled with the above limitations, the contract was reasonable. A contract made upon a valuable consideration, and which does not impose an unreasonable restraint upon engaging in business, is valid.(fn9)

Four years later, in 1898, the Nebraska Supreme Court in Downing v. Lewis(fn10) followed the reasonableness standard articulated in Mollyneaux. The Downing case involved the sale of a laundry business in which the seller was restricted from competition in Kearney for a period of five years. The supreme court found this time restriction to be reasonable. Conversely, in 1905, in Roberts v. Lemont,(fn11) the Nebraska Supreme Court refused to uphold a covenant-not-to-compete in the sale of a business where the covenant did not contain limi-tations on time or territory.(fn12) The defendant, after selling his insurance business in Norfolk, agreed to "quit the business."(fn13) The court held that "[o]rdinarily a contract prohibiting one of the parties from carrying on a specific trade or business, without any limitation as to time and place, is against public policy and void."(fn14)

In 1924, the Nebraska Supreme Court in Dow v. Gotch(fn15) upheld a covenant-not-to-compete contained in an employment contract.(fn16) Dow operated a beauty parlor in Grand Island, employing Gotch. Eventually, Gotch left Grand Island to take a post-graduate course in Chicago. But before she left, Dow and Gotch agreed that Dow would pay her one hundred dollars to defray expenses, provided that upon her return to Grand Island, she would resume her employment with Dow for at least twelve months thereafter. Furthermore, Gotch agreed that upon her return from Chicago, she would not go into competition with Dow in Grand Island. However, no time limitation was placed upon this covenant-not-to-compete. Nevertheless, following Gotch's return, and after only several months of employment with Dow, Dow allowed Gotch to leave and seek employment in Wyoming. When the Wyoming employment did not prove satisfactory, Gotch returned to Grand Island and went into competition with Dow. Dow sued to enforce the non-competition contract and successfully enjoined Gotch from operating her business.

The Nebraska Supreme Court noted that covenants-not-to-compete were once rendered void by the courts of England in an earlier era only because the typical employee was not expected to travel far from his birthplace. Hence, such a restriction would deprive him of his livelihood. However, the supreme court upheld the covenant, noting that, because modern America was a highly mobile society, the reasoning underlying the old rule had departed.(fn17) The court held that equity now lies with the employer, not the employee, reasoning that:

While we recognize the principle that estoppel does not serve to give relief to one who relies upon a void contract, it seems well-nigh intolerable that a party should be permitted to take a sum of money from another, upon solemn agreement not to compete with such other, and then use what she has received in doing the very thing which she agreed not to do, while still retaining the money so paid.(fn18)

In 1936, the Nebraska Supreme Court further outlined its reasonableness standard for covenants-not-to-compete in an employment contract in Personal Finance Co. of Lincoln v. Hynes.(fn19) In Personal Finance, the Nebraska Supreme Court recognized that "[a] contract restricting employment in a competitive business for one year within the city, or the environs or trade territory, imposes reasonable conditions and is valid and enforceable."(fn20)

Even though the Dow case and the others mentioned previously are part of the historic legal record in Nebraska on this issue, the truly definitive Nebraska case for the reasonableness standard in covenants-not-to-compete in the modern era is Securities Acceptance Corp. v. Brown.(fn21) In Securities Acceptance, the plaintiff was in the consumer loan business, employing Brown at its North Platte branch office. After Brown was hired, he signed a contract that included a...