Compass Bank v. Hartley

• Court: U.S. District Court — District of Arizona
• Writing for the Court: Silver
• Citation: Compass Bank v. Hartley, 430 F.Supp.2d 973 (D. Ariz. 2006)
• Decision Date: 28 April 2006
• Docket Number: No. CV 06-0402 PHX ROS.,CV 06-0402 PHX ROS.
• Parties: COMPASS BANK, an Alabama state banking corporation, Plaintiff, v. Kenneth R. HARTLEY, Jr. and Kelly Hartley, husband and wife; and Erisey Wealth Management, LLC, an Arizona limited liability corporation, Defendants.

430 F.Supp.2d 973

COMPASS BANK, an Alabama state banking corporation, Plaintiff, v. Kenneth R. HARTLEY, Jr. and Kelly Hartley, husband and wife; and Erisey Wealth Management, LLC, an Arizona limited liability corporation, Defendants.

No. CV 06-0402 PHX ROS.

United States District Court, D. Arizona.

April 28, 2006.

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COPYRIGHT MATERIAL OMITTED

Lawrence Jay Rosenfeld, Michael Cajer Mason, Greenberg Traurig LLP, Phoenix, AZ, for Plaintiff.

Kimberly A. Fatica, Brockelman Fatica PLC, Tempe, AZ, for Defendants.

ORDER

SILVER, District Judge.

On February 3, 2006, Plaintiff filed its Complaint as well as a Motion For Preliminary Injunction (Doc. # 2). Defendants filed an answer on February 27, 2006 (Doc. # 37) and a Response to Plaintiff's Motion For Preliminary Injunction on March 3, 2006 (Doc. # 3). A preliminary injunction hearing was held on March 10, 2006 and March 16, 2006. For the reasons set forth below, Plaintiff's motion will be granted. The parties are ordered to submit a joint statement of proposed injunctive relief within seven days from this Order.

I. BACKGROUND

This case arises out of several agreements entered into between Plaintiff Compass Bank ("Compass") and its former employee Kenneth R. Hartley ("Hartley") containing certain post-employment restrictive covenants. Compass filed a motion for preliminary injunction seeking enforcement of the covenants, and other injunctive and monetary relief, against former employee Hartley and the company he founded, Erisey Wealth Management, LLC ("Erisey").

The following agreements are at issue:

(1) February 19, 2001 Offer Letter— This letter purports to offer Hartley employment with Compass as a Senior Portfolio Manager on certain terms and conditions, including a post-employment non-solicitation covenant for two years. See Pl. Exh. 6. Hartley signed and returned this offer on February 21, 2001.

(2) 2001 Stock Option Agreement.¹ See Pl. Exh. 1

(3) 2002 Stock Option Agreement. See Pl. Exh. 2.

(4) 2003 Stock Option Agreement. See Pl. Exh. 3.

(5) 2004 Stock Option Agreement. Dated April 20, 2004, this agreement contains both non-solicitation² and non-disclosure³ covenants for a duration of 2 years/18 mo./12 mo. (step-down provisions). It also contains a loyalty provision.⁴ By its terms, this Agreement amends all earlier stock option agreements by replacing the restrictive covenants in those earlier agreements with the restrictive covenant in the 2004 Agreement, such that the restrictive covenants in the 2001-2004 Agreements also contain the step-down provisions. See Pl. Exh. 4.

(6) 2005 Stock Option Agreement. Dated April 15, 2005, this agreement contains non-solicitation,⁵ non-compete,⁶ and non-disclosure⁷ covenants, as well as a loyalty provision,⁸ as set forth in Section 8 for 2 years/18 mo./12 mo. (step-down provisions). See Pl. Exh. 5.

(7) 2004 Promotion Letter. Dated September 24, 2004, this letter purports to confirm Hartley's promotion to Executive Vice President of the Wealth Management Group pursuant to the terms and conditions therein; it contains no restrictive covenants. See Pl. Exh. 7.

II. PRELIMINARY INJUNCTION STANDARD

Under Ninth Circuit law, the traditional equitable criteria for granting preliminary injunctive relief are: (1) a strong likelihood of plaintiff's success on the merits; (2) the threat of irreparable harm to plaintiff if the injunction does not issue; (3) the relative balance of harm to the parties; and (4) the public interest. See Los Angeles Memorial Coliseum Commission v. National Football League, et al., 634 F.2d 1197, 1200 (9th Cir.1980). Because this is a diversity action, Arizona law governs the substantive aspects of the case.⁹

III. ANALYSIS

A. Likelihood of Success

1. The Validity of the Covenants

a. Ancillarity¹⁰

"In Arizona .. . . a restrictive covenant .... must fall within the requirements of a valid contract, and it must be incidental or ancillary to an otherwise legally enforceable contract." Am. Credit Bureau v. Carter, 11 Ariz.App. 145, 462 P.2d 838, 840 (1969). The signing of an otherwise valid restrictive covenant at the inception of a written at-will employment relationship is but one way to establish "ancillarity" and sufficiency of consideration. Lessner Dental Labs. v. Kidney, 16 Ariz.App. 159, 492 P.2d 39, 40 (1971). In addition, the promise of continued employment validates a covenant executed after the employment relationship has commenced, even where it continues to be on an at-will basis. See Mattison v. Johnston, 152 Ariz. 109, 730 P.2d 286 (App. 1986).

Hartley agreed to restrictive covenants as part of his 2001 Offer Letter¹¹ and annual stock option agreements. Pursuant to the terms of the stock option agreements, the consideration for the grant of stock options was the promise not to compete or solicit, but the covenants are valid for another reason. Under Arizona law Compass has the right to require at-will employees to sign the restrictive covenants as a condition of continued employment. See Am. Credit Bureau, 462 P.2d at 840 (holding that continued at-will employment of defendant by plaintiff for three years at a sizeable salary constitutes sufficient consideration to support a noncompetition agreement); Amex v. Mascari, 150 Ariz. 510, 724 P.2d 596, 602 (App. 1986) (finding ancillarity sufficient to enforce restrictive covenant where employment agreement clearly contemplated a substantial promotion). For this reason, the restrictive covenants contained in the stock option agreements are ancillary to Compass' promise of continued employment, regardless of whether Hartley exercised them or not. See Field v. Alexander & Alex. 503 N.E.2d 627, 631 (Ind.App. 1987) (holding that restrictive covenants in a stock option agreement ancillary to the employment relationship and the stock options were consideration whether or not they were exercised); Campbell Soup Co. v. Desatnick, 58 F.Supp.2d 477, 492 (D.N.J.1999).

Defendant relies on Olander v. Compass Bank, 44 Fed.Appx. 651 (2002) (unpublished), which is distinguishable on several grounds. Significantly, Olander is not good law in Arizona, because it relies on the reasoning set forth in Light v. Centel Cellular Company of Texas, 883 S.W.2d 642, 647 (Tex.1994) which rejects the Restatement that is followed in Arizona. Under the Restatement, "a legitimate restraint may be ancillary to a transaction or relationship, and not necessarily a contract per se." Id. (citing Business Electronics v. Sharp Electronics, 485 U.S. 717, 729 n. 3, 108 S.Ct. 1515, 99 L.Ed.2d 808 (1988)). The Light court held that a covenant must be ancillary to an "otherwise enforceable agreement," requiring that the restraint enforce a contractual obligation of one of the parties, not merely the employment relationship. Id. (emphasis added).

b. Reasonableness

A covenant not to compete is generally enforceable as long as it is no broader than necessary to protect an employer's legitimate business interests. See generally Restatement (Second) of Contracts, §§ 186-188. The burden is on the employer to prove the extent of its protectable interests, and if it cannot, the entire covenant will be deemed unenforceable.

Based principally on the testimony of Brian Coughlan ("Coughlan") and Hartley, the Court finds that one year is long enough for a new Portfolio manager to gain the requisite confidence of clients to entrust the manager with his investments. Although Charles Watts, Coughlan, and John Sawyer all directly or impliedly testified that it would take at least two years to gain a customer's trust sufficient for maintaining a customer's account, Coughlan was not afforded a real opportunity to do so because none of Hartley's accounts had been fully transferred to him. In addition, Coughlan testified that he had successfully established relationships with the few clients who were transferred to him while Hartley was with Compass and after Hartley left.

The Court is also persuaded that under Arizona law, two years is unreasonable. In nearly all of the breach of contract cases filed in 2003-2005 in the District of Arizona involving the requested enforcement of post-employment restrictive covenants in the financial-services industry, the duration requirements are only for one year. See e.g., Citigroup Global Markets Inc. v. Early, et al., Case No. CV 05-00709 (D. Ariz. filed November 30, 2005) (financial company seeking, among other things, enforcement of one-year non-solicitation provision contained in a "Franchise Protection Program Agreement"); Chase Investment Services Corp. v. Tolan, et al., Case No. 05-03872 (D. Ariz. filed November 30, 2005) (financial company seeking, among other things, enforcement of one-year non-solicitation provision contained in a "Supervision, Confidentiality and Non-Solicitation Agreement"); Merrill Lynch, Pierce, Fenner & Smith v. Brown et al., Case No. 05-00513 (D. Ariz. filed August 23, 2005) (financial company seeking, among other things, enforcement of one-year non-solicitation provision contained in a "Financial Consultant Employment Agreement and Restrictive Covenants").

With regard to the geographical scope of the covenant, Plaintiffs stated that should the Court find the covenant otherwise valid, 25 miles would be deemed reasonable. The Court finds the geographical location reasonable, but because the duration and scope provisions are unreasonable, the entire covenant is invalid unless the Court finds the step-down provisions are an acceptable application of Arizona's blue-pencil law.

c. Blue-Penciling and Step-Down Provisions

Both the non-solicitation and non-competition covenants were drafted in an attempt to fit within Arizona's "blue pencil" rule, whereby a court is empowered to cross out over broad, unreasonable provisions in an agreement while keeping in place less onerous, enforceable ones. Valley Medical Specialists v. Farber, 194 Ariz. 363, 982 P.2d 1277, 1286 (1999) ("Arizona courts will ...