The Declaratory Judgment Act requires that an “actual controversy” exist for courts to have jurisdiction. Likewise, the courts of most states have construed their respective versions of the Uniform Declaratory Judgment Act to require an “actual controversy” before suit can be filed. Thus, for former employees bound by a restrictive covenant and for their current or prospective employers, the question becomes: When does an actual controversy exist between a former employee and former employer regarding the validity of a restrictive covenant?
It is not difficult to see how the answer to this question can have significant implications for both the individuals subject to the restrictive covenants and the companies that currently employ or would like to employ them. The limits on where or from whom an individual can solicit business can have a drastic impact on the value of that individual to a current or prospective employer. Further, the uncertainty surrounding the scope or validity of the former employee’s restrictive covenant could force his or her current employer to choose between exposing itself to potential liability and forgoing business opportunities it may be entitled to pursue. The uncertainty could also lead prospective employers to decide not to hire the former employee in the first place. Unfortunately, determining when the former employee or his or her current employer can bring suit to challenge the scope or validity of a restrictive covenant often is difficult.
There is no precise test for defining a “case or controversy” for purposes of Article III, Section 2. The basic inquiry is whether the conflicting contentions of the parties present a real and substantial controversy between parties having adverse legal interests, and whether a dispute exists that is definite and concrete, not hypothetical or abstract. See Babbitt v. United Farm Workers Nat’l Union, Ariz., 442 U.S. 289 (1979). Similarly, for a controversy to be “actual” within the meaning of the Declaratory Judgment Act, the facts must set forth the existence of a substantial controversy between parties having adverse legal interests, of sufficient immediacy and reality to warrant the issuance of declaratory relief. See Step-Saver Data Sys. v. Wyse Tech., 912 F.2d 643 (3d Cir. 1990).
In Chestnut v. Pediatric Homecare of America, Inc., No. 90-7920, 1991 WL 197319 (E.D. Pa. Sept. 26, 1991), the court addressed a former employee’s action for declaratory judgment against a former employer seeking to void her noncompetition agreement. The former employer moved to dismiss the action, arguing that the former employee failed to present either a justiciable “case or controversy” under Article III, Section 2, or an “actual controversy” under the Declaratory Judgment Act. The former employee asserted that the covenant was unenforceable and that it impeded her ability to find new employment or engage prospective business partners. The former employer, on the other hand, asserted that the covenant was valid and maintained its right to enforce the covenant in the future. The court concluded that a case or controversy existed between the parties in light of the fact that the uncertainty regarding the enforceability of the restrictive covenant impaired the former employee’s search for employment and the former employer would not relinquish its rights under the contract. In reaching this conclusion, the court emphasized the fact that the former employer “never state[d] that it would not seek to enforce the covenant against [the former employee] should she accept employment in the [industry].”
The level of controversy required to proceed under the different versions of the Uniform Declaratory Judgment Act enacted by the states varies significantly. For example, in Enron Capital & Trade Resources Corp. v. Pokalsky, 490 S.E.2d 136 (Ga. Ct. App. 1998), a former employee and his new employer sought a declaration that the restrictive covenants in the former employee’s employment agreement with his former employer were unenforceable. The former employer argued that the matter did not present a justiciable case or controversy because declaratory judgment is not available to confirm the propriety of actions already taken, the former employee had already accepted a job with a competitor in violation of the restrictive covenant, and the plaintiffs could only speculate as to what the former employer’s position on the former employee’s new employment would be. Reviewing the question under Georgia’s declaratory judgment statue, Ga. Code Ann. §§ 9-4-1 to 9-4-10, the court nonetheless found that declaratory relief was available, because “[a]t the time the lawsuit in this case was filed, [the former employee and his new employer] were uncertain whether their employment could legally continue in the future.” Pokalsky, 490 S.E.2d at 138.
By comparison, Stevenson v. Parsons, 384 S.E.2d 291 (N.C. Ct. App. 1989) seems to set a slightly higher threshold. In Stevenson, a former employee brought a declaratory action against his former employer, seeking to void a covenant not to compete from his employment agreement. The former employer contended that the matter did not present an actual controversy between the parties and that litigation was not unavoidable. The court noted that while North Carolina’s Uniform Declaratory Judgment Act, N.C. Gen. Stat. §§ 1-253 to 1-267, did not expressly provide as much, the North Carolina Supreme Court has held that “courts have jurisdiction to render declaratory judgments only when it is shown that an actual controversy exists between parties having adverse interest in the matter in dispute,” and that for an actual controversy to exist, “it must appear that litigation is unavoidable.” Stevenson, 384 S.E.2d at 292. The court then held that because the former employer had since filed a separate action asserting a violation of the covenant not to compete, an actual controversy existed and litigation was unavoidable.
A higher threshold still is apparent in Rosenberg v. D. Kaltman & Co., Inc., 101 A.2d 94 (N.J. Super. Ct. Ch. Div. 1953), where the court was faced with an action by a former employee under New Jersey’s Uniform Declaratory Judgment Act, N.J. Stat. Ann. §§ 2A:16-50 to 2A:16-62, seeking a determination that a second, less restrictive non-compete agreement superseded a first non-compete agreement with his former employer. The former employer argued that the former employee must seek new employment in violation of the non-compete agreement and wait to be sued before he could challenge the application of the first non-compete agreement. The court found, however, that a threatened lawsuit by the former employer and the harm this posed to the former employee’s efforts to obtain new employment created an “actual and bona fide controversy affecting both the [former employee] in his future employment and the [former employer] in the conduct of its business.” Rosenberg, 101 A.2d at 96.
Similarly, in Schmidl v. Central Laundry & Supply Co., Inc., 12 N.Y.S.2d 817 (N.Y. Sup. Ct. 1939), the court found that a declaratory action by a former employee challenging the validity of a restrictive covenant was justiciable where a former employer threatened litigation against the former employee, which prevented him from obtaining new employment.
It is clear that a claim for declaratory relief will not be able to proceed for lack of an actual controversy where the former employee does not, at the very least, allege an intent to engage in conduct that implicates the restrictive covenant at issue. For example, in Edwards v. Davis, 286 S.E.2d 301 (Ga. Ct. App. 1981), the court dealt with an ophthalmologist who had entered a contract to transfer his practice to another ophthalmologist only to attempt to void the entire contract on the basis that a covenant not to compete contained therein was void. The court denied relief under Georgia’s declaratory judgment statute on the basis that the first ophthalmologist had failed to demonstrate an “actual controversy.” The court based its conclusion on the fact that the first ophthalmologist “asserted no specific right he wished to exercise and [the second ophthalmologist] has not contested the exercise of any right by [him].” Id. at 303.
Although there is no clear standard as to when a “case or controversy” or “actual controversy” exists when it comes to the validity of restrictive covenants, it is possible to glean some practical tips from the cases that have addressed this topic. First, particular attention must be paid to the express terms of the Uniform Declaratory Judgment Act enacted in your state and how it has been interpreted. As we have seen, what is deemed a sufficient controversy in one state may not be deemed sufficient in another. Second, a former employee or current employer should be prepared to demonstrate an intent to engage in conduct that could fall within the challenged restrictive covenant. Finally, a former employee or current employer should consider investigating whether the former employer would seek to enforce the restrictive covenant or otherwise contest the intended conduct. Where the former employer has not manifested a position on the issue, whether by threatening suit or otherwise, the former employee or current employer could send a letter to the former employer, requesting guidance as to its position on the validity or scope of the restrictive covenant. The former employer’s response would either establish a legitimate controversy and pave the way for a declaratory action or, even better, reveal that there is no controversy.
The question of how to deal with a potentially invalid or overbroad restrictive covenant is a challenging one for former employees and their current and prospective employers. Competing with a former employer or soliciting former customers could expose both the former employee and his or her current employer to liability. At the same time, forgoing legitimate business opportunities out of deference to an invalid or overbroad restrictive covenant brings harm as well. Thankfully, after taking steps to evaluate the existence of a “case or controversy” or “actual controversy,” parties can obtain declaratory relief.
Keywords: litigation, employment and labor relations law, noncompetition agreement, non-solicitation agreement, Declaratory Judgment Act
Michael J. Miles is an associate at Brown & Connery, LLP, in Westmont, New Jersey.