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ADP, LLC v. Rafferty

United States Court of Appeals, Third Circuit

April 26, 2019

ADP, LLC, Appellant

          Argued: September 6, 2018

          On Appeal from the District Court of New Jersey (D.N.J. No. 2:18-cv-01922) Honorable Jose L. Linares, U.S. District Judge

          On Appeal from the District Court of New Jersey (D.N.J. No. 2:17-cv-04613) Honorable Claire C. Cecchi, U.S. District Judge

          Harris S. Freier, Timothy J. Lowe [Argued] James J. Giszczak McDonald Hopkins Counsel for Appellant

          John H. Schmidt, Jr. [Argued] Lindabury McCormick Estabrook & Cooper Counsel for Appellees Nicole Rafferty and Kristi Mork

          Before: HARDIMAN, KRAUSE, and BIBAS, Circuit Judges



         I. Introduction

         In this appeal, we must determine whether certain restrictive covenants, which high-performing employees enter into as a condition of a stock award, constitute an impermissible restraint on trade under New Jersey law. We conclude that these restrictive covenants are not unenforceable in their entirety because they serve a legitimate business interest, but they may place an undue hardship on employees because they are overbroad. Accordingly, we will remand for the District Court to consider whether and to what extent it is necessary to curtail the restrictive covenants' scope, which is the approach prescribed by the New Jersey Supreme Court when confronted with overbroad restrictive covenants such as these.

         II. Factual Background

         ADP, LLC (ADP) is a human capital management company that sells technology products and services related to payroll, human resources, benefits, talent management and recruiting to customers worldwide. ADP imposes restrictive covenants on its sales employees[1] in two layers. The first layer, which applies to all employees and includes a Sales Representative Agreement (SRA) and a Non-Disclosure Agreement (NDA) entered into at the time of hire, is a condition of employment at ADP. The SRA and NDA prohibit ADP employees from, among other things, soliciting any ADP "clients, bona fide prospective clients or marketing partners of businesses of [ADP] with which the Employee was involved or exposed" for one year after termination. Rafferty JA 42.

         The second layer functions differently. High- performing ADP employees who meet their sales targets are eligible to participate in a stock-option award program, but only if they agree to an additional restrictive covenant known as the Restrictive Covenant Agreement (RCA). Participation by eligible employees in the stock option program, in other words, is voluntary but conditioned on their assent to the terms of the RCA. ADP does not attempt to impose the RCA on other employees or in circumstances outside of the stock award program. It is not imposed, for instance, as a condition of initial or continued employment or in connection with other employment milestones such as a promotion or transfer. Nor does it entitle ADP employees to any employment benefits beyond the compensation of the stock option award itself, such as more or different training or access to proprietary information.

         The RCA is undisputedly more onerous than the SRA and NDA, and makes it more difficult for former employees bound by its restrictions to compete with ADP upon their separation from the company. Specifically, the RCA contains a strengthened non-solicitation provision (Non-Solicitation Provision), which prohibits employees-for a period of one year following their termination (voluntary or involuntary)- from soliciting any ADP clients to whom ADP "provides," "has provided" or "reasonably expects" to provide business within the two-year period following the employee's termination from ADP. Rafferty JA 78. Thus, unlike the SRA, which only prohibits solicitation of those ADP clients with whom the former employees "w[ere] involved or exposed," Rafferty JA 42, the RCA also prohibits solicitation of all current and prospective ADP clients. And while the SRA limits former employees' solicitation of ADP's "marketing partners," Rafferty JA 42, the RCA prevents former employees from soliciting ADP's "Business Partners," which is defined to include "referral partners" in addition to "marketing partners," Rafferty JA 76, 78.[2]

         The RCA also contains a non-compete provision that is absent from the SRA and NDA (Non-Compete Provision): For a period of one year following their termination, employees will not "participate in any manner with a Competing Business anywhere in the Territory where doing so will require [them] to [either] provide the same or substantially similar services to a Competing Business as those which [they] provided to ADP while employed," or "use or disclose ADP's Confidential Information or trade secrets." Rafferty JA 78. The term "Territory" is defined as the "geographic area" where the employee worked or had contact with ADP clients in the two years prior to her termination. Rafferty JA 77.

         Appellees Nicole Rafferty and Kristi Mork are both former employees of ADP who, shortly after voluntarily leaving ADP, began working at Ultimate Software Group (Ultimate), a direct competitor of ADP. Rafferty and Mork each signed the SRA and NDA at the outset of their employment in Boston and Chicago, respectively, and each were eligible for and accepted restricted stock awards pursuant to the RCA over several consecutive years.[3]

         III. Procedural History

         After ADP learned that each of Appellees joined Ultimate upon leaving, it filed a motion for preliminary injunction against each of Rafferty and Mork in the District of New Jersey, seeking enforcement of the SRA, NDA, and RCA, and alleging breach of contract, breach of duty of loyalty, and unfair competition. Their cases were consolidated only for purposes of this appeal.

         A. District Court Proceedings in ADP v. Rafferty (No. 18-cv-1922)

         In ADP's action against Rafferty in the District of New Jersey, which was assigned to Judge Linares, ADP sought to justify the imposition of all three restrictive covenants. Relying on the sworn statement of an ADP executive, ADP argued that the SRA and NDA, for their part, contain reasonable restrictions designed to protect "the client relationships and the goodwill that sales associates will develop and help develop in the course of their job duties." Rafferty JA 146. The RCAs, it urged, are similarly reasonable-albeit "more extensive"-because those employees that qualify for the stock award "demonstrate that they maintain the strongest personal relationships with their contacts at ADP and ADP's clients and prospects," "generally are involved with and have the most information about the largest number of ADP's clients and prospects," and have "demonstrated the greatest ability to attend to the specialized needs of ADP's clients quickly and with continuity." Rafferty JA 147. Thus, because the loss of high-performing employees to a competitor poses a "particularly high risk to ADP with respect to interference with customer and prospect [sic] relationships," ADP maintained that the "heightened restrictive covenants in the RCA provisions" are justified. Rafferty JA 148.

         After a hearing, the District Court granted some of the relief requested by ADP.[4] Acknowledging Solari Industries, Inc. v. Malady, 264 A.2d 53 (N.J. 1970), where the New Jersey Supreme Court articulated factors to determine whether a post-employment restrictive covenant is enforceable-including whether it "[1] simply protects the legitimate interests of the employer, [2] imposes no undue hardship on the employee, and [3] is not injurious to the public," id. at 56-the District Court concluded that the RCAs were unenforceable per se. Citing Laidlaw, Inc. v. Student Transp. of Am., Inc., 20 F.Supp.2d 727, 762-63 (D.N.J. 1998), it reasoned that because ADP "does not require its employees to enter into the RCAs and does not even offer the RCAs to all of its employees," the "purpose behind the RCAs is not to protect [ADP]'s legitimate interests but rather to decrease competition." ADP, LLC v. Rafferty, No. 18-1922 (JLL), 2018 WL 1617705, at *3 (D.N.J. Apr. 2, 2018). The Court also suggested that the RCAs "may also impose an undue hardship" on Rafferty because, notwithstanding its geographic and temporal scope, the "RCAs apply broadly to all of [ADP]'s current or prospective clients regardless of whether [Rafferty] had contact with those clients. . . ." Id. at *4 (emphasis in original).

         As to the enforceability of the SRA and NDA, however, the District Court reasoned that ADP had shown a likelihood of success because, under Solari, they serve a legitimate business interest in that they "are intended to protect [ADP]'s confidential and proprietary information and client relationships," and are "narrowly tailored" to that end.[5] Id. Because Rafferty had conceded at a hearing that the SRA and NDA were enforceable against her, the District Court did not further elaborate as to how those agreements satisfied the Solari factors.

         B. District Court Proceedings in ADP v. ...

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