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Court Finds That Traditional Limits on Restrictive Covenants Do Not Apply to Employee Stock Option Agreement

Commercial Litigation Law Update Sean M. Scullen

Historically, it was thought that the exacting scrutiny imposed upon restrictive covenants by Wisconsin Statute § 103.465 applied to all such agreements entered into between employers and employees. However, the Wisconsin Court of Appeals' (the "Court") recent decision in Selmer Co. v. Rinn concludes otherwise, exempting a restrictive covenant contained in a stock option agreement from the purview § 103.465.

Wisconsin Statute § 103.465

Employers are no doubt well aware of the restrictions imposed upon restrictive covenants by § 103.465. See The Selmer Co. v. Rinn, 2010 WL 2733361, ¶ 1 (Wis. App.). Pursuant to § 103.465, such agreements:

  1. are prima facie suspect;
  2. must withstand close scrutiny to pass legal muster as being reasonable;
  3. will not be construed to extend beyond their proper import; and
  4. are to be construed in favor of the employee.

Id. at ¶ 16. Importantly, § 103.465 prohibits the partial enforcement of overbroad covenants. Thus, if a covenant subject to § 103.465 is deemed overbroad in any respect, courts are prohibited from enforcing any portion of it (i.e., they cannot "blue-pencil" or judicially modify the covenant).

In light of these principles, a party seeking to enforce a restrictive covenant would prefer to be outside the confines of
§ 103.465 for two reasons: (1) less scrutiny as to the reasonableness of the covenant and (2) the possibility of partial enforcement through blue-penciling. Thus, the Court's decision in Selmer Co. v. Rinn provides employers with good news, indicating that not all restrictive covenants entered into in the employment context will be subject to the exacting requirements of § 103.465.

The Selmer Co. v. Rinn Decision

In Selmer Co. v. Rinn, the employer offered its key employees the option to purchase stock in its parent company at
a reduced price. The option agreement contained a nondisclosure clause and a nonsolicit agreement prohibiting the employee from soliciting any of the employer's customers for a one-year period. The defendant - who served as the employer's vice president of Sales and Marketing - was given the opportunity to participate in the stock option agreement. The defendant was not required to accept the agreement, and his continued employment was in no way conditioned upon his execution of it. Ultimately, the defendant executed the stock option agreement and purchased
eight shares of stock in the parent corporation.

Several years later, the defendant resigned and joined a competitor. Shortly thereafter, he sold his stock in the parent corporation, making a profit of over $10,000. The defendant went on to violate the nonsolicit portion of the stock option agreement. The employer sued the defendant for breach of contract. In response, the defendant argued that the restrictive covenants contained in the agreement were overbroad and unenforceable under § 103.465. The trial court ultimately disagreed, concluding that § 103.465 did not apply and that, under the less stringent common law "rule of reason," the agreement was enforceable.

The Court of Appeals agreed with the trial court. In doing so, the Court noted that the agreement at issue was not plagued with the same issues typically found when an employer presents an employee with a restrictive covenant. The defendant, for example, was not in a position of unequal bargaining power. The defendant's execution of the agreement was entirely voluntary, and his continued employment was not conditioned upon his execution of it. Accordingly, the Court determined that the agreement was not subject to the "exacting scrutiny" imposed by § 103.46 but rather the common law "rule of reason." Under this rule, the restrictive covenant need only be: (1) "reasonably necessary" for the employer's protection; (2) reasonable as to time, space, purpose and scope; and (3) "not specially injurious to the public." The Court concluded that the restrictive covenants at issue satisfied these standards. While the Court's opinion strongly suggests that the agreement could have been modified to the extent overbroad (i.e. partially enforced), it never had to reach the issue since it determined that the agreement was reasonable in its entirety.

Procedural Status

The defendant has petitioned the Wisconsin Supreme Court for review of the Appellate Court's decision. Accordingly, while Selmer Co. v. Rinn is good law at the moment, there is the possibility that it will be overturned.

What Selmer Co. v. Rinn Tells Us

The Court's decision in Selmer Co. v. Rinn indicates that § 103.465 does not govern every restrictive covenant entered into in the employment context. Courts may consider the voluntary nature of the agreement at issue, its reasonableness and the bargaining position of the parties in determining whether § 103.465 applies. While the Selmer Co. v. Rinn decision applied to a stock option agreement, the Court's analysis could apply in other contexts. A voluntary severance agreement, for example, is arguably subject to the same reasoning and could thus be found exempt from § 103.465, since an employee's execution of the agreement is voluntary.

For questions about the Selmer Co. v. Rinn decision or about restrictive covenants generally, please contact
Quarles & Brady attorneys Sean Scullen at (414) 277-5421 / [email protected].

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