1st American Systems, Inc. v. Rezatto
1981 S.D. LEXIS 347, 311 N.W.2d 51 (1981)
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Rule of Law:
Under South Dakota law, a non-compete clause for an employee is void as an illegal restraint of trade unless the employee is a licensed professional; however, a separate, divisible nondisclosure and nonsolicitation clause in the same contract is not a general restraint of trade and is enforceable to the extent it is reasonable in duration and scope.
Facts:
- 1st American Systems, through its agency Insurance Counselors, employed Brian Rezatto for approximately seven years as an insurance salesman and later as an office manager.
- Rezatto signed an employment contract that included a 10-year, 25-mile non-compete clause and a separate 10-year clause prohibiting him from soliciting the company's customers or disclosing confidential information like renewal dates and customer lists.
- During his employment, Rezatto was responsible for about 90% of the agency's sales and had access to all customer data, which the contract deemed confidential.
- After failed negotiations for Rezatto to purchase the agency, 1st American Systems terminated his employment.
- Shortly after his termination, Rezatto established a competing insurance agency in the same city, Aberdeen.
- Rezatto admitted to obtaining customer files from Insurance Counselors after his termination and using that data to solicit his former employer's clients.
- Of Rezatto's 101 new customers, 49 were former customers of Insurance Counselors, and they accounted for over 50% of his new agency's premium revenue.
Procedural Posture:
- 1st American Systems (plaintiff) sued its former employee, Brian Rezatto (defendant), in a South Dakota trial court.
- The suit sought injunctive relief and damages for breach of contract and misuse of trade secrets.
- The trial court granted summary judgment for Rezatto on the breach of contract claim, holding that the entire employment agreement was a void restraint on trade.
- The tort claim for misuse of trade secrets proceeded to a jury trial, which resulted in a verdict for Rezatto.
- 1st American Systems (appellant) appealed both the summary judgment and the jury verdict to the Supreme Court of South Dakota.
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Issue:
Does a contractual provision that prohibits a former employee from soliciting his former employer's customers or disclosing confidential customer information constitute an unenforceable restraint of trade under South Dakota law, even if a separate, broad non-compete clause in the same contract is void?
Opinions:
Majority - Morgan, Justice
No, a nondisclosure and nonsolicitation provision is not automatically an unenforceable restraint of trade simply because a separate non-compete clause in the same contract is void. The court reasoned that the non-compete clause (paragraph 8) was void under SDCL 53-9-8 because selling insurance is not considered a 'profession' under the statutory exception (SDCL 53-9-11), which is strictly construed. However, the nondisclosure clause (paragraph 7) is distinct and legally severable from the non-compete clause, as indicated by the contract's severability provision. Unlike a non-compete agreement, which is a general restraint of trade, a nondisclosure agreement that protects confidential information and prohibits solicitation based on that information prevents 'unfair competition' and is not a general restraint on trade. The court, citing precedent from California and Oklahoma with similar statutes, held that customer information like expiration dates, policy details, and client lists, when taken together and designated as confidential by contract, constitutes a protectable trade secret. While the nondisclosure clause is not void outright, its enforceability is subject to a rule of reason. The court found the 10-year duration and the prohibition on 'accepting' business (as opposed to soliciting) were potentially overbroad and remanded the case for the trial court to determine a reasonable duration and scope for the covenant.
Analysis:
This decision establishes a crucial distinction in South Dakota employment law between covenants not to compete and covenants not to disclose or solicit. It clarifies that while general non-compete agreements are statutorily disfavored and narrowly applied, agreements protecting an employer's trade secrets, such as customer lists and data, are viewed as legitimate tools to prevent unfair competition. The court's adoption of the 'blue pencil' doctrine allows for partial enforcement, meaning courts can modify unreasonable terms (like an excessive duration) to make a covenant enforceable rather than voiding it entirely. This provides employers with a viable path to protect their client base through carefully drafted nondisclosure agreements, even when broader non-compete restrictions are unavailable.
