Compass Bank v. Hartley

United States District Court, D. Arizona
430 F. Supp. 2d 973 (2006)

ELI5:

Rule of Law:

In Arizona, restrictive covenants containing “step-down” provisions, which provide pre-defined, alternative restrictions, are an enforceable application of the blue-pencil rule, allowing a court to enforce a reasonable, lesser restriction if the primary one is found to be overbroad.

Facts:

Kenneth R. Hartley began employment with Compass Bank in 2001, signing an offer letter that included a two-year post-employment non-solicitation covenant.
From 2001 through 2005, Hartley signed annual Stock Option Agreements as part of his compensation.
The 2004 and 2005 agreements contained non-solicitation, non-disclosure, and non-compete covenants that included 'step-down' provisions, specifying alternative durations (2 years, 18 months, or 12 months) and geographic scopes (50 or 25 miles).
Hartley voluntarily terminated his employment with Compass Bank to found his own company, Erisey Wealth Management, LLC.
Immediately upon resigning, Hartley instructed his wife to send pre-prepared, overnighted announcement letters to 56 Compass Bank clients.
The letter announced Hartley's new firm, Erisey, and provided contact information, including phone numbers and an email address.
Following his departure, Hartley accepted business at Erisey from former Compass Bank clients.

Procedural Posture:

Plaintiff Compass Bank filed a complaint against its former employee, Defendant Kenneth R. Hartley, and his new company, Defendant Erisey Wealth Management, LLC, in the U.S. District Court for the District of Arizona.
Concurrent with the complaint, Compass Bank filed a Motion for a Preliminary Injunction to enforce the restrictive covenants in Hartley's employment agreements.
Defendants filed an answer to the complaint and a response opposing the Motion for a Preliminary Injunction.
The district court held a two-day evidentiary hearing on the motion for a preliminary injunction.

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Issue:

Under Arizona law, is a restrictive covenant in an employment agreement that contains 'step-down' provisions—offering alternative, less restrictive terms if the primary terms are found unreasonable—an enforceable application of the 'blue-pencil' rule?

Opinions:

Majority - Silver, District Judge

Yes, a restrictive covenant with 'step-down' provisions is an enforceable application of Arizona's 'blue-pencil' rule. The court reasoned that such provisions are distinct from impermissible judicial rewriting of a contract because they represent pre-negotiated, severable alternatives that the parties contemplated at the time of signing. This demonstrates a 'meeting of the minds' on the less restrictive options, allowing a court to simply cross out the unreasonable terms (e.g., a two-year duration) and enforce a reasonable, pre-defined alternative (e.g., a one-year duration) without adding new language. The court found that Hartley's covenants were ancillary to his continued at-will employment, which constituted sufficient consideration. It then determined the primary two-year duration was unreasonable but upheld a one-year, 25-mile restriction based on the step-down provision. Finally, the court concluded that Hartley's targeted mailing to former clients constituted solicitation and a breach of the enforceable covenants.

Analysis:

This case establishes an important precedent in Arizona by validating the use of 'step-down' provisions in restrictive covenants. It provides employers with a strategic tool to draft more resilient non-compete and non-solicitation agreements, increasing the likelihood that a court will enforce a modified version rather than voiding the entire covenant. This shifts the risk in drafting, as employers can set an aggressive primary restriction with the confidence that a more moderate, pre-written fallback option will likely be enforced. For employees, this decision means it is harder to escape a restrictive covenant entirely on the grounds of overbreadth if such provisions are present.

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