Schmit Towing, Inc. v. Frovik: Independent Consideration is Not Required for Non-Compete Agreements With Independent Contractors

In a recent decision, Schmit Towing, Inc. v. Frovik, 2010 WL 4451572 (Minn. Ct. App. Nov. 9 2010) (unpublished), the Minnesota Court of Appeals held that a non-compete agreement entered into with an independent contractor subsequent to an initial contract did not require independent consideration. The court declined to follow the traditional rule, developed in the employment context, that non-compete agreements entered into following commencement of the relationship must be supported by independent consideration such as a raise or bonus. The Schmit case is important because it clarifies when non-compete agreements with independent contractors are enforceable and makes it easier to enforce such agreements with independent contractors.

The Facts of Schmit
Schmit Towing, Inc. (“Schmit”) entered into a subcontract with defendant Chris Frovik, doing business as Frovik Towing and Recovery (“FTR”), to perform towing services. The first agreement did not contain a non-compete clause. Approximately one year later, the parties terminated the first agreement and entered into a second agreement which contained a non-compete clause. Later, FTR began providing towing services for Schmit’s competitor. Schmit sued FTR, claiming that FTR had breached the non-compete clause.

District Court Invalidates the Non-Compete
The district court concluded that the non-compete agreement was invalid and granted summary judgment in favor of FTR. The district court reasoned that the first agreement was a valid contract, for an indefinite term, which could be terminated by either party upon notice. The court went on to describe the parties’ relationship as an “independent contractor arrangement,” which was “akin to that of an at-will employer/employee relationship, wherein either party may terminate at will.” The court compared the parties’ termination of the first agreement and execution of the second agreement to terminating an at-will employee and telling the employee that he or she can be rehired only by signing a non-compete agreement. The court then applied the independent consideration requirement applicable to post-employment non-compete agreements. The independent consideration doctrine provides that a non-compete agreement entered into subsequent to an initial employment contract requires independent consideration (such as a promotion, raise, bonus, or something else of value). The district court ultimately concluded that the non-compete clause contained in the second agreement was invalid because it lacked independent consideration.

Minnesota Court of Appeals Holds That Independent Consideration is Not Required
Schmit appealed to the Minnesota Court of Appeals, which reversed the ruling of the district court. The court recognized that in the employment context, a non-compete agreement entered into subsequent to an initial employment contract requires independent consideration. The court observed that this requirement reflects the fact that employers and employees have unequal bargaining power. The court stated that “[t]he underlying public-policy concern is based on the disparity in bargaining power that exists in an employer-employee relationship or that may exist in the relationship between an employer and an independent contractor.” The court concluded that “where no disparity exists, public policy is not at issue and the parties are free to contract as they wish.”

The Minnesota Court of Appeals ultimately rejected application of the independent consideration requirement, observing that “the requirement of independent consideration to validate a non-compete agreement entered into subsequent to an initial contract has only been applied in the context of employer-employee relationships.” The court noted that the task of extending existing law falls to the Minnesota Supreme Court or the legislature, not to the Court of Appeals. Accordingly, the court held that the district court improperly applied the post-employment independent consideration requirement to the parties’ independent contractor agreement. The Court of Appeals reversed the grant of summary judgment in favor of FTR and remanded the case back to the trial court to be analyzed under legal principles generally applicable to non-compete agreements.

Although the ruling was favorable to Schmit, and will likely make it easier for companies in Minnesota to apply non-compete agreements to independent contractors even absent independent consideration, the court left the door open to possible challenges if the non-compete agreement is the product of unequal bargaining power.

Lessons For Independent Contractors

If you are an independent contractor who entered into a non-compete agreement lacking independent consideration during the midst of an ongoing contractual relationship, the Schmit decision suggests that the agreement may still be valid despite the absence of any raise, promotion, or other benefit.
Based on the language of the court’s decision in Schmit, the existence of unequal bargaining power may influence whether independent consideration is required to support a non-compete agreement. For that reason, if you are compelled to sign a non-compete agreement on a “take it or leave it” basis, with little or no opportunity to negotiate over its terms, with little or no time to bargain, or without an opportunity to seek independent legal counsel, you should document these facts for later use in challenging the agreement.

Remember that non-compete agreements with independent contractors must still follow legal principles generally applicable to such restrictive covenant agreements. For example, the agreements must protect a legitimate business interest (such as confidential information, trade secrets, or customer goodwill). Further, they must be reasonable in substantive scope, duration, and geographic territory.

Lessons For Businesses Hiring Independent Contractors

If your business is entering into a non-compete agreement with an independent contractor following the creation of a contractual relationship, independent consideration may not be required.

Notwithstanding the Schmit decision, non-compete agreements entered into with independent contractors that lack independent consideration may be subject to legal challenge where there is unequal bargaining power.

In order to demonstrate equality of bargaining power, you should give the independent contractor a reasonable amount of time to review the non-compete agreement, the chance to negotiate its terms, and an opportunity to seek the advice of an attorney. Document the negotiation and any changes that were agreed to with the contractor, as well as the involvement of their legal counsel, for later use.

Keep in mind that many companies inadvertently “misclassify” as “independent contractors” persons who are truly employees. Thus, before relying on the Schmit decision when entering into a non-compete agreement with a purported “contractor,” you should carefully evaluate whether the independent contractor has been properly classified. If the individual might qualify as an employee, in an abundance of caution, you may wish to provide the contractor with independent consideration (such as a raise in compensation, bonus, or some other incentive or benefit) to minimize the risk of legal challenge.

Because Schmit was an unpublished decision of the Minnesota Court of Appeals, its holding may not be followed by subsequent panels of the Court of Appeals or it may be overruled by the Minnesota Supreme Court. Accordingly, it may be wise to provide independent consideration when entering into non-compete agreements with both employees and independent contractors wherever practical.

Conclusion
The Schmit decision is significant and may signal a growing willingness by the Minnesota courts to enforce non-compete agreements, especially those entered into with independent contractors. It will be interesting to see if other courts follow the Schmit decision and whether the Minnesota Supreme Court eventually weighs in on the issue.

In the meantime, whether you are a business, independent contractor, or employee, if you need assistance drafting, reviewing, or litigating a non-compete agreement, please contact the employment law attorneys of Trepanier MacGillis Battina P.A.
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About the Author:
Minnesota non-competition agreement attorney Craig W. Trepanier represents both employers and employees in a variety of employment law matters, including negotiation of non-compete agreements and handling non-compete agreement litigation. Craig may be reached at 612.455.0502 or craig@trepanierlaw.com. Trepanier MacGillis Battina P.A. is a Minnesota non-competition agreement law firm located in Minneapolis, Minnesota.