Monday, August 17, 2015

Hawaii Goes Deep on Non-Compete Law

The mentions that the State of Hawaii gets on this blog are, predictably, few and far between. However, in the span of just a few weeks, we have two significant legislative and judicial updates.

The first concerns Act 158, which Governor David Ige signed into law in June. The law is limited in scope and is industry-specific. The main thrust of the law is that it bans enforcement of non-compete agreements for employees of technology businesses. A technology business is defined as one which derives more than half of its gross sales from "sales or licensing of products or services resulting from software development or information technology development." The law further defines those terms.

The law also prohibits the use of non-solicitation covenants, which are defined exclusively as those restrictions that prohibit an employee from soliciting a former co-worker. It does not include any restrictions on contacting, servicing, or soliciting customers or clients of a former employer, meaning Act 158 expressly leaves open the question of whether this type of restrictive covenant in a technology business is prohibited. By omitting it, it is likely that such covenants will continue to be scrutinized for reasonableness under the common law.

Act 158 took effect on July 1, but the law has prospective effect only. For an excellent summary of Act 158, read Robert Milligan's analysis here.

While Act 158 is decidedly pro-employee, a Hawaii federal district court rendered a decidedly pro-employer decision in a non-compete case. The question presented in The Standard Register Co. v. Keala, 2014 U.S. Dist. LEXIS 73695 (D. Haw. June 8, 2015), was whether continued employment constitutes sufficient consideration to enforce a non-compete against an at-will employee. This issue continues to divide courts across the country. In the past year or so, some courts (Wisconsin) have veered towards a pro-enforcement stance when this type of consideration is at issue. Others (Illinois and Kentucky) continue to lean pro-employee and require additional consideration beyond employment itself. And we await a ruling from Pennsylvania on this same issue.

The district court in Standard Register noted that the Supreme Court of Hawaii never had addressed the question, so it surveyed the majority and minority rules across the United States. In following the majority rule, the court also relied on the forthcoming Restatement of Employment Law, Section 8.06, which appears to endorse the majority position - that forbearance of the right to discharge is itself sufficient consideration. The Restatement goes on to criticize the middle-ground approach taken by Illinois courts (as well as a handful of others) which examine whether the employment continues for a substantial period of time.

Wednesday, August 5, 2015

A Federal Trade Secrets Statute Appears Inevitable, Questions and Concerns Remain

Last week, the Defend Trade Secrets Act of 2015 was introduced in both the House of Representatives and the United States Senate. The text of the proposed legislation appears below. This is a bipartisan, bicameral bill that likely will become law in 2015.

The structure of the DTSA is very familiar to practitioners and to those who follow trade secrets developments. Currently, trade secrets law is the only branch of intellectual property that is regulated by state law. Since 1979, the Uniform Trade Secrets Act has been part of our state-law landscape, and over the years almost every state has adopted some form of the UTSA. (The variations by state are minor and generally relate to ancillary topics like the statute of limitations and preemption. New York and Massachusetts remain holdouts for reasons that are unknown.)

If Congress passes the DTSA, then this state-law regulatory framework will change dramatically. To be sure, it is unlikely to disappear; litigants still may be bring a state-law claim for trade secrets theft. The draft of the DTSA does not contain a broad preemption clause, but eventually state cases would run off into the remote reaches of the court system. And federal courts would bear the burden of hearing trade secrets disputes.

The structure of the proposed DTSA builds upon existing law, but not in a way that is seamless. It would amend the rarely-used Economic Espionage Act, which is contained in title 18 of the United States Code. The EEA criminalizes trade secret theft, but contains no private civil enforcement mechanism. In 2013, there were only 25 prosecutions under the EEA. The case law, which would aid a federal court in a DTSA claim, is almost non-existent.

The DTSA, to that end, adopts the EEA's definition of a "trade secret," which differs at the edges from the UTSA's definition. On this score, under the EEA, a trade secret must meet a two-part standard. The owner of the claimed secret must take reasonable measures to keep the information. And, substantively, the information must derive independent economic value from not being generally known to "the public." Under the UTSA, the second part of the definition is slightly different. The information must derive economic value from not being generally known "to other persons who can obtain economic value from its disclosure or use." Conceivably, under the DTSA, a plaintiff could bring two claims for trade secrets theft under two different statutes with two different definitions accorded the central issue in the case. Some lawyer somewhere is going to have a field day with that. (I happen to know of a few of those lawyers, who shall remain nameless.)

Another source of potential controversy is the DTSA's proposed process for enabling plaintiffs to obtain an ex parte seizure order. This would allow a court to authorize a seizure of trade-secret instrumentalities, such as computer hard-drives, thumb-drives, and even cell phones where purloined data may exist. In contrast to other branches of intellectual property law, these instrumentalities may have an entirely lawful purpose. On the other hand, think of counterfeit goods or pirated CDs, where the products themselves are infringing.

The seizure order is modeled after something called an "Anton Piller Order," which is fantastically named and derives from English law. This type of seizure order has a quaint, colorful, and interesting history in and of itself. Commentators are concerned that plaintiffs may abuse the process of seizing trade secret instrumentalities on an emergency, ex parte basis. However, I do not see this as a real issue for two reasons. First, federal judges would be inclined against issuing such orders, and a plaintiff who proceeds without caution faces the possibility of sanctions later in the case. Second, courts already have the authority, either under Rule 65 or the inherent authority power, to allow for seizure of items on a basis at least very similar to what the DTSA proposes. In light of the concerns, though, I expect the DTSA, when it's passed, to water down the seizure order provision or eliminate it entirely.

One final point: I feel that with the adoption of the DTSA, most non-compete disputes will now end up in federal court as a result of the courts' ability to exercise supplemental jurisdiction over state-law claims. Since trade secrets often comprise the legitimate business interest supporting a non-compete claim, a plaintiff will have every incentive to load into a non-compete dispute a corresponding trade secret claim just to get into federal court. This will complicate otherwise straightforward disputes, increase litigation costs, and tax the federal judiciary. By my estimation, if we assume that trade secrets cases are as common as patent and trademark suits, then the passage of the DTSA will result in an addition 10 to 14 new cases per district court judge per year. If there is an ancillary impact because of the desire to get non-compete cases in federal court, then the number would be higher.

I remain opposed, but not in a hand-wringing, teeth-gnashing sort of way. Two years ago, I conducted a podcast along with Russell Beck and John Marsh discussing the pros and cons of a federal trade secret statute. A link to the post and the podcast itself can be found here.

Friday, July 31, 2015

Seventh Circuit Endorses Use of Blue-Pencil Rule for Non-Competes

More times than not, courts in non-compete disputes confront restrictive covenants that have problems. Sometimes the problems are severe and other times they are revealed through the unique facts of the case, rather than the face of the document.

Yesterday, I spoke at the Annual Meeting of the American Bar Association and gave an update on key issues in non-compete and trade secrets law. One of the issues I discussed was the partial enforcement rule - in other words, how courts handle problems of overbroad covenants in enforcement actions.

Interestingly, the day before my presentation, the Seventh Circuit issued its opinion in Turnell v. CentiMark Corp. (embedded below). That case discussed Pennsylvania law concerning partial enforcement of covenants following an appeal from a preliminary injunction. CentiMark is a leader in a certain type of commercial roofing material used on commercial and industrial buildings. Turnell ran the Chicago District and had multi-state responsibilities.

The district court found that, under Pennsylvania law, Turnell's agreement was overbroad. But, after an evidentiary hearing, it reduced the scope of the agreement and enforced the reasonable parts. In doing so, the court properly found instances of overbreadth that are fairly common: (a) the non-compete banned work in an industry similar to that in which CentiMark engaged, meaning it covered too many products; (b) the non-compete barred sales to even prospective, as opposed to actual, customers; and (c) the geographic scope was vague and reached territories where Turnell was not primarily working.

On appeal, Turnell did not challenge the terms of the injunction and argued the district court should not have wielded the fictional blue-pencil to rewrite the contract. But the Seventh Circuit found that Pennsylvania law allowed the court to use its discretion to fashion an injunction remedy.

During oral argument, the Court was sympathetic to the possible overuse of the blue-pencil rule. And Judge Kanne's clear, insightful opinion reflects the tension and perverse incentives that the rule sometimes creates. Interestingly, the Court stated that "to some extent overbreadth is unavoidable given the imprecision of our language. "Ultimately, however, the Court did not seem persuaded that the terms of Turnell's agreement with CentiMark reflected bad faith or an intentional overreach on the employer's part.

I noted at the ABA Annual Meeting that there are four approaches to partial enforcement of overbroad agreements:

1. The "no modification" or red-line rule, which holds that courts will not modify agreements. Put another way, the covenant must be enforceable as written. Virginia adopts this approach.

2. The strict blue-pencil rule, which provides that courts can excise or eliminate overbroad, severable portions of an agreement. But the court will not add terms or use discretionary powers to modify the covenant. Indiana adheres to the blue-pencil rule.

3. The equitable modification principle, which was at issue in Turnell. This approach trades predictability for flexibility, because a trial judge can in effect become a third-party to the contract and impose terms that appear nowhere in the contract. Ohio adheres to this rule, and so does Illinois, but only in a more cautionary sense (for it can implicate public policy concerns). For instance, had Turnell challenged the Pennsylvania choice-of-law clause, Illinois' public policy may have called on the district to apply more favorable law.

4. The mandatory modification rule, which requires courts to reform agreements if they're overbroad. Texas endorses this rule, but provides that if a court orders a reformation, damages are then not available.

The equitable modification rule is, in many respects, very problematic. And in other cases similar to Turnell, courts have refused any sort modification. The approach often leads to the "right" result from a policy perspective, but it has a damaging collateral effect divorced from the litigation. Attorneys often cannot advise clients as to expected litigation outcomes, because it is very difficult to predict how a court will apply the reformation concept. As a result, many employees forego challenging the agreement altogether because of unpredictability (and their lawyers' hedging).

In light of the Court's recent opinion in Instant Technology (see post below from July 15, 2015), it surprises me that the Court did not mention the importance of predictability and clarity in the law of non-competes. In the end, though, the Court was constrained by Pennsylvania law, which allowed the district court to exercise her discretion and reform Turnell's contract.

Wednesday, July 15, 2015

Seventh Circuit Smartly Avoids Fifield Issue, Disses Illinois Law

In the detritus of Illinois law following the Fifield v. Premier Dealers Services case, one federal case actually appeared to have the potential to reshape how state courts (not to mention an increasing number of lower federal courts) viewed the issue of non-compete consideration for at-will employees.

Instant Technology, LLC v. DiFazio (7th Circuit, Nos. 14-2132 & 14-2243) was one of the diversity cases where the court followed Fifield and endorsed the two-year, bright-line consideration rule, which holds that non-compete/non-solicit covenants are enforceable only if an at-will employee has been employed two years or more. (This, of course, assumes the only consideration offered was employment itself, not something more tangible.) Other diversity cases declined to follow Fifield on the grounds that it did not accurately state the law in Illinois. Those cases have said that if the Illinois Supreme Court were confronted with the issue, it would come out with a different rule than that set forth in Fifield.

Instant Technology was always somewhat of a flimsy candidate for a broad, doctrinal repudiation or endorsement of Fifield, since the case appeared to founder on whether the covenants in the IT staffing business supported a "legitimate business interest." The district court found not, and the Seventh Circuit held that this finding was supported by the evidence. And on that score, Judge Easterbrook's opinion in Instant Technology gave nary a mention of Fifield or the current debate over consideration.

However, at oral argument, the Court discussed Fifield at length. And Judge Easterbrook is not the kind to wilt away and blindly assume the appellate court got it right in Fifield. He would seem to have little trouble excoriating the state court rule if he felt the legal standard was groundless. But his opinion avoided the issue, so we have nothing authoritative from a case that at least held out the possibility of being a game-changer in the consideration debate.

But, not surprisingly, Judge Easterbrook used the opportunity to take a not-so-veiled shot at Illinois law, and in particular the "totality of the circumstances" test from Reliable Fire Equipment Co. v. Arredondo. That case changed the analytical framework for determining how an employer can establish a legitimate business interest to support a non-compete. It discarded the traditional approach - which looked at whether an employer had a near-permanent relationship with clients or whether it sought to protect confidential business information the employee subsequently tried to use - and set forth a rather malleable (cavernous?) test that considered the totality of the facts from the case.

In Instant Technology, the IT staffing firm disputed the district court's analysis and basically said the judge didn't consider "everything," without specifying what it exactly it was that the court missed.

Judge Easterbrook says:

"Making validity turn on 'the totality of the circumstances' - which can't be determined until litigation years after the events - makes it hard to predict which covenants are enforceable. If employers can't predict which covenants courts will enforce, they will not make investments that may depend on covenants' validity, and they will not pay employees higher wages for agreeing to bear potentially costly terms. Both employers and employees may be worse off as a result. Risk-averse employees who hope that their covenants will be unenforceable, but fear that they will be sustained, may linger in jobs they would be happier (and more productive) leaving. But our rule of decision comes from state law. Erie R.R. v. Tompkins, 304 U.S. 64 (1938). Reforming that law, or trying to undermine it, is beyond our remit."

This passage largely pivots off many of the questions Judge David Hamilton asked during oral argument in the case. Judge Hamilton was concerned about the blank-slate landscape of Illinois law (a term used by Instant Technology's counsel) and the lack of apparent predictability in an area that demands it. Predictability and certainty usually arrive in the form of bright-line rules, which (oddly enough) Fifield establishes. As for the broader question of reasonableness, the Seventh Circuit seems to be saying that Illinois employers got what they asked for: flexibility. The price? Often times, disappointment.

Wednesday, June 17, 2015

Florida's Non-Compete Law Is, Apparently, "Truly Obnoxious"

One of the most important issues in analyzing any non-compete agreement is choice of law. My experience is that at least 9 out of 10 contracts contain explicit choice-of-law clauses, which describe in the contract which state's law will govern enforcement.

A few years ago, I represented the prevailing defendants in Tradesman Int'l v. Black, 724 F.3d 1004 (7th Cir. 2013). Judge David Hamilton's concurring opinion in that case illustrates the importance of choice-of-law clauses and how predictability over which state's law applies is essential to litigation strategy. It is an extremely thoughtful and interesting opinion, and my post discussing it can be found here.

There are a number of red-flag states where choice-of-law issues are bound to come up. Certainly, if California has any kind of a nexus to the proceedings, then choice of law will be front and center. Other states, like Wisconsin, also pay particular attention to clauses that select another state's law. And Florida, by virtue of its pro-enforcement stance, is a third example.

On this score, Illinois courts will not enforce Florida choice-of-law clauses because they are contrary to our state's public policy. Recently, New York courts have followed this lead and have held that a Florida choice-of-law provision in an employment non-solicitation covenant is unenforceable and contrary to New York public policy.

The case is Brown & Brown, Inc. v. Johnson. The Court of Appeals of New York set forth the standard for invalidating a contractual choice-of-law clause: the foreign law must be "truly obnoxious." Now, that's a standard.

So what's the problem with Florida law, and why do some courts view its stance on non-competes as contrary to public policy. The New York court identified the following:

  1. The employee largely bears the burden of proof to show that enforcement is not necessary to protect an asserted business interest.
  2. Courts many not consider hardship to the employee from the covenant's enforcement.
  3. Courts may not use rules of contract construction that would require a court to construe a vague or unclear contract against the employer.
Overall, the New York court - like the courts in Illinois before it - were concerned with "Florida's nearly-exclusive focus on the employer's interests" in contrast with the traditional balancing test that governs enforcement.

Going back to my post from two years ago when I analyzed Judge Hamilton's concurring opinion in Tradesman, there still is no clear test that I can find to determine when a state's law contravenes another state's public policy. I raised three possibilities:

  1. The legislature has spoken on the issue and declared the state's public policy, much like California has done.
  2. A state's case law reflects a clear, uniform rule applicable without regard to the specific facts of the case. An example would be a court's refusal to partially enforce an overbroad agreement.
  3. The difference between the chosen state and the forum state would be outcome-determinative.
After reading Brown & Brown, I might add a fourth possibility: the chosen state's rules disproportionately favor the employer and undermine the foundation of the rule-of-reason analysis.

Friday, June 12, 2015

Mid-Year Legislative Update - Arkansas, New Mexico, and ... Jimmy John's?

This year, we have seen a slight uptick in proposed legislation concerning non-compete agreements. In previous posts, I've written about legislative efforts in Wisconsin, Washington, and elsewhere. However, while most bills stall out, a few gain momentum. And recently, we have two actual legislative enactments that will change existing law.


The first new law comes from Arkansas, where Gov. Asa Hutchinson signed Act 921. This new law allows a court to enforce reasonable aspects of a non-compete agreement. Previously, Arkansas courts would not allow a court to blue-pencil an agreement that would allow for partial enforcement. That is, an agreement with any overbroad sub-parts rendered the whole document unenforceable. A court's ability to sever offending provisions is weapon in an employer's enforcement arsenal and encourages overbroad drafting.

Act 921 also provides for a presumption that a covenant lasting two years or less is reasonable. Finally, Act 921 specifies an array of employer protectable interests, which include goodwill, confidential information, and training. (The list also identifies protectable interests as "methods" which I found odd.)

Act 921 takes effect on August, 6, 2015.

New Mexico

In April, New Mexico enacted Senate Bill 325, which limits the enforcement of non-competes for health care practitioners (which is defined to include physicians, dentists, podiatrists, and nurse anesthetists). The law is available here.

The law, however, contains a number of significant limitations. First, it does not apply to heath care practitioners who are shareholders or partners in a practice. Second, it does not prohibit a practice from binding a health care practitioner to a non-solicitation provision with regard to patients and employees of the practice (as long as the covenant is 1 year or less). And third, it does not preclude use of a liquidated damages provision. Therefore, we can expect to see physician employment contracts track the language of the statute and (in all likelihood) tie a breach of a non-solicitation covenant to some formula for liquidated damages.


Nationally, we have a new bill tied to enforcement of non-compete agreements and, of course, it arises out of the infamous Jimmy John's case. Illustrating once again that there is no limit to legislators' imagination when it comes to giving legislation creative and idiotic names, several Senate Democrats have backed the Mobility and Opportunity for Vulnerable Employees (MOVE) Act. A copy of the bill is available here.

The essence of the bill is that it would bar use of non-competes for low-wage workers, generally defined as those earning less than $15 per hour. A violation would result in a fine of up to $5,000 per employee subject to the non-compete, and the law would empower the Secretary of Labor to investigate complaints concerning the improper deployment of non-competes. The law also contains a posting requirement (the violation of which is punishable by a flat $5,000 fine) that would tell a low-wage employee of the ban on non-competes.

The bill also would require employers who propose to use a non-compete to disclose this to the employee before employment and "at the beginning of the process for hiring" the employee. While some states have examined this kind of notice requirement in recent years, this would mark a substantial change in the law. Best practices certainly call for up-front disclosure, but it is still very common for employees who leave a job and accept a new one to see a non-compete on the first day of work.

Friday, May 29, 2015

Seventh Circuit Seems Uninterested in Fifield Rule

Last week, the Seventh Circuit heard oral argument in the case of Instant Technology v. DiFazio, No. 14-2132. The DiFazio case is one of several Illinois district court cases that apply the so-called Fifield rule on consideration.

Readers of this blog know all too well the contours of this rule, but as a refresher, it holds that at-will employment itself only can serve as consideration for a non-compete agreement if the employment lasts at least two years. Effectively, the rule means that employers must consider alternative forms of consideration, such as a signing bonus or grant of severance, to bind at-will employees to a non-compete or non-solicit covenant.

(My discussion of the district court's ruling is found here.)

DiFazio was a pro-employee decision, as the district court found that several of the individual defendants had unenforceable non-competes by virtue of their short stint of employment with Instant Technology. The defense-friendly decision had a litany of other facts, particularly concerning the protectable interest underlying the covenants, so consideration was somewhat of a tangential issue in the case. It's likely that even without the rule the employees would have won.

Will the Seventh Circuit weigh in on whether Fifield is good law? That's undecided even after oral argument. Instant Technology downplayed Fifield in its appellate briefs. And then it hired as appellate counsel the same attorney, Anthony Valiulis, who argued on Fifield's behalf in the Appellate Court of Illinois. That must have been awkward, and indeed Mr. Valiulis made light of this during his presentation.

By and large, I thought the argument was a let-down. The panel consisted of Judges Frank Easterbrook, David Hamilton, and Ann Williams. In particular, Judge Hamilton has a strong interest in this area of the law, as he handled a number of trade secret and non-compete cases while in private practice. And as usual, Judge Hamilton asked the best, clearest questions. (Judge Easterbrook, surprisingly, asked none).

On Fifield, though, the court revealed very little. Judge Hamilton asked Mr. Valilulis whether the Appellate Court correctly decided Fifield. Not surprisingly, he had to admit that the court got it wrong. Instant Technology argued that consideration should be judged by a totality-of-the-circumstances approach, consistent with the underlying rule-of-reason analysis concerning a covenant's terms. That strikes me as a position that is principled, in that it relies on prior precedent in this area, but ultimately misguided since it conflates two entirely separate legal concepts. However, none of the circuit judges really took issue with Mr. Valiulis' argument on this.

Though not speaking about consideration necessarily, Judge Hamilton said when questioning Mr. Valiulis that non-compete law is an area where predictability is incredibly important, both for employees and employers. That may provide a justification for the Fifield rule, which for all its faults is at least easy to apply in practice. In fact, Mr. Valilulis conceded that was one of his arguments in the Fifield case for the bright-line rule.

One issue did not come up. The court didn't even suggest that it would certify the consideration question to the Supreme Court of Illinois, which it is able to under Seventh Circuit Rule 52 (as well as state Supreme Court Rule 20(a)). It may be that the other flaws in Instant Technology's case prevent this, because Circuit Rule 52 only allows for certification on a state-law question that "will control the outcome of a case."

My guess is that Judge Hamilton will write an opinion affirming the district court's ruling and will discuss in passing the controversy concerning Fifield's consideration rule. Ultimately, though, because it may not be case-dispositive, I do not think he'll weigh in on what the rule should be.

Friday, May 22, 2015

More Discord In Treatment of CFAA "Exceeds Authorized Access" Claims

The scholarship and divergence of opinion on the Computer Fraud and Abuse Act's reach has become so pervasive that the issues no longer seem as complex as they once did.

Most practitioners still are not familiar with the CFAA, and since it's buried in the criminal code, civil litigators shouldn't have much reason to learn the statute's intricacies. But since it's a federal statute that has criminal and civil reach, the CFAA occupies a somewhat unique place for trade secret and non-compete litigators. In essence, the CFAA can serve as the jurisdictional hook to get competition cases into federal court.

The statute is densely worded and a patchwork of amendments. But for simplicity it enables an employer to pursue a civil cause of action if an ex-employee took information out of a protected computer (essentially anything hooked to the internet) and caused damage or loss. There are permutations to the various sub-sections, but that's the CFAA's civil reach in a nutshell.

I wrote recently about another CFAA case that arose in the employment context, which I felt crystallized the deep split among courts about how to apply the statute when insiders access information to use it contrary to their employers' interests. The issue comes up often because it is easy to misappropriate information out of computers, and at least half of trade secret defendants get tripped up through electronic evidence.

But the actual language of the CFAA is not easy to apply. In the employment context, one can use it against an employee who access a computer "without authorization" or in a manner that "exceeds authorized access." This raises the question - not easily solved - of whether an employee who has the ability to access corporate information, but who intends to misuse it, really has violated the CFAA at all.

The case of American Furukawa, Inc. v. Hossain, 2015 U.S. Dist. LEXIS 59000 (E.D. Mich. May 6, 2015), provides a clear illustration of all the CFAA issues that crop up in employment cases. They include allegations of improper downloading of files to an external drive, planned competition, questionable conduct on the employee's part around the time of departure, and then the fortuitous discovery of actual competition through a misdirected e-mail. (Yes, auto-fill is a boon to the plaintiff's bar.)

With those allegations, the court allowed the CFAA claim to persist, even disagreeing with other courts within the same judicial district. In essence, the court gave deference to limitations the employer placed on computer access, use, and purpose. It held that the misuse of information in violation of policy or contractual limitations can give rise to an "exceeds authorized access" claim. Succinctly put, the court stated "such explicit policies are nothing but 'security measures' employers may implement to prevent individuals from doing things in an improper manner on the employer's computer system."

The opinion itself is notable for its harsh criticism of the decision in United States v. Nosal, a decision out of the Ninth Circuit that takes a very narrow interpretation of the CFAA and its "access" language. In fact, in several places, the district court cited the government's brief before the Ninth Circuit, in which it argued for a broad access definition. The case provides an interesting survey of the law surrounding the circuit split in the CFAA. And it further underscores the need for legislative reform or (less likely) a case to make its way to the Supreme Court.

Friday, May 8, 2015

Supreme Court of Wisconsin Follows Majority Rule on Non-Compete Consideration

Wisconsin generally is known as a pro-employee state when it comes to enforcement of non-compete agreements. However, last week it gave employers a fairly significant victory in Runzheimer Int'l, Ltd. v. Friedlen, when the state supreme court held that an employer's election to refrain from firing an existing at-will employee constitutes lawful consideration for signing a non-compete agreement.

The Supreme Court of Wisconsin correctly noted that this issue has divided courts across the country, with a minority taking the opposite approach. Pennsylvania happens to be considering a similar question right now. Illinois courts are a mess when it comes to determining the adequacy of consideration for non-competes in the at-will context. In the past, Wisconsin courts had sent mixed signals and had not definitively reached the issue presented. The Court's decision - confusing in its rationale, to be sure - at least provides much-needed clarity for employers and employees moving forward.

The issue that percolates beneath the surface in cases like this is the employer's ability to fire the employee. So the reasoning goes, an employer can "trick" an employee into signing a non-compete, secure that commitment, and then fire the employee without any liability (for at-will employment is a relatively risk-free relationship). According to the Court, it's not correct to view the forbearance from firing as "illusory consideration." Rather, other contract defenses (like fraudulent inducement) provide a legitimate check against such trickery.

The other, less formal, check is that an employer which engages in these kinds of tactics will be less attractive to potential new hires. Further, when it comes time to enforcement, an employer will have a separate issue to confront wholly apart from the consideration question: whether enforcement after involuntary discharge is reasonable. Part of the reasonableness test will examine whether enforcement will present an undue hardship on the employee.

In the past, I have been an advocate for looking at this hardship factor when the employment ends at the behest of the employer, rather than the employee. It is an issue separate from the four corners of the contract, but it still relates to the reasonableness of enforcement. Courts will view attempts to enforce non-competes against terminated employees with much greater suspicion than those who leave of their own volition.

As Runzheimer suggests, we can view this issue wholly apart from the element of consideration. It may be another contract defense. It may be within the overall reasonableness inquiry. But it clearly is something, and employers always will need to factor in the equities when enforcing non-competes.

Friday, May 1, 2015

On Predatory Lawsuits and Bad Faith in Trade Secrets Claims, California Continues to Lead the Way

Trade secrets claim are inherently fraught with a startling reality: they have the potential to morph into opportunistic litigation.

What I mean by this is that a party can use a trade secrets lawsuit for a purpose unrelated to the merits. Put another way, the suit can be a means to heap costs on smaller competitors, discourage the development of a competing product or service, or deter perfectly lawful employee recruitment. Trade secrets suits are often fraught with complexity, which means that it's hard for a judge to snuff out bad faith. They also are exceedingly difficult to dismiss early, because they are fact-intensive. These factors, and more, result in a potential toxic brew that can masquerade a plaintiff's bad faith until well into the litigation process.

I have been fortunate (or, from my client's perspective, unfortunate) to have litigated for the defendants a bad-faith trade secrets claim all the way to the Seventh Circuit Court of Appeals. In Tradesman Int'l, Inc. v. Black, 724 F.3d 1004 (7th Cir. 2003), the Court found under Illinois law that a trial court need not examine a plaintiff's bad faith at the time a lawsuit is filed. Rather, the inquiry is more flexible, and a court is empowered to award fees if it maintains a suit in bad faith. By definition, this requires an ongoing examination of a case to determine if and when a party's bad faith starts.

The Tradesman case is one of a handful of cases - indeed, one of the most important - outside California that examine the notion of bad faith in the specific context of a trade secrets suit. The Uniform Trade Secrets Act, adopted by nearly all states, allows for fee-shifting if a prevailing defendant illustrates bad faith. But relatively few cases reach that stage, and even fewer result in persuasive opinions that practitioners can use for future guidance.

Enter Cypress Semiconductor Corp. v. Maxim Integrated Products, which is surely the most important bad faith case since Tradesman. The case does not establish any new law, as California already has cemented its two-part "objective speciousness/subjective bad faith" test. But the facts of the case, and the Court of Appeal's analysis are powerful and serve to guide lawyers over the bad faith question.

The case arose out of nothing more than Maxim's apparent recruitment (through a headhunter) of Cypress employees - particularly in the area of touchscreen technology. Since California has banned employment non-compete agreements, the broad theory of trade secrets liability ("you're targeting our employees to acquire trade secrets") was dubious out of the gate. Even more problematic for Cypress was California's refusal to adopt the "inevitable disclosure" doctrine - which is broadly used as a justification to enforce non-competes and is more controversially used sometimes as a free-standing claim to bar competition even in the absence of a non-compete.

So, from the start, Cypress' case was in trouble. It veered further off the rails when Maxim demanded a trade secrets identification, which California law requires early in the case. Here's what Cypress disclosed:

(1) A compilation or list of Cypress employees who worked with Cypress's touchscreen technology and products area and their employee information, including contact information.

(2) Cypress's substantive confidential information regarding its proprietary touchscreen technology and high performance products.

Well now. That's seems compelling.

As for category (1), Cypress ran into trouble when Maxim found those same employees - whose identifies were apparently trade secrets, in the Cypress world - on LinkedIn and other social networking sites. Problem.

As for category (2), I am not sure what to say. Identifying your trade secrets as "substantive confidential information" regarding all your products seems a wee-bit circular. Adding adjectives was not all that helpful.

The opinion (embedded below) is replete with an often harsh characterization of what Cypress did with this profoundly silly lawsuit. It supported its bad-faith finding with a wide-ranging criticism of Cypress's improper identification, rank speculation that Maxim even was offering Cypress employees positions on touchscreen technology, and its use of litigation to achieve an improper purpose.

Of greater interest, though, was Cypress's novel defense: since it voluntarily dismissed the lawsuit, Maxim could not be a "prevailing party" under the bad-faith statute. Here, the theory was that Cypress could have refiled the case in the future. Demonstrating a fair amount of arrogance, Cypress contended it was the prevailing party since Maxim voluntarily stopped soliciting Cypress's employees.

The Court of Appeal reached a pragmatic result by rejecting this voluntary dismissal defense. By finding that the plaintiff acted in bad faith, a court will have ensured that the defendant did not achieve some "superficial or illusory success" by virtue of the voluntary dismissal. Put another way, the bad-faith finding is itself a determination that the plaintiff would have lost - badly, in fact. Therefore, there is no real justification for denying fees to a defendant who wins simply because the plaintiff elected to ditch its case in the face of inevitable loss. The Court asked rhetorically "why a party who has made a trade secret claim in bad faith should be permitted to inflict the costs of defense on his or her opponent."

In finding that Maxim was the prevailing party, the Court of Appeal sensibly resolved an issue that trade secrets defendants fear (particularly in state court): the plaintiff's use of expensive litigation to achieve some temporary objective - a standstill agreement to stop competing, piling on of legal fees - only to cut and run after it sends its marketplace message. In these circumstances, a defendant can be left holding the bag with fewer fee-shifting options because it will not have a judgment on the merits.

But as the Court found, the bad-faith finding is tantamount to such a judgment because it serves as a finding that not only was the defendant not liable, but also that the plaintiff knew from the start that it never could be. From a policy perspective, the bad-faith statute has far less teeth if the plaintiff can use the safe-harbor of a voluntary dismissal to avoid even the specter of a fee claim. This is the sort of loophole that should a liberal construction of the bad-faith statute can close.

The issue of bad faith and predatory litigation is one that is not going away, and the Cypress decision serves as a road map for how defendants can fight back against frivolous, anti-competitive claims.