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.

Monday, April 27, 2015

I Cannot Stop Writing about Sergey Aleynikov

When Sergey Aleynikov sued the FBI agents responsible for his 2009 arrest, his journey through the court system officially became what we call "Batshit F**king Crazy." After all, this guy appears not to have injured (physically, emotionally, or financially) anyone. His ex-employer, Goldman Sachs Group, seems to have survived his resignation just fine.

Aleynikov, for those who still don't know, is a former Goldman Sachs computer programmer who left to join Teza Technologies in Chicago. However, he made some mistakes when leaving. He apparently transferred computer data from Goldman's high-frequency trading platform to a remote server in Germany, allegedly for use at Teza. (The conclusion may be dubious, for it's unclear what value a fraction of HFT code would have to a third-party, but that's for Aleynikov's highly skilled lawyer to argue - not me.)

To be sure, many a trade-secret defendant makes a similar mistake. But not everyone works for a Goldman Sachs. Aleynikov has turned the tables on Goldman before, and with his most recent lawsuit, he now seeks to turn the tables on those who Goldman allegedly conscripted - the officers who arrested him after he took the computer data.

In most cases, a fact set like this gives way to a rather bland cease-and-desist letter (or more accurately, a cease-desist-and-return letter). Perhaps the parties fight and end up at an injunction hearing. Even then, 90+ percent of such cases settle fairly quickly - often without payment of any money and relatively minor conduct restrictions agreed-upon.

If only it were so easy for Sergey.

To put this in context, we're talking about a guy who:

  1. Provoked an Illinois lawsuit involving Aleynikov's would-be employer, Teza Technologies, LLC, which resulted in a significant and somewhat controversial non-compete rule in our state;
  2. Was convicted in federal court under the National Stolen Property Act and the Economic Espionage Act for transferring some of Goldman's high-frequency trading source code to a remote server in Germany;
  3. Served 51 months in federal prison;
  4. Had his conviction reversed by the Second Circuit Court of Appeals;
  5. Was released from federal prison the same day as his lawyer's oral argument in the Second Circuit;
  6. Effectively encouraged (through the reversal of his conviction) Congress to amend the Economic Espionage Act for the purpose of redefining what type of conduct violate the statute, on a vote of (hold your breath) 388-4;
  7. Was re-arrested and charged under New York state law for theft of intellectual property;
  8. Sued Goldman Sachs to have it advance his legal fees in the New York state proceeding;
  9. Won that advancement action on summary judgment;
  10. Had his advancement case reversed, over a dissent, by the Third Circuit Court of Appeals;
  11. Served as the inspiration for Michael Lewis' phenomenal book Flash Boys, which itself delayed the IPO of Virtu Financial;
  12. Went to trial on the state intellectual property theft charges last week, with a jury still (as of this writing) deliberating over his fate (the trial judge appeared skeptical though); and
  13. (as noted below) Sued FBI agents in a so-called Bivens suit for violating his constitutional rights in arresting him without probable cause back in 2009.

In my opinion, Aleynikov's Bivens case may run directly into the defense of qualified immunity since he must show that the officers violated clearly established law in arresting him back in 2009. Taking the allegations as true, it's hard to see how the law back in 2009 was clearly established such that the federal officers responsible for his arrest now must account for legal damages. After all, Congress did amend the Economic Espionage Act after the Second Circuit reversed Aleynikov's conviction. And the case law on EEA prosecutions is (and was) sparse at best.

The most interesting aspect of the Bivens case is that Aleynikov's essentially treats the FBI as Goldman's agents, willing to do Goldman's bidding in a criminal case. In truth, he needs to make those allegations to get around qualified immunity. His case isn't frivolous, but he seems to be swimming uphill.

Strictly from a lawyer's perspective, even if the Bivens suit fails, I again have to commend Aleynikov's lawyer, Kevin Marino. From his work in getting the conviction overturned to the advancement proceeding in New Jersey, he has achieved simply extraordinary results for Aleynikov and has managed, at times, to outwit the Manhattan DA, the US Attorney, and Goldman itself.

The complaint he filed in the Bivens case is at times bombastic and inflammatory, but it's pretty damned effective and a great read. He knows precisely what he's doing. Whatever happens, and against all odds, Aleynikov fought back and then some. And that too is pretty rare to see.

Friday, April 17, 2015

The Golden Rule: Ninth Circuit Issues Odd, Unclear Opinion on No-Employment Clauses

My colleague Robert Milligan at Seyfarth Shaw predictably beat me to the punch in commenting on the Ninth Circuit's recent opinion in Golden v. Cal. Emergency Phys. Med. Group, which is embedded below. But at the risk of repeating his fine and thorough discussion of the case, it's potentially an important enough development for me to comment on as well.

The court held that a "no-employment" clause in a settlement agreement could constitute an invalid restraint of trade under Section 16600 of California's Business & Professions Code. No-employment clauses are neither unusual nor controversial, and they often appear in settlement agreements arising out of employment lawsuits.

Dr. Golden appeared to have settled an employment dispute with California Emergency Physicians Medical Group, which is apparently a large consortium of physicians that staffs ERs in California. As part of the settlement, Dr. Golden had to agree to a no-employment clause with CEP and any facility that CEP may own or with which it may contract in the future. It also gave CEP the right to terminate Dr. Golden from a facility if CEP acquired it in the future.

Dr. Golden, though, balked at signing the settlement agreement on account of the no-employment provision, arguing that it violated Section 16600 of the Code. Courts have interpreted that provision broadly, invalidating virtually all forms of employee covenants not to compete. However, the no-employment clause is not really a covenant not to compete. It arises in the context of a settlement, rather than as part of any hiring or other employment condition.

The Ninth Circuit sided with Dr. Golden and remanded the case back to the district court for fact-finding. Importantly, the court did not find that the no-employment clause was an impermissible restraint of trade under California law. Rather, it found the district court erred by categorically holding that it wasn't. Put simply, a "no-employment" clause can implicate Section 16600 and that section is not limited to a traditional non-compete. Therefore, a remand was necessary so the district could "conduct further fact-finding as it deems prudent."

That's where the case is a bit of an oddity (shocking for the Ninth Circuit). As the dissent points out, fact-finding over what, exactly? The agreement is what it is, and there was nothing immediately that impacted Dr. Golden's employment. So what are the pertinent facts?

Perhaps the court is saying that the trial judge must determine how significant a player CEP is in the regional ER staffing business and how its market power could affect Dr. Golden. If so, this starts to sound like a mini-antitrust trial in the context of an employment settlement. Lovely. Or maybe the trial judge will examine CEP's expansion strategy to see how big it could get. Without question, CEP will love to reveal those cards. Or should a labor economist testify about the potential future impact on Dr. Golden's ability to practice medicine and what opportunities he might have to forego? That seems more valid, but who pays for that? Does Dr. Golden's settlement cost him expert witness fees, all of a sudden? Ultimately, the case isn't clear, and there's little guidance for the district court on remand.

The impact of this case beyond the facts is unclear. In my opinion, lawyers may make more of this than they actually should. A typical no-hire clause in an employment settlement agreement will limit an employee's ability to work for that employer. It's unclear that many employees would want to contest that, and Dr. Golden is in somewhat of a unique position given the size and scope of the consortium he sued. Too, Dr. Golden and his lawyer appear to have had some sort of a falling out, and Dr. Golden held up the settlement on account of this provision. This doesn't happen all that often, so it's pretty likely that even if these clauses are unenforceable no employee is going to torpedo a settlement because of its inclusion.

Almost certainly, employers will want to add some representation or warranty in a no-hire clause from the employee that he does not believe the clause will constitute a restraint of substantial character on his trade or profession. That may help, but it's not failsafe. Or, employers could leave the clause out entirely and just not hire the person back. I don't see what's so wrong with that solution. Seems simple and less of a lawyer quandary.

Friday, April 10, 2015

New Ruling on Computer Fraud and Abuse Act Illustrates Division in Eleventh Circuit

The reach of the federal Computer Fraud and Abuse Act continues to divide courts and commentators. The friction spills over into statutory language that seemingly is pretty clear: one cannot access a protected computer to obtain information in a manner that exceeds the user's authorized access.

The phrase "exceeds authorized access" has yielded a split among many federal courts. On one side sits the pro-employer theory: that an employee cannot access information for reasons inconsistent with the employer's interest. On the other side, employees argue that the CFAA's definition does not turn on subjective intent as to use and that the statute only bars the accessing of information that the employer did not allow.

The Fifth and Seventh Circuits have pretty well-established rules that fall on the pro-employer side, though the rationales are not identical. The Fourth and Ninth are decidedly pro-employee and construe the CFAA much more narrowly.

The Eleventh Circuit's history on this is not straightforward.

Courts within the Eleventh Circuit (that is, district courts in Florida, Georgia, and Alabama) are divided on how to interpret and apply the CFAA. Some follow the pro-employee construction. Others disagree and side with the Fourth and Ninth Circuit line of authority. The problem seems to be a criminal case from the Eleventh Circuit itself, United States v. Rodriguez, which arguably requires a pro-employer construction of the CFAA.

Illustrating this divide is Enhanced Recovery Co., LLC v. Frady (opinion embedded below), which canvasses the law and decides not to follow Rodriguez - arguably binding precedent in the Eleventh Circuit. Frady involves perhaps the most common, ubiquitous CFAA fact pattern in employee mobility cases. The allegations hinged on an employee's act in preparing to compete by sending corporate documents from a company e-mail account to a personal web-based e-mail. Under the employer's theory, this transmission of e-mails is antagonistic to its business interests and constitutes the use of company information in an unauthorized manner.

As with many close CFAA cases, the fact pattern in Frady adds a twist because the employer had fairly clear policies against non-disclosure of information and a requirement to return company materials at the termination of employment. One reasonably could make the argument that these policies at least put the employee on notice that accessing corporate information for a prohibited use exceeded any authorization to use that information.

The district court in Frady was not persuaded and held this wasn't enough. In doing so, it seemed to tread a very narrow path through the Rodriguez case, which seems on first read to warrant a broader application of the CFAA.

My personal opinion is that something else must be going on here. I have seen judges walk this tightrope before, and I believe that regardless of any formal legal analysis, many remain troubled by the extension of the CFAA well beyond its intended purpose to punish hackers criminally. Courts, of course, acknowledge this but judges must default back to the statutory text to see whether conduct falls within the statutory proscription. And they are certainly bound by circuit law. In the CFAA arena, the distinctions that judges are drawing appear to be so fine and nuanced as to be meaningless.

This is not to say that the court in Frady got the result wrong as a normative matter, because the CFAA is overused. It is, to be sure, not a trade secrets law substitute - though many attorneys perceive that it is. And if the Obama Administration has its way, this divide over the meaning of authorized access will get cleaned up in a way that (surprisingly) favors the employer. Ultimately, I think this too is wrong. The existing legal framework under state law works just fine, and a federal trade secrets act may be okay too (though I am more lukewarm on that than others in my profession).

However, extending the CFAA and criminalizing conduct that doesn't even violate state trade secret law is not the right way to go about protecting intellectual property. In the employment realm, it remains a terrible fit. How judges get there is concerning, but if they agree, then I'm okay with a formal legal analysis that leaves me scratching my head.

Thursday, April 9, 2015

Streisand Effect Bedamned: Jimmy John's "Prevails" In Class Action Non-Compete Dispute

Quite possibly because my 3-year old loves Jimmy John's sandwiches, I have a profound affinity for the place. It's a minimum once-per-week destination. Plus, I went to law school in Champaign, Illinois, where Jimmy John's is somewhat of a revered institution.

Even I have to admit that I was a bit discouraged by reading the negative publicity surrounding Jimmy John's standard "Confidentiality and Non-Competition Agreement." It appears to apply to your average sandwich-maker and prevent him from jumping ship to Subway (but not Chipotle!). The mind reels at the thought of a stoned 19-year old testifying on the stand about the proprietary nature of applying roast beef between lettuce and mayo.

But the lawsuit - which sought a declaratory judgment that the non-compete was invalid - seemed doomed from the start. And yesterday, Judge Charles Kocoras dismissed the putative class action in Brunner v. Jimmy John's LLC, 2015 U.S. Dist. LEXIS 46018 (N.D. Ill. Apr. 8, 2015). The rationale was lack of standing, a somewhat formal legalist concept that the plaintiffs did not present enough of a concrete case to have a court decide.

In other words, the mere existence of the agreement was not enough to create a controversy that a court is capable of deciding. The putative class plaintiffs alleged - and I believe them - that they didn't really know what the non-compete meant or how Jimmy John's might apply or enforce it. This, by itself, did not create enough of an apprehension that a lawsuit was imminent. Put another way, the dispute was too hypothetical.

Jimmy John's also offered, sensibly in my view, affidavit testimony that revealed an intent not to enforce the non-compete against the putative class plaintiffs in the future. This, alone, may not be enough to demonstrate the lack of a case or controversy, but it sure helped Jimmy John's here.

(As an aside, the standing rules in federal court are a bit more stringent than in many state courts. Having had first-hand experience dealing with this, it's pretty clear that any type of a non-compete declaratory judgment case in federal court runs the possibility of being dismissed for lack of standing.)

Despite the win, this all feels like somewhat of a loss. The publicity on The Huffington Post and elsewhere surrounding the corporate mandate certainly damaged Jimmy John's and created a storm of negative publicity. just removed its non-compete for hourly workers, a tactic which resembles Jimmy John's representation that it won't enforce the agreement.

This whole affair reminds me of the Streisand Effect, although the analogy is imperfect. The thinking is that the attempt to remove information can have the effect of promoting it. This unintended consequence often appears in defamation cases, where a plaintiff attacks a disparaging comment only to put his reputation on trial.

The lawsuits and publicity surrounding the Jimmy John's and non-compete work a bit in reverse, but the concept is the same. Even a win may be a defeat.

Friday, April 3, 2015

Michigan Legislator Introduces Bill to Ban Non-Compete Agreements

As reported recently by Crain's Detroit Business, State Rep. Peter Lucido introduced House Bill 4198, which would ban employee non-compete agreements in the State of Michigan. The bill, which has no co-sponsors (and which has little chance of passage), proposes to amend MCL 445.774a, the state code section pertaining to covenants not to compete.

As amended, the proposal would allow for enforcement of covenants incidental to the purchase of goodwill. However, it specifically would void any restrictive covenant entered into between employer and employee.

Michigan has a somewhat circuitous history with regard to non-competes. Thirty years ago, employment non-competes largely were void, subject to some narrow exceptions. In 1985, however, the legislature reformed non-compete law to bring the state largely within the majority of other states, effectively allowing them as long as the terms are reasonable and are designed to protect a valid competitive business interest. Lucido would take the law back to its pre-1985 status.

Matt Marx, Deborah Strumsky, and Lee Fleming published a well-known Management Sciences article in 2009, which tested the effect of the law's evolution on the mobility of Michigan employees. The study concluded that the change in Michigan law positively correlated to a brain drain, as star inventors left Michigan for states with more lax non-compete enforcement policy. In many respects, the Marx-Fleming study is the intellectual forbear to Orly Lobel's book Talent Wants to Be Free (Yale Univ. Press 2013).

In the Crain's article, attorney Bernard Fuhs takes issue with Rep. Lucido's rationale for getting rid of non-competes. Confidentiality Agreements, Lucido says, are sufficient to protect intellectual property. Fuhs offers the best retort: it's virtually impossible to police compliance with a non-disclosure agreement absent evidence from a whistleblower or through sheer dumb luck.

Non-competes provide a more objective means to ensure protection of intellectual property, even if they are somewhat overinclusive. By "overinclusive," I mean that non-competes impede a flow of knowledge or value that can be restricted only incidentally and that may not provide any competitive advantage at all.

The entire rationale for enforcing non-competes is that the economic benefit from preventing disclosure of proprietary information exceeds the social cost in preventing use of non-proprietary spillover knowledge .

Monday, March 30, 2015

What's Driving Wisconsin Senate Bill 69?

Wisconsin long has been a red-flag state for employers. For many years, attorneys have struggled with how to enforce non-compete agreements against Wisconsin employees. This past year, the Supreme Court of Wisconsin has considered whether continued employment constitutes sufficient consideration for an at-will employee's non-compete, joining a growing number of states that are reevaluating this important issue.

Wisconsin Senate Bill 69 is somewhat out of left field and comes at a time when the state's highest court is reviewing the consideration question. A summary and text of the proposed law is linked here.

The proposed law appears to draw from a number different legislative enactments and proposals to make Wisconsin far more friendly to enforcement. The law is not as long as Florida's over-lawyered statute, but it's still pretty wordy.

A couple of key, notable provisions of the law include:

  1. Continued employment would constitute sufficient consideration for a non-compete, which would resolve (at least going forward) the Runzheimer case currently pending before the Supreme Court. If this is the sole basis for consideration, the employee must receive a "rate of pay and benefits that is equal to or greater" than that which pre-dated the non-compete. Generous.
  2. A court must modify an overbroad restraint and "grant only such relief as is reasonably necessary to protect" an asserted legitimate business interest. This would shift Wisconsin from a state that will not modify covenants to one that must modify them. Major shift in policy.
  3. When assessing reasonableness, a court must consider "evidence of common practice with respect to the duration, scope, and nature of restraints in the specific industry of the person seeking enforcement" of the non-compete. Alternatively known as the "Expert Witness Full Employment Act of 2015," this should add another layer of complexity and cost to what should be a fast-paced, efficient procedure. The mandatory nature of the rule is particularly striking and without precedent.
  4. A court must presume that a non-compete of 6 months or less is reasonable, while one 2 years or longer is unreasonable. This is a sensible rule that seems to follow a popular trend.
  5. In considering whether to enforce a restrictive covenant, a court cannot consider individualized economic or other hardship that may result from enforcement "unless that person shows that exceptional personal circumstances exist." In other words, the section is meaningless.
  6. A court cannot narrowly construe a non-compete against the party who drafts it, and "shall construe a restrictive covenant in favor of providing reasonable protection to all legitimate business interests" established by the party seeking enforcement. The narrow construction rule is a perfectly sensible device that requires an employer to provide clear guidance and avoid the uncertainty associated with dense, vague language - hallmarks of non-compete disputes.
  7. Courts must enforce attorneys' fees clauses, and "may award costs and attorneys' fees to the prevailing party" in the absence of a contractual restriction. The statute does not provide any guidance here, so a court has unvarnished discretion to rule. This could help deter truly meritless suits.
The statute contains other nits, but these seven changes stood out as stark and marked departures from existing law. Senator Paul Farrow, a Republican leader in the State Senate and a small business owner, introduced the bill. 

Friday, March 6, 2015

Minnesota's Justification Rule Shield Employer Liability on Non-Compete Claims

The economics of non-competes often don't work.

Injunctive relief is expensive and sometimes yields a hollow remedy if customers start to bolt regardless. As for damages, many employees aren't collectible.

This is where the new employer comes in. If there is real customer attrition linked to a non-compete violation, the new employer becomes the target simply because the old employer perceives it as able to satisfy a damages judgment.

The theory of liability hinges on the tort of "interference" with contract rights - encouraging the non-compete breach, in other words. For companies trying to enforce the non-compete and collect damages, it's essential to consider how to prove interference.

Most states apply the tort the same way, but crucial differences can arise.

The principal difference involves "justification" - that is, a party's ability to interfere with a contract to further its own business enterprise. In that respect, one question that frequently comes up is whether counsel's advice that a non-compete is unenforceable can rise to the level of legal justification absolving the tort. If so, the new employer may not face liability even if the employee breaches the contract and must pay damages.

This was the question before the Supreme Court of Minnesota in Sysdyne Corp. v. Rousslang, decided this past Thursday.

The Court found that the justification defenses encompasses the honest reliance on advice of counsel. In Rousslang, the Court applied the defense to the fact-pattern described above: the advice that an employee's non-competition covenant was unenforceable.

The Court's opinion provides what appears to be a safe harbor for new employers. The ruling is demonstrably unsound because it extends the concept of justification beyond the honest furtherance of one's own contractual right. A new company does not have a "right" to employ a particular individual. It may want to and may feel that person would be a valuable asset. However, this interest should not provide a third-party a pathway to interference, because it then would eviscerate the tort claim entirely (even outside the non-compete context). A party always will be able to claim a business interest in something.

The advice-of-counsel defense effectively undercuts any viable damages remedy, leaving the enforcing party with potentially a hollow judgment. The Court in Rousslang did not articulate what kind of inquiry a new employer must make, defaulting only in the broadest sense to a "reasonable inquiry" standard to be applied under the facts of each case.

So what kind of facts would the new employer establish as part of the advice-of-counsel/justification defense? Here are some:
  1. Testimony concerning how the company retained counsel and the experience of counsel.
  2. Evidence that it sent counsel the agreement for review.
  3. A description of the facts the company gave counsel (such as the employee's experience, exposure to customers, training, access to confidential information).
  4. The opinion itself, whether verbally or in writing.
  5. Billing records and e-mail correspondence.
All of this puts counsel in an awkward spot, of course, as her advice may be on trial (at least to show it was reasonable, not necessarily that it was correct). Getting past that awkwardness, an attorney really has no malpractice exposure as long as she follows some basic protocols like understanding the facts, reviewing the agreement, and communicating the basis for advice to the employer.

And on the flip side, it will be awfully difficult for the old employer to prove that counsel administered advice flippantly. One key fact could undermine the advice-of-counsel defense: is the new employer asking the employee to sign a similar non-compete? Relatedly, does the company use non-competes for similarly situated employees? If so, then it's going to be awfully difficult to claim the justification defense because there's no objective honesty in the advice.

To me, this collateral inquiry into what an attorney did in terms of advising a client is no way to run a non-compete case. It adds a layer of transaction costs into what otherwise should be a fairly straightforward case about breach and the protectible interest supporting the covenant. It brings into play the specter of expert witnesses opining on whether the new employer's attorney did what a reasonable lawyer should have.

Other courts disagree with the Minnesota approach and do not allow the advice-of-counsel defense to a tort claim. The Rousslang decision is below.