Friday, December 31, 2010

2010, Yer Outta Here!

It's time to put a wrap on 2010, a very satisfying year for me personally and professionally. On the personal side, I saw something I was convinced I'd never see in my lifetime: a Stanley Cup brought home to the City of Chicago. My parents saw something they never thought they would see in their lifetime: their only son get married.

On the professional side, I've advised many great clients on some very challenging and interesting issues. I won the only trial I had this year and was able to help several clients negotiate their way out of tough situations. Last year at this time, I wrote a post that captured some thoughts and impressions I formed through advising clients, litigating cases and studying other lawsuits and trends. I'd encourage readers to click on the link and read that post, as I think many of the same comments apply.

As for 2010, it was a more interesting year than 2009 for sure in regards to non-competes. A couple of points to highlight:

(1) As Jay Shepard writes, the volume of non-compete cases and disputes continues to rise and shows no signs of slowing down.

(2) Georgia enacted significant non-compete reform that will take effect for contracts entered into after today.

(3) Illinois, my home state, produced a number of significant state and federal court decisions, highlighted by the opinion in Reliable Fire Equipment - discussed at length this month.

(4) The number of cases involving the Computer Fraud and Abuse Act in the context of garden-variety employee unfair competition claims has declined significantly.

(5) And, I saw the absolute dumbest non-compete agreement I've seen in 13 years of practicing law: a non-solicitation restriction buried in a 52-page employee handbook that itself contained a disclaimer that it was not a contract. Hard to believe.

As for 2011, I look forward to the third full year writing this blog. Honestly, I feel like I'm just getting warmed up. I still plan to write 2 to 3 times per week, but I have some ideas to mix up the content a bit. Once per month, I will write a "Spotlight" column, focusing on a state, an industry or a legal topic. It will be a bit more in-depth than my regular columns, kind of like a poor man's bar journal article. I also plan on sharing more of what my blogger colleagues write. I've done that some, but not enough. There are a lot of great law blogs out there, and I plan to highlight and discuss others' posts. Some of the best are listed on my Blog Roll (look to your right...).

I would like to hear from you too. I have been blessed to have more than 45,000 visitors to my site this year, and I always look forward to the thoughtful e-mails my readers send to me. If there is a topic or issue on your mind, please feel free to send it along and I will see if I can work it into a column.

The end of the year always means that it's time for every scribe, professional and amateur alike, to put together a top 10 list of sorts. Throughout the year, I've offered several comments about what employers need to consider when drafting or enforcing non-compete agreements.

It occurred to me, though, that since a fair percentage of my clients are employees, rather than companies, I really ought to put together a list for them. I thought a great deal about what kind of list to draft, and I wanted to do something different and practical.

So I put together this list of ten things employees need to provide their attorneys to receive non-compete advice.
  1. Copies of all employment contracts - This may seem self-evident, but I emphasize the word all. I have met with many clients who have non-compete obligations expressed in several different agreements, and it's essential that your lawyer have a full understanding of all contracts and terms.
  2. Personnel file - In some states, employees have an automatic right to receive their personnel file. If you live in one of these states, you should always request a copy of your file.
  3. Cease and desist or "reminder" letters - It is fairly standard now for any departing employee to receive a not-so-friendly reminder from an ex-employer about the terms of a non-compete agreement. If you have received such a letter, don't sweat it. If you haven't, it could help establish that your ex-employer has not been vigilant about protecting its confidential information.
  4. Prior job description or resume - In assessing your non-compete, it is imperative that your attorney have a full understanding of what it is you do and how you could potentially harm your ex-employer's business interest.
  5. Company proprietary information - If you left and retained company proprietary documents, your lawyer needs to see them. This could avert a potential claim and allow the employee to walk into court with clean (or cleaner) hands.
  6. Prior legal opinions - If you've met with other attorneys about your non-compete and received an opinion letter, bring it with you. It is important for your lawyer to understand what advice - good or bad - you have received previously.
  7. Stock or equity option agreements and plans - Participation in a company incentive plan can trigger a whole separate set of agreements (usually called award agreements). Those documents may contain restrictions on competing, though they are more likely tied to paying back income received from exercising options.
  8. Employee handbook - Particularly in involuntary termination cases, it is important for your attorney to assess whether you might have some severance, progressive discipline or other right that has not been resolved.
  9. New employment documents - This could include a number of documents if you're already employed or have a new opportunity on the horizon: an indemnification agreement, employment agreement, offer letter, and new job description.
  10. Questions - Yes, you should list out any questions you have for your attorney. Hiring an attorney is often a new experience for many employees. Unfortunately, it is stressful too and you're bound to forget questions you want to ask. No question is dumb, so write them down and bring that list with you.
Well, that's it. Thank you, again, to each of my readers, colleagues, and especially my clients for another great year!

Monday, December 27, 2010

Wal-Mart/CVS Dispute Over Mullany Illustrates Problems of Hiring the "Senior Big Dog"

The Delaware Non-Compete Law Blog has a couple of excellent posts on the recent decision by Judge Travis Laster enjoining CVS Caremark from hiring Hank Mullany, a former senior executive with Wal-Mart Stores, Inc.

At the time of his departure, Mullany was the Executive Vice-President and President of Wal-Mart North, a position that reported directly to Wal-Mart's CEO. Mullany oversaw store operations, real estate and supply chain functions for 19 states, stretching from Illinois all the way to eastern seaboard states from Maine to North Carolina.

Mullany gave notice of his resignation in October, about 10 months after his promotion to President of Wal-Mart North. Wal-Mart later found out that CVS intended to hire Mullany. According to Wal-Mart's Complaint, CVS and Wal-Mart compete in the retail pharmacy market and other associated markets, such as beauty aids, consumables and groceries. Mullany's non-compete agreement with Wal-Mart prohibited him from working with any general or specialty retail store with a gross revenue threshold of $5 billion.

Vice-Chancellor Laster found that, in signing the non-compete agreement, Mullany knew exactly what he was signing and that the covenant appeared reasonable under Delaware law. It is true that one does not necessarily think of CVS and Wal-Mart as direct competitors, but in the retail space, with whom wouldn't Wal-Mart compete at least in some respect?

In his decision, Vice-Chancellor Laster specifically noted that if non-compete agreements should apply to anyone it is to "senior big dog executives." Though it is relatively uncommon for a state's non-compete test to hone in on the position or pay grade of the employee, it is not a stretch by any means to think that courts consider an employee's level of sophistication and business acumen to be a significant factor when determining to what extent the covenant should be enforced.

This relates, most often, to the protectable interest of "confidential information." Wal-Mart's Complaint was replete with references to the types of information and business strategies Mullany was able to access while at Wal-Mart. Those allegations portrayed a convincing story of how Mullany could use that information to run CVS' operations and take on Wal-Mart directly, particular in the pharmacy and prescription drug market. In competitive transitions like the one Mullany sought to make, a non-disclosure agreement is of limited use because compliance is hard to monitor. It is much easier to determine whether an executive employee is working for a competitor, and nearly impossible for outsiders to determine exactly what information he or she is using to perform day-to-day duties.

Monday, December 20, 2010

Bobby Petrino's New 7-Year Deal With Arkansas Contains Only In-Term Non-Compete Restriction

As the University of Arkansas prepares to play The Ohio State University (my alma mater) in the Sugar Bowl after the New Year, it apparently does not need to worry about perennial navel-gazer Bobby Petrino looking for greener pastures.

It was reported a few weeks ago that Arkansas locked up Petrino to a new employment agreement that runs through 2017, a move clearly necessitated by high-profile job openings at Florida and Miami. One aspect of Petrino's original deal that was somewhat controversial was his non-compete agreement, which was limited to the SEC's Western Division. As any college football fan well knows, the SEC is somewhat of an incestuous conference, with several coaches - Nick Saban and Houston Nutt, to name a few - jumping from one conference rival to another in a relatively short time-frame.

Notably, Florida is in the SEC's Eastern Division. Had Petrino been offered and taken the Florida job (which went to Texas' high-profile assistant, Will Muschamp), the non-compete would not have applied. Florida would have been on the hook only for the buyout payment to Arkansas, but Petrino likely would not have faced an injunction to prevent him from taking the position altogether.

Petrino's new contract contains a significant pay raise and a non-compete that extends to the entire SEC. The long form of Petrino's new deal with Arkansas is not yet final, but should be within several weeks. His letter agreement contains a total compensation package averaging $3.56 million per year. The non-compete clearly applies during the term of his employment with Arkansas only. So if Petrino reaches the end of his current 7-year deal with Arkansas, and an SEC job is open, he is free to take it. As we all know, coaches almost never reach the end of a deal. They are either extended or fired. On this score, if Petrino were fired without "cause", the SEC non-compete would not apply.

Most courts consider in-term non-competes like the one Petrino has to be far less problematic than post-termination non-competes. They are viewed as a reasonable exchange for those individuals offering unique personal services, and there is little concern about loss of livelihood or income. In fact, the interest that an employer like the University of Arkansas is seeking to protect through its in-term non-compete is the loss of Petrino's services, not irreparable harm from an ex-employee through direct competition.

I don't know how Arkansas courts have construed in-term non-competes, but the law of other states clearly demonstrates that such covenants are enforced much more broadly.

Friday, December 17, 2010

Equitable Tolling of Non-Compete Not Available In Massachusetts Absent Contract Provision (EMC Corp. v. Arturi)

A federal district court has held that, under Massachusetts law, a non-compete restriction cannot be extended beyond the terms of the contract.

The case involved a suit filed by EMC Corporation against Chris Blotto. EMC originally filed suit in March of 2010, about 4 months after Blotto left EMC to join Knowledgent Group. It did not pursue injunctive relief until August, and at that time, it only sought to enforce a customer non-solicitation provision given evidence that Blotto was soliciting an EMC customer.
In November, EMC filed a second preliminary injunction motion, this time seeking, among other things, to prevent Blotto from working with Knowledgent for one year from the date of the order. The court denied the motion on the grounds that extending the restriction past December 4, 2010 was not allowed under Massachusetts law.

The court declined to endorse a broad application of the equitable tolling rule and indicated that EMC could easily amend its employment agreement to give it the right to toll the non-compete period during the period of an employee's breach. The court did not find that the reason for delay in seeking injunctive relief was important to its holding.
Court: United States District Court for the District of Massachusetts
Opinion Date: 12/15/10
Cite: EMC Corp. v. Arturi, 2010 U.S. Dist. LEXIS 132621 (D. Mass. Dec. 15, 2010)
Favors: Employee
Law: Massachusetts

Thursday, December 16, 2010

Part V: What's Next After Reliable Fire Equipment v. Arredondo

This is Part V, the final installment, in a series discussing the holding in Reliable Fire Equipment v. Arredondo. Please scroll down for further discussion of this case.

Over the past several days, I have discussed the impact and meaning of Reliable Fire Equipment, the most recent of three appellate cases that directly address the viability of the so-called "legitimate business interest" test under Illinois non-compete law. The case is obviously important because it portends a shift in how courts will analyze non-compete agreements. But it is far from perfect and it means that the real answers to big questions will be provided in the next covenants case to hit the appellate courts.

Today, I want to tie this up and discuss where courts in Illinois are likely to head next.

In the short term, it is clear that courts will start to discard and move away from the rigid two-part legitimate business interest test that has been used by Illinois courts to examine the validity of non-compete agreements. That test served a gatekeeper role that demanded employers establish either that the ex-employee had access to near-permanent customer relationships or attempted to use confidential information when competing. Absent a showing of one of those two interests, the court did not need to consider whether the covenant was reasonable.

After Reliable Fire Equipment, courts will be inclined to examine whether an employer had other protectable interests if it cannot establish either of these two traditional business justifications for enforcing a covenant.

In that respect, courts will need to consider the parameters of what a protectable interest is. Does it include mere "access" to confidential information, rather than an attempt to use it? Similarly, can true sales-oriented businesses rely on covenants or will courts continue to find that those businesses by definition have more fleeting, tenuous relationships that cannot be restrained?

What about goodwill, unique services and special training? In many states, these are recognized as protectable employer interests. Courts in Illinois have had little to say about them. For high-level executives, these interests alone could support a non-compete regardless of whether the executive attempts to use confidential information to compete.

A couple of other related questions loom. How will courts examine non-solicitation agreements? Do the same protectable interests apply to both? Since they are less restrictive and more readily enforced, will courts be more lenient in finding the presence of a legitimate employer interest? Again, courts in Illinois have mixed the two analyses up on many occasions and have not reached consistent results.

Eventually, though, courts will need to formulate an actual, usable test. Illinois has cobbled it together over time, and even the most recent cases are not exactly clear on what an employer must show to demonstrate enforceability.

There is plenty of good law to draw upon. Assuming courts in Illinois will require an employer to demonstrate some protectable interest, then a model for courts to consider will be the old balancing test used in Iowa and other states.

That test requires a showing that: (a) the covenant is no more extensive than reasonably necessary to protect the employer's business interest; (b) the covenant does not impose an undue hardship on the employee; and (c) the covenant does not prejudice the public interest.

Importantly, the concept of "reasonableness" fits within both categories (a) and (b). Because it is not overly formulaic, a court could still uphold a covenant that is broader in scope but narrower in time. The way the current law reads, an employee could make a good faith argument that a covenant must be reasonable in each of time, territory and scope. A more robust, big-picture analysis seems more logical.

This test also links the notion of reasonableness and a protectable interest. As I wrote when assessing Sunbelt Rentals and Steam Sales, the two concepts are completely interrelated. It makes no sense to analyze whether a covenant is reasonable without assessing what it is the employer is seeking to protect.

All of these questions need to get answered by the Supreme Court, which has been less than helpful in clarifying the law of restrictive covenants. There is an upside to all the recent confusion in the Illinois cases. The Supreme Court may have no choice but to step in and provide answers to these and other important questions.

Tuesday, December 14, 2010

Part IV: The Dissenting Opinion in Reliable Fire Equipment v. Arredondo

This is Part IV in a series discussing the recent holding in Reliable Fire Equipment v. Arredondo. Please scroll down for further discussion of this case.

From my vantage point, Justice O'Malley's dissenting opinion in Reliable Fire Equipment is notable in three respects.

First, he articulates that based on the concurring opinion, his dissent and the most recent holdings in other Illinois appellate cases, courts have abandoned the "legitimate business interest" test as it was previously formulated. He argues that because two of the three justices (and perhaps all three) agree that the categorical rule cannot stand, that the legitimate business interest test is no longer the law in Illinois until the Supreme Court steps in. I agree with this. It is clear the test is not really viable any longer, and attorneys should be prepared to analyze an employer's protectable interest in light of each case's facts.

Second, despite his clarification of the current status of what is not the test, he doesn't do much to articulate a usable test. He suggests in sort of a meandering way that the totality of the circumstances must be considered to determine whether there is a legitimate employer interest that would uphold a non-compete clause. But he uses muddled (and loaded) terms like "unfair competition", and "fiercer than ordinary", without really describing the significance of them. The closest he comes to articulating a test is very early on in his opinion by stating that the totality of the circumstances test requires a court to first determine whether a protectable interest is present, followed by an analysis of whether a covenant is reasonable in time, territory and scope of activity. It is unclear why he is equating "protectable interest" with terms like "fiercer than ordinary" competition or "unfair competition." In fact, it's possible he is not equating them at all.

(I am at a complete loss, though, why courts refuse to adopt a clear test like the one Iowa courts use. That three-part test, long advocated by influential scholars, provides that employment non-compete arrangements will be sustained if: (a) they are no more restrictive than reasonably necessary to protect an employer's business interest; (b) they do not impose an undue hardship on the employee; and (c) they are not prejudicial to the public interest. More on this tomorrow.)

Third, he suggests that appellate courts have misapplied the law by holding, as a general rule, that a non-solicitation covenant cannot be enforced it if prohibits a former employee from working with customers that he or she never had contact with while working for the original employer. There is some merit to this. After all, how could a non-compete ever be valid if this were true? By definition, a prohibition on competing means that an employee won't be able to work with any customer in a competing business, whether that customer was one of his former employer's or not. I am not sure his analysis and conclusion on this point are particularly well-developed, for Illinois courts have applied this rule only to customer non-solicitation provisions. I think courts will have to analyze this further, but Justice O'Malley's opinion points out a rather obvious flaw that has been ignored for years.

The dissenting opinion certainly provides some clarity for attorneys, but it does more to highlight what may be on the horizon. Next, I will discuss some longer term implications for Illinois courts following Reliable Fire Equipment.

Monday, December 13, 2010

Part III: The Concurring Opinion in Reliable Fire Equipment v. Arredondo

This is Part III in a series discussing the recent holding in Reliable Fire Equipment v. Arredondo. Please scroll down for prior posts and information about this case.

The concurring opinion in Reliable Fire Equipment clarifies a great deal about how to evaluate restrictive covenants in Illinois. The thrust of the concurrence is that there are no hard and fast rules about what qualifies as a "legitimate business interest" in terms of a non-compete's enforceability. Justice Hudson correctly noted that the cases have been less than clear on how rigid Illinois' two-part test was.

As it stands now, courts within the Second District will have to assess the employer's legitimate business interest under a "totality of the circumstances" test. This is more in line with the intensely fact-based nature of non-compete cases, departs from the two-part test used by courts, and expands the overall analysis to more than "time, territory and scope" as is currently used in the Fourth District.

As I have mentioned before, courts in many states look at an array of protectable interests, from customer contacts and access to confidential information to unique services and special training. In Illinois, the inquiry has been very narrow and many fact patterns just don't seem to fit the analysis at all.

On Wednesday, I will discuss this in more detail about what may be next after Reliable Fire Equipment, but for now, employers may take some comfort in the fact that other interests may be used to justify a restriction on competition. Just by way of example, an employer may now be able to enforce covenants against not only those employees who "attempt" to use confidential information against an ex-employer, but also against those whose employees whose position poses an inevitable risk of disclosure of confidential information.

Saturday, December 11, 2010

Part II: Application of the Legitimate Business Interest Test in Reliable Fire Equipment

This is Part II in a series discussing the recent holding in Reliable Fire Equipment v. Arredondo. Please scroll down for further discussion of this case.

In Reliable Fire Equipment v. Arredondo, the Appellate Court found that the legitimate business interest test had to be applied to determine whether the non-compete agreement was enforceable. Though my prior post noted that the Appellate Court seemed to back away from a rigid two-factor test, it went ahead and applied the same historical test courts previously have used in Illinois. In that respect, the court analyzed whether Reliable Fire Equipment could show the presence of confidential information or near-permanent customer relationships that would allow it to enforce the non-compete.

The discussion on confidential information was fairly brief, and the Appellate Court accepted the trial court's conclusion that much of the relevant data available to the ex-employees - customer lists and pricing information - was easily findable and within the public domain. The Appellate Court was not willing to reverse this conclusion under an exacting standard of review.

The Appellate Court's discussion of customer relationships was more extensive. The court approved the two alternate tests courts have used to determine whether an employer has a legitimate interest in protecting its customer base. It discussed the "seven-factor" approach and the "nature of the business" test. Concluding that Reliable Fire Equipment's business was a sales-driven business, typified by common sales techniques and cross-purchasing by customers, the Appellate Court found that in such a circumstance a "near-permanent" relationship is generally absent. In the court's view, there continues to be a rather significant distinction between a professional services business (such as accounting, consulting, medical practice) and a sales-driven business.

Having concluded that, the court went on to discuss the seven-factor test, which applies various indicators to determine whether a true sales business still can have near-permanent relationships with its customers. The Appellate Court applied those factors and found the trial court's conclusion that Reliable Fire Equipment did not satisfy the test was not erroneous.

In particular, the court noted that buyers of fire alarm systems typically placed a project for bid and accepted the lowest quote. The court also noted that the sales staff had to supply their own computers and cell phones and had a limited entertainment budget. The court further stated that customers were well-known and could be located through access to public directories. Finally, the court determined that the business' relationship with customers was at-will and not exclusive.

The last point the Appellate Court made concerned the reasonableness of the employees' agreements with Reliable Fire Equipment. In particular, the court expressed concern as to the broad scope of the covenant, determining that the restriction prohibiting the employees from working with all customers of their ex-employer was too broad. Under Illinois law, the restriction really should extend to those customers with whom the employee developed a business relationship.

On Monday, I will discuss Justice Hudson's concurring opinion.

Friday, December 10, 2010

Part I: The Majority's Holding in Reliable Fire Equipment

This is Part I in a series discussing the recent case of Reliable Fire Equipment v. Arredondo. Please scroll down for my initial post concerning this case.

What is most notable about the majority opinion in Reliable Fire Equipment v. Arredondo is its length and depth of analysis. Keep in mind the backstory, here. Illinois Appellate Courts, for years, have failed to examine the precedents of the Supreme Court of Illinois when examining covenants not to compete.

This may sound unusual, and it its, but pick a random, garden-variety covenants case from the last 30 years and any citation to any Supreme Court precedent will be extremely difficult to find.

Lawyers have known this for quite sometime, that the two appellate branches of our courts seem to treat the other as if it does not exist. Because the Supreme Court has taken so few covenants cases - and almost no true employee cases - it was just assumed that you would cite to the appellate courts and nothing else.

That changed a few years ago when Justice Steigmann of the Fourth District had his ear bent by a well-known Chicago lawyer and began looking into historical precedent more carefully. He eventually unwound the legitimate business interest test in Sunbelt Rentals v. Ehlers, a case that focused the analysis of non-compete agreements on whether the time, territory and scope of the covenant was reasonable. Put another way, the gloss of whether a covenant supported a "legitimate business interest" was stripped away as being inconsistent with years of Supreme Court precedent. Justice Steigmann traced the Court history and commented that the interest test was created by Appellate Courts out of whole cloth.

After Sunbelt Rentals was decided, I noted that Justice Steigmann's holding was a bit incomplete because it failed to address one critical case, House of Vision v. Hiyane. In particular, House of Vision discussed an employer's interest in protecting customer relationships. While it is true the Court did not formulate the legitimate business interest test as the Appellate Courts have since classified it, it clearly recognized that reasonableness was not to be viewed in a "scope, time and territory" vacuum.

Reliable Fire Equipment takes much the same approach. After a careful analysis of the Supreme Court's prior cases - including a critical and extended discussion of House of Vision - the Appellate Court concluded that it was essential for the promisee (i.e., the employer or one receiving the benefit of the covenant) to demonstrate an interest worthy of protection.

Here's where the court's holding becomes more interesting and esoteric. It seems to portend a clear departure from what attorneys have always believed to be a two-part inquiry into what actually constitutes a "legitimate business interest." As readers of this blog know, in Illinois courts have recognized the following as protectable employer interests:

(1) "near-permanent" customer relationships the employee would not have had but for his or her relationship with the employer; and

(2) access to, and an attempt to use, confidential information or trade secrets of the employer.

The court is somewhat vague on whether the legitimate business interest test is so limited, obliquely saying that the test "need not be inflexible if broadly construed." I'm not sure what this means. Later, the court stated that "[o]ther criteria may exist that warrant protection under the law beyond those enumerated in the two traditional prongs of the...test."

More on this when I discuss the impact of Reliable Fire Equipment, but it is fair to say for now that lawyers have some room to argue that other interests worthy of protection - special training, unique services - may support a non-compete agreement.

On Monday, I'll discuss the application of the legitimate business interest test to the facts of Reliable Fire Equipment.

Second District of Illinois Appellate Court Reaffirms (Kind of ) Legitimate Business Interest Test (Reliable Fire Equipment v. Arredondo)

There is officially a true conflict within the Illinois Appellate Courts over how the enforceability of non-competition agreements will be determined.

In Reliable Fire Equipment Co. v. Arredondo, the Second District of the Illinois Appellate Court reaffirmed application of the "legitimate business interest" test, at least in some modified format, for employment restrictive covenants. The court engaged in a lengthy historical analysis of non-compete law, both in Illinois and under the common law. Because of the importance of this opinion, I will write five separate posts on this blog.

Part I: The Majority's Holding
Part II: Application of the Facts
Part III: The Special Concurrence
Part IV: The Dissent
Part V: What's Next


Court: Appellate Court of Illinois, Second District
Opinion Date: 12/3/10
Cite: Reliable Fire Equipment Co. v. Arredondo, 405 Ill. App. 3d 708 (2d Dist. 2010)
Favors: Employee
Law: Illinois

Thursday, December 9, 2010

Trade Secrets Theft By Ex-Valspar Employee Results In 15-Month Prison Sentence

David Yen Lee, of Arlington Heights, Illinois, was sentenced to 15 months in federal prison arising out of his theft of trade secrets from Valspar Corp. in late 2008 and early 2009. An article from today's Daily Herald concerning the sentence can be found here. Lee was a technical director for Valspar when he began downloading to a thumb drive batch paint formulas, which he apparently intended to use for his soon-to-be employer in Japan, Nippon Paint.

The value of the stolen formulas was estimated to be between $7 million and $20 million.

It is certainly true that the overwhelming majority of trade secrets claims are civil matters. However, when the value of the secrets is large and there is an international element to the threatened or actual misuse, the chances of a federal prosecution grow significantly.

Though not expressly part of the statutory framework, it is apparent from the cases prosecuted criminally that prosecutors will look at a defendant's attempt to sell stolen commercial information. Put differently, improper retention of corporate information by an ex-employee - which happens all the time - is not in and of itself likely to draw the ire of an AUSA. Stealing the formula to Coca-Cola, on the other hand, with the intent to auction it off is certain to result in an arrest.

The Economic Espionage Act of 1996 criminalizes theft of trade secrets, and as is typical of similar statutes, the impact must touch and concern interstate or international commerce. The maximum penalty is 10 years in prison and a fine not to exceed $5,000,000.

Tuesday, December 7, 2010

Employee Handbooks Not Relevant to Whether Computer Use Was Unauthorized Under CFAA (Accenture v. Sidhu)

One of the many unanswered questions surrounding the federal Computer Fraud and Abuse Act has to do with employee policies or handbook provisions.

Put simply, lawyers have been mulling over whether an employer can demonstrate that an employee's computer use was "unauthorized" within the meaning of the CFAA if the employee signs off on corporate policies that put him or her on clear notice of what kind of computer use in the workplace is prohibited. Though policies and agreements vary, one of the central tenets of this practice is to include as an unauthorized use the downloading or transferring of corporate information to a personal e-mail account or thumb drive. Policies also can be written such that information printed or stored off of an employer's computer server may not be used for competitive purpose, and that if the employee does so, such use will be considered unauthorized.

These policies are designed to expand an employer's remedies for unfair competition. But do they?

According to one recent federal court, the answer is "no." The case of Accenture, LLP v. Sidhu deals with the impact of policies very similar to those identified above. Because the employee allegedly violated those policies, Accenture filed suit in federal court under the CFAA. (In California, this issue is critical given its long-standing policy against post-employment restraints.)

The court dismissed the claim and noted that "[t]he relevant inquiry is whether the employer allowed the employee use of the computer system, irrespective of whether the employer would have revoked permission if it understood the employees' intent, or knew about the employees' conduct." The court also noted that a carve-out exception would undermine existing precedent and, more fundamentally, graft "corporate policy into the substance of the CFAA."

Policies like those above, however, still are very useful for employers. For one, it can help establish breach of contract, may eliminate an employee's rights to severance pay, and demonstrate knowledge of wrongful conduct.


Court: United States District Court for the Northern District of California
Opinion Date: 11/9/10
Cite: Accenture, LLP v. Sidhu, 2010 U.S. Dist. LEXIS 119380 (N.D. Cal. Nov. 9, 2010)
Favors: Employee
Law: Federal

Friday, December 3, 2010

Liquidated Damages Formula Needs a Sound Rationale (Cottingham & Butler Ins. Svcs., Inc. v. Jacoway)

I've often written on the topic of liquidated damages, because I believe if properly drafted, those clauses provide the most sound, definitive calculation of damages in non-compete/non-solicit disputes. However, the key word is "properly drafted." This is an area of non-compete law riddled with examples of drafting errors.

Simply by way of brief background, "liquidated" damages is legal concept indicating an agreed calculation of damages before a breach happens. The calculation normally provides for a formula to be applied rather than a fixed sum of money, and it must be exclusive of other damage remedies. That is, it has to be a true liquidation - no additional sums can be owed on top of what the contract provides.

A recent case out of Iowa in the insurance brokerage context illustrates exactly how employers ought to be thinking of what should go into a liquidated damages calculation. As is common in many brokerage-agent relationships, the liquidated damages clause provided for payment to the ex-employer of a multiple of gross receipts per misappropriated customer. In this case, the multiple was 2.25 times average client remuneration over the two years preceding the employee's termination of employment.

The employer offered a very sound reason for why the calculation was set forth this way in the contract. An officer of the brokerage testified that the company had a valuation conducted every year, and that the valuation at the time the contract was signed revealed that the fair value of the company was 2.25 times revenue. Hypothetically, then, if the agency were to lose a customer, it would translate into a reduction of the firm's going concern value by a factor of 2.25 times gross receipts attributable to that customer.

Depending on what judge draws a case, he or she may have perceptions of how fair liquidated damages clauses are. Because they can be abused, some judges have negative feelings about applying those clauses and tend to default to the rule that they are disfavored as penalties. But testimony like that offered above enables a court to find that a liquidated damages clause is reasonable and proportionate to the anticipated monetary harm caused by a breach.


Court: Court of Appeals of Iowa
Opinion Date: 11/24/10
Cite: Cottingham & Butler Ins. Svcs., Inc. v. Jacoway, 2010 Iowa App. LEXIS 1393 (Iowa Ct. App. Nov. 24, 2010)
Favors: Employer
Law: Iowa

Wednesday, December 1, 2010

In Non-Compete Cases, Judges Determine Which Facts Are Important (FBK Partners v. Thomas)

Clients never like to hear my standard advice that each non-compete case turns on its own facts, and that no two cases are alike. But it is true. Lawyers can advise their clients as to the general rules of law and analyze a set of facts based on those rules. However, absent a dispute over solely a legal issue (which is rare), it is nearly impossible to look at two non-compete cases the same way.

Reading cases and explaining them here is helpful so that clients (a) know a bite about the law, and (b) see how outcomes similar to theirs may be decided. It is also helpful to see what facts judges cling to. I've said before, and I'll say it again, that judges' perceptions of facts often are colored by one simple, overriding theme: which party is wearing the "white hat"? But even taking that principle as a truism, it is still interesting to see which particular facts judges examine when ruling on a case.

Take the recent case of FBK Partners v. Thomas, a garden-variety non-compete dispute in Kentucky federal court. The employee, Thomas, had discussed leaving FBK to join a start-up, and apparently started moonlighting with the start-up prior to his last day at FBK. Aside from that, the facts of the case weren't all that different than a typical non-compete dispute.

The case isn't particularly notable for announcing a new rule of law or applying a rule in a curious way. However, it is notable for a couple of key facts that seemed to sway the judge's decision. Here are three such facts that caused me to do a double-take:

(1) The court rejected the employee's argument that the employer breached his employment agreement by modifying his duties. No real surprise that the argument is rejected. But the court's justification for it? Read this:

"There is evidence in the record that he knew the non-compete was valid when he began considering working for [the start-up]. Why else would he have provided [his new employer] with a copy of the non-compete?"

I don't understand this point at all. Employees are supposed to provide a copy of their non-compete to a new employer, and doing so should not amount to an admission that the non-compete is valid.

(2) The first point makes even less sense when you consider what the court said about the non-compete's reasonableness. The geographic scope of the non-compete included the entire United States and Mexico. However, Thomas worked for FBK in two states and in Mexico. At a minimum, Thomas had a good argument the geographic scope was unreasonable (which may have been why he showed a copy to his new employer). In enforcing the non-compete, the court did not modify the agreement to encompass a narrower geographic scope. The court's rationale was based in part on Thomas' failure to argue for a modification, but look at what else the court said:

"Furthermore, this Court is not inclined to modify an agreement that the parties entered into with full knowledge and adequate consideration."

This makes no sense. If a contract has no consideration, it isn't valid, so refusing to modify it on the basis that it has consideration is non-sensical. The fact that an employee signed an agreement with "full knowledge" of its terms has never been a proper rationale for applying the modification rule. It doesn't even make sense.

(3) The third fact is the most curious, though it didn't appear to sway the outcome at all. In assessing Thomas' potential breaches of the non-compete, the court said as follows:

"Thomas likely committed breach as early as December of 2008 by traveling to Kentucky to meet with [the new employer] and view [its] site in contravention of the agreement's prohibition on 'seeking employment' with a competitor."

This is the first time I have ever seen a court make such a statement. I don't think it is all that significant, because it would be nearly impossible for an employer to prove any damages associated with such a breach. However, if the employment contract contains a clause like this, interviewing, or seeking employment, with a competitor may allow an employer to terminate a contract for "cause" and avoid paying severance.


Court: United States District Court for the Eastern District of Kentucky
Opinion Date: 11/23/10
Cite: FBK Partners, Inc. v. Thomas, 2010 U.S. Dist. LEXIS 124579 (E.D. Ky. Nov. 23, 2010)
Favors: Employer
Law: Delaware

Tuesday, November 23, 2010

Boring Case On Venue Dispute Leads Us Into the Holidays (Rihani v. Team Express Distributing, Inc.)

I'm not working tomorrow, and I really don't feel like working today. No, it isn't because I can't wait to listen to the new Kanye West album. It has been a very busy few months, and there is no better way to unwind than to transition right into the suffocating crush of holiday expectations.

But enough sarcasm. I still have to contribute to this blog.

Struggling to find an appropriate topic to talk about today, I was reviewing some of my colleagues' recent posts for inspiration. Rob Radcliffe wrote recently about how it is important when assessing a non-compete agreement to get a proper framework for analysis and lay of the land. He points to venue, waiver of jury trials, and arbitration as three factors any lawyer must consider when examining a non-compete agreement. In Rob's view, these provisions "define the playing field."

It got me thinking that I haven't really spent any time looking at contractual provisions over venue. My readers probably are thanking me for that, but I did stumble across an interesting case from Maryland earlier this year that addressed sort of an interesting contract interpretation question.

The clause in Rihani v. Team Express Distributing provided that "venue for all actions arising out of or in any way related to this Agreement shall be irrevocably set in Howard County, Maryland." The plaintiff filed suit in federal court. Problem: there is no federal court in Howard County, Maryland. The defendant moved to dismiss, contending that the only reasonable interpretation of the forum selection clause means that the action had to be filed in state court.

The court agreed and found that "when [the venue clause] prohibits venue outside a geographic boundary, it must be interpreted to prohibit venue in any court that sits outside that geographic boundary." Interestingly, courts are split on this issue. Some courts reason that under near-identical language, a federal court may have jurisdiction because it is the court with venue over a particular county. I'm not sure after reading this case if I became more educated or more confused.

The bottom line is this: attorneys drafting agreements for their employer clients may want to revisit provisions like the one above. Venue clauses are one area where I see a wide range of contract language, and I can see how disputes like this arise. It probably is a better practice to reserve the option of pursuing a case in either federal or state court located within a certain geographic region. In many cases, federal court is clearly a better option.


Court: United States District Court for the District of Maryland
Opinion Date: 4/30/10
Cite: Rihani v. Team Express Distributing, LLC, 711 F. Supp. 2d 557 (D. Md. 2010)
Favors: N/A
Law: Federal

Wednesday, November 17, 2010

Consideration Rule Not Applicable to Independent Contractors (Schmit Towing v. Frovik)

I've written before about the independent consideration rule for "afterthought" covenants - that is, those non-competes that are entered into after the start of employment. States vary on their rules relative to consideration, with some demanding valuable consideration (such as a bonus) beyond mere continuation of employment.

Minnesota is one of those states that seems to be fairly exacting when assessing the adequacy of consideration, noting the inherent lack of bargaining power that employees have when presented with such covenants. I wrote last month about an extension of this independent consideration rule that illustrates how careful employers and their attorneys must be.

In an unpublished opinion, the Court of Appeals of Minnesota held that the independent consideration rule does not apply, however, outside the employment relationship and specifically not to independent contractors. In Schmit Towing v. Frovik, the defendant operated a business towing vehicles and received work from the plaintiff pursuant to a subcontractor agreement. The first agreement contained no non-compete clause. But the second contract, which took effect the same day the first one ended, prohibited the defendant from providing towing services to a competitor.

The Court of Appeals reversed the grant of summary judgment and refused to extend the independent consideration rule outside the employee-employer relationship, holding that to do so would be an extension of the law - a matter reserved only for the Supreme Court and the legislature. The court did not address any other issue surrounding the covenant.


Court: Court of Appeals of Minnesota
Opinion Date: 11/9/10
Cite: Schmit Towing, Inc. v. Frovik, 2010 Minn. App. Unpub. LEXIS 1101 (Minn. Ct. App. Nov. 9, 2010)
Favors: Employer
Law: Minnesota

Monday, November 15, 2010

Defendant's Gains From Breach of Non-Compete Not A Proper Measure of Damages (Phelps v. Wystrach)

The Court of Appeals of Arizona found recently that in the sale of business context, the purchaser could not rely upon the seller's gains from the breach of a non-compete agreement to establish damages.

The factual matrix in Phelps v. Wystrach is a common one. Wystrach sold her veterinary practice to Phelps and in turn gave Phelps a 5-year, 40-mile non-compete. That covenant, apparently, also included a separate covenant that Wystrach would not solicit the practice's former clients. It is not clear if this covenant contained any time or territory limit.

Following the closing of the practice's sale, Wystrach serviced the veterinary business of her former largest client, a breeder and trainer of show horses in Tucson. The owner of the horse farm testified she would not have worked with Phelps even if Wystrach had been unavailable. This is a classic third-party refusal to deal defense, which the court noted was irrelevant to the issue of whether Wystrach breached the non-compete agreement.

The issue of damages was a different matter, however.

The court found that evidence of Wystrach monetary gains from working with the horse farm was not a proper basis upon which to award Phelps damages arising out of the non-compete agreement. The holding is similar to TruGreen Cos., LLC v. Mower Bros, Inc., which I discussed a few years back that held under Utah law unjust enrichment is not a basis for awarding damages for a non-compete claim.

The concept of unjust enrichment damages in a sale of business context seems materially different than in a normal employee case. In a business sale, a purchaser is specifically paying the seller to avoid soliciting or working with customers of her former firm. Any breach would logically compromise the value of what was paid for the business. Employment cases, obviously, lack this key damages metric.

This highlights the need for sellers to include liquidated damages clauses in the purchase agreement. A predetermined damage formula can avoid the problems of proving lost profits and obtaining only chimerical relief at trial, like the buyer did in Phelps.


Court: Court of Appeals of Arizona, Division Two
Opinion Date: 10/29/10
Cite: J.A. Phelps v. Wystrach, 2010 Ariz. App. LEXIS 201 (Ariz. Ct. App. Oct. 29, 2010)
Favors: N/A
Law: Arizona

Thursday, November 11, 2010

Federal Court In Maine Holds Involuntary Termination Can Be Considered In Enforcement of Non-Compete (OfficeMax v. County Qwick Print)

Having a federal court judge in Maine draft an opinion which discusses and analyzes, in some detail, a law review article is not all that common.

And it's certainly not very common when the author of that law review article happens to be, um, me, and when I have no involvement representing a party in the case. In a way, it's kind of like watching your own funeral.

But on with it.

I wrote an article for the DePaul Business & Commercial Law Journal about 8 years ago that canvassed the law on the enforceability of non-competes in involuntary discharge cases. The law was, and remains, a bit scattered, with courts coming down in four general categories:

(1) The non-compete is per se invalid;
(2) There is a presumption against enforceability;
(3) The circumstances of termination are a factor to consider in an overal balancing analysis; and
(4) The termination is not even a factor a court can consider.

A federal court in Maine, in OfficeMax Inc v. County Qwick Print, acknowledged no decision in that state had considered the impact of involuntary termination on a non-compete. After summarizing my law review article, it determined that "the safer approach is to consider the circumstances of [the defendant]'s termination as a factor in balancing the relative equities between the parties." In so deciding, the court exercised some restraint by not attempting to create a new rule of substantive law for the state of Maine. Put differently, the court examined this factor under its procedural injunction rules rather than as a question of state substantive law.

This is an understandably cautious approach, but consistent with what I suggested courts adopt as far as considering the impact of termination. In my article, I recommended that the most sound analysis was option (3), the balancing inquiry. Stated another way, courts should scrutinize under the rubric of "reasonableness" how an employee's tenure ended. This would not bind courts to bright-line rules and would allow for some needed flexibility, rather than having the case turn into a collateral after-the-fact job performance inquiry, something totally ill-suited to emergency, expedited proceedings.

In this regard, I still believe that how employment ended is highly relevant to the question of reasonableness of a post-employment restraint. It is at least as important of whether third-parties or the public will encounter some hardship through enforcement.

Anecdotally, I know judges are sympathetic to employees who have been terminated for reasons other than cause and are more troubled by sudden, abrupt resignations that leave an employer in the lurch with a key account or at an important juncture of a project. Though courts may not voice every single factor that comes into play in their decision, I think it's reasonable to assume that a terminated employee stands a better chance of prevailing in a close case.


Court: United States District Court for the District of Maine
Opinion Date: 11/8/10
Cite: OfficeMax Inc. v. County Qwick Print, Inc., 2010 U.S. Dist. LEXIS 119070 (D. Me. Nov. 8, 2010)
Favors: Employer
Law: Maine

Monday, November 8, 2010

The Continuing Futility of the "They Forced Me to Sign" Defense (Ayco Co. v. Feldman)

I cannot tell you how many times a client calls me and feels as though he or she has a strong defense to a non-compete claim because of duress - "the company forced me to sign it."

This defense of duress or coercion is by and large unavailable. Here are the three biggest rationales (or some variant) that I hear for a client who thinks duress is the ticket to avoiding the impact of a non-compete clause:

(1) I was a long-time employee, and all of a sudden my new manager made me sign a non-compete agreement. It blew me away!

(2) If I didn't sign it, I was told I would be fired.

(3) I am the sole breadwinner in my house and needed to keep my job.

Let me address each factual scenario.

First, this is an issue of consideration - not duress. In many states, the concept of "continued employment" is enough to make a non-compete enforceable. In some states, though, it is not. In those states that frown upon so-called afterthought covenants, your argument is lack of consideration - not duress.

Second, the threat of lawful termination cannot possibly constitute duress. Generally, an employer can fire an at-will employee for any reason as long as it is not illegal (like termination on the basis of race or gender). Refusing to sign a non-compete agreement is perfectly acceptable. But, with very rare exceptions, so is an employer's decision to terminate on this basis.

Third, this is an issue of hardship. In many states (like Iowa), courts consider whether the covenant places an "undue hardship" on an employee in determining whether the restriction is valid. (Note: Some states forbid this factor to be taken into account. Yes, I'm looking at you, Florida, Section 542.335(1)(g)(1) of your annotated statutes.) An employee often times can make a convincing argument that a covenant will work an undue hardship on his career, particularly in cases where the extent of that covenant goes beyond what is necessary to protect an employer's interests.

Many employment agreements provide for contractual acknowledgments that the employee read the contract and had an opportunity to consult with counsel. This certainly is not required, but it is good practice.


Court: United States District Court for the Northern District of New York
Opinion Date: 10/22/10
Cite: The Ayco Co., L.P. v. Feldman, 2010 U.S. Dist. LEXIS 112872 (N.D.N.Y. Oct. 22, 2010)
Favors: Employer
Law: New York

Thursday, November 4, 2010

Court Rejects "Inevitable Disclosure" Claim Arising Out of Failed Transaction (Texarkana Beh. Assoc. v. Universal Health)

Courts still struggle to uphold the "inevitable disclosure" doctrine.

There's no easy way to say it. The idea of enjoining a party based on the theory that disclosure (really, use) of trade secrets is inevitable is a difficult one to grasp. Courts are called upon to make inferences and assumptions that are tough to make when the end result is a restraint on trade.

Inevitable disclosure is a theory of misappropriation. It is not based on actual use or even an identifiable threat to use a particular secret. Rather, it revolves around the idea that a party, even one who tries in good faith, cannot help but use certain secrets for an unfair competitive advantage.

A dispute arising out of a failed acquisition illustrates the struggle that courts have. The case is notable in that it does not follow the usual factual matrix of an employee leaving to join a competitor. Rather, it concerned a dispute between two nationwide healthcare management companies that operate behavioral health centers following a failed acquisition.

The two companies, Texarkana Behavioral and Universal Health Services, were direct competitors, and UHS tried to buy Texarkana in 2004. Negotiations broke down that year. Two years later, UHS bought property in Fayetteville to build a health care facility. Texarkana appropached UHS and inquired whether it was interested in buying Texarkana's facility in Fayetteville. The parties entered into a confidentiality agreement, shared business information and discussed an acquisition, but negotiations again broke down.

UHS then moved forward with constructing its own facility in Fayetteville. Texarkana sued, claiming trade secrets theft under the inevitable disclosure doctrine. The court noted that Texarkana likely had not identified its trade secrets well enough, but assumed for summary judgment purposes that it did. The court held, however, that Texarkana established nothing to demonstrate that it was inevitable UHS would disclose anything secret to Texarkana.

Three facts were central to the court's holding. First, one of Texarkana's key executives (a former UHS employee) stated that he felt as though he could perform his duties at TBA without using anything confidential to UHS. Second, UHS never manifested any intent to use anything proprietary to Texarkana. Third, and most importantly (in my mind), the confidentiality agreements contained no provisions that restricted what UHS could construct or operate around Fayetteville.

The inevitable disclosure doctrine, as applied in the commercial context, can be particularly difficult to justify. In an arms' length transaction such as the one entered into between Texarkana and UHS, the parties could have bargained for a limited non-compete as a condition to exchanging sensitive information. Clearly, Texarkana had to know in 2007 that UHS would have constructed a health facility if the deal did not go through. Texarkana did not obtain any sort of activity covenant from UHS, however.

Courts rightly should be concerned about applying the inevitable disclosure doctrine when sophisticated entities (particularly those with a history of failed negotiations) enter into a contract for a potential acquisition, are aware of the consequences of not closing the deal, and don't include some type of a non-compete. Allowing a party like Texarkana to use the inevitable disclosure doctrine in this circumstance would have vitiated those negotiations and allowed it to create non-compete provision when none was ever anticipated. Both parties had to know the potential risks if the deal did not close.


Court: United States District Court for the Western District of Arkansas
Opinion Date: 10/26/10
Cite: Texarkana Behavioral Assocs., L.C. v. Universal Health Svcs., Inc., 2010 U.S. Dist. LEXIS 114112 (W.D. Ark. Oct. 26, 2010)
Favors: N/A
Law: Arkansas

Wednesday, November 3, 2010

Georgia Voters Approve Constitutional Amendment

Yesterday, Georgia voters overwhelmingly approved a constitutional amendment that has the practical impact of enabling courts to more readily enforce non-competition agreements. The voters approved the measure with 67% in favor of the amendment.

Previously, the Georgia legislature passed a law codifying the new statutory requirements for non-compete agreements. Because of the way Georgia's constitution was written, however, an amendment was needed to enable the law to take effect. The new law will be effective as soon as the Secretary of State certifies the election results.

The law does not contain any retroactivity provision, so existing contracts will be analyzed under the law as it exists prior to the amendment. This has happened several times before following legislative action, as courts in Florida and Michigan, for instance, had to assess covenants under different standards depending on when the contract at issue was signed.

More on the substance of the Georgia law to follow later in the week (or next), but there are a few notable changes, the most significant of which is that courts will be allowed to blue-pencil employment non-compete contracts. One can certainly expect Georgia employment law attorneys to be busy rewriting non-compete agreements for their clients.

Thursday, October 28, 2010

Sunbelt Rentals Redux: The Same Argument Was Just Made In Michigan (Teachout Security v. Thomas)

Pardon my continued discussion of Sunbelt Rentals, but it's kind of important.

As readers know, the Appellate Courts in Illinois are in flux as to what an employer must prove to enforce a non-compete. To recap, the law in four appellate districts requires an employer to prove:

(a) that the covenant is reasonable in time, territory and scope; and
(b) that the covenant supports a recognized legitimate business information of either: (i) near-permanent customer relationships the employee would not have had access to but for his employment; or (ii) use of confidential business information.

The other appellate district dispenses with requirement (b). My point all along is that it is almost impossible to assess the notion of reasonableness without asking the employer to articulate what it is trying to protect. I think, as do many lawyers, that the legitimate business interest test is dated and incomplete. And I am fine with reformulating the test entirely, but at some point, an employer has to show what the protectable interest is for anyone to assess whether it's reasonable.

Illinois, it turns out, is not the only state to run into this precise issue. Michigan has the same dispute, though it doesn't appear to have been discussed much.

The case of Teachout Security Svcs., Inc. v. Thomas notes that Michigan courts have struggled to define the role of a legitimate business interest in the non-compete analysis. In that case, a security firm sought to enforce a non-compete agreement against its ex-employees. The employees prevailed on summary judgment, as the trial court found that the employer was trying to limit its employees' general skill and knowledge, not the use of anything proprietary.

The employer argued the trial court did not have to do anything more than analyze whether the covenants were reasonable. In support, the employer cited another Michigan court that bought into this argument - effectively the identical argument that the court in Sunbelt Rentals accepted. The Court of Appeals of Michigan, though, disagreed and held the trial court was correct in considering whether the employer had a "reasonable competitive business interest justifying the non-compete agreement."

The statutory framework in Michigan had to influence the court's decision and renders a Sunbelt Rentals-like analysis hard to fathom. For instance, Michigan's statute specifically states that "[a]n employer may obtain from an employee an agreement or covenant which protects an employer's reasonable competitive business interests..." Accordingly, the Legislature has conditioned enforcement on an affirmative showing of what the employer is trying to protect through a non-compete.


Court: Court of Appeals of Michigan
Opinion Date: 10/19/10
Cite: Teachout Security Services, Inc. v. Thomas, 2010 Mich. App. LEXIS 2011 (Mich. Ct. App. Oct. 19, 2010)
Favors: Employee
Law: Michigan

Wednesday, October 27, 2010

Seventh Circuit Reaffirms Complete Salary Forfeiture Principle (Gross v. Town of Cicero)

The most powerful remedy for a breach of fiduciary duty claim is that of salary forfeiture. The Seventh Circuit reaffirmed the availability of this remedy in a long-running municipal dispute involving the Town of Cicero. While the facts of that case don't shed any light at all on salary forfeiture in the context of unfair competition cases, the Court cited a number of past precedents.

In particular, the Court stated that "[t]he salary subject to forfeiture is not limited based on the ratio of injurious to legitimate work performed, since an agent who breaches his fiduciary duty has no right to any compensation while acting adverse to the principal's interests." Put differently, there really is no proportionality defense available though my experience is that courts (and juries) effectively consider how serious the fiduciary's transgressions actually were.

The key to salary forfeiture is determining when the fiduciary breach began. For any plaintiff pursuing this remedy against a disloyal employee, it is critical to tailor discovery to find out when precisely an agent started acting in a manner directly adverse to his or her principal.

Often times, this is not easy because of the preliminary stages doctrine. Agents can "prepare to compete", and there is no real bright-line between preliminary competitive activities that are acceptable and actual competition that is not. Each case, of course, turns on its own facts in this regard.


Court: United States Court of Appeals for the Seventh Circuit
Opinion Date: 8/27/10
Cite: Gross v. Town of Cicero, 2010 U.S. App. LEXIS 17911 (7th Cir. Aug. 27, 2010)
Favors: Employer
Law: Illinois

Saturday, October 23, 2010

"Head-Start" Rule Applies to Damages, As Well As Injunctions (Berardi's Fresh Roast v. PMD Enterprises)

The concept of a "head-start" injunction is well-established in unfair competition law. The idea of it is rather simple. In a case involving trade secrets misappropriation, a defendant may be enjoined - or prevented from using the secret - if the plaintiff can show the defendant's efforts to bring a product or service to market were substantially shortened as a result of the misappropriation.

We often see this in cases where the secret is some sort of tool used to develop a product. Take, for instance, an engineering drawing for a complex piece of equipment. A defendant who has misappropriated a proprietary drawing may try to claim he could easily reverse-engineer the drawing from the product itself. However, this may take a long time, depending of course on the complexity of the product. By short-circuiting the process and stealing a drawing, a defendant can reduce his time to market a competing product.

A plaintiff is justified in seeking relief for this head-start the defendant unfairly obtained through misappropriation of the secret product. Courts often will require a defendant to refrain from exploiting the benefits of a secret for a period commensurate with the unfair head-start.

The notion of head-start relief, however, is not limited to equitable relief. As a recent Ohio appellate decision noted, "a trade secret defendant's damages may be limited to the time the defendant saved in getting a product to market by virtue of its misappropriation." The amount of damages will be a factual question. A judge or jury must determine the actual lead-time or head-start the defendant unfairly obtained, a question often requiring detailed fact and expert testimony.

It should be noted, too, that the head-start concept applies outside the trade secrets arena. It is a very common remedy in cases of insider duty of loyalty claims. If a key employee competes unfairly before quitting and seeks to misappropriate a corporate opportunity, courts are more than willing to force the executive to sit on the sidelines for a time equal to his period of disloyalty. In this context, calculating the head-start may be much easier. Rather than figuring out how long the reverse-engineering process might be (as in a trade secrets case), a plaintiff likely need only show when a key emloyee's fiduciary breach began.


Court: Court of Appeals of Ohio, Eighth Appellate District
Opinion Date: 10/21/10
Cite: Berard's Fresh Roast, Inc. v. PMD Enterprises, Inc., 2010 Ohio App. LEXIS 4314 (Ohio Ct. App. Oct. 21, 2010)
Favors: Employer
Law: Ohio

Wednesday, October 20, 2010

Debts Incurred for Violating Non-Competition Provision Usually Are Dischargeable (In re: O'Connor)

In most competition cases, a defendant's obligation to satisfy a monetary judgment entered against him or her may be impacted by the decision to file for bankruptcy.

As a general matter, contract debts are dischargeable. So, if an employee is found liable for breach of a non-compete contract and found to owe lost profits or liquidated damages to the ex-employer, he may be able to avail himself of bankruptcy law and avoid the obligation. It is likely in such a factual matrix that the debt would be discharged.

There are a few notable exceptions, however. If a damages judgment is rendered on a breach of fiduciary duty claim (which often is added to a non-compete case, depending on the pre-termination conduct), that would not be dischargeable as long as the trust relationship existed prior to the act creating the debt. Note that in some jurisdictions (e.g., New Hampshire) ordinary employees do not automatically owe a fiduciary duty to their employers. The test is usually whether the employee was in a supervisory or managerial capacity, but these are rare exceptions.

Another provision of the bankruptcy code provides for non-dischargeability in the event of a willful or malicious injury. No matter how much an employee intends to violate a non-compete, however, the question of malice in a contract claim is meaningless. There is nothing inherently wrong with breaching a contract, as long as the non-breaching party is made whole.

There is one interesting other exception to the non-dischargeability rule: a judgment of damages following a finding of contempt will not be dischargeable. Say, for instance, that a defendant breaches a non-compete agreement and is enjoined by order of the court (or, even by agreement) from further violating his or her contract. If that defendant subsequently competes in a way that violates the court order, any damages arising from the contempt proceeding are non-dischargeable under Section 523(a)(6). This rule applies to both temporary and permanent injunctions.


Court: United States Bankruptcy Court for the Western District of Louisiana
Opinion Date: 9/30/10
Cite: In re O'Connor, 2010 Bankr. LEXIS 3475 (W.D. La. Sept. 30, 2010)
Favors: Employee
Law: Federal

Wednesday, October 13, 2010

An Illinois Court Finally Address Sunbelt Rentals (Steam Sales v. Summers)

It took a while...but we finally have a follow-up to the important Sunbelt Rentals case that the Appellate Court of Illinois issued in 2009. As readers may recall, that decision by the Fourth District held that employers need not demonstrate that a restrictive covenant be supported by a "legitimate business interest". Rather, the employer only needed to establish the reasonableness of the covenant in terms of time, territory and scope.

In the intervening months, commentators - including this one - had a lot to say about Sunbelt Rentals, but few courts even addressed the decision. The few that did were federal district court opinions that dealt with Sunbelt Rentals in an oblique way - acknowledging its existence, but treating it as an interesting anomaly.

My take on Sunbelt Rentals was, I think, fairly reasonable. I indicated that I was not sure how a court could assess the "reasonableness" of a non-compete restriction without identifying what it is the employer sought to protect - that is, the so-called "legitimate business interest." Here is a fragment of what I wrote when Sunbelt Rentals was decided:

"It's hard to see, though, how a court can determine whether a covenant is "no greater than is necessary for its protection" without analyzing what business interest it seeks to protect in the first place. The legitimate business interest test fills that vacuum and allows a court to fashion an appropriate restraint, or strike one entirely if the employer can't articulate the need for a restriction."

In that sense, I thought Sunbelt Rentals was interesting and somewhat well-reasoned - I still do - but perhaps a bit narrow and incomplete. I was looking for some acknowledgment that a court can't entirely divorce the reason for the covenant from its terms.

The Second District case of Steam Sales Corp. v. Summers discusses Sunbelt Rentals but is careful not to adopt or reject the rationale of that case. It leaves us wanting a bit more clarification, but the gist of what the Second District held is right in line with the issue I noted after Sunbelt Rentals came out.

Steam Sales acknowledges a tension that exists in that if an employer does not satisfy Illinois' wounded "legitimate business interest" test by showing that the covenant protects either near-permanent customer relationships or confidential business information, then the employer cannot enforce a perfectly drafted covenant. To try and resolve the tension, Steam Sales states that the "reasonableness of time and territory should still be evaluated in relation to a protectable interest." Note the court did not use the term "legitimate business interest", but rather a broader term - "protectable interest." The court does not adopt or reject Sunbelt Rentals, but it tries to build upon its strengths and correct its limitations.

The court does not come out and say what I would like it to - that there are other protectable interests out there (think goodwill and special training for starters) which can support a covenant. But it comes quite close and certainly hints at it. By suggesting that reasonableness must be examined in light of what it is the employer is trying to protect, the court seems open to a more modern, malleable definition of "protectable interest" that can fit the facts of a particular covenant case.

In my opinion, courts here are ready to dispatch the legitimate business interest test that was created out of whole cloth by the appellate courts and just adopted wholesale throughout the state for decades. I think it is almost inevitable that courts build upon Steam Sales and hold that reasonableness must be examined in light of an asserted protectable interest. That there is no particular limitation on what that means seems inevitable.


Court: Appellate Court of Illinois, Second District
Opinion Date: 10/4/10
Cite: Steam Sales Corp. v. Summers, 405 Ill. App. 3d 442 (1st Dist. 2010)
Favors: Employer
Law: Illinois

Monday, October 11, 2010

Post-Employment Compensation Can Provide Consideration for Afterthought Covenant (Thiesing v. Denstply Int'l)

Minnesota is one of a number of states that prohibit an employer from binding an employee to an afterthought non-compete agreement - one signed after the beginning of employment - absent independent consideration. The most common types of consideration are special training, the opportunity to participate in incentive programs, payment of one-time bonuses, or a promotion.

But another, frequently overlooked type of consideration that is not as immediately recognizable is "post-employment compensation."

How does this work, and how can it provide the requisite consideration to support a covenant?

The employee's agreement specifically provides that if an employee is unable to obtain work reasonably commensurate with his or her education and experience as a result of a covenant, then the employer must make the employee whole in terms of compensation for a the shorter of the period of unemployment or the expiration date of the covenant.

The agreement also should contain a make-whole provision so that if an employee finds a lower-paying job, the employer must pay the difference between the new wage and that the employee earned at the time of termination.

Not every post-employment compensation provision will satisfy contract formation requirements. For instance, some provisions place a subjective standard on the employee to diligently or conscientiously look for work and document efforts to the ex-employer. As should be apparent, there is wide latitude for the employer to deny compensation under such clauses. Courts in Minnesota have held that when an employer chooses to enforce a non-compete, a conditional promise to pay - that is, upon the employer's finding that the employee diligently searched for work - is illusory. An unconditional promise, however, will provide consideration.

In contract provisions calling for post-employment compensation, an employee must examine whether the employer retains discretion to pay or to impose conditions on pay. This ordinarily will determine whether the consideration element can be met.


Court: United States District Court for the Eastern District of Wisconsin
Opinion Date: 9/28/10
Cite: Thiesing v. Dentsply Int'l, Inc., 2010 U.S. Dist. LEXIS 102373 (E.D. Wis. Sept. 28, 2010)
Favors: Employer
Law: Minnesota

Saturday, October 9, 2010

Franchise Non-Compete Agreement Enforceable By Sylvan Learning Center (Sylvan Learning v. Gulf Coast Ed.)

It has been a while since I've written on non-compete covenants in the context of franchise agreements. The overriding protectable interest that franchisors assert to justify such covenants is "goodwill" - which is the notion that a business's value as a whole is greater than the sum of its parts.

Other common protectable interests - confidential information, long-term clients - may not directly apply to franchise operations. What a franchisor seeks to protect against is the ability of a franchisee to learn its system and simply replicate a business model under a different name.

I've been an advocate of employing non-solicitation clauses, rather than non-compete agreements, for sales employees. The opposite is true with many retail franchise operators. Non-solicitation covenants probably don't protect the franchisor enough. Given the nature of consumer-driven retail businesses, location, advertising and a unified system of operations often bring in business more than direct solicitation of customers. In this sense, it is very common to see non-compete agreements against terminated franchisees enforced regularly.

A good example of this concerned a recent dispute over the operation of a Sylvan Learning Center. Joe Jezewski's franchise and license agreement with Sylvan Learning was terminated, and he immediately began operating a competing educational center in the same store location with the same phone number and same method of conducting business. A district court in Alabama, applying Maryland law, had little trouble issuing a preliminary injunction against Jezewski and enforcing a 20-mile non-compete agreement.

Of interest was the way Sylvan presented the non-compete. It was very careful to point out what Jezewski could do and it emphasized how limited in scope the restriction actually was. Because courts always will consider the potential hardship to one bound by a covenant, plaintiffs - whether employers or franchisors - should always make as part of their case an affirmative showing that they are not seeking to restrict too much.

Also, the court was careful to note that failing to enforce a non-compete against Jezewski would undermine the franchise system, which is built on permitting franchisees to exploit someone else's investment in branding, advertising, and development of goodwill. In this respect, it is much more difficult for franchisees to claim that restrictions are overbroad on hypertechnical grounds or to assert that the covenants do not protect a legitimate interest.


Court: United States District Court for the Middle District of Alabama
Opinion Date: 10/6/10
Cite: Sylvan Learning, Inc. v. Gulf Coast Education, Inc., 2010 U.S. Dist. LEXIS 107160 (M.D. Ala. Oct. 6, 2010)
Favors: Franchisor
Law: Maryland

Monday, October 4, 2010

Fee Agreements and Time Sheets Discoverable In Non-Compete Dispute (OfficeMax Inc. v. Sousa)

Key employees who leave one firm to join a rival often have their attorneys' fees paid for by the new employer. Agreements to indemnify an employee for fees are sometimes contained in a negotiated new employment contract as a material inducement for the employee to defect and join a competitor. Indeed, many employees on the fence may not leave without some security that litigation will be financed by the new employer, which - to be sure - is in a better position to provide for and fund a legal defense.

Indemnification arrangements, however, are fully discoverable in litigation. A plaintiff's first discovery request almost always will include a demand for any employment agreements the defendant has signed in connection with his competing job. Also discoverable are facts related to fees paid by the new employer for a new employee. In a case where the employee does not have a written indemnification agreement, a plaintiff may seek and obtain discovery from the new employer about whether it has paid for the employee's legal fees.

This discovery even may extend not just to the fact of payment, but also the amount and the description of legal services performed. As a recent federal district court case held, records revealing "the general nature of legal work performed are not within the attorney-client privilege" because they do not contain confidential communications.

That is not to say all fee sheets are fully discoverable. For attorneys whose time entries are more detailed and may suggest the type of communication between the attorney and the client, a court certainly has the discretion and ability to cloak time entries with a privilege. But it is a mistake for counsel to assume that all fee sheets are privileged. They're not, even if the time entries generally describe the nature of the work performed and suggest what an attorney and a client may be discussing.

Aside from privilege, there is another point attorneys and clients also ought to be aware of regarding indemnity rights. Courts rely on indemnification agreements to support the conclusion that an injunction may issue. In particular, courts reason that if an employee is indemnified by an employer for legal costs, he or she won't suffer tremendous hardship from a temporary restraint on competitive conduct. This finding is more prevalent in cases where the indemnification agreement states that the employee will be paid his or her full salary even if a court-ordered injunction materially limits the prospective job responsibilities that the employee was hired to perform. Though indemnification agreements provide some insurance for competing employees, they also can actually help a plaintiff in seeking equitable relief.


Court: United States District Court for the District of Maine
Opinion Date: 9/29/10
Cite: OfficeMax Inc. v. Sousa, 2010 U.S. Dist. LEXIS 103736 (D. Me. Sept. 29, 2010)
Favors: Employer
Law: Federal Rules of Civil Procedure

Monday, September 27, 2010

Lost Profits Always Difficult to Prove In Trade Secrets Case (SKF USA v. Bjerkness)

You have established that your ex-employees copied thousands of files on storage devices before quitting.

You have proven they serviced your key customers after quitting.

You have even convinced a judge that those employees used the very purloined documents to service those same diverted accounts.

Slam dunk case on damages, right?

Not so. Damages often times are the tail wagging the dog in trade secrets cases. Even on those occasions when they are not, parties get bogged down in issues of proof.

In SKF USA v. Bjerkness, a federal district court again held that a plaintiff in a strong liability case could not prove lost profits relating to the defendants' use of trade secrets. The rationale has to do with proximate cause: the customers did not leave the plaintiff because the defendants used stolen documents. Rather, they left because of a change in the plaintiff's ownership and their relationship with the defendants. Absent a non-compete, there is "nothing illegal about that", the court said. Proof of lost profits therefore failed.

Of course, this does not mean that a defendant can simply walk without financial liability. It still must account for its unjust enrichment in a trade secrets case - the profits related to those customers taken and for whom secret information was used. Frequently, in start-up businesses, though, this is an exercise in futility. New businesses frequently are unprofitable, and a plaintiff simply cannot apply its gross margin to the defendant's start-up.

This was the defendant's problem in Bjerkness. Rather than counter evidence of an applicable margin rate, the defendant simply contended it was not liable at all. Accordingly, the court used the plaintiff's margin as a substitute and based unjust enrichment by applying that percentage the defendant's gross sales. The court did not have to accept this as an evidentiary basis for damages.

All this makes injunctive relief more critical in trade secrets cases. Damages are notoriously difficult to prove, at least in "soft secrets" cases. What I mean by that is the sort of operational business information that may contain or reference admittedly confidential information but is not the crown jewel of the company. How do you prove damages from someone's disclosure of an outdated financial statement.

Damages cases are much different when a "hard secret" is at issue. On that score, think of a key engineering drawing, proprietary source code or a product formula as a revenue-enhancing secret for which damages may be eminently more provable. If, for instance, a proprietary drawing is taken and used to engineer a competing product, all profits from sales of that unfairly developed product provide a sound evidentiary basis for damages.


Court: United States District Court for the Northern District of Illinois
Opinion Date: 8/9/10
Cite: SKF USA Inc. v. Bjerkness, 2010 U.S. Dist. LEXIS 80776 (N.D. Ill. Aug. 9, 2010)
Favors: Employee
Law: Illinois