Saturday, July 28, 2012

Fourth Circuit Adopts Reasoning From U.S. v. Nosal in Limiting CFAA Application

In my opinion, the civil remedy provisions of the CFAA - outside those applicable to hackers - are totally useless.

The Act is nothing more than a jurisdictional hook to get into federal court, where a host of state law claims are the real focus of a case. In a case where there is diversity of citizenship, the Act is uber-useless.

The Fourth Circuit in WEC Carolina Energy Solutions LLC v. Miller, 2012 U.S. App. LEXIS 15441 (4th Cir. July 26, 2012), affirmed the dismissal of a CFAA complaint arising out of an allegation that an ex-employee improperly downloaded confidential business information and used that information to make a presentation on behalf of a competitor following termination of employment.

The court agreed with the Ninth Circuit's narrow view of "without authorization" in United States v. Nosal and disagreed with the Seventh Circuit's expansive application of the CFAA under common-law agency principles in Int'l Airport Centers, LLC v. Citrin. Readers may recall that Nosal was written by Judge Kozinski and Citrin, the "cessation-of-agency" theory, was the work of Judge Posner.

The Fourth Circuit did not extend liability to so-called use-policy violations. In other words, if an employee obtains or access information from a protected computer to which he or she is not entitled to retrieve in the first place, then the CFAA would provide a remedy under the plain text of the statute. Conversely, misusing information to which the employee had a right to access falls outside the Act's scope.

Because the CFAA is both a criminal and civil statute, the Fourth Circuit relied on the rule of lenity to chose an interpretation of the statute that would not result in criminal sanctions. The court indicated its holding would "disappoint employers hoping for a means to rein in rogue employees," but it also noted that other legal remedies exist. Indeed, these types of disputes are fundamentally the province of state contract and tort law. Just as much of trade secret law is in fact duplicative of common law remedies, so too is the CFAA. WEC Carolina - the plaintiff - has a state court complaint pending against the same defendants in the federal case, a case that has nine other claims for relief.

Thursday, July 19, 2012

The Bad Edition: On Bad Faith and Bad Laws (Courtesy of Judge Posner)

Describing the parameters of bad faith should be no more complicated than Justice Potter's famous test for identifying pornography: you know it when you see it.

Trade secrets laws generally allow for a prevailing defendant to recover its attorneys' fees if a claim of misappropriation is made in bad faith. The uniform act contains no definition of what that means, but really it's no more complicated than the "exceptionality" standard used to determine fee-shifting for patent and trademark infringement. If a plaintiff uses the litigation process to heap litigation costs on a competitor (and not to win), then this is pure abuse of process - the normative equivalent of bad faith.

The trade secrets provision hasn't been the subject of much litigation outside California, and the interpretations of bad faith generally hinge on some showing of objective speciousness in the claim. Many courts also look for some indicators of the plaintiff's subjective intent to harass or abuse the litigation process.

A recent California case demonstrates that the concept of bad faith has to be flexible and necessarily looks at a variety of circumstances outside the initial pleadings. In SASCO v. Rosendin Electric, 2012 Cal. App. LEXIS 797 (Cal. Ct. App. 4th Dist. 2012), the Court of Appeal affirmed an award of nearly $500,000 in attorneys' fees for the defendants who prevailed on a trade secrets claim arising out of "off-the-shelf"software. (They prevailed, actually, because SASCO voluntarily got rid of the case before entry of summary judgment.)

The court discussed the objective/subjective test, noting fees are proper if a plaintiff either brings or maintains a claim in bad faith. The court rejected the defense argument that it was appropriate to look to California's Rule 11 equivalent in determining the speciousness of the claim. Rejecting this argument, the court stated: " simply makes no sense as a matter of statutory interpretation to insert a general pleading abuse statute applicable to attorneys or others signing pleadings and motions...into a ...section limited to the recovery of attorney fees and costs in trade secret misappropriation claims."

This malleable use of bad faith dovetails nicely with the abuse of process, or exceptionality, test used by some courts - notably the Seventh Circuit - in other intellectual property litigation. Both the Patent Act (Section 285) and the Lanham Act (Section 1117) allow for fees in "exceptional" cases. Equating exceptional cases with those containing "abuse of process" elements is pragmatic and recognizes the realities of competitive litigation, much of which is driven for retributive - not remedial - purposes. So exceptionality equals "abuse of process" equals "bad faith."

Speaking of might have heard Apple and Motorola's dust-up over smart phone technology ended with a whimper, not a bang. Judge Posner presided over that trial, sitting as a district court judge, and ruled that neither damages nor injunctive relief was appropriate. The ruling is certain to be appealed. What's interesting, though, is Judge Posner's general views on the problems with our patent laws and how they can be fixed. His op-ed article from The Atlantic describes why there are too many patents and how the current system is broken.

Firms generally make decisions whether to patent or keep valuable information secret. Those are mutually exclusive ideas. If Posner's views on reform are implemented, it is likely that many firms would be encouraged to exploit ideas or inventions through secrecy rather than a government-sanctioned monopoly. I don't necessarily think that's a good thing, since trade secrets are not objectively verifiable and are often overused to cannibalize general knowledge. But Posner's clearly right that the patent system is a wreck.

So we come full circle on fees. The best way to deter this overuse of the trade secret branch of intellectual property is to give some real teeth and meaning to fee-shifting. Given the sheer expense of trade secrets litigation (the Rosendin Electric case being an example), the deterrent effect of pursuing a weak claim would be quite high if fee-shifting were more than a pipe dream. Courts in California, where much of our technology innovation occurs, have taken steps in interpreting its trade secrets laws to create the proper incentives and to put trade secrets plaintiffs on notice that unsupported claims will result in a significant sanction.

Wednesday, July 4, 2012

Applying the Logic of Empro to Non-Compete Cases

One of my favorite opinions is Judge Easterbrook's decision in Empro Mfg. Co., Inc. v. Ball-Co Mfg., Inc., 870 F.2d 423 (7th Cir. 1989). It's classic Easterbrook: short, clear, rooted in public policy, and beautifully persuasive in the way it resolves an issue that divided courts. Judge Easterbrook himself has said that he is surprised Empro still has enduring impact more than 20 years after he wrote it.

The case dealt with pre-closing liability, addressing what legal obligations parties to a business transaction have to each other when they reach a preliminary agreement (that is, a letter of intent) with details to be ironed out later. Judge Easterbrook applied an objective theory of contract law, finding that the parties' "intent" is grounded in the contract terms they use, not some ephemeral, or subjective, "meeting of the minds." Written terms are the best expressions of intent; the parties tend to forget, or selectively interpret, what they said leading up to the contract signing.

Okay, so on its face, the case has nothing to do with non-competes. Or does it?

Non-compete agreements are one of main areas of litigation that deal with common-law (not UCC) contract rules. General principles of contract construction often are front-and-center in non-compete litigation. And, from my experience, non-compete cases bear a tang of similarity to the Empro problem. Let me explain three situations in which the parties' subjective expectations - expectations which often are not contained in a contract term or condition and which arise pre-closing - can become an issue in litigation.

Preliminarily, it's important to keep in mind that non-competes usually are standardized agreements that are applied (perhaps slightly modified) throughout an organization. This is a good thing, as form agreements reduce transaction costs - savings that are passed down throughout the company in the form of better bonuses, commissions, and salary increases. But because agreements are standardized, they often are not tweaked when an employee is brought on board. So pre-signing discussions or "terms" may not make their way into a final signed document, even if the new employee and his recruiter (usually a mid-level manager or human resources officer) have some preliminary understanding of what is expected. This is the Empro problem through and through. Here are three paradigms:

  1. The scope of restricted customers. This problem creeps up often. A sales employee who accepts a job may have a garden-variety customer non-solicitation covenant. He or she may think that any customer brought to the new company should be exempted from the restriction. After all, the employer may do nothing to facilitate the relationship. But unless something is written in the contract to express this intent objectively, the employee will have to defend on reasonableness - a much more arduous task than defending on breach.
  2. Policy on enforcement. I've had many employee clients come to me after a lawsuit has been filed and who have said something along these lines: "When I was hired, I was told as long as I avoid my top accounts, the company wouldn't come after me." This may persuade an employee to join, but it's certainly not a binding statement and shouldn't even be admitted into evidence. Still, it is an unfortunate reality of non-compete cases when an employee seeks broad, irrelevant discovery into the company's "policy" of enforcement, either in whole or in part.
  3. Indemnification. What happens when an employer tells an employee that it will "cover" any litigation costs incurred as a result of hiring him or her away? The best protection for an employee is to make sure the indemnity is contained in some agreement - usually the new employment agreement or a separate indemnity contract. Often, though, employers won't write in such an obligation. If litigation ensues, the employer may feel differently about spending money on lawyers. For starters, the employee may not perform up to anticipated standards, so the marginal cost of retaining that employee through a lawsuit is prohibitive. The litigation itself could be expensive. And it could go south quickly, particularly if a restraining order is entered. An employee's expectation to receive a continued defense, or even salary indemnity, may not be binding if a contract does not contain a term confirming this expectation.
These problems may give rise to other defenses. But Empro would seem to significantly undercut alternative theories of recovery or extra-contractual defenses. The beauty of a case like Empro is its certainty and clarity. In a perfect world, parties would set forth all the material terms and conditions rather than rely on pre-contract expectations. The world of non-compete litigation is not perfect, though, and these issues creep up repeatedly. An Empro-like analysis would go a long way towards simplifying litigation. 

Tuesday, July 3, 2012

Post-Reliable Fire, Illinois Courts Are Really All Over the Place

When the Supreme Court of Illinois rendered its decision in Reliable Fire Equipment Co. v. Arredondo, I really didn't think much had changed. Though I suspected courts would be less susceptible to motions to dismiss, Reliable Fire really did not set forth any hard-and-fast rules - even if it did broaden the types of interest a company can protect through a non-compete agreement. In essence, I thought employers might have a slightly easier time enforcing contracts than in the past.

Less than a year later, courts continue to struggle with Reliable Fire in application. The problem continues to be that each judge views non-competes differently, and that very few generalist judges are in the position of reading the 150 or so Illinois decisions to try and reconcile cases all over the map. Further, there are very few areas of commercial litigation that call upon courts to make policy judgments and to resolve tensions with significant public interests at stake.

But non-compete litigation poses a number of challenges for litigants, attorneys, and judges. For instance, it's widely assumed - rightfully so - that only the most extreme non-competes will be tossed before discovery. This is what Judge Holderman held a week or so ago in Instant Technology, LLC v. DeFazio, 2012 U.S. Dist. LEXIS 90911 (N.D. Ill. June 26, 2011). That case involved a three-year non-solicitation covenant in the IT staffing business - one of my top three markets for non-compete litigation (insurance agents and medical device sales run a solid one and two). Citing Reliable Fire, Judge Holderman noted that the three-part reasonableness test requires a court to balance the totality of the circumstances to determine whether a covenant is enforceable.

But the Appellate Court of Illinois looked at the issue differently in Kairies v. All Line, Inc., 2012 IL App (2d) 111027-U, when it affirmed a circuit court's order granting judgment on the pleadings in a non-compete case. That dispute involved a declaratory judgment claim brought by an employee who was bound to a two-year non-solicitation/non-compete covenant. The court found that the non-solicitation covenant was unenforceable on its face because it extended to all of the company's customers - not just those the employee contacted or developed. The non-compete proved an easier analysis, because it was an outright prohibition on competition anywhere (though, for some reason, the court never notes the absence of a geographic term).

The really screwy part of this is that the Kairies court held Reliable Fire was of limited impact, since the "principles governing the determination" of the non-solicitation covenant's reasonableness were "well settled and predate Reliable Fire." Essentially, Kairies seems to suggest Reliable Fire only deals with determining the existence of a legitimate business interest, and that prior cases concerning reasonableness were undisturbed.

But this can't be right. If Reliable Fire requires consideration of the totality of the circumstances, and indeed says that the "identical contract and restraint may be reasonable and valid under one set of circumstances...and invalid under another set" then a court must look at the protectable interest and the covenant's language together, with the unique facts of each case.

As an example, a customer non-solicitation covenant may not have the necessary tie in to the employee, which the agreement in Kairies did not. But what if the facts show that the company was small and that all employees had access to, or worked on, all customers' accounts? Or what if the employee was a manager, such that he had indirect contact with (but extensive knowledge of) a wide range of customers?

This is not to say that some agreements are so patently overbroad that a pre-discovery motion is never a useful tool to dispose of a case. But there is no way that the Supreme Court intended for Reliable Fire to be interpreted so narrowly.

It's hard to say whether Kairies will be revisited on a motion to reconsider. It has a shaky foundation. At this point, it's non-precedential (why, I don't know...) under Rule 23. For lawyers, the case is a continuing reminder that they must be careful advising clients on enforceability. Courts just continue to miss significant legal issues.

A final word. I am not defending the contract provisions in Kairies. They weren't the greatest, and perhaps the employer deserved its fate. The policy rationale, and the potential impact, for future cases, though, is of real concern.