Tuesday, December 31, 2013

2013: The Top 10 List (Part II)

I hate to see 2013 leave, so I stretched my annual year-end review into two parts. Yesterday, I discussed the first half of my top 10 developments in non-compete and trade secret law. And today, I conclude the year with numbers one through five.

Here we go....

5. Aleynikov's Advancement Victory Highlights Oft-Overlooked Issue in Competition Suits. Former Goldman Sachs code developer has the distinction of making the Top 10 list in back-to-back years. (He is, in essence, the Arcade Fire of trade secrets litigants.) In last year's post, I summarized his legal high-wire act and predicted that he just might win his indemnification and advancement suit against Goldman Sachs. Well, he prevailed at least in part, with a federal district court finding that Aleynikov is entitled to have Goldman advance his legal expenses to fight the ongoing state criminal case in Manhattan. This development is significant because advancement and indemnification rights are the soft underbelly of many competition cases and often can throw a wrench into a company's plans to fight unfair competition. States recognize the broad policy goals of advancement and indemnity and will apply these statutes liberally to further those goals. Aleynikov's case, and others like it, should teach plaintiff's counsel to carefully consider how to plead and pursue competition claims. For a recap of Aleynikov's win in New Jersey, read my post from last month.

4. Federal Court Convicts David Nosal of Computer Fraud. The Computer Fraud and Abuse Act continued to wreak havoc on logic and reason (and more than a few lives) in 2013, and the case of David Nosal is one such example. The former Korn/Ferry search executive was convicted for violating the CFAA and the general federal conspiracy laws in California federal court. Nosal's plight (he will again appeal) indicates that conduct often giving rise to civil claims for unfair competition can actually result in criminal charges. Nosal's conviction generated a fair amount of controversy and demonstrates the broad applicability of the CFAA. For a discussion of the Nosal conviction, listen to the Fairly Competing podcast that John Marsh, Russell Beck, and I produced and posted back on May 28.

3. Illinois Appellate Court Issues Controversial Fifield Decision. No single non-compete has generated more buzz than the Appellate Court of Illinois' opinion in Fifield v. Premier Dealer Services. The case holds that a non-compete given in exchange for employment is not sufficient consideration unless the employment continues for at least two years. (To those unfamiliar: this is a case not legislation. I know it's confusing.) The rule broadly impacts at-will employees and has caused business counsel to lose sleep and wring their hands over just how to draft employment contracts. The Supreme Court of Illinois tacitly approved of the holding, declining to take the petition for leave to appeal. They were not persuaded, apparently, by my "dissenting opinion" in Fifield as the phantom Fourth Justice. (For those of you interested in assessing blogging metrics, this post - by a factor I can't even count - generated the most hits, the most e-mails, two news magazine interviews, and three citations in opposing counsel's legal briefs.) For my follow-up take, you can read more on Fifield here. (And if you want even more, just Google "Fifield." You'll find plenty.)

2. Seventh Circuit Decides Tradesmen Int'l v. Black. My case. Navel-gazing. Can say no more. Read here and here.

1. Federal Legislation to Protect Trade Secrets on the Horizon? Number one is a runaway. Not even close. It is difficult to overstate the importance of many proposed bills that are currently working their way through committee or that could be reintroduced in some form or fashion. Of particular note in 2013 was "Aaron's Law", which Zoe Lofgren introduced to cut back on the perceived unfairness and breadth of the CFAA. John, Russell, and I discussed the CFAA prosecution of activist Aaron Swartz on our Fairly Competing podcast early this year. Rep. Lofgren also introduced the Private Right of Action Against Theft of Trade Secrets Act, which would create a private civil cause of action at the federal level. Other legislative activity at the federal level included introduction of the Deter Cyber Theft Act, which would establish a "watch list" of countries that engage in cyber theft and require border patrol to bar imports from those countries. My June 4 discussion of the Act can be found here. Finally, and most recently, Senator Flake introduced the Future of American Innovation and Research Act. This legislation would provide a federal trade secrets remedy against those acting outside the U.S. or for the benefit of a foreign actor. It also provides for an ex parte seizure order, subject to some limitations. And finally, if you're interested in listening to further discussion about the federalization of trade secrets law, listen to the podcast John, Russell, and I produced on May 17.


That's a wrap on 2013. Again, many thanks to my readers and those who are kind and thoughtful enough to e-mail me. You have made this a truly enjoyable experience once again. A less warm farewell for the year to those spammers who have ruined the commenting portion of this blog permanently. Such is life on the internet.

I am looking forward to starting Year 6 and reaching that milestone of post number 500. See you in 2014!

Monday, December 30, 2013

2013: The Top 10 List (Part I)

And so ends Year 5, my fifth full year writing this blog. Sometime during the first quarter of next year, I will be penning my 500th post. I guess that qualifies as a milestone, but I'm not exactly sure how to celebrate. Perhaps a guest column? We'll cross that bridge later.

For now, we'll have to make do with what has become an annual tradition - a countdown to the Top 10 most significant developments for the past year. Some on this list will be familiar, some perhaps not. And as usual, I have my own reasons (which I'll try to explain) for why I think a development is signficant.

This year, I am breaking the post into two parts. Not so much to speed-up the countdown to Post No. 500, but to continue on with the suspense-building tradition of bifurcating Top 10 lists (see Pitchfork's Top Albums list, for instance).

So here goes Part I, in which I'll summarize 10 through 6. Tomorrow, we'll conclude the year with Part II, in which I outline the five most important developments of 2013.

10. State Legislatures Continue Examining Non-Compete Agreements. Every January we see legislatures consider a host of new bills - many of which are unpassable sops to constituents. It has become commonplace to see the introduction of bills regulating non-compete agreements. This year was no different, as legislatures in Minnesota, Illinois, New Jersey, Connecticut, and Oklahoma all considered regulating various aspects of non-compete law. For a take on the Oklahoma bill, read my post from June 10.

9. First Circuit Addresses Scope of "Solicitation." One of the year's more interesting circuit opinions comes from Massachusetts and the always-reliable Judge Selya. The case of Corporate Techs. v. Hartnett addressed a frequent problem posed by non-solicitation covenants: just what is a "solicitation" anyway? The case pragmatically concludes that there is no real viability to a "first contact" rule, and that business realities must play some role in assessing whether an employee has impermissibly solicited a client in violation of a contractual restriction. For a summary of Hartnett, read my October 17 post.

8. Fracking Bills Intersect Public Policy with Trade Secret Rights. For those of you interested in our country's continuing debate over energy independence, the very word "fracking" can invoke a visceral reaction. It is beyond dispute, however, that the renewed interest in fracking as a means of energy production has led to job creation, particularly in areas hard-hit by the recession (including my state of Illinois). As a result, state legislatures are considering or enacting bills to allow (and heavily regulate) this method of energy production. But in doing so, states are having to consider how to protect the trade secret rights of oil and gas producers. Understandably, many environmental groups want to know what kinds of chemicals the producers are using in their fluid compositions (which is critical to the fracking method). And this leads to an explosive intersection of public policy and private ordering of trade secret rights. For my take on the issues likely to come up time and again in fracking cases, read my May 2 post.

7. Supreme Court Validates Use of Forum Selection Clauses. It is near-sacrilege on this blog to discuss matters related to venue and jurisdiction, if only to prevent internet-induced boredom. But there is no doubt for practitioners that these issues are important to understand. For the second straight year, the Supreme Court has issued an opinion that will be critical for those attorneys who deal with the enforceability of non-compete agreements. While last year's decision dealt with arbitrability, this year, the Court reaffirmed the notion that forum selection clauses are presumptively enforceable. As it stands right now, the only real method of shifting venue when the underlying contract contains a forum selection clause is to argue third-party inconvenience. For my summary of the Atlantic Marine case, read my post from last week.

6. Courts of Appeal Affirm EEA Convictions. The Economic Espionage Act continues to generate much discussion among commentators, particular given the importance of trade secrets in our economy. This year, we saw two courts of appeal affirm EEA convictions arising out of theft of trade secrets. In one case, the Seventh Circuit affirmed Hanjuan Jin's conviction arising from her misappropriation of technology from Motorola (though the technology is now somewhat dated). In the more interesting case, the Sixth Circuit affirmed the convictions of Clark Roberts and Sean Howley for misappropriating Goodyear's tire-assembly machine technology. But it reversed the sentences the district court imposed, particularly given Goodyear's inability to describe adequately the economic loss it incurred from the theft. For my discussion of the Goodyear case, read my February 6 discussion in USA v. Roberts.


Stay tuned for Part II (5 through 1) tomorrow afternoon, featuring proposed federal legislation, criminal convictions under the Computer Fraud and Abuse Act, and developments in Illinois.

Tuesday, December 24, 2013

Supreme Court Finds Forum Selection Clauses Presumptively Valid

For the second straight year, the Supreme Court has issued an opinion which impacts procedural issues surrounding many non-compete disputes.

Last year, the Court held that when an employment contract contains an arbitration clause, an arbitrator - not a court - must determine the enforceability of a restrictive covenant. This year, the Court addressed an issue which seems more and more pervasive in covenant fights: the enforceability of forum selection clauses. These procedural disputes are time-consuming, expensive, and totally ancillary to the merits.

Venue provisions seem to be part and parcel of any employment agreement nowadays, with those clauses specifying what law the parties agree to apply and where any dispute should be heard. Although it is not uncommon to see venue provisions as merely optional or permissive, it is far more frequent in my opinion to see mandatory clauses that specify the employer's home state as the exclusive place for dispute resolution.

The problem concerning enforceability of these clauses generally arises when an employee lives and works out of state. Often times, the employee - anticipating a covenant lawsuit - will file preemptively in his or her home state to establish a venue different than that specified in the contract. Just as frequently, the employee's first response in a covenant suit is to try to dismiss or transfer the case on venue grounds to his or her home district.

Is this permissible? The Court in Atlantic Marine Constr. Co. v. U.S. Dist. Ct. makes it much more difficult for the employee to raise this defense.

The Court in Atlantic Marine held that a district court should enforce the forum selection clause and transfer the case to a different federal court (the one in the pre-determined venue) unless extraordinary circumstances "unrelated to the convenience of the parties" work against a transfer. Effectively, the forum selection clause has controlling weight in the case, and a district court judge should transfer the case unless non-parties would be inconvenienced.

For an employee, the only practical way to prevail in this type of forum fight is to introduce by way of affidavit specific testimony showing that nearly all of the relevant witnesses are located out of state. This would cause a court to consider whether maintaining the suit in the chosen state would work a hardship on third-parties and lead to problems with subpoena compliance. Even that may not be enough, since presumably the employer will introduce counter-testimony showing which witnesses reside in the contractually agreed-to state. The availability of video testimony or use of depositions at trial further work against the employee. That said, the employee's showing must be compelling, detailed, and substantial if he or she is to have any shot at all.

It is important to remember that when a venue fight like this arises it usually takes place in federal court. If the employee files a preemptive suit in another state, it is a virtual certainty there will be complete diversity between the parties so the suit will end up somehow in federal court (either on its own or through the process of removing it out of the state court into the federal court). When seeking to enforce a forum selection clause, the employer is going to move to have the case transferred to a different federal court or dismissed so it can refile in the appropriate state court. However, the Court's opinion indicates the same test concerning enforceability of the forum selection clause will apply regardless of whether the motion is for transfer or dismissal.

Friday, December 13, 2013

Is the definition of a "trade secret" too complicated? Judge Posner says yes.

Courts long have recognized that a trade secret is one of the most "elusive" concepts in the law. This recognition results from a misunderstanding of what kind of protection the law will afford commercially sensitive material. It also results fr
om the fact that owners of business information tend to overvalue it and, hence, claim trade secret protection over too much material.

In the high-profile Chicago case of U.S. v. Jin, No. 12-3013 (7th Cir. Sept. 26, 2013), Judge Posner somewhat criticized the definition of a trade secret under the Economic Espionage Act. He called the definition elaborate and disconnected from a trade secret "in the ordinary sense." He specifically called out the element of the definition that a trade secret have "independent economic value from not being generally known to ... the public." It was this definition that allowed Hanjuan Jin to challenge her conviction.

Jin's defense centered on value, because the stolen trade secrets - Motorola's dated mobile telecommunications system - were losing commercial value. Not surprisingly, Judge Posner found that the United States, in proving its case, did not need to prove that Motorola lost money as a result of Jin's theft. (Incidentally, this was one of those cash-in-the-luggage, one-way-ticket-to-China-with documents-in-hand fact patterns that had all the hallmarks of cloak-and-dagger stuff. Hard to believe any jury would have much sympathy for that.)

The Court then noted that a trade secret need only have potential value, not actual, and that the "damage" may have come in the fact that Motorola had to reveal "that it couldn't keep secrets or prevent rivals from stealing its technology." Judge Posner long has endorsed trade secret rights, and this opinion reflects his effort to broadly define value - even though he found the EEA's trade secrets definition unduly "elaborate."

(This is the definition from the Restatement of the Law (Third), Unfair Competition, Section 39:

A trade secret is any information that can be used in the operation of a business or other enterprise and that is sufficiently valuable and secret to afford an actual or potential economic advantage over others.)

A copy of the Opinion is below.

Tuesday, December 3, 2013

Reflecting on Garden-Leave and the English Approach

Last month, the Illinois Bar Journal published a feature article I wrote called "Non-Traditional Non-Competes: Designing Non-Competition Agreements to Hold Up in Court."

The stated premise of my article was fairly straightforward and uncontroversial: non-competes are tough to enforce, and attorneys should think creatively about how to make them more reasonable and reflective of an arms-length transaction. I described three basic templates attorneys could consider using to make agreements more enforceable. These templates, which generally adopt a garden-leave approach to enforcement, would all but eliminate any line of attack concerning lack of consideration and undue hardship.

The unstated premise was more nuanced: by paying employees not to compete, employers will avoid more litigation and challenges to enforceability. Since non-compete litigation itself costs money and infrequently results in monetary judgments, the net economic benefit to a garden-leave approach isn't quite as bad as it might seem when first thinking about it.

I started the article with a discussion of the famous case from the English Court of Appeal, Evening Standard v. Henderson, in which a London-area paper successfully prohibited an employee from working for another employer during his garden-leave (or extended notice) period. The other day, I read another English decision, JM Finn & Co. Ltd. v. Holliday, which granted injunctive relief (just as in Henderson) to keep an an investment manager on the sidelines during his one-year notice period after he indicated he was leaving to join another brokerage firm. The decision can be found here.

The mechanics of garden-leave can be somewhat confusing. The general approach is that an employer, like JM Finn, has the ability to enforce what's called a "notice period" when it receives a resignation letter, like Holliday provided to it. At that point, the employer continues paying the employee to sit out and importantly (at least in the United States) the employee continues to owe duties of loyalty and fidelity to his then-employer (even though he is not actively working). As I discuss in my article, it's best that the employer not retain any discretion to conscript the employee into performing any type of work during the notice period.

Garden-leave is prevalent in the financial services sector, but as I point out in my bar journal article, it has received almost no attention in U.S. courts. Maybe this proves my point. If these clauses are in use, shouldn't they result in less litigation (meaning, fewer searchable cases) and reduced attorneys' fees?

Tuesday, November 19, 2013

Georgia Court of Appeals Discusses Anti-Severability Rules

One of the defining characteristics of a state's non-compete law is its application of the blue-pencil rule. Although several variations of the rule exist, states generally fall into one of two camps: those that readily modify overbroad covenants to make them reasonable, and those that generally frown on modification or blue-penciling.

Georgia historically has been one of the states that enforces only those agreements that are reasonable as written. That is to say, courts cannot modify overbroad agreements to make them enforceable. In essence, Georgia judges will decline to force the parties to accept a contract they could have, but didn't, make.

Georgia law continues to evolve, and a new statute governs contracts entered into after May of 2011. However, it doesn't impact contracts signed before the effective date, and courts will continue to apply the old common law for many years to come.

The Court of Appeals discussed at length the state's anti-severability rule in Lapolla Industries, Inc. v. Hess. As the Court described, the anti-severability rule applies to the following types of restrictive covenants:

  • covenants restricting employment or competition generally in a relevant market;
  • covenants restricting the solicitation of business from actual or potential customers; and
  • covenants restricting the acceptance of business from actual or potential customers.
(There was another type of restrictive covenant at issue in Hess, which I still don't understand after reading it several times and which the Court of Appeals intelligently glided over. Lapolla (the ex-employer) had a non-solicitation covenant that prohibited the employee from soliciting or accepting business from a business competitive with or similar to Lapolla. In other words, the employee could not vend any kind of product or service to a Lapolla competitor. Silly.)  

However, the anti-severability rule does not apply to covenants that either:

  • restrict solicitation or hiring of certain employees or independent contractors; and
  • restrict disclosure of trade secrets or confidential information.
Like many states, Georgia historically has frowned upon so-called market-based restraints, which contain broad prohibitions on working for a competitor in any capacity. Georgia's case law, however, also has applied strict scrutiny to lesser restrictive customer-based restraints, such that a number of appellate decisions strike down clauses that many other states would deem enforceable. For instance, Georgia courts have frowned upon customer-based restraints that prevent an employee from accepting, instead of soliciting, a customer's business. This distinction never has made much sense to me, since it's virtually impossible without the aid of legal process to determine who solicited whom.

The Court also discusses at length in Hess Georgia's reluctance to enforce choice of forum and choice of law clauses in contracts when application of a foreign state's law would lead to a result contrary to Georgia's public policy. In keeping with one of my sacrosanct rules to limit discussion of venue and jurisdiction disputes to an absolute minimum, I will say no more regarding this subject.

Wednesday, November 6, 2013

Even Reprehensible Terms of Service Violations Do Not Yield CFAA Claim

Although the Computer Fraud and Abuse Act frequently has been described as extremely broad in reach, it's also important to recognize its limitations.

One of the most substantive, sweeping limitations involves potential violations of website "Terms of Use" or "Terms of Service." Largely as a result of the case law that has developed out of the Ninth Circuit Court of Appeals, courts have recognized that pursuing a CFAA claim (or prosecuting a CFAA crime) on the basis of TOS violations poses significant problems.

The CFAA, somewhat famously, prohibits access to a protected computer without authorization or (critically) in a manner that "exceeds authorized access." Shoehorning a TOS violation into the "exceeds authorized access" framework has caused a great deal of handwringing among academics, prosecutors, defense attorneys, and judges.

The most well-known case involved Lori Drew, the MySpace Mom who created a fake account to contact a 13-year-old girl with whom her daughter was friends. The girl later committed suicide after corresponding with a person she thought to be a 16-year-old boy, the identity Drew assumed online with the fake account. After the U.S. Attorney's Office prosecuted Drew under the CFAA for a TOS violation, the district court judge threw out the conviction and held that the CFAA - as applied in the case - was void for vagueness. (Professor Orin Kerr represented Drew in this case.)

A similar dust-up ensued in an Oregon middle school recently, when a number of students created fake Facebook and Twitter accounts under the name of their assistant principal, Adam Matot. The students would then invite children to be friends with "Matot", and upon receiving an acceptance of the invitation, they would send the children obsene material (including pornographic images).

Matot's grievance, however sympathetic, simply did not state a CFAA claim for many of the same reasons the government couldn't maintain a conviction against Drew. The TOS violation, under Ninth Circuit law (Matot filed suit in Oregon), was not enough to demonstrate that the children exceeded their authorized access to a computer, since that statutory term restricts only access to a protected computer - not the misuse of information contained within the protected computer.

It is important to remember what function website terms of service play in commerce. As Professor Kerr mentioned in testimony before the U.S. House of Representatives, "[c]ompanies write those [TOS] conditions broadly in part to avoid civil liability if a user of the computer engages in wrongdoing....Those terms are not designed to carry the weight of criminal liability."

The same analysis generally will apply to civil claims involving the CFAA. In a majority of federal jurisdictions, courts will look at whether an individual had permission to use a protected computer in the first place and will not focus on whether the individual's use of information was wrongful.

Friday, November 1, 2013

Aleynikov Turns the Tables on Goldman Sachs Group

Score one for the underdog.

In Sergey Aleynikov's latest legal battle against Goldman Sachs, he emerged victorious. Earlier this month, Aleynikov prevailed on summary judgment and obtained an advancement (that is, prepayment) of legal fees related to his legal defense of state criminal charges brought by the Manhattan District Attorney.

As many readers know, Aleynikov was convicted by a federal district court of violating the Economic Espionage Act related to his alleged theft of Goldman's trade secret high-frequency trading source code. The Second Circuit reversed that conviction - after Aleynikov spent many months in federal prison before the reversal - leading to a quick modification of the federal statute.

Soon thereafter, a grand jury in New York indicted Aleynikov on similar state charges. It's unclear what the DA hopes to accomplish since even if Aleynikov is convicted, he will receive credit for extensive time he served in the federal case. But, now at least, Aleynikov will be able to have Goldman advance his legal fees and forge a defense to the latest round of criminal charges.

Although Judge McNulty called the advancement question a close one, there are several lessons to be learned.

First, the advancement and indemnification rights afforded corporate officers and directors are broad in scope. To that end, any ambiguities are resolved in the indemnitee's favor. Here, although Aleynikov was not an "officer" in the traditional sense (as would be the case for Lloyd Blankfein), the court found Goldman reserved for itself broad discretion to determine who was eligible for fee advancement. In fact, Goldman had advanced fees to 51 of 53 people who applied for it (apparently, one other unlucky soul found himself viewed as equivalent in stature to Aleynikov) over a six-year period.

Second, rights to advancement require an analysis of state corporation law, corporate bylaws, and any governing agreements (such as employment contracts). Advancement rights are treated differently by the states, and often times states make distinctions between officers, directors, and employees. In some states, for instance, a corporate charter must opt-out of advancement for directors, or else it's mandatory. Goldman's corporate bylaws, mandated advancement to officers as long as certain conditions were met.

Third, the key analysis usually turns on whether an individual is a defendant "by reason of the fact" that he was an employee, officer, or director. This is usually where advancement cases turn, although in Aleynikov it wasn't the flash point at all. In Delaware (which most states will turn to for interpretive questions), this requires a court to consider the nexus or causal connection between the alleged wrongdoing (whether civilly or criminally based) and the individual's status. In Aleynikov's case, his theft of trade secrets occurred solely because of his access to them while he was a Goldman employee. To be sure, the act of misappropriation occurred before he quit. Therefore, Aleynikov wouldn't have been able to misappropriate the code (or understood his value) but for the exercise of his official duties as a Goldman employee. Several other courts have found improper pre-termination competitive activity (usually for trade secrets theft or violation of a fiduciary duty) as sufficient to establish the "by reason of the fact" test. Individual obligations arising after service ends, such as a non-compete violation, won't fall within the causal nexus and won't trigger advancement rights. (For this reason, it's exceedingly important for a plaintiff to consider the implications of its allegations and sought-after remedies.)

Simply because Aleynikov is entitled to fee advancement does not mean he is off the hook. If he loses and is found guilty by a Manhattan jury, he'll have to repay his fees - hence, the title "advancement." But he doesn't have to post security as a condition. Advancement is an unsecured undertaking (unless the corporate charter says otherwise), and it's hard to see where Aleynikov would ever have the practical ability to repay if things head further south.

A copy of Judge McNulty's lengthy advancement opinion is contained below.

Tuesday, October 29, 2013

Inevitable Disclosure Theory Not Available as a "Stand-Alone" Claim

Ever since the Seventh Circuit decided PepsiCo v. Redmond in 1995, there has been an almost insatiable desire for plaintiff's attorneys to apply the "inevitable disclosure" doctrine to claims of trade secret theft.

As I've written before, the doctrine serves as a proxy for actual misappropriation and is based on the idea that despite one's best intentions he cannot serve in a particular employment position without relying on specific trade secret knowledge gleaned elsewhere.

The concept is similar to a party's request for a broad manufacturing or production injunction, akin to what the court ordered in the now-famous case of E.I. duPont v. Kolon Industries. So the theory goes, if a party has incorporated a stolen secret process into its manufacturing line and cannot help but rely on that process, then a mere "use or disclose" injunction plainly is insufficient. A broader, prophylactic order prohibiting conduct related to the trade secret is necessary to protect it.

It is important to understand the limits and parameters of the inevitable disclosure doctrine. It is not a stand-alone claim for relief, as a federal district emphasized in Janus et Cie v. Kahnke, 2013 U.S. Dist. LEXIS 139686 (S.D.N.Y. Aug. 29, 2013). It is a means to obtain a preliminary injunction under state trade secret law or to demonstrate a protectable interest for purposes of enforcing a non-compete agreement.

This means, for all intents and purposes, two things. First, if a plaintiff asserts a claim based on the inevitable disclosure theory without moving for a preliminary injunction, then the claim isn't plausible. Second, a plaintiff almost certainly won't be able to obtain damages (or fees) under state trade secrets law absent some actual misappropriation.

The inevitable disclosure doctrine is a very narrow path to secure injunctive relief, and the court's stringent four-factor test to award such relief typically guards against unduly speculative, factually empty cases. On top of that, the states treat the inevitable disclosure doctrine in different ways, with some adopting what many believe to be a "pure" form of relief and others limiting the doctrine substantially or declining to adopt it altogether.

Thursday, October 17, 2013

So, What Is a "Solicitation"?

One of the most frequently asked questions I get when advising clients is deceptively complex:

What does it mean to solicit a client?

On its face, this probably sounds like it should be an easy question to answer. However, it's really not. Since courts are hesitant to enforce broad non-compete agreements (particularly as to sales persons), many disputes hinge on the applicability of a customer non-solicitation covenant. The scope of those covenants can range from the very broad to the much narrower, both in terms of the type of activity prohibited and the customers covered by the prohibition.

A broad non-solicitation covenant reads something like this:

Employee agrees for a period of one year not to solicit, contact, or provide services to a Restricted Customer for the purpose of providing Competitive Products.

A narrow non-solicitation covenant usually reads this way:

Employee agrees for a period of one year not to solicit or entice away a Restricted Customer for the purpose of providing Competitive Products.

The difference between the two is that the narrow covenant does not prohibit so-called "passive" solicitation, where a client reaches out to the employee. As a practical matter, these more narrow covenants lead to just as much litigaton because most times an employer won't know who contacted who. But it will justifiably be concerned about the fact the employee is continuing to work with the client. It only will be able to discover what actually happened through the litigation process.

In these cases involving narrower covenants, the issue of breach often hinges on whether the employee actually solicited the customer, or whether the customer sought out the employee. The First Circuit's recent opinion in Corporate Techs., Inc. v. Harnett illustrates a common fact-pattern and rejected a bright-line "initial contact" test. In that case, the ex-employee's new company sent out a blast announcement that piqued the curiosity of a targeted group of customers that happened to fall within the terms of the employee's non-solicitation covenant. Upon receiving that announcement, customers started contacting the ex-employee.

The court specifically noted that "initial contact" is somewhat amorphous and "can easily be manipulated" depending on the facts of a particular case. This is particularly so with businesses where the selling cycle is long, such that the initial contact would be "unlikely to bear fruit in the absence of subsequent solicitation." It had little trouble affirming a preliminary injunction that enforced the non-solicitation covenant.

The takeaway from cases like Harnett is that employees must understand that the issue of "solicitation" is intensely fact-laden and that it's awfully hard to play cute and end-run the contract. Courts will need to consider how employees typically communicate with customers, and whether the employee set in motion a chain of events designed to lead to contact by the customers themselves. Targeted announcements are an obvious invitation to cause a customer to contact the employee and present a fairly easy case for determining that a solicitation has occurred. Even more problematic are personal e-mails, LinkedIn invitations to connect, and other one-on-one activity that suggests an effort to continue a business relationship.

Tuesday, October 15, 2013

Illinois Supreme Court: Fifield Stands

When the Appellate Court of Illinois ruled in Fifield v. Premier Dealer Services, Inc. that an
employer needed to provide consideration beyond mere employment itself to validate a non-compete, most business (read: management-side) attorneys thought this decision was a misread that was inevitably headed for reversal.

Not so.

The Supreme Court of Illinois has denied the Petition for Leave to Appeal that Premier Dealer Services filed after Fifield prevailed on his consideration argument. Anyone following this blog knows I have been critical of the Fifield holding to the extent it applies broadly to employees who choose to leave their employment voluntarily and in its rather arbitrary setting of a two-year period in which an employee must remain employed for the employment itself to constitute sufficient consideration for the non-compete.

But now that Fifield stands, what impact will this have? Here's several implications:

(1) Venue fights are inevitable. The Appellate Court has five districts. The First (from which Fifield hath sprung) is by far the largest and includes Cook County. However, many employers operate in other counties that are both nearby and outside the First District. Look for employers to enforce covenants outside Cook County and include choice-of-venue clauses in contracts that get them out of the First District.

(2) A potential conflict may be looming. I have heard stories of employers in other districts (namely, the Fourth - generally viewed as the most friendly towards enforcement) setting up lawsuits to create a conflict with Fifield. It will be worth watching if an employer has a suit disposed of quickly to get it to the appellate court and potentially create a district split. This would enhance the chances for the Supreme Court to take a case, much like it had to do with Reliable Fire Equipment Co. v. Arredondo a few years back.

(3) Employers will look to rewrite their agreements. Now that the consideration rule effectively grants at-will employees the opportunity to void their non-competes for a two-year period after the start of employment, employers are scrambling to fix contracts. My experience is that this new decision may mean employers will create contracts that contain consideration in the form of: (a) a guaranteed term of employment; (b) a severance or garden-leave option triggered post-termination; or (c) a signing bonus that is irrevocable.

(4) Some legislator will introduce something in January that addresses this. (Note: This is not a real implication because most proposed legislation never goes through committee, and this wouldn't generate any attention at all. At least that's my opinion.)

For several years, the playing field in non-compete suits was whether the employer had a legitimate business interest to protect. Now, it will be the question of contract formation entirely - whether the employer ever provided enough consideration to make the non-compete enforced at all.

Wednesday, September 25, 2013

Old Georgia Law Still Invalidates Many Restrictive Covenants

When the Georgia General Assembly passed the Restrictive Covenant Act in 2009, it substantially changed the playing field between employers and employees. Under the common law, it was exceedingly difficult for employers to enforce anything but the most perfectly worded and narrowly tailored covenant. Cases repeatedly failed on the facial ambiguity or overbreadth of the covenant, leading to judicial invalidation. And the blue-pencil rule was not available to save overbroad (even slightly overbroad) contracts.

But the new Act did not become effective until 2010 and only applies to contracts entered into after November 3, 2010. A great many employees and independent contractors signed agreements well before that, and their enforceability continues to be subject to the old common law.

A recent district court summary judgment decision illustrates how strict this old common law actually is.  The case involved a dispute in the credit-card merchant processing industry. This is a rapidly growing market where companies provide merchants - often, retailers - a wide range of credit-card processing services. Those services range from simple payment processing to mobile processing to "tokenization" (a fancy way of saying that the processing company will enable merchants to store credit card data safely and securely).

The defendant was an independent contractor who marketed the processor's services to merchants for a fee. In his Independent Contractor Agreement, he agreed to two broad covenants:

(1) An in-term non-compete restriction that prohibited him, during the term of his relationship with the plaintiff, from entering into agreements to solicit merchants for the merchant-acquiring program of any bank or third-party financial institution, or from entering "into any relationship with any organization...that would effect an indirect relationship with any" organization.

(2) A 5-year, post-termination non-solicitation restriction that prevented him from calling on the plaintiff's customers, regardless of whether he had a relationship with those customers.

The district court had little trouble under Georgia common law striking down both clauses. The ruling on the non-solicitation covenant was not much of a surprise, since Georgia law (like some other states) generally does not look favorably upon non-solicitation covenants that extend to customers the employee did not serve - particularly when there is no geographic restriction. And the 5-year term was well beyond the 2-year rule Georgia courts long have advocated.

The more surprising aspect of the ruling is the fact the court struck down the in-term non-compete arrangement. It held the general rules pertaining to non-compete agreements apply, even though it did not prohibit any post-termination activity. In-term covenants rarely are litigated because in an at-will environment, employees (or, as here, independent contractors) simply terminate the relationship before leaving to compete.

The court, though, struck the non-compete and held that its activity scope was unreasonable - mainly due to the quoted, italicized language above. The court found that the prohibition on the defendant from entering "into any relationship" with a bank was ambiguous and ill-defined. In reality, it didn't appear to be as broad as the court held. Rather, it seems the clear intent of the covenant was to prohibit the defendant from entering into a similar arrangement with another credit-card processor while he was soliciting merchants for the plaintiff. The language of the non-compete which the court deemed problematic only appeared to further restrict the plaintiff from circumventing this fairly clear covenant in a more indirect manner.

Still, the ruling indicates that courts often are troubled by restrictive covenants and their impact on competition as a whole. I've written before about how judges sometimes will gloss over a contract's intent to find an ambiguity, even though it's questionable such an ambiguity exists. That seems to be what happened here as well.

Saturday, September 21, 2013

Inevitable Disclosure Doctrine Inapplicable to Contract Damage Claims

As readers of this blog may know, the "inevitable disclosure" doctrine is a theory of trade secrets misappropriation.

A plaintiff need not show either actual or threatened misappropriation if it can prove that it's inevitable a defendant either will use or disclose trade secrets. In many competition cases, a plaintiff asserts an inevitable disclosure claim in tandem with breach of contract claims. For remember that most employees who join a competitor (and who are worth the expense of a lawsuit) probably have some sort of non-disclosure agreement.

This raises the issue of whether a plaintiff can use the inevitable disclosure doctrine to prove breach of contract. There are relatively few cases that seem to address the issue, although the logical answer seems to be "no." The better way to apply the inevitable disclosure doctrine is to use it as a means to seek preliminary injunctive relief, as a recent Arkansas federal district court did.

In Nanomech, Inc. v. Suresh, the court rejected the plaintiff's effort to extend the inevitable disclosure doctrine to a breach of contract claim for damages, stating:

"The doctrine has only been applied in Trade Secrets Act cases, particularly where plaintiffs have alleged the 'threatened misappropriation of trade secrets,' a discrete violation of the Act that is inherently speculative in nature."

When asserting a claim for damages, it makes little sense to use the inevitable disclosure doctrine. Damages presume that some wrong already has occurred and caused an economic loss. If disclosure of trade secrets is merely "inevitable," then it's illogical to conclude the plaintiff incurred a loss. By definition, the wrong would not have occurred. Rather, the only use for the doctrine would appear to be securing injunctive relief.

This raises a related issue. Many times a non-disclosure covenant will be written in such a way as to bar a threatened disclosure of confidential information. In this circumstance, a plaintiff - faced with imminent disclosure - probably doesn't need to wait until actual breach and can instead sue on the contract. However, it's easy enough to just allege a violation of the contract, along the lines of anticipatory breach, for pleading purposes
. Too, until such time as there is an actual disclosure, a plaintiff's request for a remedy should be limited to an injunction.

Saturday, August 31, 2013

Dumb Settlement Comments Can Help Establish Bad Faith in Trade Secrets Case

There's a perception that anything written in a settlement letter is privileged.

This perception is decidedly wrong.

Offers of settlement are not admissible to prove liability because we want to encourage parties to resolve their disputes out of court. If those offers were admissible, then parties would be hesitant to mediate disputes. This is a simple, common-sense rule. But that rule doesn't give a party carte blanche to say whatever it wants in a settlement letter and then hide under the cloak of privilege.

As readers of this blog know, trade secrets disputes can go horribly wrong for plaintiffs, my case of Tradesmen International v. Black from the Seventh Circuit being a recent example. But because of the overly emotional nature of competition cases, plaintiffs frequently double down when litigation goes south. It is quite common, in fact, for trade secrets plaintiffs to make outrageous settlement demands, or ridiculous statements in a settlement letter, even in the face of a significant defeat.

Those plaintiffs better be careful what they say in settlement letters, however.

If those letters contain over-the-top missives, improper threats, or even pie-in-the-sky demands, the statements aren't privileged and can help establish bad faith. Remember: a defendant gets his attorneys' fees if he can prove a plaintiff brought or maintained a trade secrets misappropriation claim in bad faith.

So what kind of statements in a settlement letter are not privileged? Generally, I find there are two categories that get plaintiffs in trouble.

First, the plaintiff often makes comments about how much continued litigation is going to cost, or indirect references to the fact that an appeal is going to be expensive for a prevailing party to defend. These sort of threats aren't privileged because even an idiot lawyer knows that further litigation costs money, and it's completely disconnected from an offer of settlement. Threatening a defendant into spending further legal fees indicates the plaintiff simply is pursuing litigation to force its adversary to bear the burdens of litigation - not to achieve a specific result at judgment.

Second, the plaintiff may make irrational demands as part of a settlement term sheet - often times totally disconnected to the actual dispute. In past cases (both in Iowa and California), courts have looked to outrageous settlement demands that have nothing to do with trade secrets claims as evidence of subjective bad faith. For instance, demanding a broad non-compete in California (where non-competes are unenforceable) as part of a settlement would demonstrate bad faith intent. So, too, would damages demands far in excess of a trial disclosure and demands to avoid certain customers or product lines, even though this is not part of the relief sought in the complaint. Even though these are terms of the offer, they aren't privileged as settlement communications because they don't tend to establish the plaintiff's case is worth less than what it claims.

Settlement letters are potential land-mines in litigation. If a trade secrets plaintiff says anything beyond conveying the offer, those statements could help show bad faith. As with most letters, it's best to keep it short and to the point.

Tuesday, August 20, 2013

Do the Final Episodes of "Breaking Bad" Qualify As Trade Secrets?

For die-hard fans of the greatest TV show of all time, these next six weeks are absolute gold.

Which led me to think: Do the plot lines over these final eight episodes qualify as "trade secrets"? Put another way, if one of the show's insiders - an actor, a writer, a key grip - published the final episodes' general plot narrative (online or in an interview), would the owners of the show - AMC - have a claim for trade secret misappropriation?

As many readers probably know, the test for determining a trade secret is relatively straightforward. An owner must show both: (a) that the information is economically valuable because of its secrecy; and (b) that it instituted reasonable security measures to protect the information.

So let's apply this to the final episodes of Breaking Bad and see if we can answer this question.

Economically Valuable Information

One argument weighing against trade secret status for the final episodes is that the information - that is the scripts and plot - are valuable as much for their novelty as for their secrecy. Secondarily, one could argue that the viewers would watch Breaking Bad even if the ending were either known or easily predictable. With this, I would disagree.

As to the first possible contention, every television show has some degree of originality, and as great as Breaking Bad is, it's not necessarily novel. After The Sopranos, it's hard to call a serial drama featuring a disaffected, criminal white male as "novel." In fact, it seems that virtually every new iteration of prestige television has such a protagonist (except, perhaps, for Orange Is the New Black).

So, since the series is not "novel," the argument for granting the last eight episodes trade secret status strengthens. That leads to the second possible argument against trade secret status: would people watch regardless of the ending? From my point of view, there are two key factors that indicate the story derives great value from its ability to hold its ending secret.

First, the show's true calling card from the beginning has been the parlor game begging viewers to speculate about the end. In other words, we know Walter White breaks bad from the first episode. Walt has cancer, meaning the show's lifespan is naturally limited. Add to the mix the compressed time frame over which the plot develops - two years' story time spread over six seasons - and the show has a frenetic, building pace that singularly drives viewers to speculate as to the ending. Since the focal point of the show always has been about the end, the plot that develops in the final season naturally has a high degree of intangible value.

Second, somewhat incredibly, Breaking Bad's viewership doubled from the last episode of Season Five to the first episode of the Season Six. This is staggering, if not ridiculous, for a serial drama that makes no sense if you jump in and start watching mid-stream. And it's due almost entirely to word-of-mouth. That is to say, those who've watched the show from the beginning have told their friends to get caught up because the end is near. Viewers of the show experience the show as much the day after it airs by reading the endless recaps and listening to insider podcasts, all of which contain a heavy undercurrent of how each episode builds towards the conclusion and what might happen in the last few episodes.

In all likelihood, 3 million new viewers have decided to watch over 50 hours of television in the past calendar year simply because the end is coming. The increased ratings for Breaking Bad likely have allowed the show to generate more advertising revenue (and possibly spin-offs for AMC), and this is mainly attributable to the fact the show is ending. Therefore, it seems logical that the narrative of the final episodes constitute some of the most valuable information about the show.

Secrecy Measures

This is somewhat of an unknown, simply because I don't know exactly what the owners of Breaking Bad have done to protect the plot details. But, from what's available in the public domain, the secrecy steps appear to be somewhat legendary.

We know from recent interviews that one of the supporting characters - "Lydia" - received scripts for the final episodes that redacted all lines but hers. We also know the scripts created by the show's writers generally contain code names (they're not labeled, for instance, Breaking Bad), ostensibly to guard against the impact of some accidental disclosure. The show has contracts with vendors that are secret and that don't reference the show at all, such that many vendors apparently don't even know they are supplying goods or services to Breaking Bad. These may seem like extreme security measures, but it signifies the show believes its ending has great value.

We also know creator Vince Gilligan will not allow previews of the coming show. That is, at the end of, say, Episode 1, we don't see scenes from Episode 2. Nor does the show preview the show in commercial spots during the week. In fact, Gilligan only will do a very short (and very oblique, to put it mildly) teaser on AMC's recap show, Talking Bad, that shows a still photo from the coming episode. His commentary is so trite as to be meaningless.

So the answer to me is a clear "yes." The plot lines for the remaining episodes qualify as legal trade secrets. But like many trade secrets, their shelf life is limited. In six weeks, all of this information will be in the public domain, and the plots lose any legal protection (except for copyright law, which is sort of besides the point for this post).

Until the final episode has wrapped, any of the show's insiders who know how it will end would be well-advised to tread lightly.

(Many thanks to Eric Ostroff for inspiring this post, based on his July entry on WWE wrestling. Eric and I reach somewhat different conclusions, incidentally.)

Thursday, August 15, 2013

More from Tradesmen Int'l v. Black: Analyzing Judge Hamilton's Concurring Opinion

When construction staffing industry titan Tradesmen International lost its appeal in the Seventh Circuit, it suffered more than just a defeat in a particular lawsuit that (in my opinion) it had no expectation of winning.

In the course of its analysis, the Court of Appeals made it perfectly clear that Tradesmen's non-compete was unenforceable under Ohio law. As Judge Tinder noted in his opinion, the non-compete had a nationwide reach and extended to all Tradesmen customers and prospects throughout the country even though the individual defendants worked solely in Indiana. Consequently, the agreement went far beyond what was necessary to protect Tradesmen's business interests.

To me, one of the more interesting aspects of the Seventh Circuit's ruling was Judge David Hamilton's concurring opinion and his discussion of the blue-pencil rule, which generally deals with a court's willingness to strike overbroad portions of a non-compete.

That Judge Hamilton wrote separately in this case is not surprising. During oral argument, it was clear to me he was troubled by the scope of Tradesmen's agreement and what precisely it was trying to protect. Though he is the newest member of the Seventh Circuit, Judge Hamilton quickly has become known as an active questioner during argument. And this case provided him the opportunity to live up to that reputation. Judge Hamilton has made it known in interviews that he has a great interest in the law of non-compete agreements and trade secrets.

Although he agreed with the majority opinion, Judge Hamilton wrote about the intersection of choice-of-law clauses and the blue-pencil rule. In Tradesmen, the individual non-compete agreements all contained Ohio choice-of-law provisions. The choice isn't unreasonable, since Tradesmen is an Ohio-based company with a nationwide footprint. Businesses certainly have an interest in seeing that its contracts are interpreted under a uniform set of rules. But the case potentially posed a significant choice-of-law issue because the individual defendants were Indiana citizens, and the litigation took place in Illinois.

Judge Hamilton, though, is troubled (and has been in the past) by courts' willingness to enforce choice-of-law clauses when another state has a greater interest in the case and the chosen state's law embraces an employer-friendly blue-pencil rule. As he wrote, even though most states assess non-competes under a general rule of reason framework, "even a gentle tap on that fragile surface of similarity shows important differences from state to state."

According to Judge Hamilton, courts should "not discount too quickly the force of ... public policy" that certain states have adopted when refusing to enforce overbroad non-compete agreements. In his mind, a state's unwillingness to rewrite or pare back non-compete agreements can be a strong enough public policy to invalidate a choice-of-law clause.

As an example, Indiana courts - like many others - subscribes to a strict blue-pencil rule. This means a court will not rewrite an overbroad contract, but will sever offending clauses from the rest of the agreement. States like Ohio, and to a lesser degree Illinois, have different policies (nuanced though they may be) that allow for courts to modify agreements or enforce them to the extent they are reasonable.

Is this a strong enough difference in public policy to invalidate a choice-of-law clause?

Judge Hamilton thinks it might be for a very pragmatic reason: an employer like Tradesmen can draft an obviously unenforceable contract and throw it to the courts to enforce a reasonable contract the parties could have signed instead. A state's unwillingness to adopt a liberal rule allowing for partial enforcement may signal a broader public policy that the state "protect[s] employees from overly broad coveants." The employer-friendly rule impacts employees who may not have the ability to obtain firm guidance on what type of competitive activity is prohibited legally, even with the sound advice of counsel.

Judge Hamilton addressed this same public policy issue in a lengthy opinion when he sat as a district court judge in the Southern District of Indiana. The case was Dearborn v. Everett J. Prescott, Inc., 486 F. Supp. 2d 802 (S.D. Ind. 2007), and the case had strong similarities to some of the issues in the Tradesmen suit concerning choice-of-law. Though his opinion in Dearborn was thoughtful and extremely thorough, I didn't entirely agree with everything Judge Hamilton wrote in that case. Still, his reasoning has great appeal, for it recognizes the critical role the blue-pencil rule plays in non-compete suits. Judge Hamilton's concurrence in Tradesmen rings many of the same alarm bells he struck in Dearborn concerning choice-of-law.

Divining when a state's public policy is so strong as to override a contractual choice-of-law clause is no easy task. To me, courts could look at this one of three ways:

(1) Has the legislature enacted a clear statement of public policy? This is the easy analysis, because legislatures typically bear the laboring oar of setting forth public policy choices. As a result, states that have strong legislative enactments on non-competes - California, North Dakota, and Oklahoma on the employee side; Florida on the employer side - present obvious examples of when parties will have to confront critical choice-of-law issues.

(2) Have courts expressed a consistent, widely applied rule that clearly expresses a public policy choice? This becomes more nuanced because non-compete cases are so fact-specific. But, taking the blue-pencil rule as an example, if a state's case law shows a uniform pattern where courts are unwilling to rewrite or modify overbroad covenants, this may rise to the level of a public policy sufficient to invalidate a choice-of-law clause. Illinois, for instance, has suggested in recent years that despite its black-letter principle of allowing modification of overbroad non-competes, public policy considerations may not allow a court to do the work an employer should have done when drafting contracts.

(3) Could the difference in state law change the outcome? This approach would take a broader view of public policy, and to me it's not the proper analysis. For instance, in some (but not all) states, "continued employment" is sufficient consideration to enforce a non-compete signed after the start of employment. Certain states seem to have broader pronouncements that a non-compete cannot extend to "prospective" customers. To be sure, these are significant differences depending on the facts of the case, and they well may be dispositive in litigation. But they are really at the edges of a state's public policy as to enforcement. Courts long have recognized that mere differences in a state's law don't rise to the level of a strong public policy.

Judge Hamilton seems to subscribe to the second approach, and he views a state's willingness to rewrite non-competes as a strong enough choice to implicate public policy concerns. Ultimately, this may signal the Seventh Circuit's willingness to examine choice-of-law issues more carefully and retreate from prior decisions where the court seemingly has deferred to a choice-of-law clause as long as it has some connection to the dispute.

In Tradesmen, I didn't make an issue out of choice-of-law for the simple reason that Tradesmen never could point to any evidence my clients breached any agreement. The issue was, to be frank, moot and not worth spending a nickel of legal fees over. Had my clients decided to challenge the enforceability of the contracts, then certainly choice-of-law would have been a more significant legal issue to consider.

Monday, August 5, 2013

Seventh Circuit: Test for Determining "Bad Faith" In Trade Secrets Case Is Common Sense

This is a case I know a little something about.

When Tradesmen International sued my clients in May of 2010 , the outcome was already clear. The claims were garden-variety; the facts weren't. The individual defendants moved out of state to avoid the territorial restriction of their non-compete contracts to form a new business that supplied labor to the construction industry.

Tradesmen elected to take the dreaded shotgun approach to litigation. Instead of honing in on the contract-based claims (which it was destined to lose), it made a broad allegation of trade secrets theft. In particular, it claimed that Dun and Bradstreet reports - purchased through a commercial service for a fee and which some of the defendants had access to - were "trade secrets" that independently barred my clients from competing.

There were a couple of, to put it mildly, problems with this theory:

1. Anyone can buy Dun and Bradstreet reports, which my clients did after they left Tradesmen.

2. Tradesmen took virtually no steps (I say, none) to preserve the "secrecy" over these reports (for good reason; such security measures would yield no marginal benefit given their availability).

3. Tradesmen admitted my clients never used the reports they had at Tradesmen to build their business.

(Actually, there were tons of other problems, but I'll have to simply ask you to check out the briefs I filed. I can't do justice in a blog post to this train-wreck of a case.)

So when the defendants successfully obtained summary judgment, I moved for my legal fees under the Illinois Trade Secrets Act. Like many versions of the Uniform Trade Secrets Act, the Illinois version allows for fee-shifting if a plaintiff makes a claim of misappropriation in "bad faith." To me, there was virtually no doubt Tradesmen pursued its claim in bad faith, but Illinois courts never addressed how this provision should be interpreted. And the district court judge had no guidance.

Ultimately, Magistrate Judge Bernthal addressed a novel issue of Illinois law and ruled the trade secrets claim had to have been "filed" in bad faith rather than "maintained" in bad faith. That later was the essence of my argument. In short, I argued a more flexible standard was appropriate since trade secrets claims have the capacity to serve anti-competitive goals, as exemplified I felt by Tradesmen's litigation conduct.

The Seventh Circuit agreed and reversed the district court order. A copy of the Opinion is embedded below. The court held that a defendant is liable for fees if it filed or maintained a trade secrets claim in bad faith. More particularly, the court stated "common sense" supports such an interpretation because "a plaintiff makes a claim in bad faith if she continues to pursue a lawsuit - even after it becomes clear that she has no chance to win the lawsuit - in order to cause harm to the defendant." Because the district court had used a narrow, "point-of-filing" inquiry, it didn't consider the proper range of factors bearing upon bad faith. And it didn't examine the "no chance to win" scenario that I felt should have been the focus of the bad faith motion.

For my clients, the issue is of obviously of great significance. But for the law, what's the impact? In my mind, a couple of considerations come to mind:

First, trade secrets plaintiffs have a greater incentive to investigate and develop their claims. They cannot, in other words, hide behind what they believed to be true at the time of filing the lawsuit and then sit back and tax the defendants in the form of lawyer's fees to achieve a win. This should encourage greater scrutiny over claims that pose a great risk of serving an anti-competitive purpose and will require a continuing reassessment of a case during litigation. In my appellate brief, I discussed this at length and argued for a flexible inquiry that takes into account the unique dynamics of trade secrets suits.

Second, fee hearings at the conclusion of a lawsuit will require a district court to be flexible in what factors it considers. Courts normally consider both objective and subjective factors to determine bad faith. In other words, what did the plaintiff do and what did it say? The inquiries overlap to a great extent, because often times the best evidence of intent is the lack of merit. With a broader standard to consider, courts will have to examine the record, the development of the claims, discovery answers, litigation conduct, and a failure of proof on key elements to establish the cause of action.

Third, if a defendant claims a suit has been "maintained" in bad faith, it must be prepared to make an articulable, intelligent analysis of when the bad faith began. Put another way, it will need to look at key moments of the lawsuit and identify that point when a continuum of "bad faith factors" coalesces into actual bad faith. This likely means a fee hearing will be a combination of evidence presentation (a mini-trial of the plaintiff's low moments, in other words) and legal argument.


In my next post, I'll discuss the Seventh Circuit's analysis of Tradesmen's overbroad non-compete agreement and how some of the key facts in my case played into the court's extended discussion as to contract enforceability.

Wednesday, July 31, 2013

Revisiting "Damage" and "Loss" Under the Computer Fraud and Abuse Act

The Computer Fraud and Abuse Act is organized about as logically as David Foster Wallace's sprawling masterpiece, Infinite Jest.

For literary fiction, that might be fine. For federal statutes, it's a disaster.

As a result, courts and commentators long have struggled over what parties must prove to establish an actual civil claim under the CFAA. And a great deal of the confusion and disagreement concerns the twin concepts of damage and loss.

At first blush, the terms sound like synonyms. But they're not. For purposes of the CFAA, each term has a precise definition.

The basic confusion has arisen because to state a civil claim, a party must have suffered "damage or loss" by reason of a substantive offense. To compound problems, certain substantive CFAA provisions require a party independently to show "damage," which renders the either/or structure a bit confusing. And a textual reading of the CFAA seems to show that in all cases (really, in all cases that deal with unfair competition) a plaintiff must show compensable "loss."

In other words, it's a total nightmare.

Or is it?

In my opinion, the concepts of damage and loss are complimentary pieces that fit together. They're not substitutes. But to understand this, it's critical to keep in perspective the overall purpose and set-up of the CFAA.

What the CFAA Does (and Doesn't) Protect?

Attorneys too often view the CFAA as a federal trade secret substitute. In other words, attorneys who want the muscle of a federal court try to shoehorn a trade secrets (or duty of loyalty) case into a CFAA violation if they determine a computer somehow was involved in facilitating the underlying act (usually, the downloading of documents). As a result, a large majority of CFAA claims in the employment context never quite fit the elements of the statute.

The CFAA protects a party from damage to computer systems (including files and programs), outside hacking, and theft of computer data. That's it. It is not a broad federal statute that displaces a wide range of contract- and tort-based claims typically reserved for state courts. And because computers are omnipresent in the way parties deal with each other, a broad CFAA construct could have the effect of federalizing competition claims well outside the statute's intent. This is part of the ongoing dispute over the CFAA's reach, a subject on which I and countless others have written.

The Concept of "Damage"

The definition of "damage" under the CFAA is decently plain. Damage is simply the impairment to the availability or integrity of data. For example, if an outsider hacks into a network and causes the deletion of files from a server, this would constitute damage. If an insider copies confidential information that otherwise remains available, this would not constitute damage because the data is still available. I'll return to this, but the word "integrity" is the key to unlocking the confusion that has arisen over when certain conduct causes damage.

Here's an easy way to understand "damage" for CFAA purposes: it's the type of injury the statute was designed to cover. As I'll discuss, the relatively limited statutory definition becomes confusing when applied to data theft cases.

Defining "Loss"

"Loss" is not the same as damage. Where damage defines the nature of the harm, "loss" covers what is compensable arising from that harm. Loss covers either: (1) costs in restoring a computer system, programs, or files; or (2) revenue lost due to an interruption in service.

A couple of examples may help clarify. If an outside hacker launches a denial-of-service attack on an e-commerce website, he can be liable for the revenue lost attributable to server downtime. Similarly, if an insider destroys the only copy of files on a shared server, she can be liable for the costs the company spends to hire a forensic technician to recover those files. These are the classic CFAA offenses.

Understanding the Types of CFAA Cases

The problem in fitting together the concepts of "damage" and "loss" arises from the predicate to Section 1030(g). This is the section of the CFAA that enables a private party to assert a civil claim.

The predicate starts off by stating unambiguously that a party "who suffers damage or loss" for an enumerated offense can maintain a civil cause of action. In reality, that language is either unnecessary or improperly worded. I maintain it's unnecessary.

The Destruction or Hacking Cases

Several provisions of the CFAA independently require a civil plaintiff to show "damage." I refer to these provisions, for simplicity sake, as the data destruction or hacking offenses. They are contained within Sections 1030(a)(5)(A)-(C). By and large, these sub-sections of the CFAA are easy to understand. They include the paradigms I described above: the outsider launching a denial-of-service attack and an insider destroying files.

In these fact patterns, which Section 1030(a)(5) clearly is designed to redress, a court first assesses whether the activity gives rise to "damage" - that is, data or system impairment - and then looks to whether the plaintiff can establish "loss." It makes little sense to view this as an either/or proposition because loss (response costs or lost revenue due to an interruption in service) flows naturally from damage. If a party can show damage, it will show loss (unless the amount is so trivial as to fall short of the CFAA's modest $5,000 jurisdictional minimum).

The Theft Cases

The other provisions of the CFAA that are frequently at issue in competition cases are Sections 1030(a)(2) and (a)(4). Those sub-sections have caused a great deal of dispute among federal courts because of the concept of "access" and whether "unauthorized access" includes misuse of data. Aside from that, both sub-sections generally provide a remedy if a party lacks proper access (however interpreted) and obtains information from a computer either with or without an intent to defraud.

The best way to look at these provisions of the CFAA is that they serve different ends than the destruction or hacking provisions of Section 1030(a)(5). In other words, Sections 1030(a)(2) and (4) provide a remedy for civil theft out of a computer. In the context of these claims, a party is not going to show "damage" to a computer because the very nature of the offense doesn't contemplate system downtime or lost files - unless we reinterpret "damage", which I argue below we must. Rather, the claim deals with the taking of information (trade secret or not). But, by virtue of the claim, the owner still has the same data (or else it simply would be a Section 1030(a)(5) claim).

From my perspective, a plain reading of the CFAA requires a plaintiff to show loss in virtually any CFAA case involving unfair competition. But since loss appears limited to damage assessment, recovery costs, and lost revenue due to a service interruption, assessing loss in a "theft" case is much more difficult to grasp. The computer isn't damaged; the data isn't gone; and the server hasn't crashed.

For this reason, courts seem to have stretched the meaning of "loss" to include the cost of retaining a forensic expert to track wrongdoing. And in the context of a CFAA theft case under 1030(a)(2) and (a)(4), this may be a "cost responding to an offense." But it's awfully difficult to fit that into the definition of "loss" unless we do more work to reconcile the CFAA as a whole. This issue receives little attention because there's so much noise surrounding the other elements of a theft case, in particular whether the term "unauthorized access" can apply to insiders who have credentials to use a computer system but act in ways contrary to their employers' interests.

Reconciling "Damage" and "Loss" Under the CFAA

As it stands, here's what seems clear. For a hacking or data destruction case under Section 1030(a)(5), a plaintiff must show damage and loss. This is based simply on a textual reading of the statute. Loss should flow naturally from damage. These are not difficult cases to understand, which is hardly a surprise given that they fall within the statute's prime focus.

A theft case is different. A plaintiff needs to show a loss, but it does not have to show damage. That much also seems clear from the plain language of the statute. Practically speaking, though, should it prove damage? I think so.

But to do this in a theft case arising under Section 1030(a)(2) or (4), a court would have to interpret "damage" as a compromise to the manner in which data was stored or protected. Arguably, this is consistent with the statutory definition, which references an impairment to the integrity of data.

Then, of course, the plaintiff still would need to show a loss. To me, it's difficult to argue loss without showing damage because (as I've noted) the concepts seem to be complements - not substitutes. Plaintiffs have figured this out by engaging forensic firms to track unauthorized access and stolen information out of a protected computer. I'm not totally convinced this is an expense that qualifies as a "loss," but if courts expand the definition of damage, then I guess "loss" would have to include investigation expenses. Regardless, it's not a totally unreasonable reading of the statute to include these expenses.

Ultimately, courts have little choice. They have to expand the definition of damage to give meaning to Section 1030(a)(2) and (4). Otherwise, if damage and loss are given a narrow reading, there's no claim under the CFAA for theft cases. It's easy to say now that the definitions simply don't match up, but it would be absurd to find there's no way to define damage for theft cases.

This expansive definition of damage may solve the riddle that confronts cases involving theft of data. More to the point, it demonstrates precisely why CFAA theft cases (as opposed to hacking or data destruction cases) should be limited to access by outsiders - those who truly don't have the credentials to access data in the first place. This is another way of saying the narrow view of what unauthorized access means is consistent with the purpose of the statute and in particular the concepts of damage and loss. Otherwise, the CFAA is little more than a substitute for state laws that already govern trade secrets theft and breach of the duty of loyalty. And given that the CFAA contains broad criminal sanctions, this is an interpretation courts should be very hesitant to adopt.

Wednesday, July 24, 2013

Trade Secrets Whistleblower SLAPPed In Effort to Dismiss Lawsuit

Several weeks ago, John Marsh, Russell Beck, and I discussed on the Fairly Competing podcast the special problems that arise when companies pursue so-called "whistleblowers" for trade secrets misappropriation.

As John wrote on his blog this Spring, such suits may have the unintended consequence of giving the whistleblower a public forum to air her grievances and enable her to draw attention to facts that are potentially embarassing or harmful to the company.

One of the issues that can arise concerns the whistleblower's claim that her activity is protected under the First Amendment. Many states, including California and Illinois, have anti-SLAPP statutes that enable parties who face frivolous strike suits to pursue an early, special motion to dismiss. (SLAPP is an acronym for "strategic lawsuit against public participation.").

This procedure generally allows for: (1) consideration of matters outside the pleadings themselves; (2) a stay of discovery; and (3) mandatory cost- and fee-shifting. Traditionally, SLAPP suits (and anti-SLAPP) motions arise from defamation claims brought against a group of citizens, or notable citizens who have spoken out on a public issue. But they can arise from claims of trade secrets theft, because disgruntled employees often feel as though the public has a right to know of certain non-public information concerning a company's business practices, services, or products.

In our episode of Fairly Competing, John, Russell, and I discussed a particularly interesting suit in California in which James Clark accused Anheuser-Busch (his ex-employer) of filing a SLAPP suit. According to Clark, A-B sued him after he participated in (really, initiated) a class action related to the A-B's supposed mislabeling of alcohol content on its beer products. A-B's claim was for trade secrets misappropriation, arising out of Clark's supposed taking of beer specification sheets and other materials before he left A-B, which arguably were instrumental in the development of the class action suit.

Last week, the California court denied Clark's special motion to dismiss, finding that the trade secrets suit was not a SLAPP under California law. The Court determined Clark's protected activity - that is, participating in the class action against A-B - was "merely incidental" to the claims of trade secrets misappropriation and therefore beyond the anti-SLAPP law. Put another way, A-B's claims stood on their own without reference to the class action suit.

The court's ruling reflects the narrow set-up of California's anti-SLAPP law. In particular, California law does not specifically cover claims brought "in response to" government petitioning activity. Had such a provision been part of the statutory scheme, the court may have considered a number of other factors bearing upon A-B's claim. Illinois' anti-SLAPP law, for instance, is much broader, in that a responsive or retaliatory claim may fall directly within the statute. Courts in Illinois consider on a case-by-case basis whether the suit is truly relatiatory and will examine "retaliatory intent."

However, the court in the A-B case stated that "evidence of [A-B]'s motivation does not establish" that its claims "arose from Defendant's protected activity." The court's decision not to consider subjective intent may be surprising given the nature and purpose of anti-SLAPP laws. As a practical matter, this objective analysis has the effect of requiring courts to assess the nexus, or fit, between the underlying claim and the allegedly retaliatory claim. If the former has an independent factual and legal basis, then it does not "arise from" petitioning activity.

The court did not consider a relatively recent amendment to California's anti-SLAPP law, Section 425.17 of the California Code of Civil Procedure. That section, enacted to prevent "a disturbing abuse" of the anti-SLAPP law, meant to exempt certain actions arising from certain commercial statements or conduct.

The provision is densely worded and may not have directly fit the A-B/Clark dispute. But, at the very least, it recognizes in the SLAPP context the principle that commercial speech generally has more limited protection under the First Amendment compared with non-commercial interests. In this sense, California seems to be shifting away from allowing anti-SLAPP motions if they do not truly concern a matter of important public interest.