Wednesday, February 27, 2013

My Thoughts on Michigan's Proposed Non-Compete Legislation

What do Michigan and New Hampshire have in common, besides being two more states Mitt Romney couldn't carry?

They have proposed or enacted legislation that restricts the use of so-called "afterthought" non-competes. This is a subject of frequent litigation and relative disagreement among the states that have considered the question of whether a non-compete that is based on no more consideration than an employee's "continued employment" is enforceable. The debate and scholarship on the issue goes back a long way.

Michigan's proposed statute, Senate Bill 786, is embedded below. But in essence, it's fairly simple. A court can't enforce a non-compete if the employer did not inform the employee of the restriction before the initial offer of employment.

This is similar to the New Hampshire legislation that passed in early 2012, which required a notice period to make the non-compete effective. A couple of remarks.

First, is the bill good for employees? Clearly, no, in two respects:

(1) It encourages employers to draft overbroad covenants in initial employment agreements before an employee may have robust customer contact or access to truly secret information. These employees may not otherwise face having to sign a contract with non-compete restrictions. Employees who advance within an organization often times receive new agreements as they advance. But in light of this law, employers likely are going to be overinclusive in the scope of restraints contained in an initial agreement. Because the mere presence of such covenants deters employee mobility, lower-level employees likely will be most impacted by the enactment of a law like this.

(2) It discourages promotions. If an employer elects not to include a non-compete in an employment contract, then the text of the legislation suggests that an employee may not be able to sign a covenant in connection with receiving a promotion. Count me in as one who is skeptical a court may give this statute such an interpretation, but others clearly believe that to be the case. If the stricter interpretation is correct, then companies will have to look elsewhere to find talent and will be hesitant to promote from within the ranks. Because external hires result in more transaction costs (that is, headhunter fees, higher salary and sign-on perks, opportunity cost associated with training), companies are likely to reduce pay or other incentives to existing employees.

Second, what steps could employers take to circumvent the statute? From my perspective, and beyond voting out any legislator who supports this tripe, the simple cure is to provide by contract when the non-compete takes effect. For instance, the non-compete may be conditional and not effective until an employee achieves a certain status within the company (which could be an identification by rank, pay, gross sales, or some other objective metric). I also believe it may be okay if an initial contract that does not contain a non-compete simply states that any promotion will require execution of a new contract with a non-compete. That would seem to satisfy the condition under the statute that the employee have prior notice that such a covenant will be required. These are the gray areas lawyers would love to litigate, but that no legislator would even think of considering.

Employees are better served by arguing lack of consideration as part of the overall non-compete "reasonableness" analysis. Per se rules and arbitrary legislative fixes like this often do more harm than good because they tend only to address cases at the extremes, and most cases are somewhere in the middle. That's the case here.

Friday, February 22, 2013

Broad Federal Policy Favors Arbitration Agreements, Can Extend to Non-Parties

With the Supreme Court last year strengthening the case for the arbitratrion of non-compete disputes, count me in as one who is fairly confident we're going to see businesses utilizing such clauses more in employment and personal services agreements.

Which begs the question...To what type of non-contract claims does the clause apply? And are third-parties bound?

The answer to the first question is generally fairly straightforward. The federal policy (expressed in the Federal Arbitration Act) generally pushes strongly in favor of arbitration, with courts resolving doubts about scope towards arbitrability.

What does this mean in practice? Let's take an example. Assume a clause provides for arbitration of claims "arising out of" the employment relationship. Then, it seems fairly clear that not only would a non-compete violation be arbitrable, but so would a common-law claim for breach of the duty of loyalty (or a statutory claim like trade secrets misappropriation). So, too, would a claim for violating my least favorite statute, the Computer Fraud and Abuse Act (as recently decided in Torbit, Inc. v. Datanyze, Inc., 2013 U.S. Dist. LEXIS 19584 (N.D. Cal. Feb. 13, 2013)). The general test is pragmatic and consistent with the scope of the FAA's reach: claims having a significant relationship to the contract are arbitrable.

The second question isn't quite so simple. To whom does it actually apply? In non-compete cases, it is very common for a business to sue a former employee's new company, most frequently on the theory it has interfered with an employment covenant and induced a breach. Does a broad arbitration clause apply? Or can a business split its claim, one against the employee in arbitration and one against the new company in court.

A non-party can compel arbitration because estoppel principles generally preclude one party (i.e., that seeking to enforce the contract) from asserting the benefits of the agreement while disclaiming other burdens under the agreement. Generally, if the claim against a non-party derives from the agreement itself, then the non-party can compel arbitration. Put differently, if the conduct of the non-signatory is substantially intertwined with the conduct of the signatory, a court's going to compel arbitration.

The relatively easy cases involve interference with contract (the non-compete covenant), because without the contract term, there's no tort. The closer cases for arbitration involve other torts that may exist independent of the contract. For instance, a business may have a dispute against an employee for violating his employment agreement, and may join into that case a dispute against the individual's current employer for deceptive trade practices (such as impermissible disparagement of a competitor's goods or services). If that's the only claim asserted, and there's no logical tie-in to the employment contact, the non-signatory may have a difficult time getting standing to compel arbitration.

Wednesday, February 20, 2013

Some Thoughts On Pursuing Expedited Discovery

Most non-compete (and some trade secrets) cases are effectively decided at the preliminary injunction stages. For counsel, this means that a significant part of the lawsuit must be tried quickly and with great efficiency.

Courts are used to parties making requests for "expedited" discovery in advance of the normal timeframes during which discovery usually is permitted. Discovery is necessary, because in competition cases, it is very hard for a plaintiff to prove a case without seeing what the defense has. In federal court, the standard is flexible - a party must show "good cause" to demonstrate the need for expedited discovery.

My experience has been that parties don't think through expedited discovery requests carefully enough, and as a result they can imperil their shot to get the most relevant facts introduced for the court on a preliminary injunction motion. At least in federal court, a substantial number of injunctions are decided on the paper and not on live witness testimony.

Based on my observations, here are some important steps for plaintiffs to take when seeking expedited discovery:

(1) File the motion at the same time as (or after) the motion for preliminary injunction. If a plaintiff has filed a motion for preliminary injunction and provided some evidentiary materials for the court to assess, a court is much more likely to understand the need to "complete the factual picture." Seeking expedited discovery without a preliminary injunction motion may lead the court to conclude there is no urgency to the case and no reason to speed up the discovery process.

(2) Narrowly tailor the requests. This is what dooms most expedited discovery motions. A couple of points here. First, don't include standard, form requests. Specific discovery requests should be customized to flesh out the facts laid out in the allegations that are most critical to the injunction hearing. Second, don't overshoot with requesting an inspection of personal devices. If the plaintiff can make a showing a particular device was used to download confidential information, then certainly the plaintiff may seek discovery on this device. But avoid a scattershot approach seeking all devices that the defendants may have used. This likely will be seen as too broad. Third, always attach draft discovery for the court so that it can assess the scope of the requests.

(3) Explain the need for discovery. This may seem obvious, but I have encountered too many motions that assume a court will grant expedited discovery without laying out the need for it. Competition disputes are characterized by each party's attempt to keep certain information from the other. Courts need to understand both what it is the plaintiff knows and what it can't know. If a plaintiff has been able to uncover some preliminary facts suggesting, for instance, a breach of a non-compete, the court should be told why it can't obtain other core facts without the use of court process. I would suggest, though, a brief of no more than 3 to 4 pages. Courts have enough to read, and the filing should get right to the point.

(4) Propose a protective order. The plaintiff should also consider preparing a form protective order to submit to the court along with an expedited discovery motion. This order will govern the exchange of discovery material. Since discovery likely will seek non-public, business information, it is easy for the defense to stall on discovery until such time as an order is entered. It is best to get out in front of this by providing a draft order that can be negotiated and entered quickly. The plaintiff may even consider requesting in a motion for entry of a protective order that the court require the parties to meet and confer over its terms within a certain number of days. Drafting a protective order right away is particularly important if the plaintiff intends to subpoena third-parties right away.

(5) Consider laying out a proposed schedule. Courts have to be convinced expedited discovery is appropriate. A plaintiff may increase its chances of obtaining expedited discovery by laying out for the court a schedule that is fair and mutual to both sides. A plaintiff should consider proposing limits on the number of written discovery requests, the number of party and non-party depositions, and the length of depositions. By doing this, the court will be assured that the plaintiff is not engaging in a broad, expensive fishing expedition.

Monday, February 18, 2013

Episode 2 of Fairly Competing: The Prosecution of Aaron Swartz

Our second Fairly Competing podcast, "The Prosecution of Aaron Swartz," is now available for download.

In this episode, John Marsh, Russell Beck, and I discuss the prosecution of internet activist Aaron Swartz under the Computer Fraud and Abuse Act. We also discuss the policy behind the CFAA, and in particular the criminalization of terms of service violations. Finally, we discuss proposed legislation and efforts to modify the CFAA in the wake of this tragic story.

You can listen to the podcast by clicking the link below. Or subscribe to the podcast on iTunes. We'd appreciate your feedback, and if you like the podcast, please give us a 5-star rating in the iTunes Store!

Our next podcast will summarize non-compete legislative updates across the country.

Listen to this episode

Thursday, February 14, 2013

Ninth Circuit Vacates MGA's Trade Secrets Counterclaim Award

The long-running dispute between Mattel and MGA Entertainment is one of the most notable, costly competition cases of the last decade. As most readers probably know, Mattel makes the popular Barbie line of dolls and sued its former designer, Carter Bryant, who allegedly conceived of the Bratz line of dolls while working for Mattel. Under his invention assignment agreement, Mattel would have been entitled to exploit these ideas and designs.

After Mattel won a large damages award, the Ninth Circuit Court of Appeals reversed and found numerous errors. Only after the case was remanded back to the district court did MGA submit a trade secrets counterclaim. When the case was retried, Mattel was far less successful, losing its principal claims and also suffering a judgment against it on the newly asserted counterclaim of $172 million.

A few weeks ago, the Ninth Circuit again reversed and found MGA's trade secrets counterclaim never should have gone to the jury. The rationale? It was not compulsory, as it was not logically related to the copyright claim. In essence, MGA's counterclaim rested on the theory that Mattel's employees posed as buyers at toy fairs and improperly gained access to confidential information through deception. This wasn't part of the principal claims in the case. A counterclaim-in-reply can only be submitted to the jury if it's compulsory.

So MGA has to start all over again on its counterclaim, which certainly will lead to another appellate chapter in this long-running saga.

California, where the suit is pending, has adopted the Uniform Trade Secrets Act, and the UTSA generally sets forth a 3-year statute of limitations for trade secrets claims. However, there are a few exceptions. States that have modified the uniform act to allow for a 5-year limitations period are: Georgia, Illinois, and Missouri. States choosing a 4-year period are: Maine, Nebraska, Ohio, and Wyoming. And Alabama maintains a 2-year statute of limitations for trade secrets actions. The non-UTSA states (Massachusetts, New York, and Texas) each adopt a 3-year period.

Tuesday, February 12, 2013

Non-Compete Case Law Update: The Mildly Interesting, But Useful, Edition

The new year is off to a pretty big start. We've already seen significant decisions from federal appellate courts on criminal trade secrets prosecutions and the epic Mattel/MGA "Bratz" dolls dispute. We have a looming debate over amendments to the Computer Fraud and Abuse Act, and pending legislation in Massachusetts concerning non-compete agreements.

But there's other activity in the trenches - the sort of routine work that parties and courts continue to crank out that don't necessarily generate headlines. Over the past few weeks, I've noticed some lower court decisions come through that are significant in their own right.

Trade Secrets Preemption in New Jersey

Last year, New Jersey became the latest state to adopt the Uniform Trade Secrets Act. Like all versions, the New Jersey Act displaces conflicting remedies based on claims of trade secrets misappropriation. However, the language of the statute preserves other common law rights and remedies, such that its text is not directly comparable on the issue of preemption in other states. As a result, New Jersey courts have not yet subscribed to the view that other civil claims are not preempted. This is an odd result, and the statute may be in for revision since it's near impossible to reconcile the preemption clause with the savings clause. The case discussing preemption is unreported and not binding on any other New Jersey court, SCS Healthcare Marketing, LLC v. Allergan USA, Inc., 2012 N.J. Super. Unpub. LEXIS 2704 (Sup. Ct. Ch. Div. Dec. 7, 2012).

Injunction Bonds

I have written in the past on the considerations underlying the need for an injunction bond - effectively, security for a preliminary order later deemed wrongfully entered. Federal courts have to consider the amount of security when entering a temporary restraining order or preliminary injunction. The case of Smiths Group, PLC v. Frisbie, 2013 U.S. Dist. LEXIS 9445 (D. Minn. Jan. 24, 2013), looked at a high-level executive's prior year's salary and ordered security in that amount as a condition for enforcing a one-year non-compete covenant.

Dischargeability of Debts Arising Out of Non-Competes

Damages claims against ex-employees often intersect with bankruptcy law. For a defendant found to be in breach of a non-compete, an award of lost profits may greatly exceed the defendant's ability to pay. As such, the specter of bankruptcy is always at the fore. A debt is not dischargeable though if it is a result of a "willful and malicious" injury to another entity or its property. In an adversary proceeding, a hair salon, contending a departed stylist's non-compete debt was non-dischargeable, was unable to show she willfully injured her ex-employer. The court focused on two factors: (a) the employee was terminated and therefore may have breached the agreement not to injure her ex-employer, but rather to pay her bills; and (b) she obtained the names of her customers largely from Facebook, the White Pages, and her memory. Finally, the court determined that the hair salon could not establish that as single customer even left, thereby indicating it suffered no real injury. Though the "willful and malicious injury" test is flexible, this was a clear case where some of the equities strongly favored the employee. The case is In re Rhoades, 2013 Bankr. LEXIS 157 (S.D. Oh. Jan. 11, 2013).

Friday, February 8, 2013

The Fairly Competing Podcast Launches

I am very pleased and excited to announce the start of Fairly Competing, a Competition Law Podcast.

It is a great privilege to join forces with two of the leading commentators in the field of unfair competition law, John Marsh and Russell Beck. The three of us will offer regular discussion about the leading news and developments in the areas of trade secrets, non-competes, computer fraud, and other emerging competition law issues.

John, Russell, and I just completed "Episode 1: The 2012 Year In Review," which you can listen to below by clicking play on the link below or by visiting here. The podcast also is available for subscription on iTunes and soon will be on Stitcher. I'll be providing updates on this blog and on Twitter to alert readers when new podcast episodes are available.

We have a list of interesting, informative topics on the way, and we'll next be discussing Aaron Swartz and the Computer Fraud and Abuse Act.

Though Episode 1 is around 40 minutes or so, we expect future podcasts to be in the range of 20-25 minutes, covering one topic per episode. I hope you enjoy the podcast, and I would love to hear any thoughts or comments you have!

Listen to this episode

Wednesday, February 6, 2013

Sixth Circuit Reverses Sentence of Engineers' Convicted of Trade Secrets Theft

In December of 2011, Clark Roberts and Sean Howley, two engineers at Wyko Tire Technology, were convicted by a jury for stealing trade secrets, a crime under the federal Economic Espionage Act (EEA). The trade secrets related to Goodyear's tire-assembly machine technology. Roberts and Howley had access to this technology because Wyko was a supplier to Goodyear. Wyko had been approached by a Chinese company, HaoHua, to supply a number of tire-building parts and stood to benefit greatly from this supply contract.

There was a problem, however. Wyko wasn't quite sure how to do the job, and its draft designs had serious problems. So when Goodyear asked Wyko to repair some tire-assembly machines, Roberts and Howley saw an opportunity and took photographs of some key devices used on the Goodyear machines. These photos (presumably) were going to help Wyko close its knowledge deficit and avoid potential penalties under its supply agreement with HaoHua. Wyko uncovered the improper activity, alerted Goodyear, and Roberts and Howley eventually were convicted.

Earlier this week, the Sixth Circuit Court of Appeals upheld the EEA convictions, but found that the sentences imposed were procedurally improper. At trial, federal prosecutors had pushed for the engineers to receive at least ten months in prison. But some of the testimony backfired, as Goodyear's expert witness arguably did not document his economic loss calculations that well. Federal law allows a court to consider a victim's economic loss as a result of the crime, which makes sense in a crime that is essentially financial. In this case, the loss would have been the impact on the value of Goodyear's trade secrets.

As a result of the testimony and mitigating evidence presented by the defendants, the district court sentenced Roberts and Howley to home confinement, community service, and probation.

The Sixth Circuit found that wasn't correct. It held the district court did not account for a "reasonable estimate" of Goodyear's loss. In particular, the court noted that even the low-end estimates offered by Goodyear yielded a sentencing guideline within the range of 3 to 4 years in prison. Also, the district court's finding of, essentially, "no loss" was inconsistent with the element of the crime that the stolen trade secret have some independent economic value from its secrecy. As a result, the district court needed to provide an estimate of economic loss and the reasons for its findings.

The case is significant, in my mind, for three reasons. First, Judge Sutton's analysis affirming the EEA convictions gives a nice summary of security measures that companies often undertake when dealing with vendors who have access to confidential information. Second, the case itself (apart from the issues on appeal) demonstrates the increasing specter of criminal liability in cases of trade secrets theft - particularly when the theft is intended to benefit companies outside the United States. And third, the decision shows that district court's have wide latitude, and an independent obligation, to assess a victim's economic loss even if the victim itself presents an estimate that might not be admissible under the rules of evidence.

Monday, February 4, 2013

Once Again, Selective Enforcement Defense Is Unconvincing

I've written in the past why the "selective enforcement" defense rarely - if ever - seems to work in non-compete litigation. For those who don't recall, the defense is based on the idea that if a company does not enforce a non-compete agreement against a previous employee who left to compete, it can't enforce it against later departing employee.

So why doesn't it work? The defense is really based on waiver, which requires an employee to show an "intentional relinquishment of a known right." That's a tall order of proof. And in cases where an employee is trying to show an implied waiver, the standard of proof is even higher. He must show that the suggestion of waiver was "clear, unequivocal, and decisive." Put another way, there can't be another explanation for the conduct.

Those aren't my words. They're straight from a summary judgment order in Custom Hardware Eng'g & Consulting, Inc. v. Dowell, 2013 U.S. Dist. LEXIS 8904 (E.D. Mo. Jan. 23, 2013), out of the Eastern District of Missouri.

From a practical perspective, the defense of selective enforcement doesn't make a whole lot of sense. The biggest hurdle to the defense is that it's entirely collateral to the action and improperly focuses the court on employees who aren't even part of the case.

In particular, assessing the defense would require the court to approve a wide range of discovery into the following subjects:

(a) former employees who had agreements and what occurred with them post-termination (degree of competition between employers, customer solicitation, disclosure of confidential information);

(b) the relative value of those former employees compared with the employees asserting the defense;

(c) the particular reasons for the former employees' separation of employment;

(d) contract formation or consideration problems relating to former employees' contracts.

That's just a start. A court could get bogged down in litigating a "case within a case" to see whether the comparison-employees and defendant-employees were even similarly situated.

A business may have a lot of reasons not to enforce a non-compete, the most obvious being that in certain cases it makes no economic sense. Suppose a former employee with a non-compete engaged in a relatively minor breach by, say, soliciting a handful of small accounts for a product or service that was marginally competitive. The company may, correctly, determine that pursuing that employee wouldn't yield a net positive economic return. And there may be mitigating circumstances, too, that would make it difficult to prevail. Approving the selective enforcement defense would, therefore, encourage wasteful, economically inefficient litigation.

A company's decision not to enforce shouldn't have any impact on enforcement against another employee in the future. Courts rightly determine that each non-compete case is different, and that every employee's situation is unique. If that's truly the case, then the only proper use of the waiver defense is when a company indicates to a specific employee that his agreement won't be enforced and then sues anyway.

Friday, February 1, 2013

IBM Suit Over Corporate Raiding Illustrates Use of Social Media Evidence

IBM has launched an assault against Virginia-based competitor, Computer Sciences Corporation, charging it with instituting a raid on its Finance Department through a departed IBM executive, Christopher Greiner.

The Complaint, filed in the Southern District of New York, alleges that Greiner was the de facto recruiter for CSC in its attempt to shore-up its finance department, allegedly wounded in the wake of an SEC investigation into financial reporting.

IBM alleged a detailed set of facts that illustrate just how prevalent issues of social media and electronic evidence have become in proving liability in non-compete cases. Greiner's agreement not to solicit his fellow IBM co-workers (a covenant contained in an equity incentive plan) is of obvious importance to IBM, because an executive employee who leaves can use his or her goodwill and knowledge of an employee base to recruit away a stable of management level employees. Similar covenants are of less value to lower-level sales employees.

Greiner was allegedly caught using an internal IBM messaging system that demonstrated his contact with IBM employees about job opportunities outside IBM. Those communications - copied verbatim into the Complaint - can have a powerful impact on a judge considering injunctive relief. The relative informality of social media communications often leads to flippant remarks that go over poorly when a third-party reads them.

Greiner also allegedly sent a LinkedIn communication with another IBM employee in an attempt to lure him to CSC. Such in-mail contacts are more and more common, as employees seem to think that such communications simply won't be discovered.

The Complaint, embedded below, is worth a read - if for nothing else in that it establishes how to lay out a factual story about a corporate raid. True, many poaching cases don't seem to involve the number of actors that are laid out here, in fairly compelling detail. But a judge would be hard-pressed not to issue an injunction after reading a pleading like this.

And that's pretty much what happened. Greiner submitted an Affidavit stating he wouldn't solicit or hire IBM employees for almost two years. So the Court had little trouble enjoining him.

One other fact is important.

IBM alleged that Greiner and other CSC employees signed similar non-solicitation agreements. What IBM was trying to indicate was that such agreements are standard among skilled executives and that they, therefore are reasonable post-termination restrictions. Evidence of an industry standard is perhaps the most compelling evidence for a court to consider when examining whether a restraint is consistent with, or against, public policy.

The difficult part for IBM with this case may be establishing damages. There is little case law out there that discusses how to quantify business losses when an employee breaches a no-hire restriction. IBM certainly would be in a position to hire qualified talent. And its most tangible loss may be recruiting and incentive pay it would have to shell out to get them on board.