Tuesday, December 29, 2015

End of the Year Post: Why I Support the Defend Trade Secrets Act

This year, I am taking a different approach for my end of the year post. Instead of recapping the year's highlights, I would like to give my perspective on the most significant development in the law of trade secrets and non-competes we're likely to see in some time: the likely passage of the Defend Trade Secrets Act of 2015. Here's my take:


On December 1, 2015, I added my name to a Trade Secrets Practitioners' Letter, which was sent to the U.S. House and Senate sponsors of the Defend Trade Secrets Act of 2015 (a copy of the proposed legislation can be found here).

The legislation, which is likely to pass with robust bi-partisan support, creates a federal civil cause of action for trade secrets misappropriation. If passed, federal law will protect all four branches of intellectual property rights - trade secrets, patents, trademarks, and copyright. It is no secret that trade secrets are an increasingly important component of our knowledge economy, and federal courts already are adept at handling these cases under their diversity jurisdiction call or as part of a case featuring a federal claim.

I was at first reluctant at supporting the DTSA, and I believed that state courts' traditional role at handling trade secrets and non-compete litigation was one that we lawyers should continue to honor. However, proponents of the DTSA have persuaded me to the merits of a federal cause of action. My rationale is different, though, than my counterparts. And although my specific reasons for supporting the bill are not contained in the Practitioners' Letter (my background is far to modest to even suggest offering changes), that's not essential to my endorsement of this potential new law.

So why do I support the DTSA? My reasons are two-fold. First, I believe federal courts have the muscle to parse out spurious claims of misappropriation and hold plaintiffs accountable for bad-faith filings. To this end, I think the existence of a federal cause of action will deter counsel from filing claims with a questionable factual basis, since federal district courts have a strong record of imposing fees for claims filed in bad-faith. State courts simply don't have this interest or capacity. The bench is often very close to the bar in state courts, meaning that judges understandably are reluctant to impose sanctions for frivolous claims. State judges also do not have the support of law clerks to conduct the necessary legal and factual research. They do not have the bandwidth to watch cases closely and are unable to engage in the type of analysis that is required to determine whether defense fee-shifting is appropriate.

Second, the changes to the Federal Rules of Civil Procedure (which went into effect today) are likely to reduce the cost of litigation and bring suits to trial more quickly than in state court. Federal courts, particularly with engaged and knowledgeable magistrates, have much greater capacity to monitor discovery for proportionality. The new rules are designed to achieve this end and should allow smaller litigants to defend cases more efficiently. State courts largely count on the cooperation of counsel to self-police discovery. Teeing up discovery disputes rarely leads to positive outcomes in state court, absent active judicial engagement. And unfortunately, many state courts lack this capacity. Therefore, I believe that the federal rules changes will cause counsel to try cases through the discovery phase more efficiently.


On November 15, a group of law professors wrote a lengthy letter opposing the DTSA. I do not believe their concerns are sufficient to override the DTSA's benefits at reducing litigation cost and remediating bad-faith claims. These are the concerns:

1. The DTSA's Ex Parte Seizure Provision May Harm Small Businesses, Startups and Other Innovators.

The DTSA contains a controversial provision that allows for the seizure (on an ex parte basis) of the instrumentalities of trade secrets theft. This is not the law's most outstanding feature, to be sure. But it's not an independent reason to defeat the law. For starters, I have a hard time believing that federal courts will warm to the idea of this remedy. It will be deployed sparingly. And the professors give judges short shrift. Judges are competent enough to snuff out abuses and impose damages for an wrongful seizure of property. This remedy potentially is a paper tiger, and it will work itself out in practice.

2. The DTSA Appears to Implicitly Recognize the Inevitable Disclosure Doctrine.

This argument stems from the provision of the DTSA that says a court may impose injunctive relief to prevent actual or threatened misappropriation, "provided the order does not prevent a person from accepting an offer of employment under conditions that avoid actual or threatened misappropriation."

How the professors conclude this endorses the "inevitable disclosure" rule is simply beyond me. No canons of statutory construction allow for this rather extraordinary position. Given the robust debate around the "inevitable disclosure" doctrine, the DTSA easily could have expanded the rights associated with seeking injunctive relief to bring the doctrine within the statutory language. It does not do so. To read some implicit endorsement of the doctrine is simply unreasonable.

3. The DTSA Likely Will Increase the Length and Cost of Trade Secret Litigation.

As discussed above, the opposite will occur - particularly given the change to the Federal Rules of Civil Procedure.

Separately, the Professors rely on a study showing that the cost of IP litigation ranges from $250,000 (for cases worth less than $1 million) to $1.6 million (for cases where over $25 million is at stake). However, this statistical evidence does not necessarily mean that trade secrets cases in federal court are more expensive. For starters, many of those cases are high-stakes patent cases. A lot of trade secrets claims are in the mold of employment (as opposed to IP disputes). Too, the Professors' reliance on this study assumes that the cost is lower in state court. I am not so sure about this, since state courts are more apt to grant continuances - the biggest cause of increased legal fees. With federal courts, you have some assurance that judges will enforce deadlines strictly.

4. The DTSA Will Likely Result in Less Uniformity in Trade Secret Law.

This justification also seems insufficient. The states have developed rules under the Uniform Trade Secrets Act, and with some exceptions, the law is indeed predictable. There are some differences in the Uniform Act concerning attorneys' fees availability and the statute of limitations. To this end, a federal law certainly will help bridge any differences.

It will take time for courts to resolve some areas of the law - like the "inevitable disclosure" doctrine - but it is very likely that courts will look to the laws in their states until such time as the circuit courts step in. That is a fairly long process that must play out, but it won't hurt parties and won't confuse lawyers. The permutations in trade secrets law among the states simply aren't that great that we will need to worry about having to cite to new law and new cases.


I realize that the arguments on both sides of this debate are well thought-out and well-intentioned. But having absorbed this debate now for a couple of years, I remain convinced that trade secrets lawsuit in federal court will weed-out weak, spurious claims and will result in a quicker disposition of cases by judges who have the staff to handle them.

Monday, December 21, 2015

Second Circuit Adopts Narrow View of Computer Fraud and Abuse Act

As the Second Circuit wades into the long-simmering fray over the Computer Fraud and Abuse Act, I am starting to wonder if this is all worth the trouble. In other words, do we have reason to be concerned about the CFAA reaching seemingly innocuous conduct, or is the statute working as intended?

For those unfamiliar with the dispute over this once-obscure law, the statutory language "exceeds authorized access" has divided federal courts for more than ten years. The CFAA imposes both civil and criminal liability for those who exceed authorized access from a protected computer and obtain certain types of information. The term "exceeds authorized access" means to access a computer with authorization and to use such access to obtain or alter information in the computer that the accesser is not entitled to obtain or alter.

The dispute in employment contexts almost always arises when an employee, before leaving to compete, accesses a company database and digitally copies proprietary files (they do not have to be trade secrets under the CFAA). The employee's access is technically authorized, but if the employee acquires information contrary to his duty of loyalty and then misuses company data, some courts have held that this improper purpose qualifies as "exceeding" authorized access. Other courts take the opposite view.

An interesting (and very disturbing) case from the Second Circuit has fueled this split in authority. The case is not an employment case and involves a disgusting set of facts that I won't repeat. The case of United States v. Valle arose when a New York City police officer accessed a computer program called Omnixx Force Mobile, which allowed him to search restricted databases like the federal National Crime Information Center database, to gain sensitive personal information about an individual. The purpose of his access was to learn details about a woman the officer knew from high school, and whom he and a co-conspirator intended to kidnap. As such, the officer had no valid law enforcement purpose for accessing the database.

Reversing a conviction under the CFAA, the Second Circuit waded into the fray over the meaning of "exceeds authorized access" and the application of that statutory term to the officer's conduct. The court acknowledged a deep circuit split over the term's meaning and then took a deep, even nauseating dive, into the CFAA's legislative history. After going through that exercise, the court ultimately found that both the narrow and broad view found some support. And because of that, the court determined that a criminal statute had to be construed narrowly (the so-called rule of lenity).

The Second Circuit then adopted the "parade of horribles" approach, articulated by Judge Kozinski in United States v. Nosal. In that case, Judge Kozinski described the potential reach of the CFAA if the court had authorized a broad definition of "exceeds authorized access," a reach that would in his view criminalize a wide range of innocuous, everyday behavior. The examples include an employee using a computer to check Facebook, in violation of a corporate computer policy and similar conduct qualitatively different than that before the court.

Given the Second Circuit's adoption of a narrow view (and its agreement with the Fourth and Ninth Circuit), the circuit split over the CFAA's reach has become deeper. It is possible that U.S. Attorney Preet Bharara will seek to file a petition for writ of certiorari over this question. Though Congress in the past has entertained amendments to the CFAA, no legislative activity is imminent. In my view, Congress easily could find a middle ground between the two lines of authority to ensure that the CFAA does cover the type of conduct at issue in Valle and even civil cases that resemble some form of insider hacking or sabotage.

But even though I have in the past endorsed the narrow view of the CFAA, I question whether prosecutors are abusing the law. While the result in Valle seems wrong strictly in terms of justice, the Second Circuit's reversal in no way suggests that prosecutors overreached by charging Valle under the CFAA. Nor am I seeing an overuse of the CFAA in the civil context. Cases like Nosal, to be sure, seem more appropriate for a civil remedy. But are they outliers? Is the CFAA actually being used selectively, rather than punitively? If so, then perhaps we need not worry so much about individuals being hailed into court based on a "confused, accidental, or otherwise inappropriate use" of a database (the coin the phrase used by the dissenting judge in Valle). Maybe we have struck the right balance and done our best with an imperfect law that can, at times, be used effectively.

Monday, December 14, 2015

Fifth Circuit Addresses Meaning of "Fundamental Policy" In Choice-of-Law Dispute

Choice-of-law clauses are one of the most important procedural frontiers in non-compete disputes.

State law concerning enforceability of covenants not to compete often contains unique twists and turns. Witness Illinois' rather unique rule on consideration in the at-will employment context. Increasingly, choice-of-law clauses are becoming prevalent in non-compete litigation. This paradigm arises because of our increasingly mobile economy where employees work for companies domiciled in other states, the effect of mergers and acquisitions, and corporate counsel's more informed awareness to selecting a particular state's law when drafting contracts in the first place.

I have written many times on the tensions posed by choice-of-law clauses, and generally courts need to assess several questions, including the connection that the chosen state's law has to the litigants. Choice-of-law clauses pose even more difficult questions when the state with the greater interest in the lawsuit has a strong public policy concerning non-competes.

A stark illustration of these choice-of-law rules comes from the recent Fifth Circuit case of Cardoni v. Prosperity Bank. The case involved a very common set of facts that can give rise to choice-of-law disputes. Prosperity Bank in Texas bought an Oklahoma-based bank called F&M, and in connection with that acquisition had key F&M employees sign new employment contracts governed by Texas law. Those contracts contained typical non-competition, non-solicitation, and non-disclosure covenants. Four bankers, who all were Oklahoma residents, then left to compete against Prosperity.

The Fifth Circuit's analysis of the choice-of-law clause focused on the degree to which Oklahoma's public policy was "fundamental" and whether it was sufficient to override the Texas choice-of-law clause. The court described the notion of a "fundamental policy" as an "elusive concept" but made clear to note that it is not one that focuses on assessing potential outcomes of the case. Put another way, courts do not look to whether the difference in state law changes the result at trial. The "fundamental policy" question must strike deeper than that. (This is not the standard in a minority of other states.)

As applied to the bankers' contracts in Cardoni, the court found that Oklahoma's public policy against enforcement of employment non-compete agreements was "fundamental" on account of its state statute. It is fairly safe to assume that a state's enactment of a statute directly concerning non-competes expresses the will of the people or, less colloquially, a "fundamental policy" for purposes of a choice-of-law analysis. Oklahoma, for its part, is one of a handful of states (along with California and North Dakota) that generally ban non-competes.

The court's analysis was different for the bankers' non-solicitation clauses, which the same Oklahoma statute generally permits. The law in Oklahoma is nuanced as to those clauses' permissive scope, but even the narrower limits of enforceability do not implicate a fundamental policy (at least in the Fifth Circuit's eyes). Therefore, in Cardoni, the court reached a somewhat unusual result that Texas law (the chosen law in the contracts) governed the non-solicitation covenants but not the broader non-competition covenants.

The result illustrates the importance counsel must pay to choice-of-law questions when cross-border disputes arise. It is crucial to examine the nature of the contacts the parties have to the competing states, the relationship of those contacts to the actual dispute, and the permutations of the law between the respective states.

Monday, December 7, 2015

Is the Majority Test for Determining Bad Faith in Trade Secrets Claims Still Good Law?

Recently, I had the opportunity to speak at the American Intellectual Property Law Association's annual Trade Secrets Summit. My topic (along with co-presenter William L. Schaller) was "Bad Faith in Trade Secrets Litigation." I know the topic well, having represented many defendants in specious trade secrets claims, including the prevailing defendants in Tradesman Int'l v. Black, 724 F.3d 1004 (7th Cir. 2013).

Although the Uniform Trade Secrets Act does not define "bad faith," its commentary in Section 4 does indicate that courts should look to the standards of the Patent Act, 35 U.S.C. Sec. 285, That section enables a court to award attorneys' fees to a prevailing party in an exceptional case. Therefore, the UTSA's commentary seems to equate "bad faith" with "exceptionality." (As a side-note, not all states that have adopted the UTSA contain a bad-faith provision on par with Section 4. At last count, four states lack a discretionary fee-shifting provision.)

The case law concerning a Section 4 claim of bad faith is relatively narrow, with few courts outside California formulating much in the way of a test. California, for its part, has long adopted a two-part "objective/subjective" test, which asks:

1. Whether the trade secrets claim is "objectively specious." This means that the plaintiff must lack proof as to one of the essential elements of the case.

2. Whether the facts support a finding of "subjective misconduct." Here, courts examine evidence of harassment, delay, and improper motive.

Lawyers who have experience with bad-faith claims often assume that this California test is generally applicable. However, a Supreme Court case from 2014 may cause attorneys to reconsider if they're examining claims of bad-faith under the appropriate framework.

Pivoting back to the Patent Act, the Court in Octane Fitness, LLC v. ICON Health & Fitness, Inc., 134 S. Ct. 1749 (2014), clarified the standard of "exceptionality" under Section 285. It stated:

"an 'exceptional' case is simply one that stands out from others with respect to the substantive strength of a party's litigating position (considering both the governing law and the facts of the case) or the unreasonable manner in which the case was litigated. District courts may determine whether a case is 'exceptional' in the case-by-case exercise of their discretion, considering the totality of the circumstances."

The standard is remarkably flexible, endorsing a large grant of discretion to a trial judge to consider whether fee-shifting is appropriate. Given the fluid "totality of the circumstances" test, virtually nothing is off-limits in establishing bad faith.

At the Trade Secrets Summit, Bill Schaller and I discussed the importance of "trigger facts" to avert a bad faith claim. Those trigger facts may insulate a plaintiff from fee-shifting, even if the case turns out poorly. Among the most common trigger facts are:

1. Some suspicious computer activity, such as mass downloads or improper use of a personal storage device.

2. Physical retention of corporate records, which could reflect company secrets.

3. Dishonest conduct at the time of departure or failure to participate in an exit interview.

4. The failure of counsel to alert the plaintiff as to erroneous facts assumed by the plaintiff in filing the case (here, most claims of misappropriation must proceed based on inference).

It is possible the Octane Fitness framework is no different than the California test, for the bad-faith determination is inherently fact-specific. However, for defendants, it seems quite clear that they have enormous flexibility in arguing a claim for fees based on the case's inherent weakness, even apart from any evidence that reflects evil motive. That is the way it should be.

Monday, November 30, 2015

Supreme Court Decides Not to Step Into Planned Parenthood's Trade Secrets Fray

The interplay between trade secrets and the public interest has deep roots in the law, but presents a thorny issues for courts to address.

In recent years, trade secrets law has been at the forefront of the public's concern over fracking technology and in particular the chemical composition data that oil and gas providers may have to make available. Recently, The Wall Street Journal ran an article concerning the software known as TrueAllele - described as a high-tech computer program that helps law-enforcement officials sort out complex mixtures of DNA at a crime scene. The scientists behind the program is resisting defense attorneys' requests to see the source code of the program, claiming it is a trade secret.

Last year, the intersection of trade secrets law and the public interest reached the headlines when the First Circuit held that Planned Parenthood need not release its Manual of Medical Standards and Guidelines based on Exemption 4 to the federal Freedom of Information Act. The suit arose when New Hampshire Right to Life issued a FOIA request to the Department of Health and Human Services after Planned Parenthood received a federal grant. The suit was partly a reverse-FOIA action, whereby Planned Parenthood sought to prevent HHS from releasing portions of documents that HHS had determined were not exempt from disclosure.

The First Circuit had held the Manual (and related pricing information) was subject to Exemption 4. Under the circuit's applicable test, Planned Parenthood did not need to demonstrate actual competitive harm. Instead, it only had to show "actual competition and a likelihood of substantial competitive injury in order" to bring the information within Exemption 4. Further, courts need not conducted a "sophisticated economic analysis of the likely disclosure."

The Supreme Court declined to weigh in and interpret the First Circuit's test concerning Exemption 4, but this denial of certiorari was not without its own headline. Justice Thomas and Justice Scalia dissented from the denial of the cert petition, with Justice Thomas stating that "Courts of Appeal have embraced varying versions of a convoluted test that rests on judicial speculation about whether disclosure will cause competitive harm to the entity from which the information was obtained."

Justice Thomas' statements are somewhat curious, because trade secrets law does not demand an actual demonstration of harm before protection ensues. Indeed, the very test associated with preliminary injunctions necessitates some degree of "judicial speculation" concerning disclosure. But that speculation must be grounded in factual support. It is unclear whether he advocates a very narrow application of Exemption 4 that would call for some broad assessment of actual, as opposed to likely, harm. Regardless, the circuit courts' apparent inconsistency in applying Exemption 4 is the focus of Justice Thomas' dissent and serves as a microcosm of the conflicting interests often at stake in trade secrets disputes.

Tuesday, November 24, 2015

Illinois Revitalizes "Old" Rule Concerning Limits on Confidentiality Agreements

Attorneys in Illinois have assumed for many years that non-disclosure agreements do not need a time limit on them.

That assumption is now conclusively incorrect.

The genesis of the problem comes from the Illinois Trade Secrets Act, which provides as follows:

...a contractual or other duty to maintain secrecy or limit use of a trade secret shall not be deemed to be void or unenforceable solely for lack of durational or geographical limitation on the duty.

The ITSA passed the General Assembly in 1985, and after that point in time, a smattering of cases dealt with the reasonableness of non-disclosure covenants and seemed to endorse them without much analysis as to scope.

But in 1985, around the time the ITSA went into effect, a case called Cincinnati Tool Steel Co. v. Breed held that durational and geographic limitations are required for a confidentiality agreement. A few subsequent cases followed Cincinnati Tool Steel, but not many and the issue was rarely litigated.

(As a potentially interesting aside, "Cincinnati Tool Steel" was not some company based in Cincinnati, Ohio but simply took its name of the president, Ronald Cincinnati. Pardon me for being somewhat of an onomastic snob, but whenever I think of this case, I cannot help but be reminded of James Spader's portrayal of Robert California in The Office, a fantastically geographic-oriented surname.)

Two recent cases, though, have revitalized Cincinnati Tool Steel. In the Appellate Court of Illinois, the case of AssuredPartners, Inc. v. Schmitt (from October 26) held that an unlimited non-disclosure covenant, both in terms of its duration and in terms of the information that fell within the terms of the covenant, was unenforceable. In particular, the court warned that such a broad covenant drastically limited the employee's ability to work in the relevant industry because it prevented him from using any knowledge he gained while employed with AssuredPartners, despite his prior work experience in the industry and regardless of whether he gained that knowledge because of his employment.

The second case, Fleetwood Packaging v. Hein, comes from the Northern District of Illinois, where Judge Tharp invoked the rationale of Cincinnati Tool Steel to conclude a non-disclosure agreement that lacked a temporal and geographic scope was unenforceable. Responding to the argument concerning the ITSA clause cited above, Judge Tharp found that it only applied to contractual restrictions that limited the use of trade secrets - not confidential information.

The reasons for demanding limitations on non-disclosure covenants are sound and generally hinge on two policy rationales.

First, as AssuredPartners recognizes, the presence of a non-disclosure covenant that is unlimited in scope can have a drastic chilling effect and can raise the possibility that an employer will attempt to bootstrap what should be a narrow restriction into a much broader non-compete that the parties never signed. Just as problematically, the relatively undefined nature of confidential information (which by definition is at least partly subjective) can leave an employee twisting in the wind if she stays in the same industry as her prior employer (which most employees do).

Second, it is awfully difficult (if not impossible) for an employee to know what remains confidential after she has left. Much ephemeral business information can lose value quickly. If corporate strategies shift, then a strategic plan that is a few years old may be of no use to anyone. Only insiders should know what remains confidential. Those who no longer are providing services to a company have no reason to know whether certain information retains some confidentiality. Therefore, it makes sense to require some reasonable limit on scope so that an employee is not left uncertain as to what she can disclose about her past work.

Allowing unlimited agreements to protect trade secrets, while certainly a fine distinction, is consistent with public policy. The challenge, of course, is to parse viable trade secrets (which should be more specific and more obvious) from general confidential information  (which likely is categorical and less obvious).

Thursday, November 19, 2015

Pennsylvania Follows Trend in "Consideration" Cases

The subject of consideration is the new frontier of non-compete disputes.

Although Illinois is at the forefront of this burgeoning consideration debate, other states increasingly have begun exploring the concept of what exactly an at-will employee receives in exchange for agreeing to a non-compete agreement. This "exchange" is the fulcrum of consideration, a legal term that ensures the enforceability of a contract obligation.

Pennsylvania, like other state supreme courts, has waded into the arena, albeit with an arcane and interesting twist to the legal problem. Yesterday, the Supreme Court of Pennsylvania in Socko v. Mid-Atlantic Systems of CPA, Inc. held that an employee can challenge a restrictive covenant agreement signed after the start of employment on the grounds that it lacks consideration, even if the agreement contains specific language that the employee "intends to be legally bound."

Why does that intent-to-be-bound language matter?

Pennsylvania is the only state to adopt something called the "Uniform Written Obligations Act." Consider, for a second, whether a statute can be uniform if 1 out of 50 states has enacted it. The Act provides that a written promise:

shall not be invalid or unenforceable for lack of consideration if the writing also contains an additional express statement, in any form of language, that the signer intends to be legally bound.

The challenge for the Supreme Court of Pennsylvania was to harmonize this very old statute with the general common-law principle that says an employee who signs a restrictive covenant after the inception of employment must receive new consideration beyond employment itself. This rule generally requires an employer to provide something tangible such as a promotion, a bump in pay, or some severance benefit. Continued employment never suffices in Pennsylvania.

The Court, facing a somewhat daunting challenge, did its best to reach what it felt was the right result, consonant with years of legal decisions in the restrictive covenants area. It concluded that, despite the plain language of the Act, extending it to contracts in restraint of trade would be "unreasonable." The Court considered the "historic background regarding" non-competes, as well as their "unique treatment in the law." Therefore, even if non-compete contracts include the mandated "intends to be legally bound" language, an employee still can challenge the agreement on the grounds that it lacks consideration.

The main canon of statutory interpretation that the Court had going for it was the strict construction rule. That rule generally states a statute in derogation of the common law must be strictly construed. Applied to non-competes, the Court traced the history of these "unique" agreements and the special issues pertaining to consideration that the law had afforded them.

The case is perhaps not a model of how to resolve questions of statutory construction. Nevertheless, it continues a clear and definite trend. In the last several years, courts seem to be pivoting away from examining whether an employer has a legitimate business interest to protect through a non-compete and towards looking at whether there even is consideration at all. To be sure, questions of reasonableness and protectable interest are vitally important in cases like this. But the consideration issue is fundamental to the issue of contract formation in the first place and often results in a rapid disposition of the suit.

Tuesday, October 20, 2015

Lost Profits and No-Hire Clauses

A common feature of employment contracts these days is the no-hire clause. This is a form of a non-solicitation covenant and specifically precludes an employee from encouraging other employees to leave the firm.

I estimate that 9 out of 10 employee clients of mine are unconcerned with this type of covenant. They simply don't care to recruit fellow co-workers to join them at a new job. For the ten percent of clients that do care, they tend to be upper-level managers or lead a sales team. Their value to a new employer may depend on replicating that sales team.

The enforceability of no-hire clauses is not something that is widely litigated. One certainly can argue with exactly what kind of legitimate business interest the clauses protect. But for the most part, I've been content to assume that an employer at least can demonstrate some kind of an interest, even if it seems to vague and ephemeral.

The question of damages, though, presents a much more confounding problem. If one employee solicits another to leave - in violation of a covenant prohibiting that solicitation - what is the employee's monetary exposure?

A couple of possible damage theories immediately come to mind:

  1. The employer's cost to replace the wrongfully solicited employee. These costs might include recruitment expenses, headhunter fees, signing bonuses, and incremental pay differentials between the former and replacement employee.
  2. Liquidated damages, if provided for by contact. Some employment agreements attempt to define the agreed-upon damages for breach of a no-hire covenant. I have seen these clauses expressed as a percentage of the solicited employee's last-prevailing rate of pay.
  3. Lost profits. The conventional form of contract damages, this would measure the loss to the employer associated with the breach of the no-hire covenant.
But as to this last category, how would one prove that? Assume that the employee who was wrongfully solicited then began contacting or soliciting customers of the former employer. Is any lost income properly attributable to the no-hire violation? This would seem to be a step removed from the underlying breach, particularly if the employee who solicited the customer had no restrictive covenant agreement prohibiting that sales activity.

This is roughly the fact-pattern of Acadia Healthcare Co. v. Horizon Health Corp., 2015 Tex. App. LEXIS 7683 (Tex. Ct. App. July 23, 2015). To be sure, the case involved a great deal of facts that supported more serious charges of conversion, trade secret theft, and breach of contract against other employees. But the case is certainly crucial for how the plaintiff was unable to use expert testimony to render a lost-profits opinion arising from a no-hire breach.

The plaintiff's expert looked at two sets of facts and gave separate damages opinions on each. As to the first, he identified a specific prospect that a former Horizon employee solicited for Acadia (the new employer). The employee himself had signed no employment agreement, but his superiors solicited him to join Acadia in violation of their own no-hire covenants. The court found that the expert's opinion on lost profits concerning the solicited account was too speculative, in that the expert assumed that Horizon would have retained the account for 15 years. The expert's inability to identify specific information supporting a 15-year contract duration was fatal to this opinion.

The other fact concerned the solicited employee's "lost production," In essence, Horizon had claimed damages from the wrongful solicitation of this employee under the assumption that, but for the solicitation, he would have produced profit for Horizon into the future. The problem with Horizon's theory was that Horizon assumed the employee, who was at-will, would have remained with Horizon, would have been offered a new sales position, and would have accepted it. And the expert again assumed that the employee would have signed hypothetical contracts with 15-year contract terms.

Acadia Healthcare illustrates how difficult it is to prove damages in competition cases. As it relates to no-hire clauses, the damages analysis becomes attenuated because the recruitment usually precedes the proximate cause of any loss. And even assuming a plaintiff can tie those causes together, the assumptions underlying any future damages projection inherently become problematic and attenuated.

Monday, September 21, 2015

The Inevitable Disclosure Rule and Commercial Transactions

Claims for trade secrets misappropriation normally arise out two types of transactions: a fractured employment relationship or a failed business strategic transaction (such as a merger or joint venture).

One way to prove threatened misappropriation (and therefore secure injunctive relief) is to claim that improper use or disclosure of a secret is "inevitable." This inevitability theory is disfavored and not even viable in some jurisdictions. However, it continues to spur litigation and debate.

In the employment context, claims of inevitable disclosure normally must meet a certain standard, though the standard is necessarily flexible and case-specific:

  1. The old and new employer must be direct competitors.
  2. The employee's new position must overlap with the old one.
  3. The new employer must fail to take some reasonable step to guard against the employee's use or disclosure of trade secrets.
  4. The employee's departure conduct must suggest the possibility of misuse (e.g., misleading the employer as to plans, suspiciously accessing proprietary data).
If the inevitability theory works in employment cases, it does so because the employee's objectively perceived value to the new employer tends to derive from her prior work experience. Put another way, the employee normally does not bring some unrelated, free-standing value apart from this job history. So (again, in theory) it's at least plausible that even well-intentioned employees will disclose something that they shouldn't.

In a failed business transaction, this rationale is absent. Businesses may combine because of synergies that are unrelated to their status as market competitors. Therefore, it is dangerous to presume that erstwhile joint venture partners, for instance, will will have any incentive to incorporate the others' trade secrets.

The Appellate Court of Illinois' decision in Destiny Health, Inc. v. Cigna Corp., 2015 IL App (1st) 142530, notes this important distinction in applying the inevitable disclosure theory and rejecting it to a failed joint venture. Destiny Health discusses the leading case involving a failed acquisition and the attempted use of the inevitability theory, Omnitech Int'l v. Clorox Co., 11 F.3d 1316 (5th Cir. 1994). Both cases expound upon the difficulty in establishing trade secrets misappropriation through the inevitable disclosure theory.

Omnitech and Destiny Health both emphasize the danger associated with inferring trade secret misappropriation after a failed transaction. This leads to one of two perverse results: (1) if a company evaluates one potential target, and then declines to acquire it, the company effectively would be precluded from evaluating other targets; or (2) the company would have to evaluate potential targets without evaluating their trade secrets. 

Ultimately, I believe that contracts should set the parameters for the inevitable disclosure rule. In commercial transactions, a simple non-disclosure agreement (signed as a condition of evaluating a business transaction) should determine any future restrictions. If, as in Destiny Health, the agreement is silent on a party's ability to develop certain products, explore certain targets, or contracting with certain vendors, then the "inevitable disclosure" theory should be unavailable.

Similarly, in the employment context, I believe that the inevitable disclosure rule only should be applied to demonstrate the employer's protectable interest in enforcing a non-compete agreement. In other words, the employer should not have to wait for the ex-employee to disclose something before seeking enforcement. As long as the employer can show extensive access to company secrets, then this should support enforcement of a non-compete - assuming of course, the terms are reasonable and the agreement carries proper consideration.

The Destiny Health case illustrates the potential misuse and overapplication of the inevitable disclosure rule. Right now, it's operating as an uncontrolled extension of trade secrets law. The rule needs standards, but few courts seem willing to apply them with regularity.

Monday, August 17, 2015

Hawaii Goes Deep on Non-Compete Law

The mentions that the State of Hawaii gets on this blog are, predictably, few and far between. However, in the span of just a few weeks, we have two significant legislative and judicial updates.

The first concerns Act 158, which Governor David Ige signed into law in June. The law is limited in scope and is industry-specific. The main thrust of the law is that it bans enforcement of non-compete agreements for employees of technology businesses. A technology business is defined as one which derives more than half of its gross sales from "sales or licensing of products or services resulting from software development or information technology development." The law further defines those terms.

The law also prohibits the use of non-solicitation covenants, which are defined exclusively as those restrictions that prohibit an employee from soliciting a former co-worker. It does not include any restrictions on contacting, servicing, or soliciting customers or clients of a former employer, meaning Act 158 expressly leaves open the question of whether this type of restrictive covenant in a technology business is prohibited. By omitting it, it is likely that such covenants will continue to be scrutinized for reasonableness under the common law.

Act 158 took effect on July 1, but the law has prospective effect only. For an excellent summary of Act 158, read Robert Milligan's analysis here.

While Act 158 is decidedly pro-employee, a Hawaii federal district court rendered a decidedly pro-employer decision in a non-compete case. The question presented in The Standard Register Co. v. Keala, 2014 U.S. Dist. LEXIS 73695 (D. Haw. June 8, 2015), was whether continued employment constitutes sufficient consideration to enforce a non-compete against an at-will employee. This issue continues to divide courts across the country. In the past year or so, some courts (Wisconsin) have veered towards a pro-enforcement stance when this type of consideration is at issue. Others (Illinois and Kentucky) continue to lean pro-employee and require additional consideration beyond employment itself. And we await a ruling from Pennsylvania on this same issue.

The district court in Standard Register noted that the Supreme Court of Hawaii never had addressed the question, so it surveyed the majority and minority rules across the United States. In following the majority rule, the court also relied on the forthcoming Restatement of Employment Law, Section 8.06, which appears to endorse the majority position - that forbearance of the right to discharge is itself sufficient consideration. The Restatement goes on to criticize the middle-ground approach taken by Illinois courts (as well as a handful of others) which examine whether the employment continues for a substantial period of time.

Wednesday, August 5, 2015

A Federal Trade Secrets Statute Appears Inevitable, Questions and Concerns Remain

Last week, the Defend Trade Secrets Act of 2015 was introduced in both the House of Representatives and the United States Senate. The text of the proposed legislation appears below. This is a bipartisan, bicameral bill that likely will become law in 2015.

The structure of the DTSA is very familiar to practitioners and to those who follow trade secrets developments. Currently, trade secrets law is the only branch of intellectual property that is regulated by state law. Since 1979, the Uniform Trade Secrets Act has been part of our state-law landscape, and over the years almost every state has adopted some form of the UTSA. (The variations by state are minor and generally relate to ancillary topics like the statute of limitations and preemption. New York and Massachusetts remain holdouts for reasons that are unknown.)

If Congress passes the DTSA, then this state-law regulatory framework will change dramatically. To be sure, it is unlikely to disappear; litigants still may be bring a state-law claim for trade secrets theft. The draft of the DTSA does not contain a broad preemption clause, but eventually state cases would run off into the remote reaches of the court system. And federal courts would bear the burden of hearing trade secrets disputes.

The structure of the proposed DTSA builds upon existing law, but not in a way that is seamless. It would amend the rarely-used Economic Espionage Act, which is contained in title 18 of the United States Code. The EEA criminalizes trade secret theft, but contains no private civil enforcement mechanism. In 2013, there were only 25 prosecutions under the EEA. The case law, which would aid a federal court in a DTSA claim, is almost non-existent.

The DTSA, to that end, adopts the EEA's definition of a "trade secret," which differs at the edges from the UTSA's definition. On this score, under the EEA, a trade secret must meet a two-part standard. The owner of the claimed secret must take reasonable measures to keep the information. And, substantively, the information must derive independent economic value from not being generally known to "the public." Under the UTSA, the second part of the definition is slightly different. The information must derive economic value from not being generally known "to other persons who can obtain economic value from its disclosure or use." Conceivably, under the DTSA, a plaintiff could bring two claims for trade secrets theft under two different statutes with two different definitions accorded the central issue in the case. Some lawyer somewhere is going to have a field day with that. (I happen to know of a few of those lawyers, who shall remain nameless.)

Another source of potential controversy is the DTSA's proposed process for enabling plaintiffs to obtain an ex parte seizure order. This would allow a court to authorize a seizure of trade-secret instrumentalities, such as computer hard-drives, thumb-drives, and even cell phones where purloined data may exist. In contrast to other branches of intellectual property law, these instrumentalities may have an entirely lawful purpose. On the other hand, think of counterfeit goods or pirated CDs, where the products themselves are infringing.

The seizure order is modeled after something called an "Anton Piller Order," which is fantastically named and derives from English law. This type of seizure order has a quaint, colorful, and interesting history in and of itself. Commentators are concerned that plaintiffs may abuse the process of seizing trade secret instrumentalities on an emergency, ex parte basis. However, I do not see this as a real issue for two reasons. First, federal judges would be inclined against issuing such orders, and a plaintiff who proceeds without caution faces the possibility of sanctions later in the case. Second, courts already have the authority, either under Rule 65 or the inherent authority power, to allow for seizure of items on a basis at least very similar to what the DTSA proposes. In light of the concerns, though, I expect the DTSA, when it's passed, to water down the seizure order provision or eliminate it entirely.

One final point: I feel that with the adoption of the DTSA, most non-compete disputes will now end up in federal court as a result of the courts' ability to exercise supplemental jurisdiction over state-law claims. Since trade secrets often comprise the legitimate business interest supporting a non-compete claim, a plaintiff will have every incentive to load into a non-compete dispute a corresponding trade secret claim just to get into federal court. This will complicate otherwise straightforward disputes, increase litigation costs, and tax the federal judiciary. By my estimation, if we assume that trade secrets cases are as common as patent and trademark suits, then the passage of the DTSA will result in an addition 10 to 14 new cases per district court judge per year. If there is an ancillary impact because of the desire to get non-compete cases in federal court, then the number would be higher.

I remain opposed, but not in a hand-wringing, teeth-gnashing sort of way. Two years ago, I conducted a podcast along with Russell Beck and John Marsh discussing the pros and cons of a federal trade secret statute. A link to the post and the podcast itself can be found here.

Friday, July 31, 2015

Seventh Circuit Endorses Use of Blue-Pencil Rule for Non-Competes

More times than not, courts in non-compete disputes confront restrictive covenants that have problems. Sometimes the problems are severe and other times they are revealed through the unique facts of the case, rather than the face of the document.

Yesterday, I spoke at the Annual Meeting of the American Bar Association and gave an update on key issues in non-compete and trade secrets law. One of the issues I discussed was the partial enforcement rule - in other words, how courts handle problems of overbroad covenants in enforcement actions.

Interestingly, the day before my presentation, the Seventh Circuit issued its opinion in Turnell v. CentiMark Corp. (embedded below). That case discussed Pennsylvania law concerning partial enforcement of covenants following an appeal from a preliminary injunction. CentiMark is a leader in a certain type of commercial roofing material used on commercial and industrial buildings. Turnell ran the Chicago District and had multi-state responsibilities.

The district court found that, under Pennsylvania law, Turnell's agreement was overbroad. But, after an evidentiary hearing, it reduced the scope of the agreement and enforced the reasonable parts. In doing so, the court properly found instances of overbreadth that are fairly common: (a) the non-compete banned work in an industry similar to that in which CentiMark engaged, meaning it covered too many products; (b) the non-compete barred sales to even prospective, as opposed to actual, customers; and (c) the geographic scope was vague and reached territories where Turnell was not primarily working.

On appeal, Turnell did not challenge the terms of the injunction and argued the district court should not have wielded the fictional blue-pencil to rewrite the contract. But the Seventh Circuit found that Pennsylvania law allowed the court to use its discretion to fashion an injunction remedy.

During oral argument, the Court was sympathetic to the possible overuse of the blue-pencil rule. And Judge Kanne's clear, insightful opinion reflects the tension and perverse incentives that the rule sometimes creates. Interestingly, the Court stated that "to some extent overbreadth is unavoidable given the imprecision of our language. "Ultimately, however, the Court did not seem persuaded that the terms of Turnell's agreement with CentiMark reflected bad faith or an intentional overreach on the employer's part.

I noted at the ABA Annual Meeting that there are four approaches to partial enforcement of overbroad agreements:

1. The "no modification" or red-line rule, which holds that courts will not modify agreements. Put another way, the covenant must be enforceable as written. Virginia adopts this approach.

2. The strict blue-pencil rule, which provides that courts can excise or eliminate overbroad, severable portions of an agreement. But the court will not add terms or use discretionary powers to modify the covenant. Indiana adheres to the blue-pencil rule.

3. The equitable modification principle, which was at issue in Turnell. This approach trades predictability for flexibility, because a trial judge can in effect become a third-party to the contract and impose terms that appear nowhere in the contract. Ohio adheres to this rule, and so does Illinois, but only in a more cautionary sense (for it can implicate public policy concerns). For instance, had Turnell challenged the Pennsylvania choice-of-law clause, Illinois' public policy may have called on the district to apply more favorable law.

4. The mandatory modification rule, which requires courts to reform agreements if they're overbroad. Texas endorses this rule, but provides that if a court orders a reformation, damages are then not available.

The equitable modification rule is, in many respects, very problematic. And in other cases similar to Turnell, courts have refused any sort modification. The approach often leads to the "right" result from a policy perspective, but it has a damaging collateral effect divorced from the litigation. Attorneys often cannot advise clients as to expected litigation outcomes, because it is very difficult to predict how a court will apply the reformation concept. As a result, many employees forego challenging the agreement altogether because of unpredictability (and their lawyers' hedging).

In light of the Court's recent opinion in Instant Technology (see post below from July 15, 2015), it surprises me that the Court did not mention the importance of predictability and clarity in the law of non-competes. In the end, though, the Court was constrained by Pennsylvania law, which allowed the district court to exercise her discretion and reform Turnell's contract.

Wednesday, July 15, 2015

Seventh Circuit Smartly Avoids Fifield Issue, Disses Illinois Law

In the detritus of Illinois law following the Fifield v. Premier Dealers Services case, one federal case actually appeared to have the potential to reshape how state courts (not to mention an increasing number of lower federal courts) viewed the issue of non-compete consideration for at-will employees.

Instant Technology, LLC v. DiFazio (7th Circuit, Nos. 14-2132 & 14-2243) was one of the diversity cases where the court followed Fifield and endorsed the two-year, bright-line consideration rule, which holds that non-compete/non-solicit covenants are enforceable only if an at-will employee has been employed two years or more. (This, of course, assumes the only consideration offered was employment itself, not something more tangible.) Other diversity cases declined to follow Fifield on the grounds that it did not accurately state the law in Illinois. Those cases have said that if the Illinois Supreme Court were confronted with the issue, it would come out with a different rule than that set forth in Fifield.

Instant Technology was always somewhat of a flimsy candidate for a broad, doctrinal repudiation or endorsement of Fifield, since the case appeared to founder on whether the covenants in the IT staffing business supported a "legitimate business interest." The district court found not, and the Seventh Circuit held that this finding was supported by the evidence. And on that score, Judge Easterbrook's opinion in Instant Technology gave nary a mention of Fifield or the current debate over consideration.

However, at oral argument, the Court discussed Fifield at length. And Judge Easterbrook is not the kind to wilt away and blindly assume the appellate court got it right in Fifield. He would seem to have little trouble excoriating the state court rule if he felt the legal standard was groundless. But his opinion avoided the issue, so we have nothing authoritative from a case that at least held out the possibility of being a game-changer in the consideration debate.

But, not surprisingly, Judge Easterbrook used the opportunity to take a not-so-veiled shot at Illinois law, and in particular the "totality of the circumstances" test from Reliable Fire Equipment Co. v. Arredondo. That case changed the analytical framework for determining how an employer can establish a legitimate business interest to support a non-compete. It discarded the traditional approach - which looked at whether an employer had a near-permanent relationship with clients or whether it sought to protect confidential business information the employee subsequently tried to use - and set forth a rather malleable (cavernous?) test that considered the totality of the facts from the case.

In Instant Technology, the IT staffing firm disputed the district court's analysis and basically said the judge didn't consider "everything," without specifying what it exactly it was that the court missed.

Judge Easterbrook says:

"Making validity turn on 'the totality of the circumstances' - which can't be determined until litigation years after the events - makes it hard to predict which covenants are enforceable. If employers can't predict which covenants courts will enforce, they will not make investments that may depend on covenants' validity, and they will not pay employees higher wages for agreeing to bear potentially costly terms. Both employers and employees may be worse off as a result. Risk-averse employees who hope that their covenants will be unenforceable, but fear that they will be sustained, may linger in jobs they would be happier (and more productive) leaving. But our rule of decision comes from state law. Erie R.R. v. Tompkins, 304 U.S. 64 (1938). Reforming that law, or trying to undermine it, is beyond our remit."

This passage largely pivots off many of the questions Judge David Hamilton asked during oral argument in the case. Judge Hamilton was concerned about the blank-slate landscape of Illinois law (a term used by Instant Technology's counsel) and the lack of apparent predictability in an area that demands it. Predictability and certainty usually arrive in the form of bright-line rules, which (oddly enough) Fifield establishes. As for the broader question of reasonableness, the Seventh Circuit seems to be saying that Illinois employers got what they asked for: flexibility. The price? Often times, disappointment.

Wednesday, June 17, 2015

Florida's Non-Compete Law Is, Apparently, "Truly Obnoxious"

One of the most important issues in analyzing any non-compete agreement is choice of law. My experience is that at least 9 out of 10 contracts contain explicit choice-of-law clauses, which describe in the contract which state's law will govern enforcement.

A few years ago, I represented the prevailing defendants in Tradesman Int'l v. Black, 724 F.3d 1004 (7th Cir. 2013). Judge David Hamilton's concurring opinion in that case illustrates the importance of choice-of-law clauses and how predictability over which state's law applies is essential to litigation strategy. It is an extremely thoughtful and interesting opinion, and my post discussing it can be found here.

There are a number of red-flag states where choice-of-law issues are bound to come up. Certainly, if California has any kind of a nexus to the proceedings, then choice of law will be front and center. Other states, like Wisconsin, also pay particular attention to clauses that select another state's law. And Florida, by virtue of its pro-enforcement stance, is a third example.

On this score, Illinois courts will not enforce Florida choice-of-law clauses because they are contrary to our state's public policy. Recently, New York courts have followed this lead and have held that a Florida choice-of-law provision in an employment non-solicitation covenant is unenforceable and contrary to New York public policy.

The case is Brown & Brown, Inc. v. Johnson. The Court of Appeals of New York set forth the standard for invalidating a contractual choice-of-law clause: the foreign law must be "truly obnoxious." Now, that's a standard.

So what's the problem with Florida law, and why do some courts view its stance on non-competes as contrary to public policy. The New York court identified the following:

  1. The employee largely bears the burden of proof to show that enforcement is not necessary to protect an asserted business interest.
  2. Courts many not consider hardship to the employee from the covenant's enforcement.
  3. Courts may not use rules of contract construction that would require a court to construe a vague or unclear contract against the employer.
Overall, the New York court - like the courts in Illinois before it - were concerned with "Florida's nearly-exclusive focus on the employer's interests" in contrast with the traditional balancing test that governs enforcement.

Going back to my post from two years ago when I analyzed Judge Hamilton's concurring opinion in Tradesman, there still is no clear test that I can find to determine when a state's law contravenes another state's public policy. I raised three possibilities:

  1. The legislature has spoken on the issue and declared the state's public policy, much like California has done.
  2. A state's case law reflects a clear, uniform rule applicable without regard to the specific facts of the case. An example would be a court's refusal to partially enforce an overbroad agreement.
  3. The difference between the chosen state and the forum state would be outcome-determinative.
After reading Brown & Brown, I might add a fourth possibility: the chosen state's rules disproportionately favor the employer and undermine the foundation of the rule-of-reason analysis.

Friday, June 12, 2015

Mid-Year Legislative Update - Arkansas, New Mexico, and ... Jimmy John's?

This year, we have seen a slight uptick in proposed legislation concerning non-compete agreements. In previous posts, I've written about legislative efforts in Wisconsin, Washington, and elsewhere. However, while most bills stall out, a few gain momentum. And recently, we have two actual legislative enactments that will change existing law.


The first new law comes from Arkansas, where Gov. Asa Hutchinson signed Act 921. This new law allows a court to enforce reasonable aspects of a non-compete agreement. Previously, Arkansas courts would not allow a court to blue-pencil an agreement that would allow for partial enforcement. That is, an agreement with any overbroad sub-parts rendered the whole document unenforceable. A court's ability to sever offending provisions is weapon in an employer's enforcement arsenal and encourages overbroad drafting.

Act 921 also provides for a presumption that a covenant lasting two years or less is reasonable. Finally, Act 921 specifies an array of employer protectable interests, which include goodwill, confidential information, and training. (The list also identifies protectable interests as "methods" which I found odd.)

Act 921 takes effect on August, 6, 2015.

New Mexico

In April, New Mexico enacted Senate Bill 325, which limits the enforcement of non-competes for health care practitioners (which is defined to include physicians, dentists, podiatrists, and nurse anesthetists). The law is available here.

The law, however, contains a number of significant limitations. First, it does not apply to heath care practitioners who are shareholders or partners in a practice. Second, it does not prohibit a practice from binding a health care practitioner to a non-solicitation provision with regard to patients and employees of the practice (as long as the covenant is 1 year or less). And third, it does not preclude use of a liquidated damages provision. Therefore, we can expect to see physician employment contracts track the language of the statute and (in all likelihood) tie a breach of a non-solicitation covenant to some formula for liquidated damages.


Nationally, we have a new bill tied to enforcement of non-compete agreements and, of course, it arises out of the infamous Jimmy John's case. Illustrating once again that there is no limit to legislators' imagination when it comes to giving legislation creative and idiotic names, several Senate Democrats have backed the Mobility and Opportunity for Vulnerable Employees (MOVE) Act. A copy of the bill is available here.

The essence of the bill is that it would bar use of non-competes for low-wage workers, generally defined as those earning less than $15 per hour. A violation would result in a fine of up to $5,000 per employee subject to the non-compete, and the law would empower the Secretary of Labor to investigate complaints concerning the improper deployment of non-competes. The law also contains a posting requirement (the violation of which is punishable by a flat $5,000 fine) that would tell a low-wage employee of the ban on non-competes.

The bill also would require employers who propose to use a non-compete to disclose this to the employee before employment and "at the beginning of the process for hiring" the employee. While some states have examined this kind of notice requirement in recent years, this would mark a substantial change in the law. Best practices certainly call for up-front disclosure, but it is still very common for employees who leave a job and accept a new one to see a non-compete on the first day of work.

Friday, May 29, 2015

Seventh Circuit Seems Uninterested in Fifield Rule

Last week, the Seventh Circuit heard oral argument in the case of Instant Technology v. DiFazio, No. 14-2132. The DiFazio case is one of several Illinois district court cases that apply the so-called Fifield rule on consideration.

Readers of this blog know all too well the contours of this rule, but as a refresher, it holds that at-will employment itself only can serve as consideration for a non-compete agreement if the employment lasts at least two years. Effectively, the rule means that employers must consider alternative forms of consideration, such as a signing bonus or grant of severance, to bind at-will employees to a non-compete or non-solicit covenant.

(My discussion of the district court's ruling is found here.)

DiFazio was a pro-employee decision, as the district court found that several of the individual defendants had unenforceable non-competes by virtue of their short stint of employment with Instant Technology. The defense-friendly decision had a litany of other facts, particularly concerning the protectable interest underlying the covenants, so consideration was somewhat of a tangential issue in the case. It's likely that even without the rule the employees would have won.

Will the Seventh Circuit weigh in on whether Fifield is good law? That's undecided even after oral argument. Instant Technology downplayed Fifield in its appellate briefs. And then it hired as appellate counsel the same attorney, Anthony Valiulis, who argued on Fifield's behalf in the Appellate Court of Illinois. That must have been awkward, and indeed Mr. Valiulis made light of this during his presentation.

By and large, I thought the argument was a let-down. The panel consisted of Judges Frank Easterbrook, David Hamilton, and Ann Williams. In particular, Judge Hamilton has a strong interest in this area of the law, as he handled a number of trade secret and non-compete cases while in private practice. And as usual, Judge Hamilton asked the best, clearest questions. (Judge Easterbrook, surprisingly, asked none).

On Fifield, though, the court revealed very little. Judge Hamilton asked Mr. Valilulis whether the Appellate Court correctly decided Fifield. Not surprisingly, he had to admit that the court got it wrong. Instant Technology argued that consideration should be judged by a totality-of-the-circumstances approach, consistent with the underlying rule-of-reason analysis concerning a covenant's terms. That strikes me as a position that is principled, in that it relies on prior precedent in this area, but ultimately misguided since it conflates two entirely separate legal concepts. However, none of the circuit judges really took issue with Mr. Valiulis' argument on this.

Though not speaking about consideration necessarily, Judge Hamilton said when questioning Mr. Valiulis that non-compete law is an area where predictability is incredibly important, both for employees and employers. That may provide a justification for the Fifield rule, which for all its faults is at least easy to apply in practice. In fact, Mr. Valilulis conceded that was one of his arguments in the Fifield case for the bright-line rule.

One issue did not come up. The court didn't even suggest that it would certify the consideration question to the Supreme Court of Illinois, which it is able to under Seventh Circuit Rule 52 (as well as state Supreme Court Rule 20(a)). It may be that the other flaws in Instant Technology's case prevent this, because Circuit Rule 52 only allows for certification on a state-law question that "will control the outcome of a case."

My guess is that Judge Hamilton will write an opinion affirming the district court's ruling and will discuss in passing the controversy concerning Fifield's consideration rule. Ultimately, though, because it may not be case-dispositive, I do not think he'll weigh in on what the rule should be.

Friday, May 22, 2015

More Discord In Treatment of CFAA "Exceeds Authorized Access" Claims

The scholarship and divergence of opinion on the Computer Fraud and Abuse Act's reach has become so pervasive that the issues no longer seem as complex as they once did.

Most practitioners still are not familiar with the CFAA, and since it's buried in the criminal code, civil litigators shouldn't have much reason to learn the statute's intricacies. But since it's a federal statute that has criminal and civil reach, the CFAA occupies a somewhat unique place for trade secret and non-compete litigators. In essence, the CFAA can serve as the jurisdictional hook to get competition cases into federal court.

The statute is densely worded and a patchwork of amendments. But for simplicity it enables an employer to pursue a civil cause of action if an ex-employee took information out of a protected computer (essentially anything hooked to the internet) and caused damage or loss. There are permutations to the various sub-sections, but that's the CFAA's civil reach in a nutshell.

I wrote recently about another CFAA case that arose in the employment context, which I felt crystallized the deep split among courts about how to apply the statute when insiders access information to use it contrary to their employers' interests. The issue comes up often because it is easy to misappropriate information out of computers, and at least half of trade secret defendants get tripped up through electronic evidence.

But the actual language of the CFAA is not easy to apply. In the employment context, one can use it against an employee who access a computer "without authorization" or in a manner that "exceeds authorized access." This raises the question - not easily solved - of whether an employee who has the ability to access corporate information, but who intends to misuse it, really has violated the CFAA at all.

The case of American Furukawa, Inc. v. Hossain, 2015 U.S. Dist. LEXIS 59000 (E.D. Mich. May 6, 2015), provides a clear illustration of all the CFAA issues that crop up in employment cases. They include allegations of improper downloading of files to an external drive, planned competition, questionable conduct on the employee's part around the time of departure, and then the fortuitous discovery of actual competition through a misdirected e-mail. (Yes, auto-fill is a boon to the plaintiff's bar.)

With those allegations, the court allowed the CFAA claim to persist, even disagreeing with other courts within the same judicial district. In essence, the court gave deference to limitations the employer placed on computer access, use, and purpose. It held that the misuse of information in violation of policy or contractual limitations can give rise to an "exceeds authorized access" claim. Succinctly put, the court stated "such explicit policies are nothing but 'security measures' employers may implement to prevent individuals from doing things in an improper manner on the employer's computer system."

The opinion itself is notable for its harsh criticism of the decision in United States v. Nosal, a decision out of the Ninth Circuit that takes a very narrow interpretation of the CFAA and its "access" language. In fact, in several places, the district court cited the government's brief before the Ninth Circuit, in which it argued for a broad access definition. The case provides an interesting survey of the law surrounding the circuit split in the CFAA. And it further underscores the need for legislative reform or (less likely) a case to make its way to the Supreme Court.

Friday, May 8, 2015

Supreme Court of Wisconsin Follows Majority Rule on Non-Compete Consideration

Wisconsin generally is known as a pro-employee state when it comes to enforcement of non-compete agreements. However, last week it gave employers a fairly significant victory in Runzheimer Int'l, Ltd. v. Friedlen, when the state supreme court held that an employer's election to refrain from firing an existing at-will employee constitutes lawful consideration for signing a non-compete agreement.

The Supreme Court of Wisconsin correctly noted that this issue has divided courts across the country, with a minority taking the opposite approach. Pennsylvania happens to be considering a similar question right now. Illinois courts are a mess when it comes to determining the adequacy of consideration for non-competes in the at-will context. In the past, Wisconsin courts had sent mixed signals and had not definitively reached the issue presented. The Court's decision - confusing in its rationale, to be sure - at least provides much-needed clarity for employers and employees moving forward.

The issue that percolates beneath the surface in cases like this is the employer's ability to fire the employee. So the reasoning goes, an employer can "trick" an employee into signing a non-compete, secure that commitment, and then fire the employee without any liability (for at-will employment is a relatively risk-free relationship). According to the Court, it's not correct to view the forbearance from firing as "illusory consideration." Rather, other contract defenses (like fraudulent inducement) provide a legitimate check against such trickery.

The other, less formal, check is that an employer which engages in these kinds of tactics will be less attractive to potential new hires. Further, when it comes time to enforcement, an employer will have a separate issue to confront wholly apart from the consideration question: whether enforcement after involuntary discharge is reasonable. Part of the reasonableness test will examine whether enforcement will present an undue hardship on the employee.

In the past, I have been an advocate for looking at this hardship factor when the employment ends at the behest of the employer, rather than the employee. It is an issue separate from the four corners of the contract, but it still relates to the reasonableness of enforcement. Courts will view attempts to enforce non-competes against terminated employees with much greater suspicion than those who leave of their own volition.

As Runzheimer suggests, we can view this issue wholly apart from the element of consideration. It may be another contract defense. It may be within the overall reasonableness inquiry. But it clearly is something, and employers always will need to factor in the equities when enforcing non-competes.

Friday, May 1, 2015

On Predatory Lawsuits and Bad Faith in Trade Secrets Claims, California Continues to Lead the Way

Trade secrets claim are inherently fraught with a startling reality: they have the potential to morph into opportunistic litigation.

What I mean by this is that a party can use a trade secrets lawsuit for a purpose unrelated to the merits. Put another way, the suit can be a means to heap costs on smaller competitors, discourage the development of a competing product or service, or deter perfectly lawful employee recruitment. Trade secrets suits are often fraught with complexity, which means that it's hard for a judge to snuff out bad faith. They also are exceedingly difficult to dismiss early, because they are fact-intensive. These factors, and more, result in a potential toxic brew that can masquerade a plaintiff's bad faith until well into the litigation process.

I have been fortunate (or, from my client's perspective, unfortunate) to have litigated for the defendants a bad-faith trade secrets claim all the way to the Seventh Circuit Court of Appeals. In Tradesman Int'l, Inc. v. Black, 724 F.3d 1004 (7th Cir. 2003), the Court found under Illinois law that a trial court need not examine a plaintiff's bad faith at the time a lawsuit is filed. Rather, the inquiry is more flexible, and a court is empowered to award fees if it maintains a suit in bad faith. By definition, this requires an ongoing examination of a case to determine if and when a party's bad faith starts.

The Tradesman case is one of a handful of cases - indeed, one of the most important - outside California that examine the notion of bad faith in the specific context of a trade secrets suit. The Uniform Trade Secrets Act, adopted by nearly all states, allows for fee-shifting if a prevailing defendant illustrates bad faith. But relatively few cases reach that stage, and even fewer result in persuasive opinions that practitioners can use for future guidance.

Enter Cypress Semiconductor Corp. v. Maxim Integrated Products, which is surely the most important bad faith case since Tradesman. The case does not establish any new law, as California already has cemented its two-part "objective speciousness/subjective bad faith" test. But the facts of the case, and the Court of Appeal's analysis are powerful and serve to guide lawyers over the bad faith question.

The case arose out of nothing more than Maxim's apparent recruitment (through a headhunter) of Cypress employees - particularly in the area of touchscreen technology. Since California has banned employment non-compete agreements, the broad theory of trade secrets liability ("you're targeting our employees to acquire trade secrets") was dubious out of the gate. Even more problematic for Cypress was California's refusal to adopt the "inevitable disclosure" doctrine - which is broadly used as a justification to enforce non-competes and is more controversially used sometimes as a free-standing claim to bar competition even in the absence of a non-compete.

So, from the start, Cypress' case was in trouble. It veered further off the rails when Maxim demanded a trade secrets identification, which California law requires early in the case. Here's what Cypress disclosed:

(1) A compilation or list of Cypress employees who worked with Cypress's touchscreen technology and products area and their employee information, including contact information.

(2) Cypress's substantive confidential information regarding its proprietary touchscreen technology and high performance products.

Well now. That's seems compelling.

As for category (1), Cypress ran into trouble when Maxim found those same employees - whose identifies were apparently trade secrets, in the Cypress world - on LinkedIn and other social networking sites. Problem.

As for category (2), I am not sure what to say. Identifying your trade secrets as "substantive confidential information" regarding all your products seems a wee-bit circular. Adding adjectives was not all that helpful.

The opinion (embedded below) is replete with an often harsh characterization of what Cypress did with this profoundly silly lawsuit. It supported its bad-faith finding with a wide-ranging criticism of Cypress's improper identification, rank speculation that Maxim even was offering Cypress employees positions on touchscreen technology, and its use of litigation to achieve an improper purpose.

Of greater interest, though, was Cypress's novel defense: since it voluntarily dismissed the lawsuit, Maxim could not be a "prevailing party" under the bad-faith statute. Here, the theory was that Cypress could have refiled the case in the future. Demonstrating a fair amount of arrogance, Cypress contended it was the prevailing party since Maxim voluntarily stopped soliciting Cypress's employees.

The Court of Appeal reached a pragmatic result by rejecting this voluntary dismissal defense. By finding that the plaintiff acted in bad faith, a court will have ensured that the defendant did not achieve some "superficial or illusory success" by virtue of the voluntary dismissal. Put another way, the bad-faith finding is itself a determination that the plaintiff would have lost - badly, in fact. Therefore, there is no real justification for denying fees to a defendant who wins simply because the plaintiff elected to ditch its case in the face of inevitable loss. The Court asked rhetorically "why a party who has made a trade secret claim in bad faith should be permitted to inflict the costs of defense on his or her opponent."

In finding that Maxim was the prevailing party, the Court of Appeal sensibly resolved an issue that trade secrets defendants fear (particularly in state court): the plaintiff's use of expensive litigation to achieve some temporary objective - a standstill agreement to stop competing, piling on of legal fees - only to cut and run after it sends its marketplace message. In these circumstances, a defendant can be left holding the bag with fewer fee-shifting options because it will not have a judgment on the merits.

But as the Court found, the bad-faith finding is tantamount to such a judgment because it serves as a finding that not only was the defendant not liable, but also that the plaintiff knew from the start that it never could be. From a policy perspective, the bad-faith statute has far less teeth if the plaintiff can use the safe-harbor of a voluntary dismissal to avoid even the specter of a fee claim. This is the sort of loophole that should a liberal construction of the bad-faith statute can close.

The issue of bad faith and predatory litigation is one that is not going away, and the Cypress decision serves as a road map for how defendants can fight back against frivolous, anti-competitive claims.

Monday, April 27, 2015

I Cannot Stop Writing about Sergey Aleynikov

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

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

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

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

If only it were so easy for Sergey.

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

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

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

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

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

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

Friday, April 17, 2015

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

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

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

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

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

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

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

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

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

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