Friday, January 30, 2015

No-Hire Provisions Are, For Some Reason, Drafting Nightmares

In the course of reviewing, say 5,000 restrictive covenants (the job can be a wee bit tedious at times), one drafting problem continually amazes me.

Restrictions imposed on employees from hiring away fellow employees appear to vex and confound those who draft contracts.

I've never quite understood this, but it's true. While it seems easy enough to draft non-compete restraints, for some reasons the same doesn't hold true for no-hire covenants.

Here's how I draft no-hire covenants in my model employment contract:

The Employee agrees that during the Restricted Period he will not solicit, hire, or induce a Restricted Employee to leave his or her employment with the Company to join a person or entity that provides similar products or services as the Company offers to others at the time of the Employee's departure.

I then define the terms "Restricted Period" as the duration of employment plus a reasonable post-termination period (say, a year). I define "Restricted Employee" as someone with management, sales, or product development responsibility (or as the client otherwise may choose in the proper case).

The bold-faced clause above is really important, or the covenant protects activity that is innocuous or could not lead to competitive harm. This is the piece I often see missing.

Below is a real beauty from a dispute I am negotiating right now for an employee (I am taking editorial liberties by deleting or revising the unnecessary legal jargon and the misspellings of commonly used words):

During Employee's employment and for two years after the end of employment, Employee shall not accept employment of any employee of Employer.

Worded terribly, this restriction only could apply in a very narrow fact-pattern. But it is not tethered to any competing work, so it's both underinclusive and overinclusive - a real achievement, if you ask me.

Reading, as I sometimes am apt to do, through recent non-compete decisions, I stumbled upon Base One Techs., Inc. v. Ali, 2015 U.S. Dist. LEXIS 5821 (D.D.C. Jan. 20, 2015). The district court dismissed a no-hire claim against two employees who the employer accused of soliciting each other to quit. (Pause to consider how to prove damages or even liability on that one.) The court confronted a covenant similar to the example I just gave, and it read (again, modified for my readers' ease):

Employee agrees not to solicit, contact, represent or offer to represent the Company's Full-Time Employees or Independent Contractors, whether or not such solicitation, contact, or offer was initiated, prompted, or in any other way developed by the Employee...


People draft agreements like this. They really do. The court was unimpressed and found that a vague and ambiguous restrictive covenant was, on its face, unenforceable. The court's particular concern was that the contract never said what conduct the employee could not solicit: "Is the employee prohibited from contacting another employee about health insurance? From soliciting another employee to attend a political fundraiser." When a court asks rhetorical questions in an opinion, that usually is a bad sign.

I believe that when attorneys start drafting contracts, every good and normal human instinct they have disappears. They are flummoxed by how to convey a relatively simple thought. They cram 75 words into one sentence. They liberally use subordinate clauses. They feel the need to use a series of three verbs for the exact same thing ("...solicit, entice, or take away..." or my favorite "...give, devise, and bequeath."

A judge once told me that a restrictive covenant should be understandable to a mildly intelligent 7th grader. I cannot say it any better than that.

Friday, January 23, 2015

New Legislation and a Sentencing for Trade Secrets Theft

The new year always means a spate of legislative activity. Proposed new laws related to trade secrets misappropriation and non-compete agreements do not generate many headlines, but they are fairly common. Two states in particular are considering revising their laws concerning enforcement of non-compete agreements.


First up is Washington. Earlier this month, several legislators in Washington state introduced a bill to restrict the use of non-compete agreements that bar physicians from practicing medicine. The twin bills (one for osteopathic medicine and surgery; the other for physicians) would make non-competes void and unenforceable. The lone carve-out is that the law would allow an action to enforce a contractual provision for damages due to termination of a contract, as long as the enforcing party establishes the reasonableness of damages by clear and convincing evidence. It's not clear from the draft bill whether "termination" means a termination before the end of a set contract term, or whether it's termination of the relationship altogether. It must mean the former if non-competes would be void under the proposed law.

Physician non-competes raise, perhaps more than any other profession, issues of public policy impact, particularly if a rural area would experience a shortage of available care as a result of non-compete enforcement. The Washington bill cites the American Medical Association Code of Medical Ethics as a policy rationale for the proposed change in the law. The pertinent code provision discourages use of non-competes.

Many state courts, such as Illinois, have not found the AMA Code to raise sufficient public policy concerns to invalidate physician non-competes across the board. It is, therefore, more of a legislative judgment, rather than one for courts to balance. Other states, like Texas, attempt to strike a balance by enabling a physician to buy his or her way out of a restrictive covenant at a fair price. Texas' statute also cites to the AMA Code.

The text of the Washington house bill is available here.


Next up - shocker - is Massachusetts. I, for one, hope that this state just does something so I can stop following what is going on.

Massachusetts has considered enacting the Uniform Trade Secrets Act for something like a decade, which is remarkable considering it's a uniform statute. Decide, already! The details of that debate are not that interesting.

Of more importance is whether the state will reform its laws concerning enforcement of non-compete agreements. A number of legislators have introduced bills to ban non-compete agreements, and Russell Beck's fine summary is available here. For those interested in why reform of non-competes in Massachusetts is of interest, Orly Lobel's terrific book Talent Wants to Be Free discusses this at some length.


On the trade secrets front, criminal prosecutions continue to garner headlines.

Another one comes from Chicago where Judge Norgle handed down a tough sentence on two former employees of Citadel LLC, a high-frequency trading (HFT) outfit. As illustrated in Michael Lewis' book Flash Boys, HFT firms engage in algorithmic equities trading, a sort of shadowy corner of the markets that increasingly garners attention in the Wall Street Journal for a variety of reasons.

Citadel's victim impact statement to Judge Norgle indicated that it had spent over $2 million in costs investigating the employees' theft of trade secrets and assisting the U.S. Attorneys' office. Interestingly, Citadel had non-compete agreements with both employees and apparently paid (or contracted to pay) them during the non-compete terms. The defendants, prosecuted in part under the Economic Espionage Act, received three-year prison terms and an order to pay over $750,000 in restitution.

The allegations of trade secrets theft generally centered on the employees' repeated downloading of trading strategies and source code from Citadel's servers onto personal storage devices. Given the value of this data to Citadel's HFT platform, and the security measures it used (detailed at length in the indictment), it is not difficult to see how this conduct rose of the level of trade secrets misappropriation.

Friday, January 16, 2015

Non-Compete Disputes and the Mootness Rule on Appeal

One of the reasons non-compete cases generate a lot of appeals is that the law is tense. By that, I mean that non-compete cases present a unique tension between freedom of contract and freedom to compete. And because public policy underlies many non-compete cases, appellate courts often scrutinize trial court rulings more carefully than garden-variety contract disputes or tort judgments.

But taking a non-compete case on appeal presents a unique legal issue: mootness. Most non-compete cases concern an agreement of relatively short duration, say one year or maybe two. Even if litigation is expedited, the non-compete period may run its course if there is an appeal.

How courts treat the issue of mootness on appeal is one of the more interesting procedural questions that non-compete lawyers face. Here are the three possible treatments:

1. Expiration of the covenant renders the appeal moot. Some courts treat expiration of the covenant on appeal as mooting any issue pertaining to injunctive relief. Remember: mootness only affects the injunction request. A damage claim can subsist for years after the defendant is free to work unencumbered. Texas is an example of a jurisdiction that seems to have a fairly strong mootness rule, as reflected in the recent case of Argo Group US, Inc. v. Levinson, 2015 Tex. App. LEXIS 250 (Tex. Ct. App. Jan. 14, 2015).

2. Expiration of the covenant does not impact an appeal. Other courts take the opposite approach, finding in essence that the appeal may not be moot. The doctrine is called "equitable tolling." A line of Ohio cases suggests an appeal from a denial of injunctive relief may not be moot even if the term of the post-termination covenant has run. But as the case of Tradesman Int'l, Inc. v. Black, 724 F.3d 1004 (7th Cir. 2013), illustrates, this doctrine relies heavily on the factual and procedural posture of the case. Generally, a plaintiff must move promptly for injunctive relief to secure the benefit of the equitable tolling doctrine. If it does so, and an appellate court finds the trial court incorrectly denied the injunction, the employer still can gain the benefit of its bargain through a new term of injunctive relief that nominally extends past the expiration date. The Tradesman case dealt with the opposite fact pattern. The employer there did nothing to pursue preliminary injunctive relief and then, after the covenants expired, sought to impose a permanent injunction - effectively restarting the non-compete period against its ex-employees. As the Seventh Circuit's opinion discusses, this type of litigation conduct will not allow a plaintiff to pursue an injunction.

3. Expiration is a function of what the non-compete says. The final approach that some courts have taken is to push the expiration or mootness issue back onto the contract itself. Courts in Illinois seem to have endorsed this approach, though the case law has enough fluidity in it to make it sound like there still are no hard-and-fast rules on mootness. The notable cases are Prairie Eye Center, Ltd. v. Butler, 329 Ill. App. 3d 293 (4th Dist. 2002), and Stenstrom Petroleum Svcs. Group, Inc. v. Mesch, 375 Ill. App. 3d 1077 (2d Dist. 2007). Both look at mootness in the context of whether the parties agreed upon an extender clause within the non-compete itself. As a result, it is fairly common to see sophisticated Illinois-based agreements with robust remedies sections incorporating the holdings in Prairie Eye Center and Stenstrom Petroleum.


I generally don't have much of a problem with options 2 or 3. Option 1 brings squarely into play the law of unintended consequences. In those jurisdictions that endorse a rigid mootness rule, the law encourages employers to adopt longer covenants so as to give them a fair chance of litigating the case, while at the same time preserving appeal rights.

In this respect, a rule that appears employee-friendly at first actually may not be. Employers will tend to compensate for the common law and "bargain" for longer post-termination covenants, knowing the mootness rule reduces the value of litigating a short non-compete in the first place.

Friday, January 9, 2015

10 Checklist Items for Every Employee Who Leaves to Compete

The dawn of the new year is always a good time to return to basics.

When consulting with individual employees, it amazes me how frequently I run through the same basic departure protocol. By now, this seems intuitive to me. But I realize that for clients it is anything but.

I can't overstate the importance of carrying out a good, clean departure, even if the end of the employment relationship is fraught with hard feelings. Most employee competition lawsuits that go sideways have at their core a common thread: a sloppy, hastily-planned exit. The general perception that an employee violated some basic business ethic on the way out the door can convert an otherwise weak plaintiff's case into one that is able at least to persist through discovery and perhaps trial. That, in and of itself, may be a net loss to an employee who is usually less able to fund a legal defense.

The following list describes ten crucial departure steps employees must take to reduce risk in the event of a competition suit. This is by no means exclusive, and I don't present this in order of importance.

10. Get your agreements in order. I believe well over half of employees now have signed something that potentially affects post-termination conduct. In many cases, the pertinent document could be just a form non-disclosure agreement, which would pose no true restriction on taking a new job. But increasingly, employees sign more extensive non-compete or non-solicitation agreements. For a recent article discussing the proliferation of non-competes, see the linked AP story from January 3 ("Scrutiny on Worker Non-Compete Deals" by Ray Henry). Employees must obtain all relevant agreements, including those they believe to be outdated. It's also important for those employees with restricted stock or stock options to obtain any award agreements, as they frequently contain restrictions or forfeiture-for-competition clauses. An attorney cannot advise a client who is unprepared. Unsigned agreements and similar agreements that co-workers once had is only marginally helpful.

9. Prepare your resignation letter. At some point, an employee who makes the choice to leave and compete should prepare a resignation letter. Even if this seems like a mere formality, a resignation letter could be an exhibit at a trial. And a carefully crafted letter will give the court evidence that the employee was, indeed, careful. A judge can perceive this as a window into an employee's mindset before litigation begins. There are three general rules for drafting a resignation letter: (a) keep it short but articulate; (b) be respectful and thankful for the opportunity; and (c) if you state a reason for departure, be clear but deferential. An employee should have counsel review any resignation letter before delivering it.

8. Return all business documents. My experience is that about 2 out of every 3 employees keeps some non-public information when leaving, even if inadvertently. In many cases, retaining confidential documents is the factual foundation for an employer's case that otherwise might founder from the start. When an employee thinks about leaving, she should make sure to gather all documents (yes, including those at your "home office") and even create an inventory of what she returns. To take it further, employees should make sure those documents are organized and not returned in a scatter-shot fashion. This will show a court that the employee was trying to act respectfully and in good faith during the departure process.

7. Inventory electronically stored information. Closely related to point 8, employees often mar an otherwise clean departure by failing to account for electronic information. This presents a particularly acute problem for the increasing number of employees who work from home. Typically, digital information resides on a personal laptop hard-drive, an external thumb drive, a cloud storage platform, or in personal e-mail that continues to be accessible past resignation. During any competent exit interview, a manager or human resources professional will ask whether the employee has deleted or returned electronic information. A common question employees have is how to "return" electronic information. My pat advice usually is to have the employee disclose all facts about where the electronic information sits and ask the company specifically how to handle any deletion or return of documents. As long as the employee does this, any technical difficulties should be easy to work through.

6. Assess terms of new job offer and proposed employment agreement. Employees frequently become enamored with the idea of a new and better job opportunity. So much so, in fact, that they often forget about what they will have to sign when starting. This is relevant for the obvious purpose that the new job may require a non-compete. But it's doubly relevant because the new hire documents can help frame a lawsuit or the response to a cease-and-desist letter. It is vitally important that the offer letter contain language that respects the enforceable agreements of competitors, ensures that the company is hiring the employee for her general skills and knowledge (and not any proprietary information of competitors), and that failure to abide by these rules will result in termination. If the employee must sign a new agreement, those same admonitions should appear in the agreement as well. Many lawsuits sputter out of the gate if a judge sees that the new employer has no need to compete unfairly and in fact prohibits it.

5. Accommodate exit interview requests. Leaving a job is not easy. Personal emotion becomes wrapped up with professional obligation. And on this score, it's relatively easy for employees to want to bail out on proper protocol, because sitting down to notify a manager that they're leaving is not the easiest thing for the average person to do. However, it is essential to go through the painful exit interview process. For one, it may be contractually required, depending of course on what the employee's agreement or corporate handbook says. Secondarily, it always looks bad if an employee refuses to sit for an exit meeting. That can at least raise the inference the employee intends on hiding unfairly competitive conduct. On the flip side, if the employee is candid during the interview process, she may gain helpful facts to use in defending a subsequent action. The most important fact is participation itself; if the employee goes through the process and participates in good faith, this moots a potential employer line of attack at trial. More dramatically, I have represented clients who have participated in exit interviews and been told by managers that their new job would not be a non-compete violation. I have even seen follow-up e-mail communications that confirm these discussions, only to have the employer reverse course down the road. Another common fact that arises because of an exit interview is the employer's lack of diligence with gathering business documents. Those sorts of facts are game-changers. And they only arise because the employee participated in an exit interview.

4. Establish the new employer's expectations. As part of the hiring process, the employee must have a clear understanding of her anticipated job responsibilities. This is essential so the employee can determine whether the new employer expects her to abide by the restrictive covenants or whether it has another goal in mind. Too often, I have seen employees who are asked to "thread the needle" once they start. They then face the Hobson's choice of violating a post-termination covenant or ignoring an assignment.The employee must be on the same page with management regarding the day-to-day expectations, and in particular how to address the difficult, close issues (such as servicing a common client or working with clients who arguably fall within the territorial scope of a non-compete).

3. Work loyally to the end. I normally tell my employee clients to make their last month at work their best. This is relatively hard to do, but it is nothing more than common sense. An employee who neglects clients, shows up late, and ignores office meetings is likely to be viewed as untrustworthy. It also may cause an employer to file suit, or at least threaten suit, when it otherwise wouldn't have. Employees are often surprised at how much goodwill they can buy just by acting like a grown-up. A lot of employees simply don't.

2. Hire counsel early. Finding a knowledgeable, trustworthy attorney is no easy task. An employee is best served by hiring a lawyer early, during the phase of a job search where a move becomes real. This frequently occurs when an employee has a hot lead on a job. It never hurts to get a legal assessment before that, but counsel needs some understanding of the new position to advise the employee fully on her exposure. Waiting to seek counsel until after the employer sues means the attorney can't help shape the "job transition" facts, many of which I've outlined above. He or she is stuck with a departure that the employee may have planned hastily.

1. Expect the unexpected. It continues to amaze me how badly employees can predict what will happen upon departure. The accuracy of their predictions seems to be inversely correlated to their confidence. The bottom line is you rarely can predict whether an employer will sue. Nor can you count on a manager "going to bat" for you. And sometimes employers act irrationally, seemingly oblivious to the fact that customers may react poorly to being thrust into a lawsuit. Competition suits take on a life of their own (at least for a while), and they often are clouded by poor judgment.


Those readers who find this post informative may want to check out a related post I wrote on May 31, 2013 titled The Employee's First Client Meeting.