Monday, January 25, 2016

Rule 5.6 and the Indirect Restraint

We lawyers love to make rules for ourselves.

As a regulated profession, lawyers are bound by their state's Code of Ethics. And while many of those provisions have nothing to do with competition, one rule in particular stands out. Model Rule 5.6 is the most widely known public-policy exception that invalidates non-competes. Through its text, Rule 5.6 prohibits a lawyer from entering into an agreement that "restricts the rights of a lawyer to practice after termination of the relationship, except an agreement concerning benefits upon retirement." Clients that come to me with a non-compete just love to hear that, legally, I can't even have one.

Despite the relatively clear nature of the rule, courts have not treated it uniformly and its bounds are not well-defined. Without fail, pure non-competition agreements are invalid. Therefore, lawyers cannot be bound by agreements that restrict their practice area or ability to service specific clients.

The more vexing question concerns the indirect restraint, known commonly as forfeiture-for-competition clauses. A typical forfeiture clause provides that an attorney who withdraws from the firm (normally an equity partner) suffers a reduction of what she otherwise is owed if she takes her clients with her. The contract, therefore, does not prohibit competition but amounts to an indirect restraint. It places a financial disincentive on competing directly for firm clients.

Is such an indirect restraint an impermissible restriction on the lawyer's right to practice. New York courts, for instance, have said "yes," that such clauses are unenforceable and against public policy. The state's Court of Appeals has said that a forfeiture-for-competition provision "would functionally and realistically discourages and foreclose a withdrawing partner from serving clients who might wish to continue to be represented by the withdrawing lawyer and would thus interfere with the client's choice of counsel."

One of the law's great anomalies is that the opposite view comes from the Supreme Court of California, where as a matter of policy non-competes are unenforceable in all lines of work. The Court in that case upheld a partnership provision that caused a withdrawing partner to forfeit withdrawal benefits if he practiced insurance defense work in a particular locale. The Court upheld the agreement, focusing on the changing nature of the law practice. In the Court's view, "these agreements address important business interests of law firms that can no longer be ignored." In fairness to this California decision and its seeming incongruity from the rest of non-compete law, the state's broad public policy restriction on non-competes does not apply to partnership contracts. So to this end, the state statute known as Section 16600 cannot provide a collateral source of rights for attorneys to attack forfeiture-for-competition clauses.

For its part, Maine goes further than California and declined to adopt an ethics rule similar to Rule 5.6. Lawyers, therefore, are free to sign non-competes without running afoul of that state's code of conduct. Just recently, a federal court in the District of Columbia - which had not addressed the scope of Rule 5.6 - predicted that it would follow New York's majority rule and bar indirect restraints.

Like many areas of non-compete law, this one is relatively unclear and varies from state to state. However, if lawyers are confused about the types of agreements to which they can be bound, they shouldn't expect sympathy from their clients in the real world. The landscape there is even more unsettled.

Monday, January 18, 2016

Writing Effective Cease-and-Desist Letters

For many business litigators, authoring a "cease-and-desist" letter is the go-to move when their clients face a threat of unfair competition. Although a cease-and-desist letter can be relatively easy in concept to draft, writing an effective one, however, is altogether different task.

The nastiness of a cease-and-desist letter often is inversely proportional to the actual threat posed by a competitor. In many cases, a strongly worded letter looks intimidating but rests on adverb-laden hyperbole, general legal principles, and unfounded assumptions of wrongdoing. These letters may placate a client, but they can do very little to help resolve a dispute. And the letter even can be a source of liability if it is defamatory or interferes with a person's employment opportunities.

So it's essential to write effective letters with a clear purpose. Having written and received many cease-and-desist letters over the years, I have distilled their principal, legitimate functions into three categories:

1. To notify a non-party of contract rights. Even if an ex-employee is clearly violating a non-compete, this does not entitle the enforcing party to seek a claim against the new employer. After all, the new employer may not know of the contract to begin with. In this respect, an employer can use the cease-and-desist letter (really, in this instance a "notification" letter) to establish on the record that the new employer is aware of the ex-employee's underlying breach. The issue of notice is particularly relevant to establishing a claim for contract interference.

2. To assist in making the case for injunctive relief. When an employer has clear evidence of a contract breach or trade secrets theft, a cease-and-desist letter may be an effective tool in helping secure an injunction. An ex-employee's refusal to respond to a clear call to action may prompt a court to understand that its immediate assistance is required. Judges never like hearing emergency injunction petitions, and an attorney who fails to make an attempt to resolve the situation before running into court may face some tough questions from a judge about whether she jumped the gun in filing a lawsuit.

3. To invite constructive follow-up from the recipient to resolve a potential dispute. Since most employers do not seek out litigation, an obvious purpose to a perceived threat is to avoid a dispute in the first place. In this respect, counsel faces a special challenge in drafting a letter in a way that pleases the client while also writing it to yield a constructive, amicable outcome short of a lawsuit.

On this third point, I have noticed that at least four out of every five cease-and-desist letters suffer from the same basic deficiency. They don't invite follow-up and simply generate a vaguely worded, unproductive response.

Something along the lines of this:

"In light of the above facts, Employer demands that you immediately cease and desist from violating the restrictive covenants contained in Paragraphs 1 and 2 of the Agreement, from maintaining any confidential information of Employer, and from interfering with Employer's business relationships. GOVERN YOURSELF ACCORDINGLY!"

Without commenting on the sheer idiocy of lawyers who include phrases like the last one, the call to action in the typical cease-and-desist letter's penultimate paragraph is highly ineffective. Assume the employee provides the letter to his new company. In most cases, corporate counsel will then take the heavy lifting. The cease-and-desist letter invites no response, and a savvy lawyer representing the new employer simply can respond with something as trite as the following:

"We can assure you that NewCo respects and honors its competitors' proprietary information and contract rights. We have assured Employee not to violate any enforceable terms of the Agreement, to disclose any confidential information, or to use any confidential information in working for NewCo. We have communicated your concerns to Employee, and if for any reason we suspect that she has ignored our admonitions, we will contact you promptly."

A more effective cease-and-desist letter follows a two-part format. It first lays out the known facts and the pertinent contract terms. It then reads like a series of specific, written interrogatories that require specific answers.

Examples of the types of questions that employers should ask in this interrogatory format include:

1. Have you contacted for business purposes any Restricted Client (as defined in the Agreement) since leaving Company's employment?

2. If yes to (1), which Restricted Client and what is the name of the key contact person at the client?

3. For each contact with a Restricted Client, what types of services did you sell or offer to sell to them?

4. Have you provided NewCo with any business information belonging to Company and, if yes, to whom?

5. Have you notified NewCo of the terms of the Agreement? If yes, please provide us a copy of that notification and any response NewCo gave to you.

6. Do you contend that any aspect of Company's factual investigation (as outlined above) is inaccurate, and if yes, please describe how.


These are illustrative examples. Each employee's situation, of course, is different and will demand some customization. The idea, though, is to write a very specific letter to get a very specific response. That response may necessitate further fact-gathering, further dialogue among the parties, or the filing of a lawsuit.

But if you serve a generic, threatening cease-and-desist letter, expect a crummy response that does nothing for your client.

Monday, January 11, 2016

The Three Categories of Business Information

The Sixth Circuit Court of Appeals recently had the opportunity to assess the three categories of business information that are at the center of nearly all non-compete and trade secrets cases:

(1) Trade secrets;

(2) Confidential information; and

(3) General skills and knowledge.

The question that often appears in lawsuits is to what extent the law protects these three categories of information. As discussed in Orthofix, Inc. v. Hunter (and countless other articles and cases), the law generally answers the question in the following way:

(1) Trade secrets are protected in most states by statutes (and in a few by the common law), irrespective of any contractual agreement. They are protected under the law of property and of confidence.

(2) Confidential information is protected if there is a specific contractual arrangement in place to do so, and information that does not rise to the level of a trade secret still can vest the owner with legal rights based on contract law.

(3) General skills and knowledge are protectable only through a non-competition agreement, which must be limited in time, scope, and duration. Importantly, the skills and knowledge must derive from the employment relationship - not the individual's free-standing experiences.


Professor Orly Lobel has written that "[e]mployers have been going after employees for using what many courts have defined as general problem-solving abilities. In response, courts repeatedly struggle with separating trade secrets from employees' aptitude, mental and physical abilities, and skills." Talent Wants to Be Free (Yale Univ. Press), at p. 107. She notes several flash-points in the law, where courts have struggled and taken different views as to the three types of business information:

(1) Training (which some courts use as a justification for enforcing restrictive covenants);

(2) Negative know-how (or, the knowledge of what does not work); and

(3) Memorized or internalized information (the so-called "embedded knowledge" problem).

Coming up with a way to differentiate trade secrets and confidential information is not an easy task, but as a shorthand approach, trade secrets typically are used continuously in the operation of a business while confidential information tends to be more ephemeral and have a shorter shelf life.Though this question is difficult in its own right, the harder question may be coming up with an intelligible standard to divide confidential information from general skills and knowledge.

And it becomes more difficult when the subject "skills and knowledge" were developed on the job (as opposed to some pre-existing job experience). The Restatement (Third) of Unfair Competition provides only the following general guidance:

(1) Separating out general skills and knowledge from protectable business information is intensely fact-specific.

(2) Trade secret rights are recognized only in specialized information.

(3) Courts will assess whether the employee took some "physical embodiment of the information" with her.

Ultimately, the Restatement (and common sense) seems to suggest that if what the employer is trying to protect is central to the employee's marketability in general, then the information likely falls within general skills and knowledge. If, however, the employer is trying to protect something unique that others have been unsuccessful in developing, then legitimate trade secrets and confidential concerns arise.

In the Sixth Circuit's Orthofix case, the court addressed a common plus-factor that allowed the employer to retain rights to certain confidential information (without concluding the same was a trade secret). The employee who left took that information with him and apparently conceded that it would take months to recreate it. The value of this specific information to the employer, coupled with a physical taking, therefore removed it from the general-skills-and-knowledge category.

Monday, January 4, 2016

Illinois Federal Courts Continue to Turn Away from Fifield Rule

When it comes to non-compete agreements, the rift between Illinois state and federal courts continues to deepen.

The so-called Fifield rule generally holds that for employment itself to constitute sufficient consideration for a non-compete agreement, the employment must continue for a period of two years. As developed, the rule applies with equal force to both existing and new employees. In this respect, Illinois appears to drift further away from a minority rule on "continued employment as consideration." That minority position looks to whether the employment continuation is "substantial" but courts adopting this position have not done stated the rule with respect to new hires - only existing ones.

For all its analytical foibles, Fifield at least provides some guidance for lawyers when drafting contracts. This is the benefit of a bright-line rule. The downside, of course, is that bright-line rules do not adjust for idiosyncratic fact-patterns, which (in truth) define non-compete suits.

And therein lies the problem for federal courts.

Their charge is to predict what the state supreme court would say, and appellate decisions are persuasive but not binding. State courts must follow appellate authority, regardless of their disagreement with it. Federal courts now have tread their own path and mostly have found that Fifield is not a case the supreme court would follow. The rationale: courts look to the totality of the circumstances when assessing a non-compete's reasonableness, so the same view should color their view as to consideration.

The Northern District of Illinois followed this very reasoning in Traffic Tech, Inc. v. Kreiter last week when it decided not to follow Fifield, denying an employee's motion to dismiss a complaint on the grounds of inadequate consideration. Of particular importance to the court's decision was the defendant's decision to leave voluntarily and the $250,000 signing bonus he received at the time he was hired (regardless of whether it was earmarked as non-compete consideration). Kreiter would be decided differently were it a state court case.

Kreiter illustrates that non-compete disputes, at their core, often rest on notions of equity. The defendant's position simply was not as appealing as those found in other cases, where at-will employees received nothing other than a job, suffered a change in their commission structure, a reduction in their sales territory, or even were terminated. In this respect, if one views consideration as a reflection of "equity," Fifield tends to fall apart quickly. If one subscribes to the need for predictability, Fifield starts to garner more merit.

The federal courts' position on Fifield seems to rest on their view that the Supreme Court of Illinois views equity as the foundation for enforcement of non-compete cases. And equity, viewed under the "totality of the circumstances" approach, demands a very fact-specific assessment as to not only the agreement's terms but also what the employee received for signing it. It is likely that the federal courts are right on this point, but it continues to be a major source of discontent for non-compete lawyers and the clients they advise. And it means that, first and foremost, any attorney needs to look at jurisdictional rules when advising on a non-compete matter. That is no simple task.