Friday, May 27, 2016

Personal Clients/Firm Clients

In 1999, the New York Court of Appeals decided BDO Seidman v. Hirshberg and said this:

" would be unreasonable to extend the covenant to personal clients of defendant who came to the firm solely to avail themselves of his services and only as a result of his own independent recruitment efforts, which BDO neither subsidized nor otherwise financially supported as part of a program of client development."

Which raises the question...

...what's a "personal client" and what's a "firm client"? The particular facts and context of BDO Seidman aren't the point of this post. Rather, the larger issue is the construct of rules in non-compete law that can have unintended consequences for the very parties those rules are intended to aid - employees bound by restrictive covenants.

The difference between a personal client and a firm client is not straightforward. An employer will no doubt contend that an employee's affiliation with it is an extension of its goodwill, branding, reputation in the marketplace, and particular product or service offering. That may be true. Or, as the employee will retort, "I did everything and got no help." That also may be true. The truth may lie somewhere in between.

Rules like that in BDO Seidman are easy to state and hard to apply. Take Marsh USA, Inc. v. Schruhriemen, a New York district court case decided earlier this month. There, Judge Jed Rakoff applied this personal client/firm client rule and entered a limited injunction that basically told the employee "I have no idea, so you're on your own." Of course, Judge Rakoff would never say just that, but he did say that "the Court cannot, without further factual development, provide a definitive ruling on whether [the subject client] falls within the scope of the 'personal clients' exemption" from BDO Seidman so "Mr. Schuhriemen acts at his own peril" if he services the client.

Rules like that announced in BDO Seidman are meant to be objective and place sensible limits on the use of restrictive covenants. But too often, these very rules (expressed objectively) invite further disputes, subject parties to immense litigation risk, and (most noticeably) increase litigation expense on the parties least able to bear them.

The personal clients/firm clients rule from New York is not alone. Disputes about non-compete consideration, the scope of legitimate business interests, and blue-penciling of overbroad agreements all deal with limiting unfair agreements. But only infrequently do these rules solve anything. And in too many cases like Marsh USA, they leave everyone twisting in the wind.

Friday, May 13, 2016

In Wake of Defend Trade Secrets Act Passage, a New Whistleblower Ruling Protects Employees

I cannot begin to wade into the commentary surrounding the passage of the Defend Trade Secrets Act, which officially became the law this week. The summaries of this new federal legislation are so numerous and sweeping that I am already too late to the game.

I would like to discuss, though, one provision of the DTSA which protects whistleblowers - those who may need to use or reveal company confidential information to expose fraud, illegality, or some wrongdoing. Section 7 of the DTSA now immunizes employees from civil and criminal liability if they disclose confidential or trade secret information to the government for reporting suspected violations of the law. I wrote recently about the DTSA's new whistleblower provision and how this obscure provision of the new law may result in employers avoiding federal court (at least for a while) during the law's honeymoon period). Mike Greco of Fisher & Phillips takes a deeper dive into the subject, which is worth a read.

Before the DTSA's enactment, the rub of any whistleblowing activity concerning trade secrets, no matter how legitimate, is the potential for a counterclaim. When whistleblowing activity results in litigation against the company, the company may fire back and claim that the disclosure of confidential documents to counsel or the government violates an existing employment non-disclosure agreement.

Two days before President Obama signed the DTSA into law, a federal district court in the Northern District of Illinois addressed the precise type of whistleblowing activity the DTSA is meant to partially immunize. In United States ex rel. Cieszyski v. LifeWatch Services, Magistrate Judge Schenkier dismissed LifeWatch's counterclaim against an ex-employee, Matt Cieszyski, for breach of a non-disclosure agreement.

Cieszyski took corporate documents as part of his pursuit of what is known as a qui tam suit under the False Claims Act. This type of action enables a private person to bring an action in the name of the government if that person has evidence that another has submitted a false claim to the government.

Judge Schenkier found that LifeWatch did not state a plausible claim for breach of the non-disclosure covenant after balancing the countervailing interests Cieszyski had in pursuing his action (which necessarily depended on the information in the claimed confidential documents). Critically, Cieszyski took what he believed was necessary and did not disclose the corporate information to any LifeWatch competitor. The key passage from Judge Schenkier's ruling reads:

"It is unrealistic to impose on a relator the burden or knowing precisely how much information to provide the government when reporting a claim of fraud, with the penalty for providing what in hindsight the defendant views as more than was needed to be exposure to a claim for damages. Given the strong public policy encouraging persons to report claims of fraud on the government, more is required before subjecting relators to damages claims that could chill their willingness to report suspected fraud."

(A "relator" is someone like Cieszyski who brings a qui tam action.)

Keep in mind that the DTSA's whistleblower provisions do not give employees a free pass to do what Cieszyski did. What Cieszyski did in limiting what he took was obviously smart. But an employer still can maintain a counterclaim against a whistleblower if the scope of his or her taking exceeded what was necessary to maintain the qui tam suit (keeping in mind the ex ante perspective used by Judge Schenkier) or if there was some separate disclosure of the documents outside the suit, such as to a competitor.

Friday, May 6, 2016

New Utah Law Limits Use of Non-Compete Agreements

Every year marks the dawn of legislative efforts to restrict or expand the use of non-compete agreements. This year is no different, and the State of Utah wasted little time drastically restricting the use of restrictive covenants.

The Post-Employment Restrictions Act, known as House Bill 251, accomplishes three major objectives: (1) it limits the use of non-compete agreements to a duration of one year; (2) it exempts non-solicitation covenants from the applicable definition of a non-compete; and (3) it allows employees to recover legal fees if an employer seeks to enforce an unenforceable agreement.

The law takes effect next week, on May 10, 2016.

There is some room for interpretive guidance that surely will come. With regard to the non-solicitation exemption, the law offers no definition. An interesting question will be whether a broad non-solicitation agreement (which restricts any service of an employer's customers, as opposed to affirmative acts of soliciting them) rises to the level of a non-competition agreement.

Several sponsors of House Bill 251 authored a column before Gov. Gary Herbert signed the new law which advocated for its passage. One particularly interesting aspect of that column follows:

"We live in a free country whose prosperity is built on the free market, and as business owners we make choices. The best way for a company to retain its most valuable employees is to treat them well and compensate them sufficiently. Attempts to use legal tools to artificially block the movement of employees leads to a loss of trust and a loss of talent."

What interested me about this comment is that it actually resembles arguments that employees make in court. And that brings to the fore the notion that legislature are best suited to reflect these kinds of normative judgments, even though legislative change happens very slowly.

The state of non-compete law, though, renders courts susceptible to de facto policy making. The very factors courts must consider appear objective, but actually aren't. Those factors tend to lead  judges down the path of making rulings that reflect their personal policy preferences. This may not be a bad thing, ultimately, if the equities of the dispute match the result. But the problem is that the matrix of legal factors and how courts will apply them are highly unpredictable and can't possibly known to litigants or their counsel.