The Reading List (2017, No. 15): Trade Secrets Theft and the Fifth Amendment

Non-Compete and Trade Secrets News for the week ended April 14, 2017

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The Fifth Amendment and Document Production

The Fifth Amendment, and its guarantee against self-incrimination, plays a role in civil litigation and certainly in trade-secret suits. Claims of theft implicate criminal prosecution both at the federal and state level. And while many prosecutors would decline to get involved in a garden-variety civil dispute, the Sergey Aleynikov and David Nosal experiences we have seen suggest that any line-drawing efforts between civil and criminal fact-patterns are tough for anyone to draw. When it comes document production, the general rule is fairly straightforward: the mere act of producing documents (think stolen plans or diagrams) may be a testimonial act for Fifth Amendment purposes. It may, to that end, be an admission that a person has documents that another claims were stolen.

The big trade secret case of the year is in the Northern District of California between Waymo and Uber. And it centers largely on Anthony Levandowski's alleged downloading of 14,000 documents. The case has taken on a life of its own, with twists and turns arising nearly every day on a host of substantive and procedural issues.

One particular filing of interest, though, is Levandowski's effort to avoid having Uber disclose detailed information about the allegedly downloaded documents. The unusual part of Levandowski's motion is that it does not come at the document production stage; instead, he attempted to claim Fifth Amendment rights in Uber's production of a privilege log concerning a particular "due diligence report" that related to Uber's acquisition of Levandowski's company after he left Waymo.

Levandowski's brief is an interesting take on the Fifth Amendment and the testimonial act of document production. It touches, crucially, on issues of attorney-client and common-interest privilege, given a joint defense arrangement between Levandowski and Uber. Here, Levandowski is trying to say that the joint defense between he and Uber allow him to step into the shoes of Uber and prevent it from disclosing details on a privilege log about the due diligence report. Note that Levandowski is not a party to the Waymo suit, but the conduct that is most relevant involves him directly and the allegedly mass download of Waymo materials. Levandowski's brief is available here.

Yesterday, Judge Alsup denied Levandowski's motion, holding that compelling Uber to produce a conventional privilege log would not violate Levandowski's Fifth Amendment rights. The decision is available here. Judge Alsup found that "mere invocation" of one's Fifth Amendment rights cannot automatically supplant conventional privilege log requirements. To this end, he stressed the need for "targeted factual support" - like a privilege log itself - that lends the Fifth Amendment assertion some plausibility.

Interestingly, Judge Alsup touched on an argument not really advanced but which it seems as though he felt was percolating under the surface. He rejected the idea that Levandowski could claim a privilege if the subject due diligence report was provided to Uber so Uber could see whether Levandowski was arriving with baggage - namely a potential trade secret claim to defend. Judge Alsup noted that one cannot use the attorney-client privilege to cloak wrongdoing through "due diligence." Therefore, as a result of the ruling, Uber will have to place the particulars of the due diligence report on a privilege log for Waymo to see. Whether Levandowski will assert further Fifth Amendment rights to its ultimate production remains to be seen. But I think I know the answer.

Bad Faith in California Trade Secrets Actions

I have an article coming out shortly in the Illinois Bar Journal, and it concerns bad faith in trade secrets disputes. In particular, I discuss Illinois' rule that is akin to a Rule 11 "frivolous pleading" standard. I also discuss the rule that seems to prevail elsewhere - the two-part test used by California courts, focusing on objective speciousness and litigation misconduct. As the Court of Appeal in Vescovi v. Clark makes clear, that test is really a one-part test. Objective speciousness probably is enough, because the litigation misconduct derives from the specious nature of the claim. Vescovi is unpublished, but it's a good read nonetheless. A copy of the opinion is available here.

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James Flynn of Epstein Becker & Green published a nice piece on Law360 concerning Justice Gorsuch's track record of resolving trade secrets disputes while a Tenth Circuit judge. It is worth a read.

Face It: Judges Sometimes Hate Competition Cases

Believe it.

One exceedingly difficult message to convey to clients is this: A judge may not view your case as importantly as you do.

In my personal view, judges should be agnostic to subject-matter. That is, he or she should (in a perfect world) treat each case with equal importance. This may mean some disputes are simple or straightforward, in which case a decision should be fairly easy to reach. But a judge's subjective view as to a type of case should not influence his or her choice of outcomes (or more accurately, his or her relative time spent thinking about the case).

In the world of non-compete and trade secrets disputes, judges often don't like these disputes.

There are a couple of reasons.

First, they usually are teed-up on an emergency basis, clogging already full judicial calendars.

Second, they smack of the ordinary rough-and-tumble of economic life, where battles should be fought in the board rooms.

And third, they almost always sometimes sound like a bunch of old people fighting over canasta points.

There's a couple of recent examples where you can get a glimpse of how judges quickly tire of non-compete litigation.

The first comes from Ohio in the case of Lawyers Title Company v. Kingdom Title Solutions. The case involved apparent pre-termination competition by a couple of ex-Lawyers Title employees. Proceeding to a jury trial and after an extensive trial court record, Lawyers Title obtained a judgment for (hold your breath) $13,000 in damages. On post-trial proceedings, the district judge - barely - upheld the verdict on the proof of damages, noting:

"...it is impossible to know why [the former customers] took their business elsewhere. But Lawyers did not call its former customers to testify, probably because none of them would ever do business with Lawyers again after being dragged into this silly litigation."

In all fairness to Lawyers, it may have felt compelled to pursue its claims against former employees who (it appears) diverted clients pre-termination. Folding the tent would send a terrible signal for the next slate of employees who may contemplate a move. In that sense, the litigation surely was not "silly." But pursuing litigation with little to no damages is sure to draw the ire of a busy district judge.

The second case, Patch Rubber Co. v. Toelke, originates from North Carolina. There, District Judge Boyle denied a preliminary injunction to enforce a non-compete against a former plant manager. The problem: a ridiculously overbroad agreement that went way beyond protecting a legitimate business interest. In North Carolina, courts cannot modify overbroad agreements, so it is fairly common to see bad contracts chucked out the door early in a case.

And the judge's displeasure at the contract may have colored his view on the remainder of the case. In the face of evidence the employee downloaded "several documents containing a strategic plan...and customer cost and formula information," the court discounted the evidence entirely. It simply found the plaintiff didn't really show how the information was confidential or trade secret material.

This is not to absolve the plaintiff. It very well may have failed to convince the judge. But often times evidence of downloading at least leads to some partial relief, such as a limited injunction to protect against disclosure or use of the downloaded material.

But it's hard not to read the case and conclude that by the time the court got around to analyzing the trade secrets component, he was aggravated by the non-compete.

For employers, it's essential to consider how a generalist judge is going to view a case. The judge will want to know what relief the company will seek and whether there is a real dispute in need of an objective decision maker. It is a stark reality that many judges feel a great majority of competition cases could have been resolved easily before litigation.

Settlements Redux: A Brief Follow-Up From My Bankruptcy Post

I received a number of e-mails on my three-part series on settlements, which ran over the past few weeks.

Of those e-mails, several dealt with a topic I raised in Part 3 - accounting for the possibility of a settling defendant's bankruptcy. So I felt it was appropriate to answer those questions in a follow-up post.

As I noted in Part 3, a plaintiff settling a competition dispute may be able to litigate, or relitigate, a claim during the course of an adversary proceeding if the defendant files for bankruptcy.

An exception to the general rule of dischargeability is the "fiduciary defalcation" provision contained in Section 523(a)(4) of the Bankruptcy Code. That generally holds that a debt is non-dischargeable when a debtor breaches a duty while acting in a fiduciary capacity.

Because all adversary claims are governed by the Bankruptcy Code, federal law will apply. And federal courts' interpretation of what qualifies for the "fiduciary defalcation" exception to dischargeability is not on all-fours with state law concepts familiar to many readers, such as the common law fiduciary duty of loyalty, rectitute, candor, and good faith.

Let's take a hypothetical and assume a fact pattern we've discussed on this blog before. If a corporate officer sets up a competing business while still employed, this almost certainly would constitute a breach of fiduciary duty under state law. That does not mean that debts arising out of that breach automatically are non-dischargeable under Section 523(a)(4).

Bankruptcy courts generally provide that the debt is non-dischargeable only if the debtor is acting in a fiduciary capacity with respect to the particular conduct giving rise to the debt.

So under the hypothetical I just outlined, the corporate officer may or may not have his debt discharged.

If, for instance, he simply starts a new business, moonlights, and then funnels new customers to his separate entity, any damages for which he's liable under the common law likely would be dischargeable. (I say "likely" because court decisions aren't totally consistent.)

However, if the officer swaps out an order intended for his current employer and runs that through a competing business - essentially the equivalent of a conversion or civil theft - then the company stands a much better chance of claiming that the debt is non-dischargeable.

This is a fine distinction to make, and courts do come out different ways on this.

The 523(a)(4) exception really is intended to provide a remedy for embezzlement or insider corporate theft, such as when a controller - say, in Dixon, Illinois - loots the company till.

Applying the exception to a garden-variety competition case founded on breach of fiduciary duty often yields few clear answers.

A Lesson In How Not to Do It: Vibra-Tech Engineers v. Kavalek

Competition disputes fascinate me partly because of the ways people manage to screw things up.

For my employee clients who are looking to leave and compete, the advice I often end up giving is simple and straightforward. In a nutshell...

1. Don't take anything when you leave.

2. Be honest and forthright on your way out the door.

3. Know your contractual obligations.

4. Don't compete before quitting.

Of course, there are the inevitable line-drawing exercises that have to be hashed out, as I end up answering countless "what if I do this" questions. But as long as employees can stick to these four basic rules, things can't go too terribly wrong.

Scott Kavalek stuck to none of these rules.

The case is Vibra-Tech Engineers, Inc. v. Kavalek, and if nothing else, it is first-rate primer on how not to compete. Earlier this year, a federal court entered a judgment against Kavalek, his wife, and their two companies in the amount of $3.39 million. The suit was a not-so-garden variety non-compete and duty of loyalty action that Vibra-Tech brought in New Jersey. And the facts were startling to read.

Vibra-Tech is in the business of measuring vibrations in construction, quarry, and mining operations, and it also performs related consulting services. Kavalek was a high-level executive and corporate officer of Vibra-Tech who, years before his termination, set up two competing businesses and actively competed with Vibra-Tech while employed by it.

Among Kavalek's actions:

1. Hiring then-current Vibra-Tech employees to work for a competing entity.

2. Diverting several large customers to his own company, costing Vibra-Tech business.

3. Setting up another company as a "supplier" of geotechnical equipment and causing Vibra-Tech to purchase equipment from this supplier at inflated rates.

4. Lying at the time of termination of his involvement in these companies.

5. Tampering with sales invoices produced in discovery in an effort to hide Kavalek's sales activity with diverted customers.

6. Causing his attorneys to make repeated false representations in court about the production of documents and his association with corporations he controlled.

In a case such as this, contractual obligations almost seem to take a back seat. And indeed, the district court in rendering its judgment makes only passing references to the non-compete's enforceability. To be certain, if Kavalek never signed a contract, the outcome would have been the same.

The only real interesting legal issue to come out of the case is that the district court applied a disgorgement theory of damages, largely under the principles of agency associated with fiduciary duty law. Vibra-Tech had offered alternative damages theories, based on both lost profits and disgorgement. Ultimately, the court had little trouble finding that punitive damages also were appropriate.

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Court: United States District Court for the District of New Jersey

Opinion Date: 3/29/12

Cite: Vibra-Tech Engineers, Inc. v. Kavalek, 849 F. Supp. 2d 462 (D.N.J. 2012)

Favors: Employer

Law: New Jersey

Case Law Update: Source Code "Crimes", The Duty of Loyalty, and Trade Secrets Preemption (My Favorite!)

The year continues to churn out some interesting cases, and they're getting a bit tough to keep up with. Here is a brief survey of some developments I found this past week, broken down by general topic. As you can tell from the title, there is a trade secrets preemption case to report on. I am, for some reason I cannot figure out, oddly fascinated by this procedural topic. This is not something to emulate or be proud of. But it is what it is. Here we go...

Trade Secrets


The Supreme Court of Georgia, in Robbins v. Supermarket Equipment Sales, LLC, 290 Ga. 462 (2012), adopted what I call broad form preemption under the Uniform Trade Secrets Act. Preemption is the idea that if you're claiming trade secret protection, that's your sole remedy; you can't default to some other common law tort as an alternate theory of recovery. In Robbins, the Court held that because the plaintiff alleged certain design drawings for refrigeration "skins" (incidentally, no clue what this is) were trade secrets, the trial court could not award injunctive relief under another equitable theory once the plaintiff failed to prove its trade secrets case. Significantly, the Court stated that because "the drawings were not ultimately found to be trade secrets under the [UTSA] did not make the preemption clause inapplicable." This is the correct result, but by no means are other states in accord.

Employee Duty of Loyalty


In most states, an employee owes a duty of loyalty to an employer. This is different than a "fiduciary" duty, which is accorded somewhat of a special place in the law - reserved in the corporate context for senior officers, directors, and shareholders.

The stinger on duty of loyalty claims is the idea of salary forfeiture. That is to say, an employer may be able to clawback salary paid during a period of disloyalty. Easier said than done. A recent case out of Alabama demonstrates why. In AK Steel Corp. v. Earley, 809 F. Supp. 2d 1326 (S.D. Ala. 2011), the court granted summary judgment in favor of a claim made against several employees for breach of the duty of loyalty. The case was decided under Ohio law, which has adopted the "faithless servant doctrine." The doctrine allows for salary forfeiture only if the acts of disloyalty "permeated" the employee's service. In that case, the employer could not show any active competition prior to termination, meaning that the transfer of a few files did not rise of the level of pervasive disloyalty required for salary forfeiture.

On to Missouri and another duty of loyalty case, Western Blue Print Co., LLC v. Roberts, 2012 Mo. LEXIS 93 (Mo. Apr. 17, 2012). This case arose in a somewhat familiar fact pattern. Roberts was a branch manager for Western Blue, a document management service company. One of the largest clients of the company was the University of Missouri. After obtaining the university contract, Western Blue had to subcontract a portion of the business to a certified minority business enterprise. At this point, Roberts took an interest in an MBE contractor but never disclosed it to Western Blue. In fact, she was approached later about it and denied any arrangement with the subcontractor at all.

When the relationship fractured, Roberts actively worked for the subcontractor, orchestrated the mass exodus of Western Blue employees, recruited them to work for the subcontractor, and bid on - and won- the university contract. This resulted in Western Blue's closure of the branch office. Western Blue sued, won $600,000 in damages, and nearly $250,000 in legal fees. On appeal, the Supreme Court of Missouri reversed, holding Roberts was not a top corporate official of Western Blue and therefore not a fiduciary. Central to the Court's reasoning was the absence of any non-compete agreement between Western Blue and Roberts, and the fact that the knowledge she obtained was simply the product of what she naturally would acquire during the course of her job. For reasons I can't figure out, Western Blue abandoned at trial a separate claim for breach of the duty of loyalty, a duty which is ascribed to regular employees.

Given the facts, this is an unusual result. The Court carefully parsed certain facts to hold Roberts did not violate any pre-termination duty not to compete with Western Blue. It overlooked some essential facts that clearly suggested she was less than forthright and might have gained a head-start when working for the subcontractor. Had Roberts been bound by a reasonable restrictive covenant, the case would have turned out completely different. Or perhaps, Roberts never would have done what she did. To put it mildly, she found a narrow path - a very narrow path - to victory.

Economic Espionage Act


The Second Circuit overturned the conviction of former Goldman Sachs programmer Sergey Aleynikov in U.S. v. Aleynikov, 2012 U.S. App. LEXIS 7439 (2d Cir. Apr. 11, 2012). The man with the name similar to pick-your-Chicago Blackhawks-defensemen from the late '90s had been convicted under various federal statutes, including the Economic Espionage Act when he uploaded source code relating to Goldman's high frequency trading operations. Aleynikov took the source code with him to Teza Technologies in Chicago, where he more than doubled his salary. After conviction in the District Court, his prison term was set at more than 8 years. (Interestingly, there was related non-compete litigation in the Circuit Court of Cook County between Citadel Investment Group and Teza.)

The circuit court found the EEA did not apply, because Goldman's HFT system was not produced for or placed in interstate or foreign commerce. Goldman kept the system confidential and had no intention of selling it or licensing it to anyone. Therefore, by the terms of the EEA, the indictment was improper. The concurring opinion is interesting, as it suggests that Congress ought to revisit the EEA so that its terms reflect its intent.

Seventh Circuit Reaffirms Complete Salary Forfeiture Principle (Gross v. Town of Cicero)

The most powerful remedy for a breach of fiduciary duty claim is that of salary forfeiture. The Seventh Circuit reaffirmed the availability of this remedy in a long-running municipal dispute involving the Town of Cicero. While the facts of that case don't shed any light at all on salary forfeiture in the context of unfair competition cases, the Court cited a number of past precedents.

In particular, the Court stated that "[t]he salary subject to forfeiture is not limited based on the ratio of injurious to legitimate work performed, since an agent who breaches his fiduciary duty has no right to any compensation while acting adverse to the principal's interests." Put differently, there really is no proportionality defense available though my experience is that courts (and juries) effectively consider how serious the fiduciary's transgressions actually were.

The key to salary forfeiture is determining when the fiduciary breach began. For any plaintiff pursuing this remedy against a disloyal employee, it is critical to tailor discovery to find out when precisely an agent started acting in a manner directly adverse to his or her principal.

Often times, this is not easy because of the preliminary stages doctrine. Agents can "prepare to compete", and there is no real bright-line between preliminary competitive activities that are acceptable and actual competition that is not. Each case, of course, turns on its own facts in this regard.

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Court: United States Court of Appeals for the Seventh Circuit
Opinion Date: 8/27/10
Cite: Gross v. Town of Cicero, 2010 U.S. App. LEXIS 17911 (7th Cir. Aug. 27, 2010)
Favors: Employer
Law: Illinois

"Head-Start" Rule Applies to Damages, As Well As Injunctions (Berardi's Fresh Roast v. PMD Enterprises)

The concept of a "head-start" injunction is well-established in unfair competition law. The idea of it is rather simple. In a case involving trade secrets misappropriation, a defendant may be enjoined - or prevented from using the secret - if the plaintiff can show the defendant's efforts to bring a product or service to market were substantially shortened as a result of the misappropriation.

We often see this in cases where the secret is some sort of tool used to develop a product. Take, for instance, an engineering drawing for a complex piece of equipment. A defendant who has misappropriated a proprietary drawing may try to claim he could easily reverse-engineer the drawing from the product itself. However, this may take a long time, depending of course on the complexity of the product. By short-circuiting the process and stealing a drawing, a defendant can reduce his time to market a competing product.

A plaintiff is justified in seeking relief for this head-start the defendant unfairly obtained through misappropriation of the secret product. Courts often will require a defendant to refrain from exploiting the benefits of a secret for a period commensurate with the unfair head-start.

The notion of head-start relief, however, is not limited to equitable relief. As a recent Ohio appellate decision noted, "a trade secret defendant's damages may be limited to the time the defendant saved in getting a product to market by virtue of its misappropriation." The amount of damages will be a factual question. A judge or jury must determine the actual lead-time or head-start the defendant unfairly obtained, a question often requiring detailed fact and expert testimony.

It should be noted, too, that the head-start concept applies outside the trade secrets arena. It is a very common remedy in cases of insider duty of loyalty claims. If a key employee competes unfairly before quitting and seeks to misappropriate a corporate opportunity, courts are more than willing to force the executive to sit on the sidelines for a time equal to his period of disloyalty. In this context, calculating the head-start may be much easier. Rather than figuring out how long the reverse-engineering process might be (as in a trade secrets case), a plaintiff likely need only show when a key emloyee's fiduciary breach began.

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Court: Court of Appeals of Ohio, Eighth Appellate District
Opinion Date: 10/21/10
Cite: Berard's Fresh Roast, Inc. v. PMD Enterprises, Inc., 2010 Ohio App. LEXIS 4314 (Ohio Ct. App. Oct. 21, 2010)
Favors: Employer
Law: Ohio

Employer Must Watch For Broad Use of Employee Indemnification and Advancement Rights (James River Mgmt. v. Kehoe)

Imagine a very common scenario where a corporate officer or employee steals valuable corporate data, deletes or compromises electronic information on his way out the door, solicits customers to leave prior to his termination of employment...and then says his employer must pay for the legal defense of is almost certain to be contentious litigation.

Is this such a far-fetched scenario?

Not really, and it all has to do with the concept of advancement and indemnification. Corporate laws across the United States provide that companies may indemnify officers, directors and employees for litigation costs and judgments incurred due to the fact of their affiliation with the company.

Advancement is a little bit different but related - it concerns the right receive legal fees prior to the time litigation is terminated and decided. In essence, it means the right to have someone else pay your attorney on a regular basis.

In many corporations, the rights to advancement and indemnification are mandatory under governing bylaws. This seems counterintuitive, but is used to attract key personnel as corporate officers and directors. An employee may even have such rights spelled out in an employment agreement.

Most of us are familiar with corporate executives being indemnified in breach of fiduciary duty cases, such as shareholder derivative actions, or even criminal suits for insider trading. But the same concepts apply in unfair competition law. Believe it or not, there are cases holding that a corporation suing a departed executive must advance legal expenses to that executive during trade secrets or fiduciary duty litigation - theories which fit the facts described in the first paragraph of this post. The reason is that advancement rights - particularly under Delaware law - are broadly interpreted.

As one court interpreting Delaware law recently stated: "The line between actions taken in a personal vis-a-vis corporate capacity is not drawn according to whether the director or officer acted detrimentally to the interest of the corporation, but instead on whether there is a nexus or causal connection between any of the underlying proceedings and one's corporate capacity without regard to one's motivation for engaging in that conduct."

In the context of trade secrets theft, an employee can claim that such conduct occurred as a result of his prior employment and that it arises directly out of his rule as a corporate fiduciary. Can the same be said of a non-compete violation? Probably not. The courts clearly hold that contractual obligations in a non-compete agreement are the product of an arms-length transaction, entered into by the employee in his personal - not corporate - capacity.

The lesson for counsel is this: don't forget about advancement and indemnity rights. The source of those rights is the governing state's corporation or limited liability company law, the bylaws or operating agreement, and any agreement the employee may have signed during his or her employment.

If the employee has advancement rights which are contested, then a court must decide those rights in a summary proceeding. The rights to advancement may be conditioned, however, on an employee's undertaking to repay such costs and fees to the corporation if his actions were not taken in good faith (or whatever the bylaws say on this). For a defendant who is in a precarious spot but wants to fight until the end, advancement only gets him or her so far. It is effectively an interest-free loan.

At the very least, though, it may give the company suing the ex-employee a strong incentive to work out an early resolution to the case.

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Court: United States District Court for the Eastern District of Virginia
Opinion Date: 12/8/09
Cite: James River Mgmt. Co., Inc. v. Kehoe, 674 F. Supp. 2d 745 (E.D. Va. 2009)
Favors: Employee
Law: Delaware

What Are the Limits on "Preparing to Compete"?

Most jurisdictions recognize that employees are able to plan, outfit and form a competitor prior to the time they quit without running afoul of their fiduciary duty of loyalty. The law concerning fiduciary duties is best understood as a gap-filler that will prohibit unfair competition, particularly when a non-compete agreement is absent or unenforceable.

This doctrine - allowing an employee to prepare to compete - has its limits, of course, and like much of the law concerning unfair competition, a lot has to do with the equities.

What is permissible? Again, that all depends, but here is a basic list of permissible preparatory activities:

1. Incorporating or organizing a business entity
2. Developing a business plan
3. Negotiating an office lease
4. Establishing a bank account
5. Raising capital
6. Purchasing a competing business (if those intentions are disclosed prior to closing)
7. Identifying potential clients or sources of supply

What is prohibited? The touchstone inquiry will be demonstrable, actual competition, not preliminary steps to compete. Another non-exhaustive list:

1. Using employer information to develop account lists
2. Selling or making sales proposals to customers prior to resignation
3. Downloading ex-employer confidential information for use in the new venture
4. Failing to follow through on sales leads in the hopes of saving that account for future competitive activity
5. Taking a corporate opportunity and failing to tender it to the employer

An employee can certainly plan a competing venture so that on the day following resignation, she is able to start contacting customers and generating sales. Most courts will look at how active an employee was in actually competing - not just preparing to compete - in assessing whether the employee has violated a common law fiduciary duty of loyalty.

Remember: this body of law tends to place limits on competition in the absence of a non-compete. Just because an employee has no post-employment non-compete agreement in place does not mean the preparing to compete doctrine can somehow be extended or rendered inapplicable.

Recently, I have seen a number of employee non-compete agreements that contain not only customer covenants, but also prohibit an employee by contract from preparing to compete. It is not clear to me that this type of restriction has any real teeth, or how a court would analyze such a restriction in light of the common law preparing to compete doctrine. In fact, it is difficult to assess what the remedy would be for such a breach as long as there is no actual competition prior to resignation.

Customer Contact May Be Prohibited In Absence of Non-Compete Agreement (Taxsalelists.com v. Rainer)

One issue that frequently comes up in my practice is the extent to which an employer can prevent an ex-employee from contacting customers when there is no non-compete or non-solicitation agreement. Though it's difficult to obtain this remedy, the circumstances are not quite as narrow as many attorneys believe.

Most frequently, post-employment competition without a valid non-compete can be restrained when an employee steals some proprietary data that bears a direct nexus to customer names or goodwill, or when the employee engages in pre-termination competitive activity with certain accounts.

As to the former, it is perfectly logical to prevent customer contact if proprietary customer information (such as a secret list) has been taken. Regarding the latter, courts call this a "headstart" injunction because it purges the unfair competitive advantage gained by an employee before his fiduciary duty of loyalty ended. So the reasoning goes, if an employee has moonlighted and diverted a customer account away for 6 months, then he or she should be restrained from working with that same customer for the same period of time.

A recent case from Colorado illustrates these two situations. In Taxsalelists.com, LLC v. Rainer., a business engaged in providing complete property tax sale lists to affiliates and subscribers suffered a bizarre familial fallout in November and early December. The owner of Taxsalelists.com, John Lane, hired his two stepsons and their wives in 2008 as employees. In July of 2009, one of the two stepsons, Matthew, resigned. While employed at Taxsalelists.com, Matthew had enabled his Gmail account to forward any personal e-mail to his company account. When Matthew quit, he forgot to disable this feature.

This might not have been a big deal, except that the plaintiff claimed Matthew was providing Taxsalelists.com's customer database to a direct competitor both before and after his employment at Taxsalelists.com ended. At the time of an injunction proceeding, a review of e-mail information seemed to confirm that the other step-son, who is still employed by Taxsalelists.com, was enabling Matthew to provide such proprietary information illegally to a direct competitor.

The court had little trouble issuing a temporary restraining order on a complaint charging violation of the Computer Fraud and Abuse Act, breach of fiduciary duty, and a host of other common-law claims. The TRO ruling is interesting in a few separate respects:

(1) It was issued ex parte (i.e., without notice) on the basis that the defendants may seek to destroy electronic evidence, hard drives and relevant information if given notice of the TRO hearing.

(2) The TRO prohibited all of the defendants from contacting any of plaintiff's customers contained on the appropriated e-mail/customer lists.

With compelling evidence of misappropriation of customer data, the court was able to fashion what amounts to a non-compete even though no contract prohibiting customer competition was in place. Under most state trade secrets statutes and the common law of fiduciary duty, courts have wide latitude to remedy acts of unfair competition, and in many cases a strong case on one of these theories may enable a plaintiff to restrain more competitive acts than even the most airtight agreement.

UPDATE X1: This matter settled with no admission of liability by the Defendants who strongly denied any misappropriation ever occurred.

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Court: United States District Court for the District of Colorado
Opinion Date: 12/11/09
Cite: Taxsalelists.com, LLC v. Rainer, 2009 U.S. Dist. LEXIS 122274 (D. Colo. Dec. 11, 2009)
Favors: Employer
Law: Federal

Nasty Employment Row Highlights Importance of Duty of Loyalty, Underscores Cost of Litigation (Lawlor v. North American Corp.)

The Chicago Tribune's business reporter, Ameet Sachdev, writes this morning on the hotly contested dispute between Kathleen Lawlor and North American Corp. of Illinois, a case recently tried to judgment in the Circuit Court of Cook County.

The dispute touches upon a number of hair-trigger employment law issues, including rights to privacy, unpaid commissions, theft of confidential information and threats to steal customers. It also makes an oblique reference to another issue that always underscores the difficulty of employment litigation: Lawlor's attorneys' fees have approached $1 million.

The case involves the marketing services industry, and the dispute arose right after Lawlor, a successful salesperson, left in 2005. She claimed she was owed accrued commissions, and her employer feared she would steal customers. It also had her followed by a somewhat amateur gumshoe, a fact that would later prove to be damaging to North American.

There was no hint in Sachdev's article that Lawlor was bound by a non-compete contract, so North American was left to pursue common-law remedies. It found potential smoking guns when a North American consutant swore out an affidavit that Lawlor offered to introduce him to a competitor before she quit, and when Lawlor disclosed historical sales and margin data to a competitor on a job interview.

This conduct directly implicated Lawlor's duty of loyalty to her then-employer. That duty prohibits an employee from disclosing confidential information, facilitating a mass exodus of co-workers, and diverting business opportunities away from the employer. Employees must take this duty seriously - a violation can result in salary forfeiture during a period of disloyalty, an injunction against competitive conduct (even in the absence of a non-compete agreement), and punitive damages.

At trial, the parties appeared to split their claims against one another. Lawlor ended up prevailing on her invasion of privacy claim, after North American's overzealous investigators improperly obtained Lawlor's phone records and gave them to the company. North American, on the other hand, was able to obtain some measure of compensation forfeiture, presumbably based on Lawlor's pre-termination activity with existing customers or improper disclosure of North American financial data. Despite relatively low actual damages ($78,781), the trial judge imposed punitive damages of $551,467 - a multiple of seven.

Aside from the enormous fees generated in this case, the litigation serves as a reminder that the absence of a non-compete agreement does not - by any stretch - sanitize an employee's conduct on the way out the door. Breach of the common law duty of loyalty provides for extensive legal and equitable remedies. Proving such a claim can be difficult for an employer, but if the employer is able to marshall evidence of improper pre-termination activity (often learned through a forensic examination of the ex-employee's computer), it may be able to put a halt to anti-competitive conduct and obtain significant monetary relief.

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Court: Circuit Court of Cook County, Chancery Division (Transferred to Law)
Opinion Date: N/A
Cite: Lawlor v. North American Corp. of Illinois, 2005 CH 13876
Favors: N/A
Law: Illinois

Stored Communications Act Playing Big Role In Competition Cases (Pure Power Boot Camp v. Warrier Fitness Boot Camp)

Back in March, I wrote an article focusing on a bizarre employment dispute between Bonnie Van Alstyne and her former employer, Electronic Scriptorium. Broadly speaking, Van Alstyne's former boss fired her and then accessed her personal AOL e-mail on numerous occasions. This conduct resulted in a federal claim brought by Van Alstyne under the Stored Communications Act, 18 U.S.C. 18 U.S.C. 2707, for which punitive damges and attorneys' fees are available.

What does all this have to do with non-compete cases? My experience shows that a substantial percentage of the relevant evidence in non-compete cases involves e-mail. Often times, this e-mail is generated, sent and stored on employees' personal accounts as they develop their departure and competitive plans. The rub lies in the fact many employees also access their e-mail from time to time at work. Depending on the particular internet settings established, the work computer may store web-based e-mail usernames and passwords. If these are not removed prior to an employee's departure from the company, he or she may be unknowingly providing the ex-employer with the tools to access private e-mail accounts.

This, in fact, is what happened to Bonnie Van Alstyne. It also happened to Alexander Fell, who planned to leaving his job at a fitness company to start his own. When Fell resigned, his boss - Lauren Brenner - was able to access a Hotmail account Fell had logged onto while at work. She was further able to obtain access to Fell's gmail account, and a separate account set up under Fell's new company's name. Brenner then found damaging evidence related to Fell's pre-departure activities.

We can expect scenarios like this to happen with increasing frequency. Brenner's conduct violated the Stored Communications Act and severely damaged her ability to pursue Fell for unfair competition. Though it is not clear whether Fell has since countersued Brenner under the SCA, he may have an independent claim to attorneys' fees and punitive damages even if he is liable to her for unfair competition. To add further insult to Brenner's (self-inflicted) injury, the damaging e-mails she obtained in violation of federal law cannot be used against Fell, unless he opens the door to them or unless they are used solely for impeachment purposes. The harsh reality is that Brenner would have been able to obtain these in the normal course of discovery from Fell or anyone who communicate with Fell - business partners, clients, vendors and the like.

Even internet or e-mail policies may not give an employer a basis to access personal e-mail accounts used during work hours. As the court in Fell's case noted, employees still have a reasonable expectation of privacy to their personal accounts. One important caveat should be noted, here, though. The court was not addressing a situation where Fell drafted and disseminated the e-mails while using his ex-employer's computer, network and server. Presumably, evidence obtained from the server itself or hard-drive would pose problems. But it seems that a court would still be very hesitant to bless any access of a personal e-mail account on this basis alone.

Employers can wade into dangerous territory by being overly aggressive in searching employee's computers. When dealing with personal e-mail accounts, it is best to obtain only what is available from the company's network and rely on the discovery process to glean relevant facts.

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Court: United States District Court for the Southern District of New York
Opinion Date: 8/22/08
Cite: Pure Power Boot Camp, Inc. v. Warrior Fitness Boot Camp, LLC, 587 F. Supp. 2d 548 (S.D.N.Y. 2008)
Favors: Employee
Law: Federal

Don't Mess With Texas (Courtroom Sciences v. Andrews)

In a relatively short amount of time, Texas went from a state where an employer virtually never was able to enforce a non-compete agreement against a departed at-will employee, to one where there seems to be a presumption that such a non-compete will be enforced. All this despite no legislative interference.

The case of Courtroom Sciences v. Andrews breaks no new legal ground, though it may be the first reported case to follow the predictable decision from the Texas Supreme Court in Mann Frankfort, about which I wrote some time ago. The beauty of this case is its non-sensical, sub-Three Stooges analysis - something all too familiar to lawyers who follow Texas non-compete cases.

Andrews, who worked in jury consultancy and trial services out of Chicago for CSI, signed an employment agreement with an array of restrictive covenants. They weren't terribly drafted, which meant she had no chance of winning. Essentially, they prohibited her from disclosing a range of confidential business information, soliciting CSI clients with whom she had a relationship, interfering with employee relationships, and working nationwide for a trial sciences consultancy firm. Other than the confidentiality restriction, the covenants lasted two years.

The court's analysis about the level of Andrews' violation of her agreement when she left abruptly to join DecisionQuest is predictably thin. It seemed to focus on her failure to return certain corporate information - not really defined at all - to CSI within 24 hours of her departure. It also seemed to suggest CSI lost business, though it's not clear Andrews solicited any clients to leave or if they just left CSI as a result of Andrews' resignation. The court didn't bother to give us that rather helpful bit of information.

Here's the richest part of this case, though. The court itself acknowledged that Texas law requires courts to modify covenants if they are unreasonable or overbroad in any respect. The court further discussed at length CSI's nationwide practice and how it would be unfair or illogical to put a geographic parameter on the non-compete. Then, despite enforcing the other activity covenants in the agreement, the court ignored the non-compete clause and did not restrain DecisionQuest from employing Andrews. Instead, it prohibited her from performing work for CSI clients through trial (in essence, what the non-solicitation clause barred), disclosing certain information unique to CSI, and soliciting employees of CSI (despite the absence of any evidence this actually took place).

So the end result of the non-compete clause was that it was not enforced despite the court's recognition that the law compelled enforcement.

Of all the inane and stupid commentary throughout the decision, however, the real head-scratcher comes in the "analysis" regarding Andrews' breach of her fiduciary duty as an employee of CSI. In citing the evidence supporting a finding in plaintiff's favor, the court actually had the temerity (or ignorance) to cite this fact: "[Andrews] obtained a 'fail-safe' contract insuring her income regardless of the result of this anticipated litigation."

Supposedly now, in Texas, it is a breach of fiduciary duty for an employee to negotiate a favorable contract with a new employer. I would argue this seems a bit ridiculous, but we've come to expect that from Texas courts.

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Court: United States District Court for the Northern District of Texas
Opinion Date: 5/11/09
Cite: Courtoom Sciences, Inc. v. Andrews, 2009 U.S. Dist. LEXIS 39917 (N.D. Tex. May 11, 2009)
Favors: Employer
Law: Texas

Illinois District Court Issues Partial TRO In Employee Competition Dispute (Hal Wagner Studios v. Elliott)

A federal district case out of Southern Illinois illustrates the difficulty employers face in attempting to enforce restrictive covenants - even those reasonably drafted.

The case of Hal Wagner Studios v. Elliott arises out of the school photography business. HWS provides yearbook and portrait services to schools in the Southern Illinois area. At the end of 2008, several of its key employees defected to a competitor, Herff Jones, and immediately began soliciting key HWS accounts. HWS also produced substantial evidence that certain of the employees misappropriated a substantial number of corporate documents. To its credit, HWS listed the specific documents missing, produced logs indicating suspicious copying and printing activity, and outlined for the court how it would be harmed by the defendant's use of those documents.

HWS also produced a non-compete agreement with the lead defendant, Kris Elliott. The non-compete was well-drafted and reasonably tailored; it only barred Elliott from soliciting school photography accounts which were in his defined territory or which he produced for HWS. (A separate aspect of the non-compete further barred Elliott from engaging in other competition with respect to those accounts, but the reasonableness of this clause was not discussed.)

HWS immediately filed suit and moved for a TRO on both the non-solicitation covenant and on several common-law claims seeking return of the information taken by the defendant group around the time of their mass exodus. The court denied HWS' effort to prevent Elliott from soliciting clients, but granted an affirmative injunction mandating return of documents.

In denying relief on Elliott's non-solicitation covenant, the court found that it was of questionable applicability under Missouri law because HWS had failed to pay Elliott commissions for a period of time. Though HWS claimed it adjusted Elliott's salary instead, the court found that a provision of the contract requiring modifications or amendments to be in writing doomed HWS' explanation. As such, and even though the court warned Elliott about the risks of further solicitation, the court could not issue a TRO in light of the likelihood HWS would not prevail on the merits.

The issue regarding return of documents proved easier for the court. Under a fiduciary duty theory, the court exercised its power of equity to demand immediate return and an accounting of documents HWS identified as missing. Key to this finding was the balance of harms analysis. Not only was HWS likely to prevail on the merits, but HWS was in a far worse position from not retrieving its documents than the defendants were from having unlawful continued access to them.

To its credit, the court issued a very specific TRO outlining by document name what should be returned and how the documents needed to be accounted for. Frequently, courts issue overbroad TROs without any degree of required specificity.

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Court: United States District Court for the Southern District of Illinois
Opinion Date: 1/15/09
Cite: Hal Wagner Studios v. Elliott, 2009 U.S. Dist. LEXIS 2778 (S.D. Ill. Jan. 15, 2009)
Favors: Employee
Law: Missouri, Illinois

JPMorgan Lawsuit May Highlight New York Docket in 2009 (JPMorgan Chase v. The IDW Group)

By all accounts, 2008 was a significant year for non-compete and trade secrets developments in New York. The injunction issued in the IBM-Apple dispute concerning Mark Papermaster certainly received a number of headlines, and the Marsh USA v. Karasaki case also involved a high-profile set of players fighting over the applicability of a client non-solicitation agreement. On top of that, Gov. David Paterson signed into law a prohibition on non-compete agreements for broadcast industry employees, bringing New York in line with other jurisdictions (Illinois, Maine, Washington, D.C., Arizona, and Massachusetts) banning such non-competes.

At the end of last year, JPMorgan Chase filed suit against one of its executive search firms - The IDW Group. The suit arose out of a series of contracts JPMorgan entered into with IDW for the placement of financial services executives. According to the allegations of the Complaint, IDW violated the retained search agreements by facilitating the departure of JPMorgan executives to Citadel Investment Group, presumably another of IDW's clients.

IDW appears to be fighting back hard, and from the publicly available information, its theory on the breach of contract claims seems to be that the Investment Bank employees at JPMorgan who left for competitive opportunities at Citadel were not off-limits by the terms of the retained search agreements. Indeed, those agreements seem to limit IDW from soliciting JPMorgan employees in the Credit Trading Hybrids Group, the North American Portfolio Group, and the Proprietary Positioning Group.

There is no mention in the Complaint's allegations that the ex-JPMorgan employees were within any of these three groups. Whether the JPMorgan Investment Bank is tied into these three enumerated groups probably will be an issue for trial.

Right now, IDW's motion to dismiss the remaining claims is pending and has been fully briefed. One interesting issue will be the ruling on JPMorgan's breach of fiduciary duty claim. The financial services behemoth apparently claims that IDW had some heightened relationship with it that transformed an ordinary commercial deal into one cloaked with fiduciary obligations. Frankly, the allegation seems bizarre. That said, JPMorgan has defended it vigorously, arguing the existence of a duty cannot be decided on a motion to dismiss.

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Court: United States District Court for the Southern District of New York
Opinion Date: n/a
Cite: JPMorgan Chase Bank v. The IDW Group (Civil Action No. 08:cv:09116)
Favors: n/a
Law: New York

Georgia Court Rejects Employer's Attempt to Recoup Money Paid for Void Non-Compete (HRH Co. of Atlanta v. Holley)

A Georgia appellate court recently addressed a novel and unusual claim made by an employer who previously lost (both at trial and on appeal) a claim involving its non-compete agreement. In particular, an insurance brokerage, Hilb, Rogal & Hamilton (HRH) continued to pursue a claim against Hugh Holley for compensation paid to him when he signed a non-compete agreement in connection with the sale of his business to HRH.

Under his employment agreement with HRH, Holley was paid separate monetary consideration for his post-employment covenant not to compete with HRH. That consideration was listed separate from his regular salary and bonus. After HRH lost its breach of contract claim due to unenforceability of the covenant, HRH claimed it was entitled to that consideration back from Holley under the theory of unjust enrichment.

The court rejected HRH's claim, citing the general rule that if an "illegal contract be in part performed and money has been paid in pursuance of it, no action will lie to recover the money." The court, therefore, left the parties where they stood following HRH's payment to Holley for a non-compete that turned out to be void under Georgia law.

On a separate matter, the court affirmed a jury award for breach of fiduciary duty against Holley which required him to pay back the last two months of his salary. Mere employees have a duty not to compete actively with their employer or engage in steps that go beyond the preliminary stages of preparing to compete. Holley had taken steps to divert a potential client during the course of his HRH employment, and the salary forfeiture award was justified under Georgia law.

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Court: Court of Appeals of Georgia, Third Division
Opinion Date: 12/2/08
Cite: Hilb, Rogal & Hamilton Co. of Atlanta, Inc. v. Holley, 670 S.E.2d 874 (Ga. Ct. App. 2008)
Favors: Employee
Law: Georgia