Colorado Court Interprets Key Remedies Section of Defend Trade Secrets Act

With only a life span of a few months, the new Defend Trade Secrets Act has produced very little in the way of interesting case law. That's hardly a surprise at this point.

For the most part, the DTSA does not change substantive state law concerning trade secrets and how one may "misappropriate" a trade secret. The statutory differences, by and large, concern the scope of available remedies. And of course, the muscle that federal courts provide is the principal value that the new statute offers. (For more discussion on litigating in federal versus state court, see my post immediately preceding this one.)

This past week, a federal district court in Colorado offered perhaps the most in-depth look yet into the DTSA. And not surprisingly, the core aspect of the opinion concerns statutory remedies, particularly those relating to injunctions.

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Injunctive relief is a default remedy for actual or threatened misappropriation. But injunctions that prohibit merely using or exploiting trade secrets are only so helpful. For one, monitoring that type of order is almost impossible. And just as problematically, trying to define what exactly is prohibited from "use" is an exercise sure to drive lawyers and judges nuts.

To be certain, injunction clauses under the DTSA and state statutory law are not so confining for aggrieved trade-secret owners. State laws don't set precise boundaries on how far injunctions can go. So a late addition to the DTSA drew quite a bit of attention when it appeared to do just that. Section 1836(b)(3)(A) of the DTSA contains two provisions that seem to limit broader conduct-based injunctions - that is, injunctions that extend beyond prohibitions on using trade secrets.

First Exception. The first expressly states that an injunction order may not "prevent a person from entering into an employment relationship, and that conditions placed on such employment shall be based on evidence of threatened misappropriation and not merely on the information the person knows." That provision is a clear, direct shot at states that endorse injunctions under the theory of "inevitable" disclosure - something broadly akin to a non-compete agreement.

Second Exception. The second DTSA provision says an injunction cannot "otherwise conflict with an applicable State law prohibiting restraints on the practice of a lawful profession, trade, or business." This simply means that plaintiffs cannot invoke the DTSA to secure more expansive injunctive relief than some employee-friendly states would allow when enforcing non-compete agreements.

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Engility Corp. v. Daniels (a copy of which is embedded below) brought these two exceptions into play. The case was a fairly typical employment-related trade secret dispute, which arose when two employees of Engility - a former division of L-3 Communications - left to form their own business. The relevant market is somewhat technical in that it concerned the sale of military communications equipment and a related network. The facts giving rise to claims of trade secret theft arose largely from one employee's retention of data pertaining to this market and his shifting story about what he did with that data for a few weeks after termination.

Engility sought more than a use-based injunction. Although it had no non-compete agreement with the employee, Engility wanted the court to prevent the ex-employees and their new firm from working with a particular military customer. The court's challenge was to apply the DTSA, and its limiting language concerning injunctions, to this particular request.

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The court found that the first remedial limitation did not apply, principally because the ex-employees formed a new business. In the court's words, the DTSA gives "no indication that 'employment relationship' encompasses the role of an outside contractor," which the new entity would be to the military customer that was the focal point of the injunction request. It might have been easier, however, if the court simply stated that the exception did not apply because the employer did demonstrate a likelihood of actual or threatened trade-secret misappropriation.

The court then turned to the second exception and found that Colorado state law independently did not bar the customer-based restraint. The question was significant, because Colorado state law is much more restrictive of non-compete use than many other states. Here, however, the court relied upon state statutory law that allows non-compete agreements to be enforced "for the protection of trade secrets." Applying this provision, the court was able to issue a broader conduct-based injunction under the DTSA since Colorado law allowed it to the extent necessary to protect trade secrets.

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The Engility decision is instructive for how the new remedies provision of the DTSA may apply in practice. Its applicability, however, may be somewhat narrow for difficult future cases. The facts of Engility established a firm basis for the court to conclude that the employee engaged in actual or threatened trade secret misappropriation - at least at the preliminary injunction phase. With those facts determined, the court didn't really have a tough call in applying the two DTSA injunction exceptions.

The much harder cases will come when employers are unable to present facts that look like theft or misuse of confidential information. The DTSA statutory exceptions should be sufficient to weed out these weak speculative claims, based largely on a theory that an employee inevitably will use something secret. That is why those exceptions are there. Broad conduct-based restrictions under the DTSA won't survive unless employers show facts in the mold of those described in Engility.

Engility v. Daniels by Ken Vanko on Scribd

Court of Appeals of Colorado Overturns Jury Verdict on Abuse of Process Counterclaim

Employees aren't equipped with an overwhelming array of weapons to fight back anticompetitive lawsuits.

I have written many times on this blog about this topic. In this author's view, the legal system works most efficiently when parties can rely upon contract law to allocate rights and responsibilities with some predictability. Though non-competes are restraints of trade, they should be struck down only when patently overbroad and when the objective intent from the contract language is to deter fair competition.

I also believe that trade secrets law is a species of property law, and that if an employer can demonstrate a taking of protected (that is, valuable and secret) property, the law should honor that. But in the absence of protection efforts that place a third-party on objective notice that the property is truly something that is "secret", trade secrets law can be a destructive, overused weapon between competitors that disrupts parties' reasonable expectations in dealing with each other.

Employees sometimes assert abuse of process counterclaims when faced with a competition lawsuit appears to be filed as an end in itself - not as a means to an end. Abuse of process claims are tough to prove, but generally require the employee to show three things:

(1) an ulterior purpose to the suit;

(2) actions by the employer that are not proper in the course of the lawsuit; and

(3) damages.

There's another hurdle to clear, though, when an abuse of process counterclaim is based on the idea that the lawsuit itself is not proper. It's called the "sham litigation" exception, because lawsuits generally are protected by the First Amendment's clause enabling parties to petition the government to redress grievances. The sham litigation exception to First Amendment immunity further requires a counterclaiming party to show an objectively baseless suit brought in bad faith.

A recent Court of Appeals ruling in Colorado reversed a district court's jury verdict in favor of ex-employees who each obtained a $200,000 judgment on an abuse of process counterclaim. The problem that the district court made was not assessing the sham litigation exception properly on a post-trial motion by the employer. Instead of assessing whether the employer's competition claims were objectively baseless and devoid of factual support, it held a reasonable jury could have found for the employees on their counterclaim.

This conclusion missed the mark, since the court - not a jury - must pass on the First Amendment constitutional issue. Interestingly, Colorado rejected a bright-line gatekeeper rule. Specifically, it found that just because an employer's competition claims survive summary judgment does not mean the abuse of process counterclaim automatically fails. The court noted that trials may often be more efficient than resolving summary judgment motions, and that summary judgment denials often don't contain the type of exacting analysis that would automatically dispose of an abuse of process counterclaim.

One issue that is not discussed in the Colorado case - or in many cases like this - is the second element of the abuse of process tort. As listed above, an employee must generally show some action "not proper in the course of the lawsuit." When the theory is that the lawsuit is a sham, it is hard to identify something concrete that is improper, such as the misuse of subpoena power. However, my view is that the sham litigation analysis subsumes the second element. If a lawsuit is objectively baseless, then the process itself - the cost of discovery, disruption in the marketplace - has been subverted entirely.

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Court: Court of Appeals of Colorado, Division Three
Opinion Date: 11/8/12
Cite: Health Grades, Inc. v. Boyer, 2012  Colo. App. LEXIS 1842 (Col. Ct. App. Nov. 8, 2012)
Favors: Employer
Law: Colorado

The Reading List (No. 10)

Today's Chicago Tribune Business section contains a lead article on the sentencing of Hanjuan Jin (right), the former software engineer who was caught boarding a plane to China with highly confidential documents misappropriated from Motorola. This is a very in-depth article and also discusses the recent Valspar case on which I have previously written.

The Colorado Springs Gazette discusses a jury verdict of $1.34 million against two former managers who violated non-competition covenants. The article seems to indicate the employees solicited customers, but does not elaborate on the basis for the high damages award. Though damages are difficult to prove in non-compete cases, a plaintiff can recover them with a sound, cohesive theory and well-prepared damages witnesses. Presumably, the plaintiff had that here.

Seyfarth Shaw's blog always contains helpful, in-depth posts, but I enjoyed Paul Freehling's article on the interplay between damages and permanent injunction awards. A similar issue arises in the context of royalty injunctions - the flip side of compulsory licensing in the patent law arena (an approach Judge Posner recently endorsed). This royalty injunction remedy essentially allows a court to condition future use of a misappropriated trade secret on payment of a reasonable royalty to the trade secret owner. But states vary on the circumstances in which a royalty injunction may be appropriate. In any event, it shouldn't be very often. While patents derive value from exclusivity, trade secrets derive value from...secrecy. A royalty injunction that allows a misappropriator to use stolen information seems to undercut the very foundation for trade secrets law.

Finally, John Marsh has outlined a series of "7 Deadly Sins" that departing employees should always keep in mind when trying to avoid litigation. His post contains an excellent, in-depth summary of what often causes non-compete/trade secrets suits to go south from the employee's perspective.

Recent Decisions of Interest (No. 1)

My regular Thursday column will survey recent decisions across the United States which touch upon non-compete or trade secret issues. The four cases I chose this week touch on a wide variety of issues, including those relevant to the corporate counsel drafting non-compete clauses.

AMG Nat'l Trust Bank v. Ries, 2011 U.S. Dist. LEXIS 149130 (E.D. Pa. Dec. 29, 2011). The court, applying Colorado law, found that a liquidated damages provision in a two-year non-compete, which called for payment of ten times the annual gross fees for each wrongfully solicited client, was voidable as a matter of law. I drafted two liquidated damages clauses this week for clients, and my advice is always the same: be able to justify the methodology you select under oath. The more random and arbitrary a clause looks, the more likely a court simply will strike it.

ISCO Indus., LLLC v. Erdle, 2011 U.S. Dist. LEXIS 148907 (E.D.N.C. Dec. 28, 2011). A North Carolina court denied entry of a preliminary injunction motion against a sales employee in the piping distribution business. The employee's covenant was not narrowly tailored to restrict him from selling only products or services competitive with those offered by the ex-employer. This further illustrates why attorneys must be careful in considering the scope of the non-compete restriction. Using hypothetical scenarios during the drafting process can help identify problems of overbreadth.

WIT Walchi Innovation Techs., GmbH v. Westrick, 2012 U.S. Dist. LEXIS 1847 (S.D. Fla. Jan. 6, 2012). A court issued an ex parte temporary restraining order against an employee who allegedly stole a laptop containing proprietary source code and programming for a software product. The court issued a broad evidence preservation order and ordered immediate return of the stolen laptop computer. No commentary necessary here. Firsthand evidence of outright theft of property warrants mandatory injunctive relief, even on an ex parte basis.

Pellerin v. Honeywell Int'l Inc., 2012 U.S. Dist. LEXIS 3781 (S.D. Cal. Jan. 12, 2012). A district court in California sustained a defense objection to the retention of a trade secrets expert on the basis that the expert was a former employee of the defendant. Such objections, usually made under the terms of protective order, are common when the expert may have had prior access to an adversary's confidential information. It may be impossible in such circumstances for the expert to provide legitimate, untainted opinion testimony.

Supreme Court of Colorado: Continued Employment Does Constitute Sufficient Consideration for Non-Compete (Lucht's Concrete Plumbing v. Horner)

Colorado was one of a handful of states - along with South Carolina, Washington and a few others - which held that continued employment was not sufficient consideration for an at-will employee's agreement to a non-competition covenant. I have written often on this subject before. The issue arises in a fairly common fact pattern. If an employer requires an existing at-will employee to sign a non-compete under threat of termination, is this ability to fire enough legal "consideration" to form a valid non-compete contract?

Colorado has now decided "yes."

In Lucht's Concrete Plumbing, Inc. v. Horner, the Supreme Court of Colorado joined the majority of states and held that continued employment does provide sufficient consideration to form a valid non-compete agreement. This reverses last year's appellate decision, a summary of which can be found here.

The Court quite simply held that since an employer may terminate an at-will employee at any time, its agreement not to discharge the employee once he or she signs a non-compete agreement is legal consideration to form a contract which is not illusory. The Court alluded to, but did not really discuss, the problematic situation of involuntary termination shortly after signing. Courts have recognized that there may be a consideration problem if the employer extracts a non-compete agreement from an existing at-will employee and then terminates him or her shortly thereafter. The Supreme Court of Colorado seemed to suggest this was not so much a consideration issue, but would bear on the agreement's overall reasonableness.

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Court: Supreme Court of Colorado

Opinion Date: 5/31/11

Cite: Lucht's Concrete Plumbing, Inc. v. Horner, 2011 Colo. LEXIS 436 (Col. May 31, 2011)

Favors: Employer

Law: Colorado

Beware Drafting Trap Under Colorado's Non-Compete Statute (Saturn Systems v. Militaire)

Colorado usually produces some interesting opinions because it has a statute that is inconsistent with traditional non-compete law.

Non-competition and non-solicitation covenants are presumptively void in Colorado. But they can be valid if they meet one of four criteria:

(1) the covenant is made in connection with the sale of a business;

(2) the contract protects trade secrets;

(3) the contract recovers an employee's training or education costs; or

(4) the contract is for "executive and management personnel" or "officers and employees who constitute professional staff to executive and management personnel."

The last exception does not apply to independent contractors, and it appears the only way to bring a contractor under a covenant is to assert that the agreement protects a company's trade secrets.

If a company relies on the second exception, there are some tricks it has to be aware of. To fall under this trade secrets exception, the covenant must be specifically be for the protection of those trade secrets and narrowly tailored to protect that interest. The statute contains no savings provision for lesser protected "confidential information," so the employer must be prepared to identify and justify information as truly trade secret material. Otherwise, it cannot invoke this exception at all.

Another tricky area is in the drafting itself. Colorado lawyers will tell you that the non-solicitation or non-competition provision should be included within the confidentiality restriction. Why? Because it is much easier to demonstrate that the restriction is designed to trade secret information if the non-compete is directly tied to the confidentiality clause.

Contrast this scheme with that found in Wisconsin, where attorneys will tell you to do the exact opposite. Separate the covenants into different paragraphs. Avoid interlocking or co-dependent terms. The reason? Wisconsin's follows a very rigid application of the blue-pencil rule, which can trip up covenants that may be overbroad in some respect but not others.

All this goes to show that non-compete law is not uniform by any stretch. The dichotomy between Colorado and Wisconsin is a perfect example from a draftsmen's perspective.

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Court: Court of Appeals of Colorado, Division Two
Opinion Date: 2/17/11
Cite: Saturn Systems, Inc. v. Militaire, 252 P.3d 516 (Colo. Ct. App. 2011)
Favors: Employer
Law: Colorado

Colorado Finds Continued Employment Is Not Sufficient Consideration for Afterthought Non-Compete (Lucht's Concrete Pumping v. Horner)

Colorado has joined the list of states to hold that an existing employee's continued employment does not constitute valid consideration for signing a non-compete agreement.

So-called "afterthought" covenants are often put in place by an employer after it realizes an existing at-will employee may have influence over customer relationships or increased access to sensitive company information. A fair number of states, including Washington, South Carolina, and Minnesota, hold that an at-will employee is not bound by an afterthought covenant unless some consideration is provided to him or her. These courts reason that an employer's forebearance from discharging an at-will employee does not rise to the level of contractual consideration.

Increased pay or new benefits will, of course, but it is not clear how substantial those perks have to be. In Illinois, the appellate courts have, with no real clarity, held that only continued employment for a "substantial period of time" will constitute sufficient consideration. The length of time that the employee remains on the job, along with the manner in which the employment ends, are relevant factors for Illinois courts to consider when examining the validity of afterthought covenants.

The Supreme Court of Colorado has granted certiorari in the case only as to the consideration issue.

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Court: Court of Appeals of Colorado, Division One
Opinion Date: 6/11/09
Cite: Lucht's Concrete Pumping, Inc. v. Horner, 224 P.3d 355 (Colo. Ct. App. 2009)
Favors: Employee
Law: Colorado

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

"Management Personnel" Exception to Colorado Non-Compete Statute Accorded Plain Meaning (DISH Network v. Altomari)

Last week, I wrote on one of the several exceptions contained in Colorado's non-compete statute, which presumptively voids restrictive covenants. That exception permitted reasonable non-competes to protect trade secrets, a curiously worded exception which could swallow the entire rule with some artful contract drafting.

Today, I review a case addressing a more sensible exception, one which finds parallels in other states' non-compete laws. The particular carve-out allows reasonable non-competes for "executive and management personnel and officers and employees who constitute professional staff to executive and management personnel." (As a grammatical aside, never underestimate the power of a group of hack legislators to forget basic comma usage norms.)

At issue in DISH Network v. Altomari was a trial court's ruling which refused to apply this exception to a communications director for DISH Network who supervised about 50 employees. Altomari signed a non-compete in connection with the issuance of stock options and sought to leave for DirecTV, a competitor specifically named as a prohibited entity in the non-compete clause.

The trial court made certain factual findings that Altomari was a mid-level manager and that he had definite management responsibilities. However, it found that he was not the type of management personnel contemplated by the statute.

The Court of Appeals of Colorado reversed, finding the trial court erred by not applying the plain meaning of the legislative exception. The court noted that the General Assembly chose not to define the term "management personnel", and that this required it to apply the term according to its plain meaning. The court then concluded that because the trial court found Altomari to be a mid-level manager vested with decision-making autonomy, he qualified as "management personnel" under the statute.

Other states have gone further than Colorado in defining key employees who are otherwise subject to non-compete arrangements, though sometimes this seems to add to the confusion. In Altomari's case, DISH Network showed he had enough autonomy and controlled enough decisions to fall within the legislative exception.

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Court: Court of Appeals of Colorado, Division One
Opinion Date: 6/25/09
Cite: DISH Network Corp. v. Altomari, 2009 Colo. App. LEXIS 1178 (Colo. Ct. App. June 25, 2009)
Favors: Employee
Law: Colorado

Drafting Non-Competes In Colorado Poses a Different Challenge (Haggard v. Synthes Spine)

In Illinois and many other states, non-competition covenants are often wrapped into broader employment agreements with little risk that this would pose any sort of hurdle to enforcement. But because non-compete law varies so significantly from state to state, this common practice may not be a great idea elsewhere.

Colorado, for instance, is one state where non-competes are regulated by state statute. The governing law generally consideres covenants void unless they meet one of four specific exceptions. Sale of business covenants generally are valid if reasonable, and courts also will uphold covenants given by "executive and management personnel." For salespersons who do not qualify as a key employee under this latter, fact-intensive exception, a covenant still may be valid if it is "for the protection of trade secrets."

Courts in Colorado generally require the purpose of the covenant to be trade secret protection. A recent case involving a dispute between a salesperson and a medical device company illustrates the importance of good, careful drafting. The court in Haggard v. Synthes Spine found that a non-compete met the purpose test in Colorado, noting specifically that the non-compete agreement carefully spelled out the exact type of information the employer sought to protect. The employer also deemed it important that the contract did not contain other provisions related to job responsibilities, pay or salary, or other incidents of the employment relationship.

This rule seems a bit technical, suggesting that a comprehensive employment agreement containing covenants and other promises regarding employment may not satisfy Colorado's statute. In other words, for a non-management employee, an employer may be better off drafting two separate agreements - one focused entirely on trade secrets and any covenants against competition intended to protect those secrets.

The opinion in the Haggard case itself was somewhat simplistic regarding the specific "trade secret" information to which the ex-employee had access. The court, like many, sort of assumed that product knowledge and customer data (e.g., contact persons, preferences) were trade secrets, though opinions are all over the map on this issue with the better reasoned approach being that employers ought to really show this information is more than just "confidential" or general knowledge learned during the course of employment. In view of its conclusion, the court enforced both a client non-solicitation and industry non-compete covenant.

Of course, the type of operational information in Haggard could be considered confidential, given its obvious importance but relatively fleeting lifespan (a fact admitted to by the employer in Haggard), and this may very well justify a covenant not to compete. But the statute requires protection of actual trade secrets - not confidential information - and so an analysis basically assuming that every bit of data about customers or products in development is a trade secret seems overly succinct and kind of silly.

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Court: United States District Court for the District of Colorado
Opinion Date: 6/12/09
Cite: Haggard v. Synthes Spine, 2009 U.S. Dist. LEXIS 54818 (D. Colo. June 12, 2009)
Favors: Employer
Law: Colorado

Faulty Affidavit Prevents Employer From Obtaining TRO (American Family v. Gustafson)

An effort by American Family Insurance to obtain an ex parte temporary restraining order against a former employee, Barry Gustafson, failed in large part because of an insufficient affidavit submitted by the plaintiff in its TRO application.

The case arose under the Computer Fraud and Abuse Act (CFAA), as well as other pendent state claims for unfair competition. Increasingly, employers are using the CFAA to federalize competition cases, particularly given the expansive reading some circuit courts have given to the statute. The gist of plaintiff's claim was that Gustafson downloaded information from American Family's computers and used that information to solicit away customers for his new venture. The TRO was denied, and the court chastised the plaintiff for its conclusory affidavit.

In particular, the court noted that the affiant could not set forth any facts demonstrating that Gustafson had solicited or continued to solicit customers improperly. Additionally, the affidavit indicated that Gustafson began soliciting customers in July or August of 2008, but given that the complaint and ex parte TRO were filed on December 21, the statements of the affiant undercut any argument of "immediate injury."

The case demonstrates the care which attorneys must take in securing testimony by way of affidavit. Too often, insufficient or hastily prepared affidavits contain inadmissible hearsay or improper conclusions. This can doom an employer's chances of obtaining immediate injunctive relief regardless of the merits.

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Court: United States District Court for the District of Colorado
Opinion Date: 12/22/08
Cite: American Fam. Mut. Ins. Co. v. Gustafson, 2008 U.S. Dist. LEXIS 103068 (D. Col. Dec. 22, 2008)
Favors: Employee
Law: Federal Rules of Civil Procedure