The Reading List (2017, No. 26): Fee Awards, New Legislation, and Inevitable Disclosure

Non-Compete and Trade Secrets News for the week ended November 3, 2017

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Illinois Appellate Court Affirms $1.5 Million Fee Award

In a Rule 23 Order, the Second District Appellate Court affirmed a substantial fee award, nearly $1.5 million, for the prevailing defendant in a fiduciary duty, trade secret, and non-compete case. I had the privilege of representing the defendant, Tom Christofilis, at trial and on appeal. It is truly a pleasure working with someone who is so candid, forthright, and credible that you don't even need to prepare him for his testimony. Good things happen to good people.

The basis of the $1.5 million fee award is rooted in corporate law and in particular the bylaw indemnification provisions that cover former employees, officers, and directors of Christofilis' former employer, Automated Industrial Machinery, Inc. I have written before that corporate indemnity procedures, whether rooted in internal documents like bylaws or through state statute, are the potential game-changer and equalizer in competition suits. It is essential that counsel fully assess the interplay of indemnity when deciding whether and how to pursue competition claims against a former insider. It is just as crucial for defense counsel to understand the legal framework and position his or her client for fee-shifting.

The Appellate Court's judgment here demonstrates the raw power of indemnification, ruling that it covered non-compete, trade secret, and fiduciary duty claims. But to be sure, this case was very fact-specific, and the availability of indemnification depended at least in part on Christofilis' complete success, the sheer breadth of the claims asserted against him, and the anchoring fiduciary-duty cause of action that brought the bylaw provisions into play.

Keep in mind the deferential standard of review applicable in this case. No two indemnification cases are the same. And the trial court retains substantial discretion in making the call as to what claims are and are not indemnifiable, given the pleadings, legal theories, and evidence.

A link to the Rule 23 Order in Automated Industrial Machinery, Inc. v. Christofilis is available here.

New Legislation on Non-Competes

For those interested in legislative updates, Russell Beck's Fair Competition Law blog is a must read. Here are a few links that discuss pending and enacted legislation on non-compete law:

October 21: Russell reports on bills in New York and Pennsylvania concerning very different aspects of non-compete reform.

October 15: Russell discusses bills in several states, including changes to Oregon and West Virginia law. Oregon now bans non-competes for home-care workers, while West Virginia outlaws certain types of physician non-competes. This continues a trend of industry-specific reform, rather than wholesale, across-the-board changes.

The DTSA and Inevitable Disclosure

The Defend Trade Secrets Act contains a crucial limitation on injunctive relief: courts cannot issue an injunction under the DTSA to "prevent a person from entering into an employment relationship." And conditions on a person's employment must be based on threatened misappropriation, not merely on information the person knows. This limitation forms part of the compromise that resulted in the DTSA's near-unanimous passage. And it departs from the law of several states that allow for inevitable-disclosure injunctions that bar employment altogether.

Courts, though, are frequently terrible at applying the doctrine of inevitable disclosure. A perfect illustration comes from the case of Express Scripts, Inc. v. Lavin, where a federal court appears to have applied the DTSA to issue an injunction, at least in substantial part on inevitable disclosure. It could be that the court was loose with its analysis, since it already had found a non-compete agreement to be enforceable. And it could be that the court was relying on Missouri law. But it sure as hell does not help to have a poorly engaged analysis like this, suggesting that the DTSA does not mean what it says.

I reviewed the briefs filed by the plaintiff's law firm (one that must remain nameless). The brief never indicates for the court that the DTSA limits inevitable-disclosure injunctions. It lumps stuff together in a way that I feel is highly misleading. That's troubling, because the court was ruling on a petition for temporary restraining order. More concerning is the court's rote copying of the law firm's brief (down to the word). This amounts to judicial abdication, not bona fide engagement.

Let's be clear: the DTSA does not permit inevitable disclosure injunctions of the kind that the court in Express Scripts may have ordered. This decision carries no weight at all. I'll chalk this one up to an emergency ruling, a busy judge, and sloppy lawyering.

A copy of the ruling can be found online (I refuse to link to it or make your job easy). The case name is Express Scripts, Inc. v. Lavin, No. 4:17-cv-1423 (E.D. Missouri). The case since has settled.

Computer Fraud and Abuse Act

The most significant CFAA case of the past several years has been United States v. Nosal, which made two trips to the Ninth Circuit. The Supreme Court has declined to grant certiorari on Nosal's latest appeal. That cert petition made headlines when Nosal enlisted Supreme Court star litigator Neal Katyal on brief. Reuters discusses the Court's decision not to review Nosal and a separate CFAA case called Facebook v. Power Ventures.

Speaking of the CFAA, it continues to generate fewer cases of interest in light of the Defend Trade Secrets Act and the federal civil remedy now available for trade secret misappropriation. But some cases still wind through the system.

The sharp divide, which stems in great part from Nosal, concerns the application of one statutory term in the CFAA: the meaning of the phrase "exceeds authorized access." In the CFAA framework, this could mean an individual's misuse of protected information in violation of a corporate policy or common-law duty. Or it could mean something far narrower, namely an employee's improper access of files in the more objective sense without regard to state of mind or intent.

In Hedgeye Risk Management, LLC v. Heldman, the United States District Court for the District of Columbia adopted the narrower reading of the CFAA. In effect, it held that the statutory language is not concerned with the purpose for which the employee accessed the computer files. In so doing, the court joins the Second, Fourth, and Ninth Circuits. On the other side of the ledger, the Fifth, Seventh, and Eleventh endorse a purpose-based analysis, with the reasoning of those courts varying to some extent. As the district court in Heldman noted, the D.C. Circuit has not weighed in.

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Last week, I had the privilege of presenting at PLI in New York for a conference titled Trade Secrets 2017: What Every Lawyer Should Know. My panel consisted of Audra Dial from Kilpatrick Townsend & Stockton in Atlanta and John Siegal of Baker Hostetler. Our moderator was the great Vicki Cundiff of Paul Hastings. In the company of such luminaries, I felt like one of those fringe candidates on stage at a debate with the audience wondering who the hell I was. But my co-presenters were just terrific, and I thoroughly enjoyed it. For lawyers seeking to learn more about trade secrets, PLI offers a similar program via webcast next week.

Years back, I butted heads with Farmers Insurance in a number of non-competition cases, all of which settled pretty amicably. Apparently, Farmers has more problems to solve in this area, as reported by Insurance Journal. This suit sounds like it fits a familiar pattern in which an employee copied a number of documents and scooted off to a competitor. Of note, it's pending in California, which does have a trade-secret "exception" to its non-compete law.

Forbes has a long article about a burgeoning dispute between Citrix and Egnyte, one that brings to the fore the difficult procedural question that often arises when employees bolt for a California company but don't live in California.

Finally, if you're interested in further reading on an array of subjects, including the Waymo v. Uber case and Defend Trade Secrets Act case updates, I suggest linking to John Marsh's Trade Secret Litigator blog and his October monthly wrap-up. Lots of excellent source material here.

Aleynikov Turns the Tables on Goldman Sachs Group

Score one for the underdog.

In Sergey Aleynikov's latest legal battle against Goldman Sachs, he emerged victorious. Earlier this month, Aleynikov prevailed on summary judgment and obtained an advancement (that is, prepayment) of legal fees related to his legal defense of state criminal charges brought by the Manhattan District Attorney.

As many readers know, Aleynikov was convicted by a federal district court of violating the Economic Espionage Act related to his alleged theft of Goldman's trade secret high-frequency trading source code. The Second Circuit reversed that conviction - after Aleynikov spent many months in federal prison before the reversal - leading to a quick modification of the federal statute.

Soon thereafter, a grand jury in New York indicted Aleynikov on similar state charges. It's unclear what the DA hopes to accomplish since even if Aleynikov is convicted, he will receive credit for extensive time he served in the federal case. But, now at least, Aleynikov will be able to have Goldman advance his legal fees and forge a defense to the latest round of criminal charges.

Although Judge McNulty called the advancement question a close one, there are several lessons to be learned.

First, the advancement and indemnification rights afforded corporate officers and directors are broad in scope. To that end, any ambiguities are resolved in the indemnitee's favor. Here, although Aleynikov was not an "officer" in the traditional sense (as would be the case for Lloyd Blankfein), the court found Goldman reserved for itself broad discretion to determine who was eligible for fee advancement. In fact, Goldman had advanced fees to 51 of 53 people who applied for it (apparently, one other unlucky soul found himself viewed as equivalent in stature to Aleynikov) over a six-year period.

Second, rights to advancement require an analysis of state corporation law, corporate bylaws, and any governing agreements (such as employment contracts). Advancement rights are treated differently by the states, and often times states make distinctions between officers, directors, and employees. In some states, for instance, a corporate charter must opt-out of advancement for directors, or else it's mandatory. Goldman's corporate bylaws, mandated advancement to officers as long as certain conditions were met.

Third, the key analysis usually turns on whether an individual is a defendant "by reason of the fact" that he was an employee, officer, or director. This is usually where advancement cases turn, although in Aleynikov it wasn't the flash point at all. In Delaware (which most states will turn to for interpretive questions), this requires a court to consider the nexus or causal connection between the alleged wrongdoing (whether civilly or criminally based) and the individual's status. In Aleynikov's case, his theft of trade secrets occurred solely because of his access to them while he was a Goldman employee. To be sure, the act of misappropriation occurred before he quit. Therefore, Aleynikov wouldn't have been able to misappropriate the code (or understood his value) but for the exercise of his official duties as a Goldman employee. Several other courts have found improper pre-termination competitive activity (usually for trade secrets theft or violation of a fiduciary duty) as sufficient to establish the "by reason of the fact" test. Individual obligations arising after service ends, such as a non-compete violation, won't fall within the causal nexus and won't trigger advancement rights. (For this reason, it's exceedingly important for a plaintiff to consider the implications of its allegations and sought-after remedies.)

Simply because Aleynikov is entitled to fee advancement does not mean he is off the hook. If he loses and is found guilty by a Manhattan jury, he'll have to repay his fees - hence, the title "advancement." But he doesn't have to post security as a condition. Advancement is an unsecured undertaking (unless the corporate charter says otherwise), and it's hard to see where Aleynikov would ever have the practical ability to repay if things head further south.

A copy of Judge McNulty's lengthy advancement opinion is contained below.

Aleynikov - SJ Opinion on Advancement (00180447).pdf

2012: Year-End Review and Top 10 List

And so concludes my fourth full year of writing non-competes.com.

I've now written over 400 articles on this site. I strive to provide fresh, interesting commentary on a range of practical, legal, and economic issues relating to non-compete and trade secrets law.

What was new to this site in 2012? Three major changes.

First, while I had intended at the start of the year to provide everyone with a weekly "Reading List", I discovered Twitter along the way. I had long avoided Twitter, for fear that the last thing my life needed was one more informational tool. Boy, was I wrong about Twitter. This is where I am increasingly getting the best content, and I encourage my viewers to follow me on Twitter to see what I am reading and who I'm following.

Second, I have started embedding files into certain posts, so that my readers can read and downloand important opinions or filings (such as the U.S. v. EBay, Inc. Complaint). I have a couple of bar journal (i.e., "old" media" publications) coming out in 2013 and look forward to sharing those files on this site as well.

Third, I waded into the world of legal podcasting with Non-Compete Radio. All of those podcasts are available on iTunes and can be accessed here as well. More on podcasting in the next few weeks...

My year-end column is my favorite because it gives me an opportunity to look at what I've read and written about for the past 52 weeks and figure out what this year really was like in my corner of the legal universe.

So here are my Top 10 Developments for 2012:

10. New Hampshire Enacts "Notice Period" for Non-Competes. Effective July of 2012, New Hampshire state law now requires employers to give two weeks prior notice when an employer asks an employee to sign a non-compete or non-solicit agreement. The law is full of potential loopholes. My earlier post on this legislation is found here.

9. Texas Courts Largely Silent in 2012. The most active state supreme court on non-compete law over the past several years has been Texas. It has completely redefined the concept of acceptable consideration, an issue that befuddled courts and lawyers for a number of years. But 2012 was notable in one respect: not much happened. While I have written often about developments under Texas' Covenants Not to Compete Act, I only had one Texas-related post this year. I am predicting 2013 to be a lot different.

8. New Jersey Enacts Uniform Trade Secrets Act. At the beginning of 2012, New Jersey became the latest state to adopt a version of the UTSA. The Act is only slightly different than what most states have enacted, and it provides a broader set of remedies for employers looking to combat trade secret theft. At this point, only Texas, Massachusetts, and New York have yet to enact the UTSA. My earlier post on this legislation is found here.

7. Sergei Aleynikov's Wild Journey Continues. Many of us in the blogging community have written extensively about the travails of one Sergei Aleynikov, the ex-Goldman Sachs trader who misappropriated GS's trading source code before departing for Teza Technologies. Aleynikov's legal journey has taken him to: the Illinois Appellate Court, a conviction in New York federal court under the Economic Espionage Act, a reversal by the Second Circuit, subsequent state law criminal charges (for which he's pled not guilty), and a federal civil case in New Jersey against Goldman Sachs in which he has sought indemnification for all of his legal fees - which he just might win. Oh, and in the meantime, he's almost single-handedly responsible for getting Congress to pass the Theft of Trade Secrets Clarification Act that will effectively prevent another result like that in his Second Circuit case from occurring in the future.

6. Illinois Appellate Courts Active in Wake of Reliable Fire. I have written throughout the year about what has occurred in my home state - Illinois - since the Supreme Court's important decision last Fall in Reliable Fire Equipment v. Arredondo. Unfortunately, the results have been mixed at best. The judgments from our appellate court have been published as "non-binding" orders and seem to have conflated and confused what Reliable Fire really meant. This lack of clarity does not serve clients or lawyers well at all.

5. The Loparex Disaster. This is Aleynikov-lite. His joyride through the legal system may be somewhat of an aberration (and for that reason, his ranking on my year-end list is lower). But the nightmare litigation of Loparex, LLC v. MPI Release Technologies, LLC is a stark reminder of a trade secrets suit gone horribly wrong. The suit started in federal district court in Illinois, where Loparex took a dismissal when the court (Judge Lefkow) told Loparex it was not identifying its trade secrets correctly. Loparex then refiled in Indiana federal district court and lost the suit on the merits, along with a bad-faith sanctions award against it and its lawyer to the tune of nearly $500,000. The basis for the award: failure to even identify a misappropriated trade secret, and the complete lack of damages. And along the way, the suit made a detour to the Supreme Court of Indiana, which reversed a decades-old line of cases discussing Indiana's Blacklisting statute. Ultimately, that pro-plaintiff ruling did not impact the defendants' ability to obtain fees given the frivolous nature of the suit.

4. DuPont's Judgment Against Kolon Industries. In one the most important trade secrets cases to go to jury verdict in recent memory, E.I. DuPont prevailed in its claim against Kolon Industries to the tune of over $1 billion in compensatory and punitive damages and a 30-year permanent injunction. The technology related to DuPont's trade secrets - 149 of them - related to the manufacture of Kevlar. My colleague, John Marsh, has written extensively about this case on his blog.

3. The Computer Fraud and Abuse Act Circuit Split Deepens. We had two important decisions this year under my least favorite statute, the Computer Fraud and Abuse Act. In U.S. v. Nosal, the Ninth Circuit limited a CFAA claim premised on an employee who "exceeds authorized access" of a protected computer to "access", not "use." And in the Fourth Circuit, the court followed Nosal and took a narrow view of the CFAA, widening an already deep circuit split. In that case, WEC Carolina Energy Solutions v. Miller, the plaintiff has filed a cert petition in the U.S. Supreme Court to resolve the split among the circuits. Will the Court take the case? It might, and this will be an interesting case to follow in 2013.

2. The Ohio Supreme Court Decides Two Important Competition Cases. The Ohio Supreme Court's decisions in American Chemical Society v. Leadscope and Acordia of Ohio v. Fishel were vitally important. In Leadscope, the Court held that malicious litigation can support a common law unfair competition claim. In the process, it upheld a $26.5 million verdict in favor of Leadscope, another result demonstrating that the court (mis)use of legal process can redound very badly to plaintiffs who underestimate how aggressive of a defense their adversaries will muster. In Fishel, the Court reversed itself and held that non-compete contracts are automatically assignable in the course of statutory mergers. The Court had held in an earlier opinion in the same case that the plain language of covenants concerning assignability would control over statutory law.

1. Supreme Court Rules on Scope of Arbitration Clauses. And in the year's most talked-about non-compete case, the Supreme Court of the United States reversed a decision of the Oklahoma Supreme Court and held that an arbitrator, not a state court, must determine the enforceability of a non-compete agreement if the underlying contract contains an arbitration clause. The case leaves open the possibility that an employee can still petition a court to determine that the underlying arbitration clause is invalid. My discussion of Nitro-Lift Techs. v. Howard is found here.

So that's 2012 for ya'. Thanks again to all my readers for the great feedback and to my fellow blogging colleagues.

I'll be back in a few days to start Year 5!

This Move Takes...Guts

The travails of one Sergey Aleynikov are well-known to trade secrets and competition lawyers like myself.

This is the ex-Goldman Sachs programmer who spurred litigation from Chicago to New York, eventually resulting in a criminal conviction that was later overturned by the Second Circuit Court of Appeals in February.

Aleynikov's legal saga began when he misappropriated Goldman's proprietary software trading code and started work with a competitor in the high-frequency trading business, Teza Technologies.

Aleynikov is now suing Goldman to recoup his legal expenses through the concept of indemnification and advancement. Because Goldman's corporate bylaws require the firm to cover legal expenses for officers and directors, Aleynikov claims Goldman must pay the legal freight to defend charges - pursued by Goldman.

Indemnification and advancement are concepts that require attorneys to examine both state corporation law and corporate bylaws. There are many exceptions and ways for companies to avoid advancing fees and costs. Aleynikov believes that Goldman is required to, however, under the clear terms of Goldman's bylaws.

A copy of Aleynikov's federal complaint, filed in the District of New Jersey, can be found here and is embedded below:

Aleynikov v. Goldman Sachs Complaint (Indemnification and Advancement) (00136749)

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