California Choice-of-Law Rulings Strike Sensible Balance

Choice-of-law and -forum clauses are not only some of the most important issues in non-compete agreements, but they also are some of the most complex.

To step back, the clauses are just what they sound like. If you have a restrictive covenant agreement, look to the back and you'll find what many normal people call "boilerplate" terms. A choice-of-law clause says what State's law will govern the agreement. And a choice-of-forum clause will tell you where the case can, or even must, be heard.

These clauses take on added importance for employees who work for larger enterprises, because often the employee's place of citizenship will differ from the corporate nerve center. A valued sales employee may have selling responsibility only on the west coast, but her company may be situated in New York or Florida. This is extremely common, and employees often don't quite know what to do when their place of residence is different than the law governing their agreements.

Red-flag States, such as California and Oklahoma, pose special problems because of clear public policy concerns that deal with non-compete law. In those States (and others), many restrictive covenants enforceable in States like Texas or Florida won't be reasonable at all. What to do, then, when a citizen of one of these States has an agreement governed by a State's law that embraces non-competes?

Let's walk through how to assess this.

Step 1: Determine the employee's place of citizenship. This should be easy, but we've seen cases where employees move in order to take a new job in a State that is somewhat hostile to non-competes. Can this move aid the employee, or is it irrelevant?

Step 2: Find out if the employee's home State poses special enforcement problems. Those States are California, Oklahoma, North Dakota, Louisiana, and Wisconsin. There may be others, too, but for certain an employee's citizenship in one of these States should cause counsel to engage in a deep enforceability analysis.

Step 3: Ascertain whether suit in State or Federal court is likely. If there is a possibility of a suit in Federal court, then the Supreme Court's case of Atlantic Marine in 2013 will be important to consider. But, that is only if the contract contains a choice-of-forum clause.

Step 4: Review State choice-of-law rules. Most States adopt the analysis from Section 187 of the Restatement (Second) of Conflicts of Laws. If the parties select a State's law to apply, it will be given effect unless one of two conditions is met: (a) the selected State has no substantial relationship to the parties or the transaction; or (b) application of the chosen State's law would be contrary to the public policy of a State that has a materially greater interest and whose law would apply absent the choice-of-law clause.

Step 5: Apply the choice-of-law rules. Often, the first exception noted above won't apply, unless you encounter the totally bonkers situation where an employer gratuitously picks the most authoritarian State even though that State has nothing to do with the employment relationship. Or, perhaps, the employer picks Delaware when the only connection to Delaware is that the company chose to be incorporated there. That may fall within exception (a).

More likely, you'll need to do a deep dive on exception (b), which often applies when an employee has little connection to the forum State. Again, consider my example where an employee sells only in Oklahoma and has no job responsibilities in New York where the company home is. Very common fact pattern.

Step 6: Assuming you have a scenario involving exception (b), consider the nature of the public-policy at stake. Do you have a California problem, where non-competes are totally off-limits? Or do you have a State with marginal deviations to the general rule of reason, like a Nebraska which does not allow overbroad non-competes to be enforced? Sometimes these small deviations can be outcome-determinative in a particular dispute, but is that enough to qualify as a "public policy"? Debatable, to be sure.

Step 7: See if some other limiting condition applies. That is, does a State have a particular rule about choice-of-law or -forum clauses that applies to employees? Some States do by statute.

There are a few recent illustrations that involve some or all of these steps. The first comes from the redundantly-named Supreme Judicial Court of Massachusetts in a case called Oxford Global Resources, LLC v. Hernandez, in which the SJC held that a Massachusetts court would not enforce choice-of-law and -forum clauses that both selected Massachusetts against a former employee residing in California. Of particular note, that employee had job responsibilities only in California. The deciding factor was California's strong public policy that I have discussed often, which bars non-competes for employees.

Conversely, the Delaware Court of Chancery addressed a slightly different question in NuVasive, Inc. v. Miles. There, an employee in California entered into an employment contract that specified Delaware law and venue. But that agreement was entered into after California amended its Labor Code, Section 925. That section was generally intended to deepen the public policy interest against non-competes by preventing circumvention of California law through choice-of-law clauses. But Section 925 also carved out contracts where the employee's counsel negotiates the choice-of-law provision. As the Delaware court found, that carve-out balanced an overriding public policy interest in favor of free competition with a countervailing interest in the freedom to contract. As such, the choice-of-law clause was valid.

These issues are extremely important, and sometimes the case law can be confusing. That is more so with venue clauses than with choice-of-law provisions. But an employee and counsel must be attuned to the importance of both when it appears they can have an impact on the agreement.

The Janitor Non-Compete, This Time for Real

The janitor hypothetical is one of the most timeless aspects of non-compete cases. That is, when illustrating how broad a non-compete is, courts and lawyers alike often resort to a sometimes absurd hypothetical. It often contains some variation of "this non-compete is so broad it would restrict [insert poor sap stuck in litigation] from being a janitor." Feigned outrage and chuckles then ensue.

Only this time, no absurd hypothetical. Enter the combatants. On one side is C&W Facility Services, which provides maintenance services to commercial property owners. On the other side is UG2, a competitor. In the middle sits poor Sonia Mercado, a non-exempt "janitorial supervisor" making $18 per hour at C&W.

C&W is faced with a contract renewal to provide maintenance services at some outfit called Lonza Biologics, a life sciences company. Apparently, Lonza put the maintenance contract out to bid and lost it to UG2. Mercado worked for C&W on-site at Lonza. From her Declaration (unrebutted), she describes her job like this:

"As a supervisor, my job responsibilities differed from clearness only in that I helped to train new staff in how to clean. Otherwise, I was a cleaner. My English is better than some of the other cleaners, and I believe this is why I was made a supervisor."

She continues, again without rebuttal:

"I cleaned in the Carpet World. The Carpet World cleaners, including myself, did vacuuming, cleaning rugs, dusting, emptying trash cans/recycle bins, and periodically washing windows. We had a small room with cleaning supplies." She went so far as to attach a goddamned picture of the room with cleaning supplies."

After C&W loses the services contract to UG2, it presents Mercado with a two-year non-compete agreement. The upshot of the agreement is that Mercado, under the agreement, could not provide services at Lonza for another maintenance company. Mind you, by this time, C&W has lost the agreement and Mercado had no involvement in that process whatsoever.

The circumstances under which Mercado signed the restrictive covenant are questionable. From her affidavit, Mercado says that C&W informed Mercado and others that they would be placed at a new facility (Lindt chocolate...overrated, by the way). Apparently, C&W felt that UG2 would have trouble handling the job and told Mercado that she would be back at Lonza in no time. Weird, but plausible.

Mercado then signs the restrictive covenant along with a bonus agreement, most of which she ultimately returns. She ends up back at Lonza working for UG2, which should have surprised no one.

C&W then takes the inexplicable step of suing Mercado to enforce the agreement. The Verified Complaint is the typical sort of canned pleading we've come to hate, playing up what a total fucking disaster it would be for the company's confidential information to be lost. Mercado had no access to any such information, but the point seems to have been lost on C&W. In fact, the so-called protectable interest allegations, to me, do not pass the smell test. If believed, Mercado's responsibilities as a janitorial supervisor are on par with Lonza's head of operations.

The district court then enters an order of injunctive relief, enforcing the non-compete for four months (not two years) and ordering C&W to pay Mercado a portion of the bonus she returned to C&W. In effect, the court told C&W its non-compete was overbroad, required some modified form of "garden leave," and then struck as unreasonable the fee-shifting clause. The ruling preserved some semblance of sanity, though the court made a grave error. It should have denied the injunction outright.

The overarching problem is the court's complete lack of engagement with the protectable interest requirement. In other words, what was C&W hoping to achieve by preventing a custodian from working for another service provider after C&W already had lost the service contract? The court never says, beyond some unconvincing reference to training costs.

This is a problem in non-compete cases. Judges must be engaged with the facts to understand the rationale behind enforcing the restriction. Too often, plaintiffs get a free pass because they lodge vague generalities about threatened injury that sound just fine on paper, but fall apart in practice. It is unclear where C&W possibly could go from here. This case won't get any better. It's likely to get far worse.

A final word. It seems pretty clear to me that C&W is using Mercado as a pawn in much larger tactical battle with UG2. C&W could care less about her - that much is clear from the mere filing of the suit. Companies that use ex-employees in this way, as well as the "lawyers" representing them, do grave damage to the labor market and the use of human capital. This particular dispute sucks, and it's a total waste of time. C&W doesn't care. No one at UG2 is likely losing sleep. But I guarantee you Mercado cares.

I know people like her. I see them at night when I am working late. I make a point to get to know them and let them know they're appreciated. They work hard, for not much money, and people take them for granted. When my father was a school superintendent, he knew each custodial worker in my high school. He knew them by name. He gave them little things, an old TV comes to mind, knowing how much they'd appreciate it. That always has stuck with me.

Ultimately, it is C&W that will suffer the consequences of this inane and utterly pathetic lawsuit. It will be used as exhibit A for non-compete abuse. It ought to be used as a justification by some future client of C&W to not hire C&W at all.

C&W Facility v Mercado by Ken Vanko on Scribd

The Reading List (2017, No. 5): Plaintiffs and Courts Avoid the DTSA's Ex Parte Seizure Order

Non-Compete and Trade Secret News for the week ended February 3, 2017

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Defend Trade Secrets Act

I alluded to this case in my prior post.

But we have another federal district court case that discusses the Defend Trade Secrets Act and the ex parte seizure order. In Magnesita Refractories Co. v. Mishra, the court found that a temporary restraining order issued under Federal Rule of Civil Procedure 65, which mandated the seizure of a defendant's laptop, did not require the plaintiff to follow the process outlined in Section 1836(b)(2) of the DTSA.

This is about as in-the-weeds as you can get, but it reaffirms the much larger point: courts are going to issue TROs that have the same effect as the seizure order. And if that's the protocol, then the seizure order may - as I predicted - be more bark than bite. A copy of Judge Simon's ruling, which is truly for nerds like me, is available here.

Non-Recruitment Clauses

Tesla Motors has sued a director of its Autopilot program, Sterling Anderson, claiming misappropriation of "hundreds of gigabytes" of confidential information and improper solicitation of Tesla employees. The Complaint reads like a typical bad divorce between a key employee and a jilted employer, with some fairly serious allegations related to efforts to conceal electronic evidence and pre-termination "cloak and dagger" meetings to plan a competing venture. In California, where the suit is based, post-employment restrictions on soliciting employees are enforceable. That's the centerpiece of the contract claim.

The case is pending in Santa Clara Superior Court. A copy of the Complaint is available here. For a detailed news account, see this article in The Verge.

Sixth Circuit Appeal

The Sixth Circuit Court of Appeals this week heard oral argument in the case of Stryker Corp. v. Ridgeway, No. 16-1654. A jury in the Western District of Michigan entered a verdict in favor of Stryker in the amount of $745,000, which was based in part on Ridgeway's breach of a non-compete agreement. Among other things, the appeal raises a very important choice-of-law/choice-of-forum issue concerning Louisiana law. That state's law is very favorable to employees, but the district court did not apply it. (The district court ruling on the choice-of-law issue is at 2015 WL 5682317.)

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Russell Beck discusses in his Fair Competition blog post the renewed efforts at non-compete reform in Massachusetts. This has become an annual rite of passage. Seyfarth Shaw discusses the same proposals floating around the Massachusetts house and senate.

IPWatchdog has posted an article entitled How to Write Enforceable Non-Compete Agreements. This is a very nice, concise summary of employers' considerations in deciding whether and how to use restrictive covenants. A number of helpful quotes from some of my colleagues...

Other colleagues of mine, from Seyfarth Shaw, have posted their Top Developments/Headlines in Trade Secret, Computer Fraud, and Non-Compete Law in 2016. This post is notably longer than my year-end list and gives a few more illustrative cases - particularly on non-competes and federal computer fraud claims.

New Legislation in Connecticut and Massachusetts Serves to Limit Non-Compete Enforcement

For non-competes, courts and legislatures often have taken incremental steps to chip away at the default reasonableness test. These steps usually are in response to some larger public-policy issue. Two more states are moving to reform the law of non-competes, and both are attempting to curtail their use.

Connecticut is the first, and it has enacted legislation (Public Act No. 16-95) that limits the enforceability of physician non-competes. For any non-compete "entered into, amended, extended or renewed on or after July 1, 2016," the new Connecticut law establishes bright-line enforceability rules. In particular, a non-compete may not exceed one year in duration (presumably post-employment, though the law oddly does not say this) and may not extend beyond a 15-mile radius from where the physician primarily practices (I am simplifying here a bit). Further, an employer may not enforce a non-compete if the physician is terminated without cause.

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Massachusetts law has not been changed, at least as of yet. But the long-in-the-works legislative changes appear to be gaining steam. Last week, the Massachusetts House of Representatives unanimously passed a bill to impose stringent limits on non-compete agreements and to adopt (at long last) the Uniform Trade Secrets Act. House Bill 4434 accomplishes several things:

(1) The UTSA piece is unremarkable, but it does require the identification of the subject trade secret "with sufficient particularly under the circumstances of the case" before beginning discovery. This is a legislative endorsement of what many courts already require, but it contains needed flexibility that enables a court to establish discovery parameters.

(2) The bill also would establish the Massachusetts Noncompetition Agreement Act, which would require:

• At least 10 days' advance notice of the non-compete;
• For existing employees, independent "fair and reasonable" consideration independent from the continuation of employment (along with 10 days' advance notice);
• A maximum 1-year duration (except in cases of breach of fiduciary duty or theft, in which case the maximum may be 2 years);
• A reasonable geographic reach, which is presumptively established if the restricted area is consonant with the employee's sphere of influence within the last 2 years of employment;
• Garden-leave payment of at least 50 percent of the employee's highest base salary within the 2 years preceding termination or other "mutually-agreed upon consideration" (which is undefined.

Finally the proposed Act would bar enforcement if an employee is terminated without cause and would ban non-competes for non-exempt workers under the Fair Labor Standards Act.

There are some definite quirks in the proposed Massachusetts law, which is to be expected after the long slog this bill has been through. The next step would appear to be a vote in the state senate.

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UPDATE (at July 12, 2016):

Apparently, my post was timely. The Massachusetts Senate has acted. I defer to Russell Beck's excellent summary. The Boston Globe article can be found here.

New Legislation and a Sentencing for Trade Secrets Theft

The new year always means a spate of legislative activity. Proposed new laws related to trade secrets misappropriation and non-compete agreements do not generate many headlines, but they are fairly common. Two states in particular are considering revising their laws concerning enforcement of non-compete agreements.

Washington

First up is Washington. Earlier this month, several legislators in Washington state introduced a bill to restrict the use of non-compete agreements that bar physicians from practicing medicine. The twin bills (one for osteopathic medicine and surgery; the other for physicians) would make non-competes void and unenforceable. The lone carve-out is that the law would allow an action to enforce a contractual provision for damages due to termination of a contract, as long as the enforcing party establishes the reasonableness of damages by clear and convincing evidence. It's not clear from the draft bill whether "termination" means a termination before the end of a set contract term, or whether it's termination of the relationship altogether. It must mean the former if non-competes would be void under the proposed law.

Physician non-competes raise, perhaps more than any other profession, issues of public policy impact, particularly if a rural area would experience a shortage of available care as a result of non-compete enforcement. The Washington bill cites the American Medical Association Code of Medical Ethics as a policy rationale for the proposed change in the law. The pertinent code provision discourages use of non-competes.

Many state courts, such as Illinois, have not found the AMA Code to raise sufficient public policy concerns to invalidate physician non-competes across the board. It is, therefore, more of a legislative judgment, rather than one for courts to balance. Other states, like Texas, attempt to strike a balance by enabling a physician to buy his or her way out of a restrictive covenant at a fair price. Texas' statute also cites to the AMA Code.

The text of the Washington house bill is available here.

Massachusetts

Next up - shocker - is Massachusetts. I, for one, hope that this state just does something so I can stop following what is going on.

Massachusetts has considered enacting the Uniform Trade Secrets Act for something like a decade, which is remarkable considering it's a uniform statute. Decide, already! The details of that debate are not that interesting.

Of more importance is whether the state will reform its laws concerning enforcement of non-compete agreements. A number of legislators have introduced bills to ban non-compete agreements, and Russell Beck's fine summary is available here. For those interested in why reform of non-competes in Massachusetts is of interest, Orly Lobel's terrific book Talent Wants to Be Free discusses this at some length.

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On the trade secrets front, criminal prosecutions continue to garner headlines.

Another one comes from Chicago where Judge Norgle handed down a tough sentence on two former employees of Citadel LLC, a high-frequency trading (HFT) outfit. As illustrated in Michael Lewis' book Flash Boys, HFT firms engage in algorithmic equities trading, a sort of shadowy corner of the markets that increasingly garners attention in the Wall Street Journal for a variety of reasons.

Citadel's victim impact statement to Judge Norgle indicated that it had spent over $2 million in costs investigating the employees' theft of trade secrets and assisting the U.S. Attorneys' office. Interestingly, Citadel had non-compete agreements with both employees and apparently paid (or contracted to pay) them during the non-compete terms. The defendants, prosecuted in part under the Economic Espionage Act, received three-year prison terms and an order to pay over $750,000 in restitution.

The allegations of trade secrets theft generally centered on the employees' repeated downloading of trading strategies and source code from Citadel's servers onto personal storage devices. Given the value of this data to Citadel's HFT platform, and the security measures it used (detailed at length in the indictment), it is not difficult to see how this conduct rose of the level of trade secrets misappropriation.

So, What Is a "Solicitation"?

One of the most frequently asked questions I get when advising clients is deceptively complex:

What does it mean to solicit a client?

On its face, this probably sounds like it should be an easy question to answer. However, it's really not. Since courts are hesitant to enforce broad non-compete agreements (particularly as to sales persons), many disputes hinge on the applicability of a customer non-solicitation covenant. The scope of those covenants can range from the very broad to the much narrower, both in terms of the type of activity prohibited and the customers covered by the prohibition.

A broad non-solicitation covenant reads something like this:

Employee agrees for a period of one year not to solicit, contact, or provide services to a Restricted Customer for the purpose of providing Competitive Products.

A narrow non-solicitation covenant usually reads this way:

Employee agrees for a period of one year not to solicit or entice away a Restricted Customer for the purpose of providing Competitive Products.

The difference between the two is that the narrow covenant does not prohibit so-called "passive" solicitation, where a client reaches out to the employee. As a practical matter, these more narrow covenants lead to just as much litigaton because most times an employer won't know who contacted who. But it will justifiably be concerned about the fact the employee is continuing to work with the client. It only will be able to discover what actually happened through the litigation process.

In these cases involving narrower covenants, the issue of breach often hinges on whether the employee actually solicited the customer, or whether the customer sought out the employee. The First Circuit's recent opinion in Corporate Techs., Inc. v. Harnett illustrates a common fact-pattern and rejected a bright-line "initial contact" test. In that case, the ex-employee's new company sent out a blast announcement that piqued the curiosity of a targeted group of customers that happened to fall within the terms of the employee's non-solicitation covenant. Upon receiving that announcement, customers started contacting the ex-employee.

The court specifically noted that "initial contact" is somewhat amorphous and "can easily be manipulated" depending on the facts of a particular case. This is particularly so with businesses where the selling cycle is long, such that the initial contact would be "unlikely to bear fruit in the absence of subsequent solicitation." It had little trouble affirming a preliminary injunction that enforced the non-solicitation covenant.

The takeaway from cases like Harnett is that employees must understand that the issue of "solicitation" is intensely fact-laden and that it's awfully hard to play cute and end-run the contract. Courts will need to consider how employees typically communicate with customers, and whether the employee set in motion a chain of events designed to lead to contact by the customers themselves. Targeted announcements are an obvious invitation to cause a customer to contact the employee and present a fairly easy case for determining that a solicitation has occurred. Even more problematic are personal e-mails, LinkedIn invitations to connect, and other one-on-one activity that suggests an effort to continue a business relationship.

Corporate Techs v. Hartnett - Opinion by Ken Vanko

Episode 3 of Fairly Competing: The 2013 Legislative Update

Our third Fairly Competing podcast, The 2013 Legislative Update, is now available.

In this episode, John Marsh, Russell Beck, and I discuss pending legislative proposals to regulate non-compete and trade secrets law in Massachusetts, Minnesota, Michigan, and Texas. We offer our thoughts on the policy behind the bills and the relative chances each will become law.

You can listen to the podcast by clicking on the link below. You can also visit the podcast website or subscribe to Fairly Competing on iTunes.

Episode 4 is coming next week.

Listen to this episode

Case Update...The Trade Secrets Edition

I've come up with a better way to differentiate between trade secrets (protected nearly everywhere by statute) and confidential information (somewhere protected by the common law; more often, by contract). I may be totally off-base on this, but here goes.

A trade secret is a form of intellectual property whose value can be monetized like a patent or trademark. Confidential information is information that generally is not available to outsiders but which lacks independent value as a firm asset.

(I actually thought of this yesterday while changing a diaper.)

We're in the dead of summer, but the law continues to churn out interesting cases for us nerds to ruminate over.

Inevitable Disclosure in Massachusetts

A preliminary injunction ruling out of the District of Massachusetts rejected a rather expansive view of the inevitable disclosure doctrine. U.S. Elec. Svcs., Inc. v. Schmidt, 2012 U.S. Dist. LEXIS 84272 (D. Mass. June 19, 2012), involved the departure of a national accounts manager who did not have a non-compete agreement with the plaintiff (he actually left to work for a subsidiary two years prior). When a project coordinator followed the manager to a competing electrical distributor, the distributor sued under a variety of theories. Surveying Massachusetts' interpretation of the inevitable disclosure rule, the district court held that the rule is best applied to establish irreparable injury - basically, a protectable interest - supporting a non-competition agreement. It did not approve of using the theory as the foundation for a trade secrets claim. Factually, the claim appeared to be a stretch since the manager had not dealt with the key customer at issue - Dollar Tree Stores - for over two years.

Royalty Damages for Misappropriation

Royalty damages are the back-up plan for victims of trade secrets theft who can't prove lost profits or gains the misappropriator realized. This is a derivative of patent law, and it seeks to figure out a hypothetical licensing price that the misappropriator would pay for the privilege of using the information taken from the owner.

An Arizona court has held that a trade secret owners license fees for other patents and investment costs in developing the trade secret can provide a basis for a royalty award. It also rejected the argument that because a product may never be brought to market - the product involved an intestinal sleeve to treat morbid obesity - damages were inherently speculative. Using corporate finance theory, the court stated that a risky future cash flow is simply discounted with a risk-adjusted rate. The case is W.L. Gore & Assocs., Inc. v. GI Dynamics, Inc., 2012 U.S. Dist. LEXIS 75055 (D. Ariz. May 30, 2012).

Attorneys' Fees In Non-Compete Agreements

What happens when an employee wins a non-compete case and tries to recover attorneys' fees he never was obligated to pay? In my experience, new employers pay the freight on non-compete suits about 1/4 of the time, depending on the employee's value and position within the company. (An executive, for instance, likely will be able to negotiate this as part of his employment agreement.)

In Rogers v. Vulcan Mfg. Co., 2012 Fla. App. LEXIS 8793 (Fla. Ct. App. June 1, 2012), the Court of Appeal of Florida reversed a $0 attorneys' fee award to the employee after he prevailed on the employer's non-compete claim. The fee-shifting clause provided the employee could recover fees "incurred to enforce any term, condition, or provision" of the contract. The court found the clear intent of the clause was that "the loser pays, and the winner does not." It did not matter who the source of the funds was, because the language in the fee provision was passive.

And who said never to use the passive voice??

Case Law and Non-Compete News Update

Some interesting news stories and cases to report on this week.

News Stories


A couple of years ago, FLIR Systems engaged in an ill-advised trade secrets action in California which resulted in a substantial fee award to the defendants under a theory of bad faith. Now, the defendants are going after FLIR's counsel in that case, Latham & Watkins, on a malicious prosecution theory of liability. Apparently, the genesis of the claim against L&W arose when the plaintiffs (that is, the defendants in the original trade secrets case) discovered FLIR was invoking the "advice of counsel" defense. There a number of interesting procedural issues which could come out of this, including the possibility that L&W may have a SLAPP defense under California law. Epstein Becker & Green discusses the case.

In this author's opinion, counsel should not be granted an absolute privilege for bad faith or malicious litigation if they act as a mere instrumentality for their client.

John Marsh discusses the high-profile dispute between sports agent Aaron Mintz and Priority Sports Entertainment, a battle taking place in California over a non-compete apparently governed by Illinois law. Given California's clear public policy on non-competes, there certainly will be questions whether the choice-of-law clause is valid. Mintz joined CAA, which represents NBA stars LeBron James, Chris Bosh, Dwyane Wade, Carmelo Anthony and others. Priority Sports is headed by Mark Bartelstein, a graduate of the University of Illinois and a resident of suburban Chicago. Some salacious details of the suit can be found here.

Reported Cases


The Tennessee case of ProductiveMD, LLC v. 4UMD, LLC, 821 F. Supp. 2d 955 (M.D. Tenn. 2011), contains a good discussion of the "same proof" standard to determine trade secrets preemption. This standard essentially examines whether proof of a non-trade secrets claim would also establish a claim for misappropriation of trade secrets. If the answer is yes, the claim is preempted. Most frequently, the same proof test will jeopardize claims of common law unfair competition, unjust enrichment, breach of the duty of loyalty (at least in part), and civil conspiracy. To my knowledge, Hawaii is the only other state which has adopted the "same proof" test of preemption.

Grace Hunt IT Solutions, LLC v. SIS Software, LLC, 2012 Mass. Super. LEXIS 40 (Sup. Ct. Feb. 14, 2012), discusses the Massachusetts rule which voids non-compete agreements if there has been a "material change" in the employment relationship. The rationale for this rule is that a material change equates to a brand new employment relationship, which requires a new non-compete to be signed. An example of a material change would be a reduction in compensation. Interestingly, in the Grace Hunt case, the court discounted the employer's point that the reduced compensation could be made up through bonuses, because the evidence equivocated over whether those bonuses could realistically be achieved.

Franchise non-competes are usually enforced, as demonstrated by Outdoor Lighting Perspectives Franchising, Inc. v. OLP-Pittsburgh, Inc., 2012 U.S. Dist. LEXIS 53583 (W.D.N.C. Apr. 17, 2012). As I have noted on this blog before, the interests to be protected under franchise covenants are different than those in an employment contract, even though most franchise covenants are non-negotiable. The interest is not only business goodwill, but protection of the franchise system itself. Often times, the court will examine the interests of third-parties, other franchisees, who need protection. The case was interesting in one respect, however. The non-compete extended to a 100-mile buffer around the ceded franchise territory and other franchisees' territories. This was too broad, almost by definition, and the court cut it back to eliminate the 100-mile buffer language. However, the court did state that the restriction on competition within other franchisees' territories was reasonable.

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.

Justice Souter Discusses Equitable Tolling Policy in EMC Case (EMC Corp. v. Arturi)

I have written frequently about the equitable tolling rule, which is one the more significant procedural issues in non-compete law. In a nutshell, the rule provides that a party who contracts for a non-compete clause should gain the full benefit of it, and the time period should be tolled during the period of breach. States have different views on it.

Readers here know my view on this by now: if employers want to use the equitable tolling rule, put it in the contract. It's not that difficult. About one sentence will suffice. I represent plenty of employers and I am no apologist for employees who willingly violate their non-compete contracts. But on the other side, I have little sympathy for employers (particularly sophisticated ones) who draft lousy contracts.

Massachusetts is one of those states where courts have indicated that, to use the equitable tolling doctrine, the contract must be clear. Last December, EMC Corporation was not able to deploy the doctrine when it sought to enforce a non-compete after the contracted-for covenant expired. I wrote about the district court opinion here. On appeal to the First Circuit, retired Associate Justice David H. Souter authored an opinion that spoke to why EMC was out of luck on its effort to impose injunctive relief:

"Like any contracting party, EMC makes its agreements subject to the rules of equity governing specific enforcement; rules, moreover, that were clearly in place in the governing federal and state cases well before the company required [the employee] to sign. Being forewarned, EMC could have contracted, as the district judge noted, for tolling the term of the restriction during litigation, or for a period of restriction to commence upon preliminary finding of breach. But it did not."

When there is contractual uncertainty in non-compete cases, the employer bears responsibility. Because an equitable tolling clause is easy to draft and a common remedy, it is not too much to ask of an employer to include it specifically so that the parties are fully aware of what rights and remedies are on the table at the start of a dispute. This is particularly so because equitable tolling can have the effect of allowing an employer a double recovery for damages (during the period of breach) and injunctive relief (extending the non-compete for more time).

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Court: United States Court of Appeals for the First Circuit

Opinion Date: 8/26/11

Cite: EMC Corp. v. Arturi, 655 F.3d 75 (1st Cir. 2011)

Favors: Employee

Law: Massachusetts

Massachusetts Non-Compete Legislation Re-Introduced

Russell Beck, author of the awesome Fair Competition Blog, has written extensively today about the refiled bill in Massachusetts that would modernize and govern non-compete agreements. Mr. Beck points out a number of changes to the prior bill and summarizes the key take-aways from the legislation. This is an excellent article worth reading in full to see what state legislatures are considering as far as reform. Remember that Massachusetts has a vibrant high-tech community, and that much debate has surfaced in recent years about whether its non-compete laws have caused a brain drain to California - the state most hostile to employee non-compete arrangements.

Meanwhile, in the great State of Illinois, which has not yet filed for bankruptcy, Rep. Jill Tracy reintroduced the Covenants Not to Compete Act, the text of which can be found here. Even assuming the General Assembly would take up this legislation and pass it through the required floor readings, the bill likely would go through several modifications. (Having written this legislation for a representative a few years ago, I would like to see something done with it in a modified form. No, not everything in this bill reflects my personal belief as to how the law should be.)

Equitable Tolling of Non-Compete Not Available In Massachusetts Absent Contract Provision (EMC Corp. v. Arturi)

A federal district court has held that, under Massachusetts law, a non-compete restriction cannot be extended beyond the terms of the contract.

The case involved a suit filed by EMC Corporation against Chris Blotto. EMC originally filed suit in March of 2010, about 4 months after Blotto left EMC to join Knowledgent Group. It did not pursue injunctive relief until August, and at that time, it only sought to enforce a customer non-solicitation provision given evidence that Blotto was soliciting an EMC customer.

In November, EMC filed a second preliminary injunction motion, this time seeking, among other things, to prevent Blotto from working with Knowledgent for one year from the date of the order. The court denied the motion on the grounds that extending the restriction past December 4, 2010 was not allowed under Massachusetts law.

The court declined to endorse a broad application of the equitable tolling rule and indicated that EMC could easily amend its employment agreement to give it the right to toll the non-compete period during the period of an employee's breach. The court did not find that the reason for delay in seeking injunctive relief was important to its holding.

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Court: United States District Court for the District of Massachusetts
Opinion Date: 12/15/10

Cite: EMC Corp. v. Arturi, 2010 U.S. Dist. LEXIS 132621 (D. Mass. Dec. 15, 2010)

Favors: Employee

Law: Massachusetts

Cut In Salary Usually Does Not Void Non-Compete Clause (Leibowitz v. Aternity, Inc.)

Clients frequently ask whether a cut in salary or commissions will void an existing non-compete obligation. Like most covenant-related questions, the answer largely depends on the contract language itself.

Employers often will address the issue of salary and compensation in an agreement that also contains a non-compete restriction. That agreement ought to contain a clear provision that allows an employer to change or modify a stated salary, benefit, commission rate, or bonus without affecting the validity of other obligations.

As a New York court (applying Massachusetts law) recently found, this is more than enough to answer an employee's claim that a cut in a commission rate somehow invalidates a restrictive covenant.

What is less clear is a contract that contains no language whatsoever allowing the employer the ability to adjust salary up or down without compromising the non-compete covenants.

If the language of the compensation terms can be read as creating an obligation on the employer's part to pay a certain salary (or even allowing for salary to be increased from time to time), then an employee may have a pretty good case that a unilateral reduction amounts to a breach of contract. Again, all depends on the language of each contract, but the employee's argument clearly is strengthened in this situation.

A more difficult case for the employee would be a contract that just says nothing at all about compensation. Of the contracts I am asked to review, well over half deal with covenants or post-termination obligations only and are utterly silent as to compensation and benefits. This presents a much more difficult issue for an employee, and if she seeks to invalidate the covenant, then she almost certainly will need something else in her favor.

Perhaps the salary cut or commission rate decrease can increase the court's sympathy for a departed employee faced with a non-compete restriction, but standing alone it is a weak defense. An employee is going to need some other contributing factor to escape a contractual obligation. It is relatively easy for an employer to justify compensation reductions based on financial performance, new competitors, or some other external market force, and this normally has nothing to do with the interest to be protected through a non-compete agreement.

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Court: United States District Court for the Eastern District of New York
Opinion Date: 7/14/10
Cite: Leibowitz v. Aternity, Inc., 2010 U.S. Dist. LEXIS 70844 (E.D.N.Y. July 14, 2010)
Favors: Employer
Law: Massachusetts

Massachusetts Legislative Update

Though Illinois has legislation introduced in the House of Representatives, the state most likely to pass a new law reforming non-compete agreements is Massachusetts. Rep. Will Brownberger has been instrumental in driving reform, based primarily on the view among some in Massachusetts' high-tech community that a significant brain drain is occurring.

The new draft of the Massachusetts bill can be found by clicking here. It is employee-friendly as one would expect and takes bits and pieces of other legislative schemes across the country. It does not touch forfeiture-for-competition provisions, garden-leave clauses or non-solicitation (customer or employee) contracts. Some of the more notable features are a gross income requirement for validity ($75,000 annualized income), consideration of at least 10 percent of compensation for "afterthought" covenants, pre-hire notice that a non-compete must be signed, and explicit rejection of the inevitable disclosure doctrine. The attorneys-fee provisions are also favorable, even providing for payment of fees as part of an interlocutory order.

The bill, however, is silent on enforceability in the event of involuntary termination. Last July, the Boston Globe wrote an editorial about the need for reform, and emphasized that the bill concerning non-competes ought to deal with involuntary termination.

Broadcast Employees Frequently Exempt From Non-Compete Agreements

Jason Shinn, author of Defending the Digital Workplace, was kind enough to e-mail me this week about a fairly new Arizona statute that prohibits broadcast employers from requiring certain employees to sign non-compete agreements. Many readers may be aware that competitive and contractual concerns were front and center in the negotiations between Conan O'Brien and NBC over his departure from the network. (No copy of Conan's agreement appears online, and since he worked in California, a non-compete likely would not be enforceable under California law. Conan's dispute really was not about the terms of a non-compete anyway, but rather an exclusive services provision for walking away from NBC.)

Arizona is certainly not alone in exempting broadcast employees from non-compete restrictions. In 2008, New York passed a similar statute. Other states which have enacted legislation concerning non-compete agreements and broadcast employees include Illinois, Maine, Massachusetts and Connecticut. Michigan introduced legislation in 2007 that would have made broadcast industry non-competes presumptively unreasonable.

Many of these statutory provisions do not apply to broadcast executives or sales managers. The clear intent is for the exemption to govern on-air talent. Why the distinction? It has to do with the test most states apply in determining whether a non-compete is valid or an illegal restraint of trade.

Applying the legitimate business interest test to on-air talent is a little different. The interest to be protected, presumably, is goodwill in audience and network sponsorship retention. That appears to be more than a valid interest for an employer to assert. One can certainly imagine a ratings decline (with correspondent economic losses) if a high-profile anchor defects to a cross-town competitor.

Because most news anchors or sportscasters do not go out and solicit clients (i.e., the viewers themselves), applying the legitimate business interest test as courts have traditionally formulated it can be a little tricky. It is for this reason that the broadcast employees' trade association, the American Federation of Television and Radio Artists, has been aggressive in pushing for legislative non-compete exemptions.

Two Views of the Computer Fraud and Abuse Act (Brekka and Pullen)

Cases under the Computer Fraud and Abuse Act arising out of employee competition continue to head down two divergent paths.

In particular, courts are faced with a decision on whether to interpret the CFAA broadly or narrowly when an employer claims an ex-employee has acted "without authorization" or has "exceeded authorization" in accessing computer-stored information prior to termination of employment.

As I have written before, the more narrow view has gained substantial favor, illustrated by the Ninth Circuit's ruling in LVRC Holdings LLC v. Brekka. That case (originating from Nevada) arose out of a claim that an ex-employee improperly e-mailed company documents to himself prior to his resignation. Of note, the employer had no policy against this, and the documents were apparently sent to facilitate the ex-employee's potential buy-in to the company as a member. Put differently, when the deal soured - and after Brekka quit - the company had very few equities weighing in its favor. Whether that affected the Ninth Circuit's decision or not is not clear.

But the court rejected the argument that the term "authorization" was somehow linked to whether the employee acts contrary to his employer's interest or in defalcation of a fiduciary obligation of loyalty. Rather, the court looked to the plain meaning of the CFAA's terms - and the fact it is at heart a criminal statute - to find Brekka used LVRC's computer system in a manner totally consistent with the access previously granted to him as an employee.

The First Circuit, however, is less sympathetic to an employee's arguments for a narrow construction of the CFAA and reads the Act more broadly. In Guest-Tek Interactive Entertainment Inc. v. Pullen, a district court from Massachusetts denied an employee's motion to dismiss on the same grounds as raised in Brekka. While not directly adopting Judge Posner's influential opinion in the Seventh Circuit's Citrin case, the court rebuffed an employee's effort to dismiss a case after he allegedly transferred thousands of confidential files to a personal USB storage device before resignation. Unlike Brekka, the equities in this case decidedly militated in favor of the plaintiff.

The court in Pullen noted the progressive expansion of the CFAA from its relatively limited origins, as well as the fact employers are customarily using the statute to - essentially - federalize trade secrets claims. How this is at all relevant is not clear, but the court deemed it worthy of mention. The First Circuit, therefore, will interpret the CFAA in a broad fashion, analogous to how the Seventh Circuit does in the aftermath of Citrin.

Having considered the divergent views of federal courts, one issue is perfectly clear. Employers have to be out in front of this issue to eliminate difficult questions of statutory construction. Specifically, employers can be more diligent about protecting digitally stored information by formulating clear computer usage policies concerning use of company data on personal computers, migration of data to internet-based e-mail accounts, and the transfer of data for competitive purposes even while still employed. Including these policies within an employee handbook can help define the scope of authorization, regardless of what the CFAA default position is.

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Brekka

Court: United States Court of Appeals for the Ninth Circui
Opinion Date: 3/13/09
Cite: LVRC Holdings LLC v. Brekka, 581 F.3d 1127 (9th Cir. 2009)
Favors: Employee
Law: Federal

Pullen

Court: United States District Court for the District of Massachusetts
Opinion Date: 10/19/09
Cite: Guest-Tek Interactive Entertainment Inc. v. Pullen, 2009 U.S. Dist. LEXIS 98737 (D. Mass. Oct. 19, 2009)
Favors: Employer
Law: Federal

Entrepreneur's Trade Secret Claim Ends Up In the Dumpster (Take It Away v. The Home Depot)

If you're anything like me, at least once every so often you have a fleeting thought that you've stumbled onto a great entrepreneurial idea sure to let your family coast into retirement much earlier than expected. At least in my case, by dinner time I've forgotten what the idea was that got me so energized.

Some folks are more resolute.

Case-in-point: William Vaccaro, Michael Walsh and Royal Murphy. Their idea, hatched in 1996, was conceived by Vaccaro while driving by a lumber yard. The gist of the idea was beyond simple: to rent dumpsters or waste bins to customers from home improvement retail locations. Vaccaro freely admitted the simplicity of his idea, stating it came to him in a matter of minutes.

For the next several years, Take It Away, Inc. (which has produced exactly $0 in revenue) embarked upon what can only be described as an aggressive sales pitch to Home Depot, one of America's ubiquitous retailers. To put it mildly, Home Depot was not enthused at the idea of partnering with Take It Away. Over the course of many years, Take It Away approached a number of managers at Home Depot trying to sell them on the idea. At one point early on, the parties even signed a non-disclosure agreement regarding Take It Away's "waste disposal business."

But after that, Home Depot showed little interest. That said, representatives from the supply store did discuss the possibility of leasing Take It Away space in retail stores to conduct dumpster rentals. However, Take It Away never made any proposals concerning this concept and apparently insisted on a middle-man or brokerage arrangement where it take 90% of any revenue from dumpster rentals and remit 10% to Home Depot.

About a year or so after discussions finally concluded, Home Depot entered into four agreements with other firms for the establishment of "dumpster rental referral programs." The concept was based on the leasing idea Home Depot apparently suggested to Take It Away - basically, to set up space in the store and pay Home Depot a referral fee - and which was rejected or just not pursued at all.

Take It Away, with no history of sales let alone profitability, then sued for damages of $60 million based on a trade secrets misappropriation claim. Not surprisingly, the district court granted summary judgment in Home Depot's favor.

Take It Away's claim stood little chance of success for many reasons. To begin with, Take It Away never protected the information in a commercially reasonable manner; the waste removal proposals were sent to Home Depot employees who refused to sign non-disclosure agreements and the original business proposal was sent to Home Depot before the retailer even signed the first confidentiality agreement back in 1997.

Ultimately, however, the transparent simplicity of the idea doomed Take It Away. Vaccaro testified the concept came to him in a matter of minutes, and the idea was little more than a general marketing idea. Once implemented, the idea could be reverse-engineered by anyone who went to the store and learned that waste removal services could be rented on-site. Virtually nothing could protect the concept once implemented.

Take It Away has filed a notice of appeal to the First Circuit.

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Court: United States District Court for the District of Massachusetts
Opinion Date: 2/6/09
Cite: Take It Away, Inc. v. The Home Depot, Inc., 2009 U.S. Dist. LEXIS 14279 (D. Mass. Feb. 6, 2009)
Favors: N/A
Law: Massachusetts

Massachusetts Court Finds Successor Company Cannot Enforce Non-Compete (Randstad Professionals v. Wilson)

I wrote yesterday regarding the law of assignment and how it pertains to non-compete obligations of employees. Though approaches vary from one state to the next, assignments of covenants not to compete are generally permitted and may even be implied if the contract is silent.

Of course, nothing precludes a contract from prohibiting assignment altogether, as a recent Massachusetts decision illustrates. In the case of Randstad Professionals v. Wilson, the defendant signed an employment contract with a professional staffing agency, New Boston Select Group, Inc., which contained an 18-month, 100 geographic mile non-compete and a customer non-solicit clause. Several years after he started, New Boston was sold to Placement Pros. In 2008, the plaintiff - Randstad - took over Placement Pros. When it became apparent that Randstad would be Wilson's new employer, he quit.

Randstad sued to enforce the non-compete when Wilson defected and joined a direct competitor. The court had little trouble denying Randstad's motion for a preliminary injunction, holding that a specific provision of the non-compete agreement provided that "Employee's obligations ... may not be assigned."

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Court: Superior Court of Massachusetts at Worcester
Opinion Date: 12/26/08
Cite: Randstad Professionals US, LP v. Wilson, 2008 Mass. Super. LEXIS 405 (Mass. Super. Ct. Dec. 26, 2008)
Favors: Employee
Law: Massachusetts

Massachusetts Legislator Files Bill to Outlaw Non-Compete Agreements

For some time now, many inside the Massachusetts technology community have been debating whether restrictive covenants have hampered its competitiveness, particularly with California companies.

Yesterday, Rep. Will Brownsberger filed a bill to ban non-compete agreements in Massachusetts. The text of the bill makes void and unenforceable any written or oral contract "arising out of an employment relationship that prohibits, impairs, restrains, restricts, or places any condition on a person's ability to seek, engage in or accept any type of employment or independent contract work, for any period of time aften an employment relationship has ended."

At first glance, the text contains one glaring loophole. It would not prohibit a non-compete if the initial relationship is between a principal and an independent contractor. The bill also does not address sale-of-business covenants, or covenants set forth in partnership or shareholder agreements. Presumably, those would still be valid.

If passed, the bill could be interpreted similar to Oklahoma's law against restraints of trade, which prohibits non-compete agreements but not customer non-solicitation covenants. California recently rejected this so-called "narrow restraint" exception to Section 16600 of its Business and Professions Code, which contains a prohibition not all that dissimilar to what Rep. Brownsberger's bill proposes.