The Reading List (2017, No. 23): The "Welcome Back, Ken" Edition

Non-Compete and Trade Secrets News for the week ended August 4, 2017

***

This week, I welcome myself back!

I'm happy to be here, really I am. The time away from blogging was great, a much-needed break. What did I do? I went camping (in the rain). I ran a race (the Bix7 in the lovely Quad Cities), and - oh yea - I tried a case in Chicago. Eventful. Not as eventful as Anthony Scaramucci's month, but eventful nonetheless.

Speaking of my trial, it was a doozy. A replevin trial over a stolen shipment of Mexican cheese, which the Chicago Tribune reported on. And, you know your case is good when it merits discussion in Food & Wine magazine. Just so you know, cheese heists appear to be a thing. But I'll take the set of facts I tried over any of these half-baked schemes. And it turned out great a - a replevin judgment about three weeks after we filed the case.

It did get me thinking about remedies, because you know I'm always looking to relate something to non-compete and trade-secrets law. Readers of this blog know that I've written a lot about the ex parte seizure order available under the Defend Trade Secrets Act. That procedure allows for an early court hearing, without notice, through which a federal court can empower a U.S. Marshall to seize stolen items containing protected trade secrets.

This replevin remedy is kind of similar, though there's process afforded. A replevin is simply an interim order that directs the seizure of property. In my case, cheese. But it could in theory be the replevin of a trade secret, too, depending on the facts. In Illinois, at least, replevin is only available for chattels or tangible goods. Again, cheese would be an example. Most trade secrets exist electronically, making the statute in Illinois a somewhat poor fit. Also, most items that a plaintiff would want back are legitimate in and of themselves (a computer, a thumb drive). In a replevin case, the plaintiff must show a superior possessory right to the thing itself - not what may reside on it.

Depending on the facts, a replevin order could issue on an ex parte basis. But in the main, a replevin claim really is an early trial that is akin to a mandatory injunction proceeding, which if successful results in a sheriff seizing property. All that said, don't overlook replevin as a potential remedy in a trade secrets case.

Anyway, on to news and updates.

***

Consideration for Non-Competes in Illinois

Illinois courts continue to debate and discuss the so-called Fifield rule of continued employment. Generally, that case suggests two years of continued employment is required to serve as adequate consideration for a restrictive covenant. The case, however, is more a result of sloppy legal writing than it is a bold pronouncement of what amounts to lawmaking.

In reality, the facts of Fifield weren't particularly compelling and the case wasn't that close. The employee had been working only for a few months before leaving, meaning his tenure was far short of the rough two-year guidepost old Illinois cases had established. And there certainly was no indication he received anything more than the job itself.

The Appellate Court of Illinois (Second District) weighed in somewhat in Paul Joseph Salon & Spa, Inc. v. Yeske in affirming the grant of a temporary restraining order. There, the defendant resigned two days before the expiration of the two-year employment period. The court held that, at least when reviewing a TRO, the court did not abuse its discretion in finding the consideration adequate even if it fell just short of the two-year mark. The case is not particularly useful since it's an unpublished decision and given the "quick-look" review afforded TROs. And in fact, the Second District in prior cases never has embraced a bright-line rule of two years' continued employment. It appears the reason why is that the two-year rule only sort of exists and stems from an unforced error in the drafting of the Fifield decision.

A link to the case is available here.

From the Southern District of Illinois, we received another district court memorandum order that rejects any bright-line rule concerning continued employment. This follows a trend of cases from Illinois federal courts. In Apex Physical Therapy, LLC v. Ball, No. 17-cv-119, 2017 WL 3130241 (S.D. Ill. Jul. 24, 2017), the court noted the problem with bright-line rules and inequitable results which could occur. Interestingly, the court stated that "consideration can be comprised of benefits beyond continued employment." As with many of the federal decisions, it is not clear what the employee's agreement said about consideration or what else the employer might have alleged in addition to continued employment.

Injunction Bonds

One overlooked aspect of injunction practice in competition cases is the need for a bond. A bond generally provides the defendant some security in case the court was wrong in issuing a preliminary injunction. To be sure, those orders can inflict economic harm on the defendant. And to complicate the equation, courts must issue those orders on a relatively undeveloped record.

In my experience, plaintiffs who seek an injunction treat the bond requirement as an afterthought. It's one thing to ask for a low or nominal bond. It's quite another to be totally unprepared in contacting a broker, filling out a surety application, and getting the bond issued. Assuming a plaintiff does secure a bond, however, it must recognize that it has responsibilities to continue with the litigation responsibly. Or else, the bond may provided the defendant with a ready source of damages.

Against this backdrop, I was interested by the North Carolina Court of Appeals' opinion in Van-Go Transportation, Inc. v. Sampson County. This is not a non-compete case, but it's about the closest analogue and certainly relevant for the bond discussion. It involved a public contract for the transportation of Medicaid patients seeking health-care services. The incumbent, Van-Go, obtained a temporary restraining order against a competing ride company that prevailed in a request-for-proposal process with a municipality. As a condition of the TRO, the court required Van-Go to post a bond.

After the defendant filed a motion to dismiss, Van-Go voluntarily dismissed its case but also sought a release of the TRO bond. The trial court denied that effort and awarded the bond proceeds among the defendants. The Court of Appeals affirmed that decision, holding that a voluntary dismissal is equivalent to an admission that the TRO was wrongfully obtained in the first instance. The ruling is obviously defense-friendly, and it forces the plaintiff to take a long-view of litigation. In rejecting Van-Go's argument that it discontinued the litigation for "responsible financial business practices," it effectively tells plaintiffs that they must continue a case in which they have secured an injunction at pain of forfeiting a bond.

Depending on the amount of the bond (and the damages a defendant can prove), that may be an acceptable risk for the plaintiff to take. But it's crucial to understand that getting an early injunction comes at a price. The plaintiff may not be able to abandon its case free of charge.

A link to Van-Go Transportation can be found here.

Independent Contractors

The enforcement of non-competes against consultants and independent contractors raises a host of tough questions. After all, the essence of being an independent contractor is freedom and, importantly, freedom to control your own work. Non-competes, by definition, stifle freedom and seem to be at odds with an independent contractor relationship. Still, many companies use non-competes with consultants or sales representatives much as they would with ordinary W-2 employees.

A pair of cases reveals the limitations, though, of shoehorning consultants into the typical employment non-compete framework. The first comes from the Eighth Circuit, where a panel concluded that a company could not restrict an outside sales representative from engaging in competing crop management and fertilizer sales since he had developed his customer contacts through his own labor and without support from the company. The case, Ag Spectrum v. Elder, is a great read on the reasonableness inquiry through its analysis of the company's protectable interest. In particular, the opinion emphasized the resources that the sales representative invested and the absence of any specialized training or assistance that the principal provided. In those circumstances, a customer non-solicitation covenant was unreasonable as applied.

The opinion from the Eighth Circuit panel is available here.

In a similar case, an Ohio federal district court denied an injunction brought by a company that sells, among other things, office chair mats against a former consultant. The non-compete entered into between the company and the consultant broadly prohibited him from competing in the sale of chair mats and other products. The problem for the company is that the consultant's work, following the end of the relationship, involved those other products. And the consultant's services had nothing to do with them. Put another way, the company was trying to prevent competition for work related to products over which its consultant had no involvement.

The opinion, written by Judge Edmund Sargas, reflects a terrific example of judicial engagement - a perspective I often find lacking in non-compete cases. Judge Sargas credited the consultant's prior history in developing the same type of products that he was offering after the end of the relationship, concluding that the consultant in fact did not try to capitalize on anything confidential he learned through his contract arrangement.

Together, both cases demonstrate the difficulty of enforcing non-competes in a more arms-length relationship where the employer simply cannot demonstrate a protectable interest - that is, an interest that stems from a significant investment of time, resources, or information.

***

Much more next week, including an update on the big Wal-Mart trade secrets case and more non-compete coverage in the New York Times.

North Carolina's Odd Rule on Appealing Injunctions

Lawyers deal with rules that are substantive and procedural.

For the most part, substantive rules - those governing the merits of a claim - contain some flexibility. That is particularly true in non-compete cases, where the flexibility is a direct reflection on the fact-specific nature of each dispute. Bright-line rules don't work as well because they are subject to manipulation. That is, they run counter to the idea that judges must rule on each case according to the facts presented.

Procedural rules, however, benefit from rigidity. Take the rules concerning time limits on when a party must file a case or respond to discovery. Without bright-line standards, there are no rules for how to conduct the litigation. The whole system becomes a game.

One area of procedural law that is smartly inflexible is appellate jurisdiction.

For many years, courts have noted that clear jurisdictional rules are essential. The Supreme Court, for its part, has worked in recent years to eliminate holes in old case law suggesting that some cases are "practically" or "effectively" final for appeal purposes.

Rules of appellate jurisdiction are crucial in non-compete disputes. Why? Most cases are practically decided at the preliminary injunction stage. In federal court, a grant or denial or injunctive relief affords the litigants a right to appellate review, even if the action itself may result in a damages trial down the road. This basis for appellate jurisdiction - known to lawyers as an "interlocutory" appeal - is crystal clear and provided for by statute.

Not all State court systems follow the federal rules, of course. In Illinois, rulings on temporary restraining orders are immediately appealable. Not so in federal court. One particularly odd rule, though, comes from North Carolina.

There, appeals from interlocutory orders - which preliminary injunctions are, because they are not "final" - are allowed only if they deprive the appellant of a "substantial right that will be lost absent review before final disposition of the case."

North Carolina's rule, as applied to preliminary injunction orders, is hard to square with the common-sense proposition that, above all, jurisdictional rules must be clear to lawyers and litigants.

What, for instance, is a "substantial right"?

That issue has led to some strange decisions involving non-compete cases. For instance, the North Carolina appellate courts have found that bona fide non-competition clauses that bar work in an industry rise to the level of a "substantial right." But they also have found that restraints on working with customers (non-solicitation covenants) do not meet this standard. The idea is that these activity-based restrictions do not prevent a person from earning a living. They merely limit it.

But what if the individual's customer contacts are her stock in trade - the way she makes her living? How is an appellate court to make that decision in the context of a jurisdictional inquiry? In fact, a 2015 case called A&D Environmental Services v. Miller noted this very problem. The court dismissed an employee's appeal from a preliminary injunction order, which limited his work with certain customers. The rationale was that the order only limited his right to earn a living but did not prevent him from doing so. In a footnote, the court then stated the problem with this approach: "We do not suggest that an injunction which merely prevents a person from working with a defined group of customers could never affect a person's substantial rights."

Good luck figuring that out when deciding whether to appeal.

I have no idea why North Carolina courts would embrace such an odd jurisdictional regime, where the appellate court must examine the substance of an injunction order to evaluate the "substantial right" argument and then determine whether the appeal from that order was jurisdictionally sound. The court's work, by that point, is already done. Why not rule on the merits? The obvious danger in avoiding the merits is that by the time the case reaches true finality, the non-compete will by over and therefore moot.

Strangely, North Carolina's appellate jurisdiction analysis may actually incentivize employers to seek narrower relief. If an employer, for instance, has two different restraints to enforce, why go for the broader non-compete if you can foreclose immediate appellate review by enforcing through a preliminary injunction only a non-solicitation covenant? This decisional process, of course, depends on the strength of the evidence and what the employer is trying to protect. But the current appellate jurisdiction case law would seem to discourage enforcement of broader, market-based restraints against salespersons whose value to a third-party employer lies in her customer contacts.

To be sure, that is an odd way for appellate courts to handle non-compete cases and injunction orders. Jurisdictional rules - as opposed to substantive ones - are meant to provide firm, clear guidance. North Carolina's framework does anything but.

The "Access and Opportunity" Argument and Evidentiary Burdens

In my last post, I discussed another bad-faith ruling in the context of misguided, opportunistic trade-secrets litigation.

When discussing that particular case, I raised the prevalence of the "access and opportunity" theory and how the use of that particular theory (and the simplistic building blocks upon which it's based) can walk a plaintiff right into a bad-faith fee claim.

This post, somewhat of a follow-up to my prior one, discusses a recent Fourth Circuit decision called RLM Communications, Inc. v. Tuschen, in which the court (applying North Carolina law) discussed the burdens of proof associated with an access-and-opportunity claim. To remind readers, an access-and-opportunity claim is one where the plaintiff's reasoning is based entirely on circumstantial evidence that pieces two innocuous facts together to lead to a conclusion. That is, the employee had access to certain trade secrets and s/he now works at a company where she would have the opportunity to benefit from using those secrets; therefore, s/he has misappropriated them.

For starters, "access and opportunity" might be called "inevitable disclosure" without the help of steroids. Typically, an inevitable disclosure claim rests on a trigger fact - that is, some suspicious fact that creates a needed evidentiary link to bolster an access-and-opportunity claim. One example might be suspicious work activity in the day or two leading to a resignation.

The Tuschen court addressed a North Carolina statute that allows an employer to establish a prima facie case of trade secret misappropriation by showing knowledge of the secret and an opportunity to disclose it. According to the court, proving these facts alone did not enable the employer to survive summary judgment. In the critical passage, the court notes:

"In the employment context, if knowledge and opportunity suffice for a prima facie case of misappropriation, then an employer can state a prima facie case against its employee merely by showing that it gave the employee access to its trade secrets. The employer therefore can force such an employee to go to trial on a misappropriation claim - unless the employee can rebut the prima facie case."

The court dealt with the burden-shifting question by finding that North Carolina courts would require employers to do more. Either the acquisition of the trade secret was through an abuse of access (which would seem to fit within the plus-factor, inevitable-disclosure analysis I describe briefly above), or the employer must come forward and rebut an employee's showing that the acquisition of the trade secret was gained through the consent of the employer. This, too, would require some form of abuse or misuse of company access to take proprietary information.

An alternative way of saying this is that, for summary judgment purposes, knowledge and opportunity is not enough. An employer must present evidence beyond this to raise an inference of misappropriation.

The decision is a fairly interesting read in that it discusses burden-shifting much like courts assess claims of employment discrimination. The larger question the court addresses, though, is that weak trade secrets claims are perfectly suited for summary determination short of trial. Clearly the court was concerned about simplistic reasoning and the piling of unreasonable inferences - when the price for that stretched logic is forcing an employee to go through the pains of an arduous trial.

The Janitor Analogy, Once Again

"The agreement is so broad that it would prohibit my client from working for his new company even as a janitor!"

- Comment attributed to every defense attorney in every non-compete case, generally accompanied by arms flailing up and down violently.

***


Despite my sarcasm, this isn't a terrible argument.

In fact, it's made repeatedly with great success. And the analogy has managed to work its way into one court opinion after another.

The cases in which you see this generally involve a broad non-compete agreement, as opposed to a more limited non-solicitation of customers restraint. The argument never works for a high-level executive because courts generally assume such executives have pervasive access to confidential information of their former employer, such that a tightly defined job-scope limitation isn't required based on the interest the company is trying to assert.

However, the argument has appeal when a mid-level sales person has a restrictive covenant that goes beyond his or her ability to service or solicit clients and that extends to a broader restriction more appropriate for those that develop products or manage the flow of confidential information. So the argument goes, the broad market-based covenant is not narrowly tailored to protect the interest (customer goodwill) the employee can impair.

Two North Carolina appellate decisions discuss broad non-competes in this context, and both came out in favor of the ex-employee. The cases are Horner Int'l Co. v. McKoy, No. COA13-964 (March 4, 2014), and CopyPro, Inc. v. Musgrove, No. COA13-297 (Feb. 4, 2014). Neither case breaks new ground, but they serve as strong illustrations of how courts examine broader covenants as applied to salespersons. Prohibitions on employment altogether for this class of employees will raise major red flags. The problems easily can be cured with more reasonably drawn non-solicitation of customers provisions.

On this score, though, there's a further problem percolating underneath the surface in restrictive covenant law. Too much, generally, is made of the need for a geographic limitation. While some businesses still are hyper-local, many aren't. As the economy continues to evolve and individual spheres of influence extend beyond particular geographic borders, courts are going to have to reformulate their enforceability tests to move away from a geographic analysis. The short concurrence in the McKoy case makes this point.

Changes to our economy pose a special challenge for lawyers who draft agreements for their employer clients. We have to begin paying more attention to scope limitations in non-competes contracts and tailoring contracts to the particular employee. This is an issue separate and apart from the utility of any geographic restraint. More and more, I am reviewing non-competes that have no real meaningful geographic restriction but which are more carefully defined in the type of role the employee would be restricted from assuming after his or her departure.

It's encouraging that drafting seems to have evolved in this respect. But as the North Carolina cases show, there still frequently is a large disconnect between the employee's activities and the employer's business, on the one hand, and the practical impact of the covenant language, on the other.

Face It: Judges Sometimes Hate Competition Cases

Believe it.

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

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

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

There are a couple of reasons.

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

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

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

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

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

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

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

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

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

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

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

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

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.

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.

Failure to Separate Covenants Invalidates Non-Solicitation Agreement (MJM Investigations v. Sjostedt)

If you're drafting non-compete agreements in a blue-pencil state like North Carolina, you have to be careful.

Proving once again that the consequences for improper drafting can be severe, the Court of Appeals in North Carolina invalidated a client non-solicitation clause due in part to overbreadth but also due to the strict application of the state's blue-pencil law.

As regular followers of this blog know, there is a sharp distinction between states which will modify covenants to make them reasonable and states which adhere to a mechanical blue-pencil approach. North Carolina falls in the latter category. (It is this scribe's humble opinion that the more equitable approach - favored in states like Illinois and Ohio - leads to less litigation and incents employees to comply with at least some restriction that an objective person would deem reasonable. That is not to say this approach does not have a chilling or deterrent effect, which it clearly does.)

This means that a court may not add or change terms of a covenant, but instead only can sever or strike out offending provisions. The covenant at issue concerned an employee's agreement not to compete and not solicit clients in a specialized, niche field related to insurance coverage. Specifically, the plaintiff assisted insurance carriers in evaluating claims made related to services provided by contractors of the federal government for work overseas.

The defendant, a consultant, terminated his agreement with the plaintiff and apparently began competing directly in the same claims processing field with the plaintiff's clients. He argued that the restrictive covenants were invalid and lost in the trial court as to the less cumbersome client non-solicitation obligation. The court struck the two-year non-compete as invalid on the grounds it was overbroad.

On appeal, the defendant obtained further relief as he successfully convinced the Court of Appeals that the client non-solicitation also could not be enforced. He won on a couple of grounds:

(1) The two-year time limit was contained only in the non-compete restriction, and since it was struck as overbroad, the non-solicitation clause had no time limit whatsoever. This is a perfect illustration of the rigidity of the blue-pencil rule, because a court in an equitable modification state could easily apply the two-year time limit to the non-solicitation clause in its discretion.

(2) The definition of "client" and "prospect client" was not defined in the agreement. In North Carolina, as in many states, a client limitation cannot extend beyond relationships the employee made while employed with his former firm. In this case, the court had ample precedent to hold the terms "client" and particularly "prospect client" were too vague to be enforced. This ruling provides a lesson for practitioners: if you're going to use defined terms in a non-compete agreement, use them to define which clients are off-limits so that an employee cannot argue vagueness. That argument often wins.

--

Court: Court of Appeals of North Carolina
Opinion Date: 7/20/10
Cite: MJM Investigations, Inc. v. Sjostedt, 2010 N.C. App. LEXIS 1280 (N.C. Ct. App. July 20, 2010)
Favors: Employee
Law: North Carolina

When the Dictionary Isn't Good Enough... (ACS Partners, LLC v. Caputo)

Ambiguity can be the death of restrictive covenants.

Common everyday words used in a non-compete agreement seem to take on a life of their own. Terms such as "solicit" or "compete" or "client" may intuitively be easy to define, but in hotly-contested competitive disputes, there is often room for defendants to parse these terms and claim ambiguity. If these claims are successful, an employer's non-compete could be at risk for non-enforcement.

One of the more common problems employers run into concerns the term "prospect" or "prospective client." In customer non-solicitation covenants, it is not unusual for the restraint to extend both to actual customers of the employer and prospects. The best practice is to define "prospective client" within the contract itself so as to eliminate the chance an employee will claim the non-solicitation provision is too broad or ambiguous to be enforced.

On this score, employers' counsel should define prospect so that it includes only identifiable prospective clients with whom an employee interacted or to whom he made a business proposal for services within a defined period of time, say, 6 months prior to departure. Including within the definition all prospective accounts in the company, even those not known to the restrained employee, is problematic due to lack of notice; that employee may simply not know who other salespersons' have been prospecting.

Absent a defined term like this, an employer is left to rely on the dictionary and argue the term be given its usual and ordinary construction. Unfortunately, this doesn't help much for some terms. As a federal district court in North Carolina recently noted, the dictionary definition of "prospect" means expected, likely or future. This clarifies nothing, since anyone could be a future client - regardless of whether they have been contacted or even identified within the records of the company. (The problem is particularly acute in states like North Carolina where its restrictive "blue-pencil" rule severely limits a court's ability to equitably modify the terms of an overbroad non-compete.)

It is cumbersome to load up an employment contract with defined terms. But certain core terms ought to be identified right away so an employee cannot later claim that the average construction of a key word within the non-compete is too ambiguous to be enforceable. The term "prospect" or "prospective customer" is one that always should be defined with some precision.

--

Court: United States District Court for the Western District of North Carolina
Opinion Date: 2/12/10
Cite: ACS Partners, LLC v. Caputo, 2010 U.S. Dist. LEXIS 19907 (W.D.N.C. Feb. 12, 2010)
Favors: Employee
Law: North Carolina

Discovery Dispute In Trade Secrets Action Symptomatic of Fishing Expedition (IKON Office Solutions v. Konica Minolta)

Trade secrets actions are notorious for creating intractable discovery thickets. The fundamental problem usually revolves around interrelated concepts: the defendant's request to know exactly what trade secrets are at issue, and the plaintiff's need to know what the defendant has. The former automatically implicates grave intellectual property protection concerns, while the latter often is a ruse to obtain more information than really should be at issue.

Very few jurisdictions place the burden on the plaintiff to disclose the precise nature of trade secrets at the outset of the case. California mandates this by statute. Illinois should have, but legislation on this issue stalled while the General Assembly tried to clean up its own act.

In almost every trade secrets suit, the defendant issues initial discovery requests seeking to place some parameters on the case by asking for an identification of what the specific trade secrets are that the defendant is alleged to have misappropriated.

In a dispute between direct competitors in the office equipment business, this tension led to a common discovery log-jam. IKON Office Solutions, the plaintiff in the case, sued Konica Minolta and William Cimler (an ex-IKON employee) under a non-compete and trade secrets misappropriation theory. Not surprisingly, the defense wanted to know what trade secrets were the subject of the complaint.

IKON balked and would not disclose the precise trade secrets at issue, identifying only a broad range of customer information. This is inadequate and abusive, particularly in a case where the crux of the dispute focuses on customer solicitation.

But litigation is a common tactic over this issue, even in cases like the IKON-Konica Minolta case where the employee's non-compete expired prior to the start of litigation and the ex-employer defaults to a trade secrets claim. Not surprisingly, Konica Minolta prevailed in its contentious discovery battle, as the court would not allow IKON to simply identify broad categories of information and to fish for Konica's own confidential business information through vague, abusive written discovery requests. The intent in cases like this is obvious: the plaintiff wants to use the litigation process to unearth for itself who its ex-employee has contacted or solicited.

In a trade secrets action, plaintiffs can and should be required to identify the allegedly misappropriated trade secrets at the outset. It is a mystery why plaintiffs don't use the procedure Judge Milton Shadur approved of years ago and simply move for an order requiring the defendant to turn over any documents or electronically-stored information in his possession so that the Plaintiff can see what he or she has taken. There is nothing wrong with waiting for this to play out prior to disclosure of a trade secrets identification statement. Without some procedural safeguards and active court involvement in discovery, trade secrets claims frequently become an abyss of litigation, bogged down in discovery squabbles where the merits of the lawsuit are tertiary and only sometimes related to one party's desire to fish around for competitor information.

--

Court: United States District Court for the Western District of North Carolina
Opinion Date: 11/25/09
Cite: IKON Office Solutions, Inc. v. Konica Minolta Business Solutions, U.S.A., Inc., 2009 U.S. Dist. LEXIS 116372 (W.D.N.C. Nov. 25, 2009)
Favors: Employee
Law: North Carolina, Federal Rules of Civil Procedure

North Carolina Court Upholds Equitable Tolling Provision (Philips Electronics v. Hope)

The concept of equitable tolling is simple: for any period of time in which an employee is found to be in violation of his non-compete agreement, that is added on to the length of the restriction. In other words, an employee cannot run out the clock during litigation and escape an order of injunctive relief. Tolling provisions, though, are rarely the subject of judicial interpretation. In most states, they appear to be valid. Often times, courts just simply default to the language of the contract.

The recent case of Philips Electronics v. Hope addressed a contractual tolling provision and held that it extended the non-compete period for 11 months. The case involved a dispute in the MP3 accessory equipment business between Philips and its former Vice-President of Sales, Jason Hope. Hope was employed by Digital Lifestyle Outfitters, prior to the time it was acquired by Philips. During the course of Hope's employment with DLO, he executed a letter agreement guaranteeing him $180,000 in exchange for a non-compete covenant. The restriction applied during his employment term with DLO and for 2 years thereafter.

Not long after that, Philips purchased all of the stock of DLO and accepted Hope's resignation as Vice-President of Sales in May of 2007. He remained on the DLO payroll, but as an at-will employee. The court found that the two-year non-compete term began to run as of the date of his May 2007 resignation from DLO, which was compelled by the terms of the business sale, and not the time he resigned as an at-will DLO employee some 18 months later. The impact of this finding potentially eliminated Philips' ability to obtain an injunction.

The court, however, found that Hope was in violation of the non-compete agreement from April 2008 (before his second resignation) through May 2009 when Hope voluntarily ceased competitive activity. During this time (and while still employed by DLO), Hope appropriated a company business plan for competitive purposes, met with potential investors to start up a competing firm, and prepared a power-point presentation using market data that DLO regarded as confidential. Following his resignation, Hope began working with Riot Outfitters in violation of his non-compete and developed relationships with some of DLO's top accounts, ones he himself was responsible for managing while at DLO.

The court interpreted Hope's non-compete agreement and specifically the tolling provision to extend the term an additional 11 months. The tolling provision stated that "the periods of protection...shall not be reduced by any period of time during which [Hope is] not in compliance therewith." The court found this language, awkward though it may be, was enough to extend the term of the non-compete by the amount of time it found Hope to be in violation of his covenant.

--

Court: United States District Court for the Middle District of North Carolina
Opinion Date: 6/30/09
Cite: Philips Electronics North America Corp. v. Hope, 631 F. Supp. 2d 705 (M.D.N.C. 2009)
Favors: Employer
Law: North Carolina

Insurance Industry Non-Compete Supported By Valuable Consideration - But Still Overbroad (Hejl v. Hood, Hargett & Assoc)

The Court of Appeals of North Carolina issued another employee-friendly ruling on a non-compete claim. In this particular dispute, two issues were up for review. First, the court had to determine whether $500 given to an existing employee for his execution of a non-compete was sufficient consideration for the contract. Second, the court addressed the employee's argument that the contract was too broad to be enforced.

At trial, the court ruled in favor of the employee on the consideration argument, but the appellate court rejected that reasoning. The issue of consideration in after-thought covenants has always been a fertile ground for litigation. States differ in their approaches, with many holding that continued employment is sufficient consideration for an at-will employee's non-compete agreement.

North Carolina is different. It requires new or separate consideration. In this case, the court found that $500 was sufficient to meet this requirement. It also noted the following would suffice:

Continued employment for specified amount of time;
Raise, bonus or other change in compensation;
Promotion;
Additional training;
Uncertificated shares of ownership;
Other increase in responsibility.

The court noted there is a difference between separate consideration and adequacy of that consideration. Clearly, the $500 payment was separate consideration. Whether it was adequate was irrelevant under North Carolina law.

However, the employee still prevailed in the end, just on separate grounds as he did in the trial court. The customer non-compete clause which bound the insurance broker-employee was too broad. In particular, the court held that since it included even prospective customers to whom the employee may have only quoted insurance products (but not necessarily sold them to), the covenant exceeded the protectable interests the employer had. Therefore, it was void and unenforceable.

--

Court: Court of Appeals of North Carolina
Opinion Date: 4/7/09
Cite: Hejl v. Hood, Hargett & Assocs., Inc., 2009 N.C. App. LEXIS 377 (N.C. Ct. App. Apr. 7, 2009)
Favors: Employee
Law: North Carolina

Unclear Territorial Restriction Renders Non-Compete Invalid (Asheboro Paper and Packaging v. Dickinson)

In virtually all states, non-compete agreements are subject to the rule of reasonableness. Reduced to its essentials, the rule requires that post-employment covenants be reasonable as to time, geography, and scope of activity. It is the last two elements that are frequently the subject of reasonableness challenges by departing employees.

Such was the case in Asheboro Paper and Packaging v. Dickinson. Asheboro Paper is a distributor of packaging products and hired Dickinson as a sales representative. His post-employment non-compete prevented him from working for one year in any capacity for a competing organization within 150 miles of Asheboro Paper's "branch offices in North Carolina and Virginia."

It was undisputed the parties intended for Dickinson - who previously worked at Unisource Worldwide - to establish and grow a branch office in Richmond, Virginia. However, at the time of hiring, Asheboro Paper had no office or physical presence of any kind in Virginia. In fact, Asheboro Paper contracted with a logistics company to rent a distribution and warehouse center for the purpose of storing inventory. Dickinson did not have unfettered access to the facility.

About two years after he started, Dickinson quit and went back to Unisource in Richmond. Asheboro Paper sued to enforce the non-compete and prevent Dickinson from working for Unisource within 150 miles of Richmond.

The court denied Asheboro Paper's motion for preliminary injunction on the grounds the non-compete was overbroad (both in terms of geography and scope of activity), and that Asheboro Paper was unlikely to succeed on the merits. The most interesting part of the opinion dealt with the territorial restriction in the non-compete.

Asheboro Paper failed to demonstrate the existence of a "branch office" in Virginia. Though it was clearly the parties' intent for Dickinson to help establish one, it never materialized. Further, the court held that Dickinson's home - where he worked and made sales calles - did not constitute a branch office. The court also remarked that Asheboro Paper failed to introduce in evidence any customer lists to justify the 150-mile radius. That radius would nominally prevent Dickinson from working in parts of Delaware, Maryland, the District of Columbia and West Virginia. Yet, Asheboro Paper conceded it had no clients in those locations.

The case presents an example of why employers should be wary of requiring salespersons to sign general non-compete agreements with bright-line territorial restrictions. A good defense attorney will generally be able to demonstrate the overbreadth of such a restriction. The better practice is to include a separate, narrowly tailored customer non-solicitation provision (either as a substitute for the non-compete or a back-up), so that questions about where an employer does or does not conduct business become moot. In Asheboro Paper, the agreement did not contain a severable non-solicitation provision, so the entire covenant failed.

--

Court: United States District Court for the Middle District of North Carolina
Opinion Date: 2/19/09
Cite: Asheboro Paper and Packaging, Inc. v. Dickinson, 599 F. Supp. 2d 664 (M.D.N.C. 2009)
Favors: Employee
Law: North Carolina

North Carolina Court Rules Non-Compete Overbroad as a Matter of Law (Medical Staffing Network v. Ridgway)

While non-compete disputes are inherently case-specific, the reasonableness of a particular covenant is a question of law for the court to decide. In a recent North Carolina appellate ruling, an employer had a $1,000,000 damages judgment overturned because its non-compete agreement was overbroad as a matter of law without consideration of any facts and circumstances regarding the employee's competitive conduct.

Medical Staffing Network v. Ridgway arose out of a dispute between two entities in the market for healthcare staffing. Defendant Ridgway was a highly productive branch manager for MSN in its Raleigh office when he was recruited away by Trinity Healthcare Staffing (through another ex-MSN employee). The evidence showed Ridgway accessed confidential documents on MSN's computer just before a lunch meeting with Trinity, something he had only occasionally done in the past.

Shortly after the meeting, Ridgway quit and joined Trinity in a directly competitive position. Ten nurses resigned from MSN and began working for Trinity. Still, it appeared as if MSN lost just one client (its largest) to Trinity.

At the trial court level, MSN obtained a judgment of $1,104,495 against Trinity and Ridgway under several theories - breach of the non-compete agreement, Trinity's interference with the same, trade secrets misappropriation, and deceptive trade practices. The appellate court reversed the judgment on breach of contract and interference with contract due to an invalid and overbroad non-compete agreement between MSN and Ridgway.

North Carolina is a relatively difficult state in which to enforce non-compete agreements. Because it adheres to a strict blue-pencil rule, any agreements that are overbroad run a serious risk of being thrown out altogether. That eventually doomed MSN.

The court noted that MSN was defined in the contract to include any of its affiliates and other divisions - even though Ridgway had not responsibility for those other divisions. Accordingly, because it would prohibit Ridgway from working in a business that had nothing to do with his MSN employment duties, the non-compete clause was held overbroad and unenforceable as a matter of law.

Also, the client non-solicitation clause - prohibiting Ridgway from soliciting the business of any MSN client - was unenforceable. It went beyond those clients with whom Ridgway had developed a business relationship at MSN, and again, included clients of MSN in other non-competitive divisions or affiliates. For the court, this was far too extensive of a restriction.

Attorneys drafting non-compete contracts governed by North Carolina must proceed with caution. While reasonable contracts will be upheld, this State takes a very careful look at the breadth of covenants and won't hesitate to grant an employee a loophole through which he or she can crawl. Simply taking a standard form contract won't work. The more narrow, specifically tailored agreement has a far better chance of being upheld than one which seems to be one-size-fits-all.

--

Court: Court of Appeals of North Carolina
Opinion Date: 1/06/09
Cite: Medical Staffing Network, Inc. v. Ridgway, 670 S.E.2d 321 (N.C Ct. App. 2009)
Favors: Employee
Law: North Carolina

North Carolina Case Demonstrates Limits of Blue-Pencil Rule (Technology Partners v. Hart)

A recent diversity case appealed to the United States Court of Appeals for the Fourth Circuit demonstrates the unreliability of the so-called "blue-pencil" rule in non-compete agreements. That rule allows a court to strike or delete offending provisions that ostensibly make a non-compete clause overbroad or unreasonable. (Some variations of the rule allow a court to modify the agreement, rather than just remove offending words.)

In Technology Partners, Inc. v. Hart, the defendant, a Vice-President of Product Management for a software development company, left his employment after more than 5 years and was recruited to work for a company called AMICAS to whom his former employer sold radiology software. (Although the case discussion is not entirely clear, it appears Technology Partners did retain some ownership rights in certain aspects of the software sold to AMICAS.) Along with its lawsuit, TP filed a motion for preliminary injunction seeking to prevent Hart from working for AMICAS.

The district court denied the preliminary injunction motion, and the Fourth Circuit affirmed. Aside from the fact that Hart's non-compete may have had a consideration problem (this issue was not analyzed), the main issue on which the court focused was the application of the blue-pencil rule to modify Hart's covenant. In particular, the court noted that no amount of blue-penciling could have solved the ambiguity caused by the terms "conflicting organization" or "business substantially similar" to TP, each of which served as the anchor to the non-compete clause itself.

North Carolina's blue-pencil rule is employee-friendly, in that it "severely limits what the court may do to alter the covenant [not to compete]. A court at most may choose not to enforce a distinctly separable part of a covenant in order to render the provision reasonable." A simple example illustrating the rule is that a court may strike out (or not enforce) a restricted geographic territory, such as a county or state, if the employee ends up not working or establishing relationships there.

--

Court: United States Court of Appeals for the Fourth Circuit
Opinion Date: 11/4/08
Cite: Technology Partners, Inc. v. Hart, 2008 U.S. App. LEXIS 22903 (4th Cir. Nov. 4, 2008)
Favors: Employee
Law: North Carolina