Case Law Update: Riding Circuit

The last few months we've seen a number of interesting decisions from the federal circuit courts of appeal, both on issues of State law and under the federal Defend Trade Secrets Act. These cases not only raise a few interesting legal issues, but they also amplify some practical concerns that lawyers and litigants should be aware of.

Soarus LLC v. Bolson Materials Int'l Corp. (Seventh Circuit)

This short decision from the Seventh Circuit stems from a short commercial non-disclosure agreement in the 3D printing industry. In essence, the dispute stemmed from a patent application carve-out to a broad confidentiality restriction. The defendant, Bolson, sought to acquire and use a type of specialty polymer in its 3D printing process, agreeing in turn with Soarus to keep information about the polymer confidential.

But the NDA contained a carve-out, which said that notwithstanding this intellectual property protection, Bolson was "free to patent and protect any new application" using the polymer in a specific type of process. Bolson in fact did so, leading Soarus to argue that Bolson breached the NDA.

The Seventh Circuit rejected Soarus' argument that no reasonably company would seek to protect confidential information around a new product and also allow that party to file information in a public document with the U.S. Patent Office. Under Illinois law, those subjective expectations could not trump an unambiguous contract provision, which the patent application carve-out was.

A relatively straightforward case of contract interpretation, to be sure. But the practical lesson is important. Commercial NDAs can arise in a number of different situations, including deal evaluations and supply arrangements. The problem is that the forms used for these situations don't necessarily translate, based on the specific business concerns underpinning the relationship. Here, Bolson and Soarus seemed to have addressed how Bolson could have used otherwise protected information in a patent filing. But a much more common situation is to have the parties sign an NDA that may have been perfectly fine for one transaction that is ill-suited to another. These particular nuances can include not only the ability to use information in patent filings, but also restrictions on which employees a party can solicit or hire, whether parties acquire any intellectual property rights or merely have the right to license them, and when the agreement expires.

NDAs are a very common commercial agreement. But the details of the restrictive clauses must align with business expectations. There is an inherent danger in simply copying a template that looks really pretty.

A copy of the opinion is available here.

Dunster Live LLC v. Lonestar Logos Management Co., LLC (Fifth Circuit)

The Defend Trade Secrets Act has only been the subject of a few circuit court decisions. In one from last year, the Tenth Circuit rejected the argument that a moving party could presume irreparable harm when evaluating a preliminary injunction predicated on a DTSA claim. And other decisions haven't told us much at all.

The DTSA reared its head again in Dunster Live LLC v. Lonestar Logos Management, but only in a cameo role. In that case, the defendant sought attorneys' fees after the plaintiff dismissed its trade secrets action without prejudice. The case stemmed from a classic business divorce, but the plaintiff soon ditched its trade secrets claim, opting to streamline its case and refile in state court. The Fifth Circuit found that the defendant was not the "prevailing party," a requirement for fee-shifting under the DTSA's bad-faith provision.

It appears the defendant raised a host of arguments for why it prevailed, but the most intriguing was the idea that the district court denied the plaintiff's preliminary injunction motion. The Fifth Circuit rejected this, holding that "prevailing party status ordinarily requires being ahead when the final whistle blows in a case, not at halftime."

Of interest to readers, the defendant racked up $600,000 in attorneys' fees before the voluntary dismissal order was entered. That's a lot, but not outrageously so if the preliminary injunction resembled a merits trial (which many do). Still, it is understandable why the defendant pulled out all the stops in seeking fees if they achieved some success short of a full win, before the plaintiff called an audible.

A copy of the opinion is available here.

Brand Services LLC v. Irex Corp. (Fifth Circuit)

The Fifth Circuit weighed in on another procedural issue under trade secrets law, one that has split courts and vexed commentators. The issue is whether the preemption clause of the uniform trade secrets act (here, the act was Louisiana's version) means that a plaintiff is barred from pursuing a civil law conversion claim for confidential information that fails to qualify as a trade secret.

In Brand Services v. Irex Corp., the court held that the preemption clause doesn't extend that far. While it's generally non-controversial that a plaintiff cannot sue for conversion of trade secrets, courts have been less willing to extend preemption to confidential information. The issue can be very confusing for lawyers and parties because it is common for claims to meld the two concepts. Often times, plaintiffs will allege something to the effect that the defendant misappropriated "confidential information, including trade secrets." Very infrequently, a plaintiff will demarcate the two in a way that allows a court to understand fully what the plaintiff is claiming as trade secrets and what it is contending as lesser-protected confidential information.

What the Fifth Circuit is saying in Brand Services is that for the latter category, a plaintiff can maintain a conversion claim for civil theft without invoking trade secrets law. That alleviates the burden of proof on some important issues, like reasonable secrecy measures. In Brand Services, the Fifth Circuit was persuaded by some intermediate appellate court law in Louisiana that took a narrower view of preemption. It bolstered its finding by looking to the text of the preemption provision, which does seem to leave open some room for common-law torts related to theft of confidential, but non-trade secret, information. For those interested in examining the range of court cases and the split of authority, footnote 4 to the Brand Services opinion contains an exhaustive range of citations.

A copy of the opinion is available here.

AirFacts, Inc. v. De Amezaga (Fourth Circuit)

The Fourth Circuit's recent opinion in AirFacts, Inc. v. De Amezaga is one of those fairly fact-intensive cases that provide only helpful guidance and not any particular rules or standards. The basic facts are fairly familiar, but for our purposes here one issue of trade secrets law caught my eye.

The employee who was sued sent himself (to a personal email account) a particular spreadsheet on his last day of employment. Part of the employer's trade-secret claim hinged on this fact. The key question: did that act rise to the level of misappropriation (for the document itself earned trade secret status)?

Here, a number of facts compelled the circuit court to adopt the district court's finding of no misappropriation. Those facts were:

• The employee's supervisors told him they might contact him if they had questions about his work;
• The employee testified this is why he sent the spreadsheet to his personal e-mail account;
• The trial judge found him credible.
• The employee did not access the spreadsheet after he left and did not disclose them to any third-party;
• Other employees regularly worked from home, which included using personal email accounts for work purposes.

This particular issue recurs time and again in departing employee scenarios, and as AirFacts demonstrates, the question of liability is intensely fact-specific. What are the lessons to be learned?

From the company's perspective, it could have dealt with this better by instituting policies and procedures that bar the use of personal email for work purposes, by clarifying the ex-employee's obligation at departure, by asking him whether he had anything in his account that was company related, and by conducting a thorough exit interview.

From the employee's perspective (though he won, he still got sued), he could have sought pre-clearance to retain the spreadsheet. That would have eliminated any factual dispute about his authority to send the document to his personal account. And he should not have deleted the sent item from his work folder, which certainly raises suspicion about his intent (though the district court didn't seem to care much).

Many disputes like this end up in court simply due to a breakdown in communication. It is pretty clear that this was not anywhere close to a theft situation. But neither party covered themselves particularly well before litigation ensued.

A copy of the opinion is available here.

Cleaning Up the Janitorial Mess

Somewhat predictably, the reaction to C&W Facility Services non-compete lawsuit against janitorial employee Sonia Mercado was swift and severe.

I wrote about this last week, offering my opinion on a number of different facets to this ill-advised lawsuit. This dispute got mention not just on the nerdosphere, but also mainstream outlets including the Financial Times and the Washington Post.

After the Post published its piece, Cushman & Wakefield (an affiliate of C&W) issued a statement withdrawing the case and apologizing to Ms. Mercado. It also offered to pay her the bonus she had given up in an attempt to avoid triggering the non-compete. Here's the apology:

"Following recent media reports related to the use of restrictive agreements with our janitorial staff, we have completed a review of the circumstances. While we do have restrictions with a select number of salaried managers, we have found that this policy was incorrectly applied in this instance. We are taking action to correct this situation. We sincerely apologize to Ms. Mercado. Restricting the employment of hourly workers is inconsistent with our policies and contrary to our values as an organization.”

There are two ways to view this. First, C&W may have just tried to pull a fast one and then issued an apology when it got caught in a media firestorm. That's probably the most plausible. Second, someone at C&W may have authorized counsel to take action without clearing it through the appropriate channels. That, too, is quite plausible. At least, that's the narrative C&W's statement seems to be trying to sell.

I maintain, as do others, that Ms. Mercado was never a real target. She was a pawn, used as part of a tactical gambit against C&W's competitor. (To continue the dorky chess analogy, she became a passed pawn ready to mate the other side until it resigned.) This happens far too often in non-compete litigation, when one individual gets caught in the crosshairs of a much larger message-sending dispute. Common or not, that is not an appropriate use of legal process.

In the end, it is at least gratifying that this story had a just ending to it. But it never should have been written in the first place.

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One noteworthy item. The Fifth Circuit, applying Louisiana law, has taken a narrow view of the preemption doctrine applicable to statutory trade-secrets claims. States that have adopted the Uniform Trade Secrets Act frequently confront the question of preemption. That is, when do other claims based on trade-secrets theft have to give way to just the statutory claim itself? The so-called narrow view is more in line with the text of the statutory preemption clause. In other words, a plaintiff cannot use another tort claim that invokes trade-secrets misappropriation. Common victims include conversion and breach of fiduciary duty. But as the Fifth Circuit held in Brand Services LLC v. Irex Corporation, claims based on misuse of confidential information that is not a trade secret do not fall within the preemption provision.

This is a textual reading of the statute, endorsing a narrow view of preemption and rejecting a more pragmatic approach favored by many courts.

The Reading List (2017, No. 27): Judicial Rock-Stars,Forum-Selection Clauses, Attorney General Suits, and Worthless Blog Posts

Non-Compete and Trade Secrets News for the week ended November 10, 2017

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Vicarious Liability Ruling in Waymo v. Uber

For those of you following the driverless car technology trade secrets lawsuit between Google and Uber, I urge you to take a break from the day-to-day litigation filings. They're interesting, to be sure. But they ain't as interesting as this article in The Verge about the judge presiding over the case, William Alsup. I can't do it justice. Read it. It is stunning.

On to more mundane topics in this case: vicarious liability. One of the defendants, Otto Trucking, is out of the case. Judge Alsup granted its summary judgment motion, soundly rejecting Waymo's theory of vicarious liability for the actions of its founder, Anthony Levandowski, the former star engineer whose mass download of files is the heart of Waymo's suit. The court specifically relied on Waymo's strategy to divide and conquer, an effort that kept its claims against Levandowski out of court and the other defendants out of arbitration. As Judge Alsup stated, Waymo could not treat the two as "fungible targets."

The issue of vicarious liability doesn't arise much in the case law, at least in terms of nuanced legal analysis. One line of cases holds that respondeat superior, or vicarious liability, is not available under the Uniform Trade Secrets Act on the grounds that it is a common-law remedy preempted by the statute. Other cases take a more flexible, case-by-case approach, relying on the equities. Judge Alsup's idiosyncratic opinion avoids this discussion entirely, and it's bereft of a single case citation. That doesn't make it uninteresting or even wrong.

To me, the better approach - one textually consistent with the state and federal statutes - is to assess each defendant separately and to determine whether the relevant conduct for each amounts to misappropriation. This is, I think, what Judge Alsup is saying. He eschews any reference to statutory preemption, but it's just a different way of getting to the same result.

Maryland Non-Compete Agreements

Judge Paul Grimm, another total judicial rock-star, struck down a five-year, market-based non-competition clause against a high-level engineer, a ruling summarized in Allied Fire Protection, Inc. v. Thai, 2017 WL 4354802 (D. Md. Oct. 2, 2017). The particular non-compete had the feel of being an amalgamation of form clauses, designed specifically to instruct lawyers on how not to draft non-competes.

For starters, the duration was five years - something sure to align the court with the affected employee. Those limits may be acceptable in the sale-of-business context, where there's equal bargaining power, but they almost never have any justification for at-will employees. Then the employer decided to bar the employee from working in a "similar" business with any of the plaintiff's former, current, or future clients. No parameters. No illustration of why. No common sense.

Judge Grimm's ruling that the non-compete was not tailored to protect a business interest, in the main, is not surprising. But it is significant that it arose in the context of a motion to dismiss, and not after the evaluation of evidence at the injunction or summary-judgment stage. These kinds of early, case-dispositive rulings happen all too frequently, but they embody a pragmatic approach sorely needed in litigation featuring an asymmetry in resources. Judge Grimm was careful to note the lack of allegations demonstrating the need for such broad covenants, a point that enabled the early dismissal.

Practice tip: if you're an employer, never lead with a frivolous argument. For reasons that confound, the employer decided it was a good idea to challenge the removal petition - the case originated in State court - on the grounds that removal jurisdiction violated Article I, § 10 of the United States Constitution - the so-called impairment-of-contracts clause. But as Judge Grimm noted, that clause applies to the States, not the federal government (and it was, after the federal government's jurisdiction that was challenged constitutionally). This approach to argument does nothing to endear one to the court.

Forum-Selection Clauses Following Atlantic Marine

On to a more challenging venue issue.

Venue, jurisdiction, and choice-of-law are heavily litigated procedural issues in non-compete and trade secrets litigation. Though it may seem like in-the-weeds, lawyer drivel, questions of procedure can be consequential. For instance, a few years back, Illinois courts held that Florida choice-of-law clauses are unenforceable because they contravene public policy. If that issue weren't litigated, cases may have come out differently.

Venue clauses may be equally as important. The Supreme Court, in Atlantic Marine Construction Co v. U.S. District Court, endorsed forum-selection clauses and has held courts must honor them in all but the most unusual cases. Practically, that means that only certain public interests (outside of any interests the litigants assert) will justify a transfer when a forum-selection clause is present. That means litigants cannot get out of a choice-of-venue clause if it is inconvenient to them. Predictably, district courts have followed Atlantic Marine and have cut back on the number of transfer orders in federal non-compete cases.

The Third Circuit, this Summer, addressed a difficult question under Atlantic Marine: how should courts apply the ruling when some, but not all, defendants are bound to forum-selection clauses that designate different federal districts? Get ready for some freakin' procedure, folks...

According to the court, there's a four-step inquiry (always a BAD sign). First, courts will apply Atlantic Marine to parties with forum-selection clauses, meaning their claims may be severed and transferred to the agreed-upon forum.

Second, courts then consider public and private interests related to the non-contracting parties (such as a corporate defendant with no direct contractual relationship to the former employer). Here the factors may suggest that the same forum is appropriate for both the contracting and non-contracting parties. And that may be enough for the court to kick or keep the whole action.

Third, if the court finds that the first two steps point in opposite directions, then it must consider severing the claims. That means that a court may need to transfer the action as to some defendants while retaining jurisdiction over others. For instance, a court may lack personal jurisdiction over a non-contracting defendant. It couldn't keep the case, in that instance, for efficiency reasons.

Fourth, if the issue of severance is not clear, then the court must evaluate "efficiency" interests and the non-contracting parties' private interests. Here, a court could find that public interests "overwhelmingly" outweigh the parties' interest in upholding the venue clause and thereby decline to enforce it.

The application of this four-step approach is fairly intricate, but the circuit court's analysis will resemble many of the same issues that arise in multi-defendant non-compete litigation, where individuals have forum-selection clauses and the new employer operates in a venue remote from the contractually chosen one. A link to the opinion is available here.

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I am not sure I understand the point of drafting worthless, uninteresting blog posts. But if you are a blogger (or aspiring to start one), then I would highly recommend reading the latest entry on the Employment Trial Report. It's a classic example of what not to do. This post caught my eye when it showed up in a blast e-mail through Lexology and purported to "analyze" a $6.8 million trade-secrets judgment in California. Sounds f**kin' awesome, bruh!

No. For starters, don't waste everyone's time talking about a default judgment involving a defendant who has no legal representation and who "failed to participate in the subsequent damages proceedings." What is the takeaway there? It's good to have a lawyer? It's advisable to contest damages? It's best to show up in court for a hearing?

And then don't tell us how the judgment demonstrates that companies "need to be vigilant and act quickly and decisively when it appears" there's theft by an insider. Has anyone ever counseled an employer that, in such a situation, companies should be sluggish and move slowly and equivocally?

Sorry, but you clog up the blogosphere and so you deserve some opprobrium. Take a stand. Say something interesting. Offer a viewpoint. Don't spew drivel. And I could care less if the mandate from the firm's Executive Committee was to fill up the site with more posts...

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Thad Felton over at Greensfelder in Chicago writes about the Attorney General's non-compete lawsuit against Check Into Cash of Illinois, Inc., calling the move "somewhat unusual." A better description would have been "entirely appropriate." The Freedom to Work Act, signed into law effective January 1, 2017, bars employers from using covenants not to compete against so-called "low-wage employees." This is a move that has gained traction across the United States, as State legislatures seek to pare back the use of overbroad restraints that do nothing to promote economic freedom and serve only to stifle competition.

According to the Attorney General's suit, brought under the Freedom to Work Act, the common law, and the Consumer Fraud and Deceptive Business Practices Act, the affected employees were store clerks, assistant managers, and managers, many of whom were paid on an hourly basis. The non-compete, recited in a pain-staking block quote, is oppressively overbroad and disconnected to any legitimate business interest. It's obviously unenforceable, despite the thatchy, semantic jungle in which the contractual language is buried.

A copy of the Attorney General's complaint is available here.

Supreme Court of Arizona Gives Trade Secrets Preemption a Narrow Construction

Perhaps the most boring question in all of trade secrets law generates a lot of commentary, particularly in the blogosphere.

The question is whether the displacement provision of the Uniform Trade Secrets Act applies to claims based on misappropriation of confidential information that isn't valuable enough to meet the trade secret definition. If that's not scintillating, I don't know what is.

If you can contain your excitement, know that courts take differing points of view on this and so the question is somewhat significant to nerds. I gave my view on this a few years back, summarizing the policy rationale for taking a broad view of preemption - one that would displace claims based on misappropriation of confidential information.

The Supreme Court of Arizona yesterday disagreed with me (who doesn't?) and found that a narrow view of preemption was appropriate, relying heavily on the text of the UTSA provision which states that preemption doesn't affect "other civil remedies that are not based on misappropriation of a trade secret." The case is Orca Communications Unlimited, LLC v. Noder, No. CV-13-0351. (This is the Scalia-Easterbrook-Garner school of textualism at its best, revealing just how influential that cadre has been at influencing law over the past 20 years.)

The defendant made some of the same arguments about the absurdity of narrow-form preemption that I have made before. There are many good reasons for broadly interpreting preemption, including some the Arizona court cited and rejected - the uniform structure the UTSA creates for dealing with claims of data misappropriation, the specter of greater punitive damages for misappropriating less valuable types of information. To me, the soundest rationale lies in the incentives that underlie preemption.

If parties have a common-law claim for misappropriation of confidential information, why would they subject themselves to having to prove that it's a trade secret? I cannot understand this. The remedies available to a trade-secret holder aren't materially more significant. The damages theories (aside, possibly, from a royalty-based theory) are not all that different than those found in tort law. But to prove the existence of a trade secret, you must show how the information derives value from being secret and rigorous security measures. Allowing a plaintiff to default to a common-law theory for virtually the same type of information would provide no incentive for a business to undertake secrecy measures.

Just as problematically, in many jurisdictions, this would enable a plaintiff to bring claims in the alternative (i.e., it's a trade secret, but if not, then it's confidential). This alternative pleading scheme, which narrow-form preemption openly invites, undermines the entire purpose of the displacement clause.

Non-Compete Case Law Update: The Mildly Interesting, But Useful, Edition

The new year is off to a pretty big start. We've already seen significant decisions from federal appellate courts on criminal trade secrets prosecutions and the epic Mattel/MGA "Bratz" dolls dispute. We have a looming debate over amendments to the Computer Fraud and Abuse Act, and pending legislation in Massachusetts concerning non-compete agreements.

But there's other activity in the trenches - the sort of routine work that parties and courts continue to crank out that don't necessarily generate headlines. Over the past few weeks, I've noticed some lower court decisions come through that are significant in their own right.

Trade Secrets Preemption in New Jersey

Last year, New Jersey became the latest state to adopt the Uniform Trade Secrets Act. Like all versions, the New Jersey Act displaces conflicting remedies based on claims of trade secrets misappropriation. However, the language of the statute preserves other common law rights and remedies, such that its text is not directly comparable on the issue of preemption in other states. As a result, New Jersey courts have not yet subscribed to the view that other civil claims are not preempted. This is an odd result, and the statute may be in for revision since it's near impossible to reconcile the preemption clause with the savings clause. The case discussing preemption is unreported and not binding on any other New Jersey court, SCS Healthcare Marketing, LLC v. Allergan USA, Inc., 2012 N.J. Super. Unpub. LEXIS 2704 (Sup. Ct. Ch. Div. Dec. 7, 2012).

Injunction Bonds

I have written in the past on the considerations underlying the need for an injunction bond - effectively, security for a preliminary order later deemed wrongfully entered. Federal courts have to consider the amount of security when entering a temporary restraining order or preliminary injunction. The case of Smiths Group, PLC v. Frisbie, 2013 U.S. Dist. LEXIS 9445 (D. Minn. Jan. 24, 2013), looked at a high-level executive's prior year's salary and ordered security in that amount as a condition for enforcing a one-year non-compete covenant.

Dischargeability of Debts Arising Out of Non-Competes

Damages claims against ex-employees often intersect with bankruptcy law. For a defendant found to be in breach of a non-compete, an award of lost profits may greatly exceed the defendant's ability to pay. As such, the specter of bankruptcy is always at the fore. A debt is not dischargeable though if it is a result of a "willful and malicious" injury to another entity or its property. In an adversary proceeding, a hair salon, contending a departed stylist's non-compete debt was non-dischargeable, was unable to show she willfully injured her ex-employer. The court focused on two factors: (a) the employee was terminated and therefore may have breached the agreement not to injure her ex-employer, but rather to pay her bills; and (b) she obtained the names of her customers largely from Facebook, the White Pages, and her memory. Finally, the court determined that the hair salon could not establish that as single customer even left, thereby indicating it suffered no real injury. Though the "willful and malicious injury" test is flexible, this was a clear case where some of the equities strongly favored the employee. The case is In re Rhoades, 2013 Bankr. LEXIS 157 (S.D. Oh. Jan. 11, 2013).

New Hampshire Takes Broad View of Trade Secrets Preemption

Courts interpreting the Uniform Trade Secrets Act interpret the preemption provision either narrowly or broadly. The narrow view does not limit similar claims for misappropriation based on lesser-protected confidential information, while the broad view does.

New Hampshire is one of the adherents to the broad view, along with a number of other states including Ohio. As explained in the recent unreported case of Wilcox Indus. Corp. v. Hansen, 2012 U.S. Dist. LEXIS 63668 (D.N.H. May 7, 2012), broad view preemption eliminates "other tort causes of action founded on allegations of misappropriation of information that may not meet the statutory standard for a trade secret." Put another way, there are two classes of information - trade secrets (defined by statute, interpreted by cases) and general knowledge (always unprotected). Something in between won't cut it.

Except if you have a contract claim. The cleanest way to assert a claim for misappropriation or improper use of confidential information is to show a breach of some non-disclosure covenant. That won't be preempted by trade secret law, and an employer need not worry about establishing the standards of secrecy applicable to UTSA claims.

In the Hansen case, the preempted claims were unjust enrichment and breach of fiduciary duty. Conversion claims and those based on common law unfair competition often suffer a quick demise at the hands of the preemption clause.

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.

California Court Holds Trade Secrets Preemption Issue Premature for Ruling (Amron Int'l Diving Supply v. Hydrolinx Diving)

The preemption provision of the Uniform Trade Secrets Act is a topic on which I write quite frequently. The idea is that the UTSA is supposed to displace conflicting tort claims based on trade secrets misappropriation.

States which have adopted the UTSA are varied in how they approach key principles of preemption. One of those concerns whether a court can determine if preemption applies when no definitive ruling has been made on whether something alleged to be a trade secret actually qualifies as such.

A California court has joined the reasoning of states holding that a court cannot adjudicate preemption on the basis of an allegation alone. It joins Virginia, Wisconsin and other courts holding that motions on the pleadings, claiming preemption under the UTSA, are premature.

Ohio is among a group of states (the majority) reaching the opposite conclusion. In such states, it is routine to see ancillary tort claims (such as conspiracy, conversion, and tortious interference) dismissed because the underlying conduct is alleged to be based on misappropriation of a trade secret.

UPDATE X1: A commenter has astutely pointed out that this ruling likely is inconsistent with California state court precedent (which would be binding, as opposed to this memorandum opinion). It appears California adopts a broad view of preemption under K.C. Multimedia, Inc. v. Bank of America Technology & Operations, Inc., 171 Cal. App. 4th 939 (6th Dist. 2009). From reading that case, it appears that courts are empowered to dismiss ancillary tort claims prior to a finding of trade secrets misappropriation. This is the far more sensible rule and is more consistent with California's policy towards non-compete and trade secrets claims.

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Court: United States District Court for the Southern District of California

Opinion Date: 10/21/11

Cite: Amron Int'l Diving Supply, Inc. v. Hydrolinx Diving Comm., Inc., 2011 U.S. Dist. LEXIS 122420 (S.D. Cal. Oct. 21, 2011)

Opinion Date: 10/21/11

Favors: Employer

Ohio Among States Adhering to Dominant View of Trade Secrets Preemption (Office Depot, Inc. v. Impact Office Products, LLC)

The preemptive effect of the trade secrets can be relatively narrow or very broad depending on which state's law applies. As explained in prior posts, preemption is the concept that a state's trade secrets act displaces conflicting state law tort claims based on misappropriation.

There are a number of preemption-related questions that courts must resolve. One of the more significant ones involves whether the trade secrets preemption clause displaces state law tort claims for misappropriation of confidential information not rising to the level of a trade secret.

The dominant view among states is that it does. Preemption would displace any tort claim based not only on trade secret misappropriation (such as conversion or unjust enrichment), but also any similar claim to the extent it is predicated on misuse of confidential, proprietary or other commercially valuable information.

Last week, an Ohio federal district court reaffirmed this principle under the Ohio Uniform Trade Secrets Act. Several Ohio cases previously addressed this issue, and it is a state squarely within the majority class adhering to a broad view of preemption.

There are two general policy rationales supporting this view. First, a narrow view of preemption would enable a party simply to default to other tort claims to avoid having to prove the statutory elements of trade secret misappropriation. If a party can sue for misappropriation of confidential information, why would it ever undertake the burden of pleading and proving the elements of a trade secret case? This would undermine the statute's goal of uniformity among jurisdictions to protect commercially sensitive information.

Second, allowing a party to bring tort claims for misappropriation of confidential information would discourage it from employing the secrecy measures of information that the trade secrets laws require. A party simply could bypass enacting secrecy measures and sue in tort for misusing confidential information that is not widely disseminated or publicly available, but still known by others in the industry. This would lead to less certainty, discourage fair competition, and impede the development of commercial ideas.

States adopting a minority view, which would allow for tort claims based on misappropriation of confidential information, include: Wisconsin, Virginia, Missouri, and South Carolina.

States which adhere to the majority view include: New Hampshire, Ohio, Hawaii, Kentucky, Michigan, and California.

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Court: United States District Court for the Northern District of Ohio

Opinion Date: 9/26/11

Cite: Office Depot, Inc. v. Impact Office Prods., LLC, 2011 U.S. Dist. LEXIS 109420 (N.D. Ohio Sept. 26, 2011)

Favors: Employee

Law: Ohio

Supreme Court of Hawaii Takes Expansive View of Trade Secrets Preemption (BlueEarth Biofuels v. Hawaiian Electric)

Warning: This post touches upon the incredibly dry subject of trade secrets preemption.

If you are still reading and you're not a lawyer, I am really impressed. The concept of trade secrets preemption is formalistic, but not difficult to understand. A few decades ago, it was generally thought the law concerning trade secrets was not particularly well-developed and somewhat confusing. When a uniform law was finally drafted (and subsequently enacted in many states), the idea was to coalesce trade secrets law so that lawyers and judges actually had some idea what to do. (Note: This is an extremely truncated, unsophisticated history of why the uniform law ever came to pass.)

Part of the problem with trade secrets law was that a plaintiff could pursue a number of different legal theories arising out of the same set of trade secrets facts - conversion, unjust enrichment to name a few. The commissioners who drafted the uniform law saw this as a problem and wanted to limit the potential claims based on trade secrets theft to just one - statutory misappropriation. Accordingly, the uniform law contains a strong displacement, or preemption, clause that indicates a clear intent that other common law, non-contract remedies are displaced.

The Supreme Court of Hawaii recently had occasion to answer several certified questions concerning the preemption clause in its version of the Uniform Trade Secrets Act. The Court took the majority view and adopted the "same proof" test. In essence, a claim will be displaced if it depends on whether the defendant is found to have misappropriated trade secrets. The most common claims that will be preempted include conversion, conspiracy to misappropriate trade secrets, and (in some states) common law or statutory unfair competition claims. The Court rejected a more narrow "elements" test that some jurisdictions have adopted, which holds that preemption applies if the same legal elements must be proven to the displaced claims. If a plaintiff needs to prove just one other element (such as an agreement in a trade secrets conspiracy claim), then preemption does not apply. This "elements" test makes no sense.

The more interesting question the Court addressed was whether preemption under the Uniform Act applies to non-contract claims based upon "confidential information" that does not rise to the level of a trade secret. Again, the Court followed the majority and held that such claims were in fact preempted (which is interesting, since the statute does not define or even mention these claims). This question, from my perspective, is a very difficult one to address, but the Court answered it the right way.

To allow non-contract claims to proceed when no trade secret is at issue actually would undermine the purposes of the uniform law and lead to a whole host of vague, potentially frivolous lawsuits. A party who diligently invests and protects truly secret information would fare no better than a party who takes only perfunctory steps towards protection (and presumably incurs fewer security measures costs). As a result, the incentive to develop secret information that yields a competitive advantage would be compromised.

Of course, if a party has an enforceable non-disclosure or confidentiality agreement and can establish a breach, then preemption has no impact on this analysis and the court proceeds to a straight contract claim. But to permit common-law, non-contract claims on the theory of misuse of confidential information is a clear invitation for abuse. Those claims should be preempted, for that is the clear intent of the Act's displacement provision.

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Court: Supreme Court of Hawaii
Opinion Date: 7/20/10
Cite: BlueEarth Biofuels, LLC v. Hawaii Electric Co., Inc., 235 P. 3d 310 (Haw. 2010)
Favors: N/A
Law: Hawaii

Contesting Trade Secret Claim May Impede Preemption Defense (E.I. DuPont de Nemours v. Kolon Industries)

In those states which have adopted some version of the Uniform Trade Secrets Act, a commonly litigated defense concerns statutory preemption. Most versions of the UTSA provide expressly that the statute preempts, or displaces, other common-law or statutory remedies for trade secrets misappropriation.

For years, defendants have been filing motions to dismiss ancillary claims tossed into a trade secrets action, such as conversion, breach of fiduciary duty and deceptive trade practices violations. At one point in time, these defenses were successful as courts broadly applied the UTSA's preemption clause.

Now, courts are taking an opposite approach.

A case out of Virginia highlights a couple of issues related to the preemption defense. In E.I. DuPont de Nemours v. Kolon Industries, the plaintiff filed a six-count complaint charging that the defendant engaged in a pattern of conduct designed to misappropriate DuPont's technical process for manufacturing high-strength fiber used in ballistics and protective apparel. The defendant denied that the information at issue constituted a trade secret under Virginia's version of the UTSA.

The court denied the defendant's motion to dismiss the ancillary claims for the simple reason that the preemption provision could not apply if the defendant contended that the purloined information was ever a trade secret to begin with. For all intents and purposes, a denial in an answer will effectively negate a motion to dismiss those other claims.

On the substance of each claim, the court still found preemption inappropriate. Without belaboring the point, for preemption to apply in a minority-view state like Virginia, the claim needs to be founded entirely on an allegation that the wrongful conduct involves trade secrets misappropriation. Merely arguing that the conduct arises out of the same core of operative facts won't cut it.

So, if for instance an employer alleges that an employee stole a chemical formula critical to the employer's business which constituted a trade secret, and also alleges the employee misappropriated lesser protected confidential information (say, financial information), a claim for breach of fiduciary duty relating to the latter would not be preempted. The reason: the employer need not prove that the confidential information was a trade secret in order to prevail. Keep in mind the law is split on this, and the majority of courts take a broader view of preemption.

Admittedly the difference is slight. However, the key principle is that in minority-view states, preemption only applies when the wrongful conduct depends on trade secret misappropriation.

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Court: United States District Court for the Eastern District of Virginia
Opinion Date: 8/27/09
Cite: E.I. DuPont de Nemours & Co. v. Kolon Industries, Inc.
Favors: Employer
Law: Virginia

Termination of Employment Will Not Constitute "Abandonment" of Non-Compete (EBI Holdings v. Butler)

The impact of involuntary termination of employment on the enforceability of a non-compete is not amenable to a quick summary. I wrote an article in the DePaul Business & Commercial Law Journal in 2002 canvassing the law on this subject, and it took me over 40 pages of dense analysis to opine that there is no real clear-cut answer. In Illinois, a 1994 case seems to hold that a non-compete agreement cannot be enforced if an employee is discharged without cause. But since that time, no cases have explained this holding or if it in fact means what it says.

In EBI Holdings v. Butler, an Illinois federal district court this week got close to addressing the issue, but ultimately declined. Since the employee's non-compete agreement was governed by New Jersey law, perhaps Butler is not a good test case on the interpretation of an Illinois case now 15 years old.

However, the plaintiff - a discharged medical products salesman - made an interesting argument. He claimed that his termination from a distributor amounted to abandonment of a post-employment covenant. The court struck his affirmative defense and noted that the agreement contemplated termination of his employment, so that abandonment under New Jersey law could not be a viable defense. It's not clear the employee raised a defense that the non-compete was unenforceable by reason of his discharge.

The case also did not address a circumstance where a discharge was inconsistent with the terms of the employment agreement. In such a case, an employee may have a viable claim that the non-compete is not enforceable because his termination was not valid or proper under the governing contract.

In a separate opinion, the court in Butler clarified the preemption doctrine in a trade secrets case. Often times, an employer will include common law claims arising out of the same operative facts as trade secrets misappropriation, such as conversion, unjust enrichment, tortious interference with contract, or civil conspiracy. The court clarified that the Seventh Circuit's decision in Hecny Transp., Inc. v. Chu limits the preemption theory to claims which rest on trade secrets theft. The test is "whether the plaintiff's claim would lie if the information at issue were non-confidential." Old district court cases taking a much broader view of preemption, and dismissing a lot of common law claims, are no longer reliable precedents.

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Court: United States District Court for the Central District of Illinois
Opinion Date: 2/17/09
Cite: EBI Holdings, Inc. v. Butler, 2009 U.S. Dist. LEXIS 11558 (C.D. Ill. Feb. 17, 2009) and EBI Holdings, Inc. v. Butler, 2009 U.S. Dist. LEXIS 11535 (C.D. Ill. Feb. 17, 2009)
Favors: Employer
Law: New Jersey, Illinois

Illinois Court Further Narrows Trade Secrets Preemption Doctrine (Jano Justice Systems v. Burton)

The trend in recent years - at least in Illinois - has been for courts to strictly construe and apply the so-called preemption doctrine embodied within Section 8(a) of the Illinois Trade Secrets Act. That provision provides that the ITSA is "intended to displace conflicting tort, restitutionary, unfair competition, and other laws of [Illinois] providing civil remedies for misappropriation of a trade secret." Section 8(b) limits the preemption, or displacement, provision by stating that the ITSA does not impact "other civil remedies that are not based upon misappropriation of a trade secret."

Prior to Hecny Transp., Inc. v. Chu, 430 F. 3d 402 (7th Cir. 2005), courts routinely dismissed a wide array of common-law claims often pled along with an ITSA misappropriation claim. These would normally include conversion, deceptive trade practices, civil conspiracy, and breach of fiduciary duty. The Seventh Circuit narrowed the reach of those prior district court decisions to the extent most can no longer be considered even persuasive authority.

Jano Justice Systems, Inc. v. Burton is an example of the very limited application of the preemption defense. In that case, the plaintiff alleged Burton breached his fiduciary duty as an employee and 50% owner of JJS. The claim rested on stealing information, setting up a competitor, and hiring away JJS employees. Each of these theories can support a fiduciary duty claim regardless of whether trade secrets were stolen or not. Importantly, the court cited with approval the language from Hecny that stealing of business information will not necessarily give rise to preemption, because a breach of fiduciary duty can arise even if information taken by a fiduciary - such as a customer list - were a public record.

Prior to Hecny, a court may have dismissed certain aspects of a common-law claim on preemption grounds if it appeared to be based on the taking of proprietary information. We are likely to see the trend contintue where the preemption defense will be considered only if a plaintiff makes a common-law claim for unfair competition, or a statutory deceptive trade practices claim parroting the trade secret allegations. For defense attorneys, the better practice is to raise preemption at summary judgment rather than the initial pleading stage.

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Court: United States District Court for the Central District of Illinois
Opinion Date: 12/11/08
Cite: Jano Justice Systems, Inc. v. Burton, 2008 U.S. Dist. LEXIS 100232 (C.D. Ill. Dec. 11, 2008)
Favors: Employer
Law: Illinois