My colleague Robert Milligan at Seyfarth Shaw predictably beat me to the punch in commenting on the Ninth Circuit's recent opinion in Golden v. Cal. Emergency Phys. Med. Group, which is embedded below. But at the risk of repeating his fine and thorough discussion of the case, it's potentially an important enough development for me to comment on as well.
The court held that a "no-employment" clause in a settlement agreement could constitute an invalid restraint of trade under Section 16600 of California's Business & Professions Code. No-employment clauses are neither unusual nor controversial, and they often appear in settlement agreements arising out of employment lawsuits.
Dr. Golden appeared to have settled an employment dispute with California Emergency Physicians Medical Group, which is apparently a large consortium of physicians that staffs ERs in California. As part of the settlement, Dr. Golden had to agree to a no-employment clause with CEP and any facility that CEP may own or with which it may contract in the future. It also gave CEP the right to terminate Dr. Golden from a facility if CEP acquired it in the future.
Dr. Golden, though, balked at signing the settlement agreement on account of the no-employment provision, arguing that it violated Section 16600 of the Code. Courts have interpreted that provision broadly, invalidating virtually all forms of employee covenants not to compete. However, the no-employment clause is not really a covenant not to compete. It arises in the context of a settlement, rather than as part of any hiring or other employment condition.
The Ninth Circuit sided with Dr. Golden and remanded the case back to the district court for fact-finding. Importantly, the court did not find that the no-employment clause was an impermissible restraint of trade under California law. Rather, it found the district court erred by categorically holding that it wasn't. Put simply, a "no-employment" clause can implicate Section 16600 and that section is not limited to a traditional non-compete. Therefore, a remand was necessary so the district could "conduct further fact-finding as it deems prudent."
That's where the case is a bit of an oddity (shocking for the Ninth Circuit). As the dissent points out, fact-finding over what, exactly? The agreement is what it is, and there was nothing immediately that impacted Dr. Golden's employment. So what are the pertinent facts?
Perhaps the court is saying that the trial judge must determine how significant a player CEP is in the regional ER staffing business and how its market power could affect Dr. Golden. If so, this starts to sound like a mini-antitrust trial in the context of an employment settlement. Lovely. Or maybe the trial judge will examine CEP's expansion strategy to see how big it could get. Without question, CEP will love to reveal those cards. Or should a labor economist testify about the potential future impact on Dr. Golden's ability to practice medicine and what opportunities he might have to forego? That seems more valid, but who pays for that? Does Dr. Golden's settlement cost him expert witness fees, all of a sudden? Ultimately, the case isn't clear, and there's little guidance for the district court on remand.
The impact of this case beyond the facts is unclear. In my opinion, lawyers may make more of this than they actually should. A typical no-hire clause in an employment settlement agreement will limit an employee's ability to work for that employer. It's unclear that many employees would want to contest that, and Dr. Golden is in somewhat of a unique position given the size and scope of the consortium he sued. Too, Dr. Golden and his lawyer appear to have had some sort of a falling out, and Dr. Golden held up the settlement on account of this provision. This doesn't happen all that often, so it's pretty likely that even if these clauses are unenforceable no employee is going to torpedo a settlement because of its inclusion.
Almost certainly, employers will want to add some representation or warranty in a no-hire clause from the employee that he does not believe the clause will constitute a restraint of substantial character on his trade or profession. That may help, but it's not failsafe. Or, employers could leave the clause out entirely and just not hire the person back. I don't see what's so wrong with that solution. Seems simple and less of a lawyer quandary.
Showing posts with label Settlements. Show all posts
Showing posts with label Settlements. Show all posts
Friday, April 17, 2015
Saturday, August 31, 2013
Dumb Settlement Comments Can Help Establish Bad Faith in Trade Secrets Case
There's a perception that anything written in a settlement letter is privileged.
This perception is decidedly wrong.
Offers of settlement are not admissible to prove liability because we want to encourage parties to resolve their disputes out of court. If those offers were admissible, then parties would be hesitant to mediate disputes. This is a simple, common-sense rule. But that rule doesn't give a party carte blanche to say whatever it wants in a settlement letter and then hide under the cloak of privilege.
As readers of this blog know, trade secrets disputes can go horribly wrong for plaintiffs, my case of Tradesmen International v. Black from the Seventh Circuit being a recent example. But because of the overly emotional nature of competition cases, plaintiffs frequently double down when litigation goes south. It is quite common, in fact, for trade secrets plaintiffs to make outrageous settlement demands, or ridiculous statements in a settlement letter, even in the face of a significant defeat.
Those plaintiffs better be careful what they say in settlement letters, however.
If those letters contain over-the-top missives, improper threats, or even pie-in-the-sky demands, the statements aren't privileged and can help establish bad faith. Remember: a defendant gets his attorneys' fees if he can prove a plaintiff brought or maintained a trade secrets misappropriation claim in bad faith.
So what kind of statements in a settlement letter are not privileged? Generally, I find there are two categories that get plaintiffs in trouble.
First, the plaintiff often makes comments about how much continued litigation is going to cost, or indirect references to the fact that an appeal is going to be expensive for a prevailing party to defend. These sort of threats aren't privileged because even an idiot lawyer knows that further litigation costs money, and it's completely disconnected from an offer of settlement. Threatening a defendant into spending further legal fees indicates the plaintiff simply is pursuing litigation to force its adversary to bear the burdens of litigation - not to achieve a specific result at judgment.
Second, the plaintiff may make irrational demands as part of a settlement term sheet - often times totally disconnected to the actual dispute. In past cases (both in Iowa and California), courts have looked to outrageous settlement demands that have nothing to do with trade secrets claims as evidence of subjective bad faith. For instance, demanding a broad non-compete in California (where non-competes are unenforceable) as part of a settlement would demonstrate bad faith intent. So, too, would damages demands far in excess of a trial disclosure and demands to avoid certain customers or product lines, even though this is not part of the relief sought in the complaint. Even though these are terms of the offer, they aren't privileged as settlement communications because they don't tend to establish the plaintiff's case is worth less than what it claims.
Settlement letters are potential land-mines in litigation. If a trade secrets plaintiff says anything beyond conveying the offer, those statements could help show bad faith. As with most letters, it's best to keep it short and to the point.
This perception is decidedly wrong.
Offers of settlement are not admissible to prove liability because we want to encourage parties to resolve their disputes out of court. If those offers were admissible, then parties would be hesitant to mediate disputes. This is a simple, common-sense rule. But that rule doesn't give a party carte blanche to say whatever it wants in a settlement letter and then hide under the cloak of privilege.As readers of this blog know, trade secrets disputes can go horribly wrong for plaintiffs, my case of Tradesmen International v. Black from the Seventh Circuit being a recent example. But because of the overly emotional nature of competition cases, plaintiffs frequently double down when litigation goes south. It is quite common, in fact, for trade secrets plaintiffs to make outrageous settlement demands, or ridiculous statements in a settlement letter, even in the face of a significant defeat.
Those plaintiffs better be careful what they say in settlement letters, however.
If those letters contain over-the-top missives, improper threats, or even pie-in-the-sky demands, the statements aren't privileged and can help establish bad faith. Remember: a defendant gets his attorneys' fees if he can prove a plaintiff brought or maintained a trade secrets misappropriation claim in bad faith.
So what kind of statements in a settlement letter are not privileged? Generally, I find there are two categories that get plaintiffs in trouble.
First, the plaintiff often makes comments about how much continued litigation is going to cost, or indirect references to the fact that an appeal is going to be expensive for a prevailing party to defend. These sort of threats aren't privileged because even an idiot lawyer knows that further litigation costs money, and it's completely disconnected from an offer of settlement. Threatening a defendant into spending further legal fees indicates the plaintiff simply is pursuing litigation to force its adversary to bear the burdens of litigation - not to achieve a specific result at judgment.
Second, the plaintiff may make irrational demands as part of a settlement term sheet - often times totally disconnected to the actual dispute. In past cases (both in Iowa and California), courts have looked to outrageous settlement demands that have nothing to do with trade secrets claims as evidence of subjective bad faith. For instance, demanding a broad non-compete in California (where non-competes are unenforceable) as part of a settlement would demonstrate bad faith intent. So, too, would damages demands far in excess of a trial disclosure and demands to avoid certain customers or product lines, even though this is not part of the relief sought in the complaint. Even though these are terms of the offer, they aren't privileged as settlement communications because they don't tend to establish the plaintiff's case is worth less than what it claims.
Settlement letters are potential land-mines in litigation. If a trade secrets plaintiff says anything beyond conveying the offer, those statements could help show bad faith. As with most letters, it's best to keep it short and to the point.
Monday, April 29, 2013
Settlements Redux: A Brief Follow-Up From My Bankruptcy Post
I received a number of e-mails on my three-part series on settlements, which ran over the past few weeks.
Of those e-mails, several dealt with a topic I raised in Part 3 - accounting for the possibility of a settling defendant's bankruptcy. So I felt it was appropriate to answer those questions in a follow-up post.
As I noted in Part 3, a plaintiff settling a competition dispute may be able to litigate, or relitigate, a claim during the course of an adversary proceeding if the defendant files for bankruptcy.
An exception to the general rule of dischargeability is the "fiduciary defalcation" provision contained in Section 523(a)(4) of the Bankruptcy Code. That generally holds that a debt is non-dischargeable when a debtor breaches a duty while acting in a fiduciary capacity.
Because all adversary claims are governed by the Bankruptcy Code, federal law will apply. And federal courts' interpretation of what qualifies for the "fiduciary defalcation" exception to dischargeability is not on all-fours with state law concepts familiar to many readers, such as the common law fiduciary duty of loyalty, rectitute, candor, and good faith.
Let's take a hypothetical and assume a fact pattern we've discussed on this blog before. If a corporate officer sets up a competing business while still employed, this almost certainly would constitute a breach of fiduciary duty under state law. That does not mean that debts arising out of that breach automatically are non-dischargeable under Section 523(a)(4).
Bankruptcy courts generally provide that the debt is non-dischargeable only if the debtor is acting in a fiduciary capacity with respect to the particular conduct giving rise to the debt.
So under the hypothetical I just outlined, the corporate officer may or may not have his debt discharged.
If, for instance, he simply starts a new business, moonlights, and then funnels new customers to his separate entity, any damages for which he's liable under the common law likely would be dischargeable. (I say "likely" because court decisions aren't totally consistent.)
However, if the officer swaps out an order intended for his current employer and runs that through a competing business - essentially the equivalent of a conversion or civil theft - then the company stands a much better chance of claiming that the debt is non-dischargeable.
This is a fine distinction to make, and courts do come out different ways on this.
The 523(a)(4) exception really is intended to provide a remedy for embezzlement or insider corporate theft, such as when a controller - say, in Dixon, Illinois - loots the company till.
Applying the exception to a garden-variety competition case founded on breach of fiduciary duty often yields few clear answers.
Of those e-mails, several dealt with a topic I raised in Part 3 - accounting for the possibility of a settling defendant's bankruptcy. So I felt it was appropriate to answer those questions in a follow-up post.
As I noted in Part 3, a plaintiff settling a competition dispute may be able to litigate, or relitigate, a claim during the course of an adversary proceeding if the defendant files for bankruptcy.
An exception to the general rule of dischargeability is the "fiduciary defalcation" provision contained in Section 523(a)(4) of the Bankruptcy Code. That generally holds that a debt is non-dischargeable when a debtor breaches a duty while acting in a fiduciary capacity.
Because all adversary claims are governed by the Bankruptcy Code, federal law will apply. And federal courts' interpretation of what qualifies for the "fiduciary defalcation" exception to dischargeability is not on all-fours with state law concepts familiar to many readers, such as the common law fiduciary duty of loyalty, rectitute, candor, and good faith.
Let's take a hypothetical and assume a fact pattern we've discussed on this blog before. If a corporate officer sets up a competing business while still employed, this almost certainly would constitute a breach of fiduciary duty under state law. That does not mean that debts arising out of that breach automatically are non-dischargeable under Section 523(a)(4).
Bankruptcy courts generally provide that the debt is non-dischargeable only if the debtor is acting in a fiduciary capacity with respect to the particular conduct giving rise to the debt.
So under the hypothetical I just outlined, the corporate officer may or may not have his debt discharged.
If, for instance, he simply starts a new business, moonlights, and then funnels new customers to his separate entity, any damages for which he's liable under the common law likely would be dischargeable. (I say "likely" because court decisions aren't totally consistent.)
However, if the officer swaps out an order intended for his current employer and runs that through a competing business - essentially the equivalent of a conversion or civil theft - then the company stands a much better chance of claiming that the debt is non-dischargeable.
This is a fine distinction to make, and courts do come out different ways on this.
The 523(a)(4) exception really is intended to provide a remedy for embezzlement or insider corporate theft, such as when a controller - say, in Dixon, Illinois - loots the company till.
Applying the exception to a garden-variety competition case founded on breach of fiduciary duty often yields few clear answers.
Wednesday, April 17, 2013
Settlements (Part 3 of 3): Dealing With a Defendant's Bankruptcy in Non-Compete Litigation
This is the third and final installment on my series devoted to settlements in non-compete litigation.
Today's topic is a little different.
This is largely a plaintiff-centric column, offering some practical points to consider when assessing the risk of bankruptcy in connection with non-compete (or other competition) litigation. Though many non-compete suits settle on straight equitable terms (such as injunctions enforcing the terms of an agreement), large-dollar settlements are not that unusual. This is particularly so if the defendant has moved a large volume of customer business in violation of a covenant, or if he has misappropriated valuable commercial data. In these cases, a plaintiff should be able to prove some consequential damages - and that may lead to a settlement comprised in part on the payment of money.
The threat of bankruptcy is a fairly significant lever for a defendant to pull. And even if a case settles on financial terms, it does not extinguish the possibility that a plaintiff will have to deal with the bankruptcy process at some point. Although there is nothing a plaintiff can do to prevent a defendant from filing for bankruptcy (such a promise or covenant would be void), it can take certain protective steps to ensure that it preserves as much of its claim as possible.
Here are some considerations:
1. Be Aware of the Preference Claim. Any time a plaintiff receives a cash payment settlement, there is a possibility it will be clawed back if the defendant files for bankruptcy within 90 days. Although there are defenses to this so-called preference action, the most common - the "ordinary course" defense - is almost certainly not available. A plaintiff can at least mitigate the risk of a preference claim by preserving the full value of a claim. For instance, if a plaintiff has a legitimate damages claim for $100,000, and settles for half of that, it should insist on a consent judgment of the full amount. After the 90 day period expires (following tender of the $50,000), it can release the full judgment. This way, if the defendant does file for bankruptcy in the preference period, the plaintiff has a larger claim to file in the bankruptcy estate and is entitled to a larger share of assets the trustee collects.
2. Obtain Personal Guaranties and a Pledge of Stock (Where Applicable). When there are corporate and individual defendants settling a non-compete case, special issues pertaining to guaranties and pledges of stock arise. Assume, for instance, that an ex-employee left to start her own company. If she is sued on a non-compete or related claim, the plaintiff may sue not only the individual, but also her new company. If the company commits to pay the settlement amount (which it would want to do to take advantage of a tax deduction), then the individual defendants should guaranty payment. A corporate bankruptcy won't affect the guaranty. Similarly, the plaintiff may want to take a pledge of the individual's stock in the defendant-company as further insurance against default on the payment obligation.
3. Obtain Admissions Where Possible. As discussed in points (4) and (5), some debts in bankruptcy are not dischargeable. Bankruptcy law contains limited exceptions to a debtor's goal of discharging her debts. Those suits - called "adversary" proceedings - are like trials, but courts will consider and give preclusive effect to admissions in related litigation. It's critical, therefore, to use admissions of the defendant where possible. If the defendant is willing to settle litigation, and bankruptcy is a real threat, a plaintiff should consider requiring the defendant to either: (a) concede in the settlement agreement that she violated her fiduciary duty of loyalty, or willfully stole confidential information; or (b) execute a consent judgment (often times in connection with an agreed injunction order) that contains similar admissions that a judge then signs off on. These can be used offensively in a later adversary proceeding.
4. Consider the "Fraud in a Fiduciary" Capacity Exception for an Adversary Proceeding. The Bankruptcy Code provides that a debt is not dischargeable if a defendant obtains property by way of fraud in a fiduciary capacity. This doesn't necessarily mean that every fiduciary defalcation is non-dischargeable. But if a plaintiff has a cognizable fiduciary duty claim and obtains strong admissions in the underlying suit (or in connection with settling the underlying suit), it may be able to pursue an adversary claim in the bankruptcy court.
5. Determine If There's a Willful or Malicious Injury. This is similar to the fraud exception, but it's far broader and captures fiduciary conduct that the previous exception might not. If a defendant commits a willful injury in tort, she can't discharge that debt. Simple as that. The common paradigm in competition cases for a non-dischargeable debt is the willful taking of a trade secret, since that is essentially a tort and would likely qualify for a strong adversary claim. A non-compete violation presents a tougher, closer question. I wrote back in February about an Ohio case where the bankruptcy court found that a straight non-compete breach did not amount to a willful injury, and the associated debt was dischargeable. But you can find cases to the contrary, such as In re Ketaner, 149 B.R. 395 (Bankr. E.D. Va. 1992). Likely, a plaintiff will need to couple a simple breach with some pre-termination conduct that smacks of unfair competition or misappropriation of company data. A simple breach of contract probably won't do, and there must be some evidence of an intent to injure and not just an intent to act. This is a terribly fine line to walk, since every breach of contract contemplates some financial gain to the detriment of others.
This is largely a plaintiff-centric column, offering some practical points to consider when assessing the risk of bankruptcy in connection with non-compete (or other competition) litigation. Though many non-compete suits settle on straight equitable terms (such as injunctions enforcing the terms of an agreement), large-dollar settlements are not that unusual. This is particularly so if the defendant has moved a large volume of customer business in violation of a covenant, or if he has misappropriated valuable commercial data. In these cases, a plaintiff should be able to prove some consequential damages - and that may lead to a settlement comprised in part on the payment of money.
The threat of bankruptcy is a fairly significant lever for a defendant to pull. And even if a case settles on financial terms, it does not extinguish the possibility that a plaintiff will have to deal with the bankruptcy process at some point. Although there is nothing a plaintiff can do to prevent a defendant from filing for bankruptcy (such a promise or covenant would be void), it can take certain protective steps to ensure that it preserves as much of its claim as possible.
Here are some considerations:
1. Be Aware of the Preference Claim. Any time a plaintiff receives a cash payment settlement, there is a possibility it will be clawed back if the defendant files for bankruptcy within 90 days. Although there are defenses to this so-called preference action, the most common - the "ordinary course" defense - is almost certainly not available. A plaintiff can at least mitigate the risk of a preference claim by preserving the full value of a claim. For instance, if a plaintiff has a legitimate damages claim for $100,000, and settles for half of that, it should insist on a consent judgment of the full amount. After the 90 day period expires (following tender of the $50,000), it can release the full judgment. This way, if the defendant does file for bankruptcy in the preference period, the plaintiff has a larger claim to file in the bankruptcy estate and is entitled to a larger share of assets the trustee collects.
2. Obtain Personal Guaranties and a Pledge of Stock (Where Applicable). When there are corporate and individual defendants settling a non-compete case, special issues pertaining to guaranties and pledges of stock arise. Assume, for instance, that an ex-employee left to start her own company. If she is sued on a non-compete or related claim, the plaintiff may sue not only the individual, but also her new company. If the company commits to pay the settlement amount (which it would want to do to take advantage of a tax deduction), then the individual defendants should guaranty payment. A corporate bankruptcy won't affect the guaranty. Similarly, the plaintiff may want to take a pledge of the individual's stock in the defendant-company as further insurance against default on the payment obligation.
3. Obtain Admissions Where Possible. As discussed in points (4) and (5), some debts in bankruptcy are not dischargeable. Bankruptcy law contains limited exceptions to a debtor's goal of discharging her debts. Those suits - called "adversary" proceedings - are like trials, but courts will consider and give preclusive effect to admissions in related litigation. It's critical, therefore, to use admissions of the defendant where possible. If the defendant is willing to settle litigation, and bankruptcy is a real threat, a plaintiff should consider requiring the defendant to either: (a) concede in the settlement agreement that she violated her fiduciary duty of loyalty, or willfully stole confidential information; or (b) execute a consent judgment (often times in connection with an agreed injunction order) that contains similar admissions that a judge then signs off on. These can be used offensively in a later adversary proceeding.
4. Consider the "Fraud in a Fiduciary" Capacity Exception for an Adversary Proceeding. The Bankruptcy Code provides that a debt is not dischargeable if a defendant obtains property by way of fraud in a fiduciary capacity. This doesn't necessarily mean that every fiduciary defalcation is non-dischargeable. But if a plaintiff has a cognizable fiduciary duty claim and obtains strong admissions in the underlying suit (or in connection with settling the underlying suit), it may be able to pursue an adversary claim in the bankruptcy court.
5. Determine If There's a Willful or Malicious Injury. This is similar to the fraud exception, but it's far broader and captures fiduciary conduct that the previous exception might not. If a defendant commits a willful injury in tort, she can't discharge that debt. Simple as that. The common paradigm in competition cases for a non-dischargeable debt is the willful taking of a trade secret, since that is essentially a tort and would likely qualify for a strong adversary claim. A non-compete violation presents a tougher, closer question. I wrote back in February about an Ohio case where the bankruptcy court found that a straight non-compete breach did not amount to a willful injury, and the associated debt was dischargeable. But you can find cases to the contrary, such as In re Ketaner, 149 B.R. 395 (Bankr. E.D. Va. 1992). Likely, a plaintiff will need to couple a simple breach with some pre-termination conduct that smacks of unfair competition or misappropriation of company data. A simple breach of contract probably won't do, and there must be some evidence of an intent to injure and not just an intent to act. This is a terribly fine line to walk, since every breach of contract contemplates some financial gain to the detriment of others.
Friday, April 12, 2013
Settlements (Part 2 of 3): 5 Reasons Non-Compete Cases Should (and Do) Settle
This is the second in a three-part series on settlements in non-compete litigation.
On Monday, I offered several reasons why non-compete cases don't settle. Today I flip this concept around.
It is true most non-compete cases do settle, a reflection that business cases get resolved for pure economic reasons. But, in the context of non-compete suits, what are the motivations that drive parties to compromise their claims and defenses? Again, I offer five:
1. Non-Compete Disputes Yield Uncertain Outcomes. There are a few overriding reasons why this is so. First, resolution of a case often depends on the rule of reasonableness, which I and others have discussed so often. By definition, courts can reach different outcomes on similar facts under this flexible, case-specific approach. Second, many jurisdictions employ a blue-pencil, or modification, rule that enables a court to award some relief even if it finds the agreement is unreasonable. Third, judges have personal views on this subject, a reflection that there is an inherent tension between the freedom to contract and the freedom to compete. Uncertain outcomes naturally drive parties to settle for fear of a loss.
2. Business Solutions Abound. Imagine a personal injury case. The lone satisfactory outcome for the plaintiff is pretty straightforward - it needs cash. A business competition case is more dynamic. Potential solutions include not only payment of cash or injunctive relief, but also the acquisition of all or part of a competitor's business. A plaintiff even may be satisfied by a lengthy "earn-out" related to certain customer business or a license fee for intellectual property in dispute. An employer may waive a non-compete so long as an employee simply stays out of a very narrow business segment, or away from a certain customer, for a period of time. In short, even contentious cases are amenable to creative business solutions not apparent in a large class of civil lawsuits.
3. Legal Fees Can Mount Quickly. Most non-compete and trade secrets are positioned for a quick injunction hearing so that the parties see a judge's initial conclusions on the merits of the case. Although this can have the effect of creating leverage for the party that achieves a favorable outcome, it also forces the parties to think settlement for fear of running up large legal bills in a compressed timeframe.
4. There's Usually An Asymmetry In Resources. In most employee non-compete cases, the defendant simply won't have the financial muscle to litigate. While this dynamic is less prevalent in trade secrets cases, competition litigation is often characterized by a vast disparity in the legal resources that the parties bring to bear. Start-ups and individual defendants are at a huge disadvantage, and there is almost never insurance coverage to backstop a defense.
5. The Attorneys Think Like Businesspeople. Compound an attorney's natural inclination to fight with the coarse feelings attending non-compete cases, and you have a toxic brew. But sometimes the attorneys can temper their clients' personal animoisities and encourage the parties to reach a sensible business result. This is when attorneys need to act as counselors - to become, in effect, part of the management team - and craft a solution that will avoid litigation and unnecessary legal expense. My experience is that, in non-compete suits, if the attorneys have a full and complete understanding of the larger business dynamics, they often can bring a fresh perspective and creative ideas to help settle cases.
Next week, I will post the final installment on this series devoted to settlements: some brief thoughts on bankruptcy considerations in the context of settlements.
On Monday, I offered several reasons why non-compete cases don't settle. Today I flip this concept around.
It is true most non-compete cases do settle, a reflection that business cases get resolved for pure economic reasons. But, in the context of non-compete suits, what are the motivations that drive parties to compromise their claims and defenses? Again, I offer five:
1. Non-Compete Disputes Yield Uncertain Outcomes. There are a few overriding reasons why this is so. First, resolution of a case often depends on the rule of reasonableness, which I and others have discussed so often. By definition, courts can reach different outcomes on similar facts under this flexible, case-specific approach. Second, many jurisdictions employ a blue-pencil, or modification, rule that enables a court to award some relief even if it finds the agreement is unreasonable. Third, judges have personal views on this subject, a reflection that there is an inherent tension between the freedom to contract and the freedom to compete. Uncertain outcomes naturally drive parties to settle for fear of a loss.
2. Business Solutions Abound. Imagine a personal injury case. The lone satisfactory outcome for the plaintiff is pretty straightforward - it needs cash. A business competition case is more dynamic. Potential solutions include not only payment of cash or injunctive relief, but also the acquisition of all or part of a competitor's business. A plaintiff even may be satisfied by a lengthy "earn-out" related to certain customer business or a license fee for intellectual property in dispute. An employer may waive a non-compete so long as an employee simply stays out of a very narrow business segment, or away from a certain customer, for a period of time. In short, even contentious cases are amenable to creative business solutions not apparent in a large class of civil lawsuits.
3. Legal Fees Can Mount Quickly. Most non-compete and trade secrets are positioned for a quick injunction hearing so that the parties see a judge's initial conclusions on the merits of the case. Although this can have the effect of creating leverage for the party that achieves a favorable outcome, it also forces the parties to think settlement for fear of running up large legal bills in a compressed timeframe.
4. There's Usually An Asymmetry In Resources. In most employee non-compete cases, the defendant simply won't have the financial muscle to litigate. While this dynamic is less prevalent in trade secrets cases, competition litigation is often characterized by a vast disparity in the legal resources that the parties bring to bear. Start-ups and individual defendants are at a huge disadvantage, and there is almost never insurance coverage to backstop a defense.
5. The Attorneys Think Like Businesspeople. Compound an attorney's natural inclination to fight with the coarse feelings attending non-compete cases, and you have a toxic brew. But sometimes the attorneys can temper their clients' personal animoisities and encourage the parties to reach a sensible business result. This is when attorneys need to act as counselors - to become, in effect, part of the management team - and craft a solution that will avoid litigation and unnecessary legal expense. My experience is that, in non-compete suits, if the attorneys have a full and complete understanding of the larger business dynamics, they often can bring a fresh perspective and creative ideas to help settle cases.
Next week, I will post the final installment on this series devoted to settlements: some brief thoughts on bankruptcy considerations in the context of settlements.
Monday, April 8, 2013
Settlements (Part 1 of 3): 5 Reasons Non-Compete Cases Shouldn't (and Don't) Settle
This is the first in a three-part series on settlements in non-compete litigation.
Every judge, lawyer, and litigant is probably familiar with the maxim that most civil cases settle. That's undoubtedly true. But some classes of suits are better positioned to settle than others. In non-compete and other competition litigation, there are many reasons why cases do settle. I'll be talking about those in my next post.
But today's post looks at settlement from the opposite perspective. What are the reasons why non-compete cases don't settle? And, to explore this further, are these reasons justifiable? For now, I'll focus on five reasons:
1. Each side thinks it will prevail. The most apparent reason that non-compete suits don't settle is that each side believes strongly in its case. This may seem obvious and intuitive, but in a large percentage of civil litigation, a determination of liability is pretty clear. Non-compete disputes are different because contracts are governed by a flexible rule of reason, meaning that courts will take a fresh look at the facts and circumstances to determine enforcement in every case. Precedent only gets you so far. In this regard, the closest parallel to non-compete litigation is in the copyright context, where the contours of the "fair use" doctrine are ill-defined and subject to a multi-factor balancing test. The rule of reason in non-compete cases is a close analogue, with parties often justifiably believing the facts will fit within their view of the rule of reason.
2. The case involves unusual facts. Cases involving strange fact patterns are hard to settle because prior results or other cases don't influence the parties as much. Non-compete disputes have their share of weird fact patterns, with the case of IBM v. Johnson perhaps the best and most notable. They also frequently involve a misunderstanding among the parties as to what level of competition actually is occurring or whether the companies offer different products or services.
3. One party is determined to have its day in court. Settling litigation is almost always an economic decision, with parties balancing litigation costs, potential exposure, and the benefits of certainty. Frequently, however, parties in non-compete cases will take principled stands and avoid the typical cost-assessment that goes with litigating. This is usually so because non-compete disputes evoke visceral reactions among the parties, partly because important societal interests (freedom of contract vs. freedom to compete) sit in tension with one another. The plaintiff feels jilted and scorned; the defendant just wants to ply his or her trade. Raw emotions are difficult to temper even with a rational cost-benefit assessment about continuing the fight.
4. The law is unsettled or unclear. Non-compete cases are heavy on the law - meaning that even if the facts are all out on the table, the impact of those facts is frequently not clear. Some of the legal issues that arise involve choice-of-law, blue-penciling, tolling of the restricted period, and sufficiency of consideration. These rules vary from state-to-state, and many states haven't clearly defined their legal standards. If an unsettled legal issue is the fulcrum of the dispute, the case automatically becomes more difficult to settle and the parties become more entrenched in their positions.
5. A larger strategic issue is at play. Non-compete suits don't settle because of strategic reasons that may not even involve the parties to the suit. One example is when a company wants a court ruling that upholds its agreement. That ruling then can be used offensively in other cases or as a deterrent among employees who are made aware of a company's court victory. Companies that settle non-compete disputes quickly often establish a market rate for breach. Even a supposedly confidential settlement may not keep that rate hidden from third-parties. On the flip side, and unfortunately, a plaintiff sometimes pursues a competition law case - even though it's terribly weak - to slow down the growth of a potential market competitor simply by causing them to spend valuable resources on legal fees.
My next post will look at why non-compete suits should (and do) settle. It will be the mirror-image of this post. And my final installment on settlements will address a very specific issue that is plaintiff-centric: how to assess potential bankruptcy issues when settling competition suits.
Every judge, lawyer, and litigant is probably familiar with the maxim that most civil cases settle. That's undoubtedly true. But some classes of suits are better positioned to settle than others. In non-compete and other competition litigation, there are many reasons why cases do settle. I'll be talking about those in my next post.But today's post looks at settlement from the opposite perspective. What are the reasons why non-compete cases don't settle? And, to explore this further, are these reasons justifiable? For now, I'll focus on five reasons:
1. Each side thinks it will prevail. The most apparent reason that non-compete suits don't settle is that each side believes strongly in its case. This may seem obvious and intuitive, but in a large percentage of civil litigation, a determination of liability is pretty clear. Non-compete disputes are different because contracts are governed by a flexible rule of reason, meaning that courts will take a fresh look at the facts and circumstances to determine enforcement in every case. Precedent only gets you so far. In this regard, the closest parallel to non-compete litigation is in the copyright context, where the contours of the "fair use" doctrine are ill-defined and subject to a multi-factor balancing test. The rule of reason in non-compete cases is a close analogue, with parties often justifiably believing the facts will fit within their view of the rule of reason.
2. The case involves unusual facts. Cases involving strange fact patterns are hard to settle because prior results or other cases don't influence the parties as much. Non-compete disputes have their share of weird fact patterns, with the case of IBM v. Johnson perhaps the best and most notable. They also frequently involve a misunderstanding among the parties as to what level of competition actually is occurring or whether the companies offer different products or services.
3. One party is determined to have its day in court. Settling litigation is almost always an economic decision, with parties balancing litigation costs, potential exposure, and the benefits of certainty. Frequently, however, parties in non-compete cases will take principled stands and avoid the typical cost-assessment that goes with litigating. This is usually so because non-compete disputes evoke visceral reactions among the parties, partly because important societal interests (freedom of contract vs. freedom to compete) sit in tension with one another. The plaintiff feels jilted and scorned; the defendant just wants to ply his or her trade. Raw emotions are difficult to temper even with a rational cost-benefit assessment about continuing the fight.
4. The law is unsettled or unclear. Non-compete cases are heavy on the law - meaning that even if the facts are all out on the table, the impact of those facts is frequently not clear. Some of the legal issues that arise involve choice-of-law, blue-penciling, tolling of the restricted period, and sufficiency of consideration. These rules vary from state-to-state, and many states haven't clearly defined their legal standards. If an unsettled legal issue is the fulcrum of the dispute, the case automatically becomes more difficult to settle and the parties become more entrenched in their positions.
5. A larger strategic issue is at play. Non-compete suits don't settle because of strategic reasons that may not even involve the parties to the suit. One example is when a company wants a court ruling that upholds its agreement. That ruling then can be used offensively in other cases or as a deterrent among employees who are made aware of a company's court victory. Companies that settle non-compete disputes quickly often establish a market rate for breach. Even a supposedly confidential settlement may not keep that rate hidden from third-parties. On the flip side, and unfortunately, a plaintiff sometimes pursues a competition law case - even though it's terribly weak - to slow down the growth of a potential market competitor simply by causing them to spend valuable resources on legal fees.
My next post will look at why non-compete suits should (and do) settle. It will be the mirror-image of this post. And my final installment on settlements will address a very specific issue that is plaintiff-centric: how to assess potential bankruptcy issues when settling competition suits.
Tuesday, May 10, 2011
Non-Compete In Post-Employment Settlement Agreement Judged With Less Scrutiny (McClain & Co. v. Carucci)
Not all non-competition covenants are judged with the same degree of scrutiny.
On the pro-enforcement side is the "sale-of-business" covenant, under which the restrictions normally are examined only for their reasonableness as to time, territory and scope. On the anti-enforcement side is the traditional employment-based covenant, which usually requires an enforcing party to show not only that the covenant is reasonable, but also tied to a legitimate business interest. The burdens on an employee's ability to earn a living, and the public interest are usually considered as well under an exacting "reasonableness" analysis.
The history of covenants not to compete is quite interesting (to me), and many would argue that the old justifications and presumptions that courts used long ago do not apply in a more modern economy. Sale-of-business covenants were the first types of covenants to be enforced by courts, and for the most part, they pose few enforcement problems. Employment covenants are a different story.
In the past on this blog, I have been critical of the sale-of-business nomenclature, because it is underinclusive and suggests to courts, lawyers, and (most importantly) clients that the test only applies to a covenant signed in connection with a business sale. Sounds logical.
But it's not right.
In point of fact, courts analyze a wide range of covenants under this more relaxed standard. Among these are covenants in franchise agreements and shareholder agreements. Last week, a Virginia court - in a matter of first impression - added another type of agreement to this list: settlement agreements.
This makes sense. Many settlement agreements are the product of arms-length negotiations and pose few problems in terms of being adhesive. That is not always the case, though. For many terminated employees, a severance agreement may not be negotiable at all and may be presented as a take-it-or-leave-it offer. A lot depends on the employee's position within the company, and pre-existing contracts he or she has which may impact the terms of any release.
In McClain & Co., Inc. v. Carucci, the employer and employee reached a post-employment settlement agreement after Carucci apparently embezzled nearly $300,000. The agreement called for him to pay the employer $250,000, grant it a 30-month non-compete, and exchange releases. The court examined the few other cases on point and concluded that the "sale-of-business" test applied to the settlement agreement, at least in Carucci's case.
The court did not lay down a per se rule on this, nor should it have. A court when confronting a non-compete in a release agreement likely will examine a number of factors, including the degree to which it was negotiated, the benefits the employee received (such as garden-leave), the circumstances of the employee's termination, and other unique circumstances.
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Court: United States District Court for the Western District of Virginia
Opinion Date: 5/4/11
Cite: McClain & Co., Inc. v. Carucci, 2011 U.S. Dist. LEXIS 48404 (W.D. Va. May 4, 2011)
Favors: Employer
Law: Virginia
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