Ninth Circuit Extends Application of Computer Fraud and Abuse Act (U.S. v. Nosal)

The Computer Fraud and Abuse Act's role in competition cases has decreased over the past few years. This is due in large part to the interpretation of the "damage" or "loss" element that an employer must show as part of a claim. It also is due, however, to courts' restrictive interpretation of an employee' improper access of a protected computer.

The Ninth Circuit was on the leading edge of the statutory interpretation issues, taking a fairly pro-employee stance in LVRC Holdings, LLC v. Brekka. In a recent decision, the court of appeals softened its stance a bit and issued a pro-employer ruling on the CFAA's scope and application.

The criminal case of United States v. Nosal puts front and center an employer's access or use restrictions. In particular, an employer's policies, most often expressed in a non-disclosure agreement, which place a restriction on the ability of an employee to use or access sensitive company data will determine the CFAA's applicability. For instance, if an employer requires all employees to agree that a CRM database can only be accessed or used for any internal client or business purposes, the use of that database for improper competitive purposes could result now in an employee "exceeding his authorized access" of the system. This would be shown, for instance, by converting a report to Excel and e-mailing it to a personal account or a co-conspirator.

An employer who does not put an employee on notice that such conduct is prohibited most likely will not be able to state a CFAA claim. Keep in mind that a CFAA claim is both civil and criminal, and it still requires an employer to demonstrate a minimum loss in the amount of $5,000. It is not an easy claim to prove. The Ninth Circuit has opened a slight window for employers in that circuit to use carefully worded policies and agreements as a basis for an "exceeds authorized access."

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Court: United States Court of Appeals for the Ninth Circuit

Opinion Date: 4/28/2011

Cite: United States v. Nosal, 2011 U.S. App. LEXIS 8660 (9th Cir. Apr. 28, 2011)

Favors: Employer

Law: Federal

Clean Departure Key To Minimizing Liability

I met with a new client yesterday who presented a non-compete problem that I see everyday:

(1) Client has an exciting new job opportunity.

(2) Client has an agreement with significant enforceability problems.

(3) Client and potential new employer have taken steps to avoid direct competition and to ensure ex-employer's interests are still protected.

But still, the new job arguably falls within the terms of the non-compete agreement. This is where the method of departure can tip the balance from a high-risk case to one that contains relatively low risk of liability.

What are the keys to a clean departure?

(1) Return all employer information, whether stored electronically or in paper. This may require the employee to work with the IT department to make sure a home computer is scanned and cleaned properly. Employees should not assume that an undisclosed, mass deletion of data is acceptable.

(2) Be honest and forthright in an exit interview. If you mislead your employer about your post-termination plans, that leads to the inference that you are hiding something.

(3) Make your last 30 days of employment your absolute best. Don't mail it in with customers, vendors, or co-workers. You don't want your employer arguing that as you prepared to leave to a work for the competition, you went in the tank with the company's five biggest clients.

(4) Work out an agreement with the new employer that protects your ex-employer. Some clients express surprise at this, but it is essential. Your new contract should require you not to use any confidential information of any ex-employer and should prevent you from bringing anything proprietary onto the new employer's premises. Ideally, it should restrict your work activities so that there is some separation of duties between your new job and previous job. This could, for instance, limit your work with a category of customers or a particular product until a non-compete period has passed.

(5) Comply with the notice and resignation provisions in your current employment agreement. This may require 30 days' notice or impose a transition obligation. Don't ignore these terms.

These are illustrative steps for an employee (and a new employer) to consider. If an employee finds himself or herself embroiled in a lawsuit, a judge ruling on an injunction motion will give careful weight to the departure and will likely consider the factors above in determining what hardship may befall a company if its non-compete is not enforced. My experience is that a court also will more carefully look at the terms of the covenant and try to find some overbreadth if the employee has acted responsibly and done his or her best to make a smooth transition.

Be Careful When Drafting Geographic Restriction in Louisiana (In re Gulf Fleet Holdings, Inc.)

Louisiana is one of those special drafting states. Attorneys must proceed with great care when drafting the scope of a non-compete restriction by virtue of a strictly applied statute. Section 23:921(C) of the Louisiana Statutes provides that for a non-compete to be enforceable specific parishes or municipalities must be identified. Even if an employer conducts business throughout the state, a blanket prohibition on competing in Louisiana will be invalid.

It is settled law in Louisiana that an employer cannot enforce a non-compete in a parish where it does not conduct business. For employers that want to restrict post-employment activities, therefore, it is essential to be consistent and include in the non-compete agreement only those parishes where it can show demonstrable business activity.

If an employer chooses to be overinclusive and list, for instance, all parishes in Louisiana, this would not necessarily be fatal or render the covenant overbroad. Several courts, including a recent adversary proceeding in bankruptcy, have allowed an employer to engage in this practice and have blue-penciled the listed parishes where the employer does not engage in business.

Another twist, however: the operative agreement must contain a clause allowing for such severing of the covenant. Finally, if the covenant applies outside Louisiana, the restrictions must also list out the prohibited territories by county. So for instance, if an employer chooses to restrict business in neighboring Texas, it too must list each Texas county it considers off-limits.

Louisiana courts place a strange emphasis on over-technical drafting. It can certainly be argued that the practice of blue-penciling specific parishes or counties creates an incentive for an employer to be overinclusive and overbroad, knowing full well courts can strike specific locations without rendering the entire agreement unenforceable.

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Court: United States Bankruptcy Court for the Western District of Louisiana
Cite: In re Gulf Fleet Holdings, Inc., 2011 Bankr. LEXIS 1396 (W.D. La. Mar. 31, 2011)
Opinion Date: 3/31/11
Favors: Employer
Law: Louisiana

What Provisions Does the Employer Need In Its Non-Compete Agreeement?

A common theme in non-compete disputes is poor drafting. This is why I always tell my employer clients that putting a binding, enforceable non-compete agreement in place requires more than just pushing the print button on a prior form.

In reality it takes a minimum of four hours to consult with a client, put a form contract together, and then follow-up to make edits and finalize it for actual use. Even this is an austere budget, but it may be doable in some cases.

I normally advise employers not to throw in the kitchen sink. But here are the key terms I generally will include in most non-compete agreements, aside from (obviously) the covenants themselves which are always different and always specifically tailored to the employee.

1. Tolling - This clause ensures the covenant terms runs from the date of breach, not the date employment ends. Not all states imply a tolling right. It may be essential for the contract to spell it out.

2. Liquidated Damages - This may not be for every situation, but ordinary lost profits are tough to prove in competition cases. A liquidated (or pre-determined) damages clause sets the formula (e.g., two times annualized commissions per solicited client) and leads to a more ready assessment of what the case may be worth on the financial side. I had a client in last week who asked whether liquidated damages are "cheaper" to prove, and the answer generally is yes.

3. Invention Assignment - This provision is most appropriate for creative employees and those who develop products, ideas, source code, and the like. Some states, like Illinois, have carve-outs that may need to be included in the contract.

4. Attorneys' Fees - Everyone is familiar with the idea, and it is generally a good idea to make sure a fee-shifting clause is mutual. Otherwise, it may not be enforced.

5. Definitions - This depends on the agreement, of course. A definitions section serves a few purposes. It usually means you have a more readable agreement, but also it clarifies the nature of the restrictions and allows an employer to address business-specific matters that may arise. An employer should consider definitions for key terms like the following:

Solicit

Restricted Territory

Restricted Customer

Business of the Company

Competition

6. The Playing Field - Venue, choice of law, arbitration, and jury trial waiver. The first two are essential for employers operating in several states.

Keep in mind this list is not exhaustive, and it certainly does not cover the prototype executive employment agreement, which itself will contain detailed terms on compensation, benefits, severance, and termination.

Court Considers Hypotheticals In Determining Overbreadth of CVS Non-Compete Agreement (Saban v. Caremark Rx, LLC)

I have written often on the important of good, clear drafting.

At a seminar I presented last week, a circuit court judge agreed with my observation on the blue-pencil rule. She stated that in 23 years, she has not modified an overbroad covenant. Courts simply do not warm to the idea of subjecting the parties to a contract to which they did not agree.

A recent case involving a former key employee of Caremark illustrates the danger of poor drafting that yields potentially absurd results. The one-year non-compete in the case of Joel Saban provided Saban could not work "in any capacity" for a business engaged in "Competition." The biggest problem for CVS was its definition of "Competition", which included for instance any retail business with plans to include a pharmacy as a "component of its business.

Saban, however, was not a CVS pharmacist or retail employee. He was, essentially, a key business-to-business guy who negotiated drug price discounts in the pharmacy benefits management side of Caremark. Utilizing hypotheticals about what the covenant would prohibit yielded "canyon-like" overbreadth in terms of potential restrictions. Caremark objected to the use of such hypotheticals, contending it was inconsistent with ascertaining the parties' intent at the time of contracting.

The court had little trouble rejecting this argument. The use of hypotheticals to demonstrate overbreadth is part and parcel of a non-compete defense on the issue of reasonableness. This all goes back to the concept of notice and basic fairness. If the terms of the covenant are not sufficiently clear to advise an employee of what conduct is prohibited, then an employee's burden to comply is too high.

Hypotheticals are most relevant to illustrate cases on the edge - where the employee believes he is complying, but the employer says he isn't. But they are still relevant even in claims where indisputably direct, vigorous competition exists. This is so because the employee challenging the covenant may have sought legal advice on whether to compete based on the reasonableness of the covenant's language.

The larger point here is that overbroad covenants do not get a free pass if the actual facts show true and substantial competition. Any employer deploying a covenant must run through a series of hypotheticals to see if the terms capture too much business activity or that commensurate with the interest it is trying to protect.

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

Opinion Date: 4/11/11

Cite: Saban v. Caremark Rx, LLC, 2011 U.S. Dist. LEXIS 38847 (N.D. Ill. Apr. 11, 2011)

Favors: Employee

Law: Rhode Island

"Reasonableness" of Non-Compete Must Be Examined In Totality (Delaware Elevator, Inc. v. Williams)

As readers know, a non-compete's enforceability depends on whether it is reasonable under the law. The idea of reasonableness is multi-layered. In most states, a court must consider time, territory, activity limits, impact on the employee, and impact on the public.

Vice Chancellor Travis Laster of the Delaware Court of Chancery wrote one of the best, most well-reasoned opinions I have seen on a non-compete case the past several years. He weaved in and out of timeless legal doctrines and contemporary economic choices that employers and employees make. He also excoriated the blue-pencil doctrine as a boondoggle that encourages poor draftsmanship.

But the most important part of the case centers on how courts should assess reasonableness. Laster favors a cohesive approach where a court examines time, territory and other restrictions of a covenant to determine how they work in combination. In short, Laster states: "All else equal, a longer restrictive covenant will be more reasonable if geographically tempered, and a restrictive covenant covering a broad area will be more reasonable if temporally tailored." He is one of the few judges who emphasize this point.

Laster likely is aware of how lawyers play the reasonableness game. Parse out one term of the agreement, cite a case that holds it is reasonable, and move on to the next point. This is fundamentally the wrong approach. A court needs to examine how the factors operate together, not in a vacuum.

Laster is relatively new to the Court of Chancery, having ascended to the position in 2009. Already, he is viewed as energetic, smart, and willing to challenge lawyers. Any case by Judge Laster is already persuasive precedent.

An excellent article on Judge Laster can be found here

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Court: Court of Chancery of Delaware, New Castle

Opinion Date: 3/16/11

Cite: Delaware Elevator, Inc. v. John J. Williams, 2011 Del. Ch. LEXIS 47 (Del. Ct. Ch. Mar. 16, 2011)

Favors: Neutral

Law: Maryland

Arbitrary Geographic Restriction May Not Be Unreasonable (Timber Lake Foods, Inc. v. Estess)

How can a nationwide business draft a non-compete so that its geographic scope is reasonable?

For starters, employers should consider less restrictive (and more enforceable) alternatives such as a client non-solicitation clause. Such a clause is self-contained, in that a court need not determine mileage scope and where exactly the agreement extends. It would be limited to identifiable clauses - assuming it is well-drafted.

An employer also could add to this a more limited non-compete, identifying prime competitors and trying to contain the non-compete in some respect. The downside to this is that it may not be all that effective in businesses with low barriers to entry or if the employer runs into a wide range of competitors.

Employers can get away with mistakes, though, and rely on more traditional time-and-territory covenants. Take the case of Stephanie Estess and her employment with abrokerof meat products, Timber Lake Foods, Inc. based in Tupelo, Mississippi.* Estess signed a 2-year, post-employment non-compete covenant that prevented her from "performing any services regarding the brokerage of meat and/or poultry prodcuts...for any person or business entity...within a 250-mile radius of Tupelo, Mississippi."**

Estess' job extended throughout the country, in that she apparently dealt with both suppliers and customers in various states. She could work from home or any location as long as she had access to a computer. Her argument was that the geographic scope was arbitrary. However, as the Court of Appeals of Mississippi held: a finding of arbitrariness "does not establish the unreasoanbleness of the geographic limit." True enough. Estess could have moved to some other locale and not violated anything.

It would have been much easier had the employer drafted the agreement only to prevent certain activities, as opposed to employment itself. That type of restraint would not have needed the geographic term. It also would have applied if Estess moved away to compete. Consider the employer lucky on this one.

* If you don't know the significance of the Elvis picture, you know nothing about music history.

** As an aside, I am not sure the covenant is as clear as the court in this case thought. If Estess could not broker food products for any person within a 250-mile radius of Tupelo, does that mean that the competitor or the customer has to be located within the 250 miles? To me, the services are provided to the customer, so the location of the competitor seems irrelevant. I think the court and the litigants may have misread what the clause actually says.

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Court: Court of Appeals of Mississippi
Opinion Date: 3/8/11
Cite: Timber Lake Foods, Inc. v. Estess, 2011 Miss. App. LEXIS 136 (Miss. Ct. App. Mar. 8, 2011)
Favors: Employer
Law: Mississippi

Supreme Court of Illinois Destined to Hear Reliable Fire Equipment v. Arredondo

As readers of this blog know, I wrote extensively last year on the important, and largely muddled, opinion in Reliable Fire Equipment v. Arredondo. The Second District Appellate Court in Illinois caused a split with its rejection of another district's approach to analyzing employment non-competition agreements. Still, it is not totally clear what test applies in the Second District, and assuming I am right, three of the five appellate districts in Illinois have different tests for enforceability.

This past week, Reliable Fire Equipment filed a Petition for Leave to Appeal to the Supreme Court of Illinois. That petition likely will be decided in the next six weeks, and the Court almost certainly has to take the case. As it stands right now, the enforceability of a non-compete in Illinois depends largely on where a suit is filed. Assuming the Court does take the case, I hope it adopts the traditional three-part reasonableness test that is common in many states, including Iowa and Ohio.

For those of you interested in my prior discussion of Reliable Fire Equipment, read here, here, here, here, here, and here. (Yeah, it was an important case.) If you haven't had enough, check out Zachary Jackson's post here.

I was gratified to be cited in the PLA under the heading discussing how litigants are divided and "unable to agree" on what test governs non-compete agreements in Illinois. In one of those odd twists of fate, my views were juxtaposed against a former adversary of mine who (unbeknownst to me) published another view on what Reliable Fire Equipment really means.

One-Way Fee Shifting Clauses and Public Policy

Fee-shifting clauses are fairly common in non-compete agreements.

While most fee-shifting provisions in negotiated commercial contracts are mutual, employment non-compete agreements frequently contain one-way clauses. Under this scheme, employers often retain the right to obtain fees if they prevail in a dispute against an ex-employee. (Not suprisingly, I have yet to see a clause that allows only the employee to obtain his or her fees in a successful defense.)

One question I often hear from my employee clients is whether such a one-way provision is even enforceable.

At least a couple of theories are available.

First, some states may have statutes of general applicability that automatically construe one-way fee shifting provisions into mutual ones. California, Montana, and Washington are examples.

Second, a judge may be receptive to an unconscionability defense. For prevailing employees, this argument doesn't appear to give them a right to recover their fees. However, it may be a viable route to avoid fee-shifting in the event of a loss. An appellate court judge in Ohio in 1992 was open to this unconscionability defense, but since the parties did not raise it before the court, the issue was never decided.

Third, the rule of equitable modification may give a prevailing employee grounds to seek fees under a one-way fee-shifting clause. In those states that adopt equitable modification, rather than a strict blue-pencil rule, courts retain the ability to modify overbroad covenants to make them reasonable.

Can this rule be extended to allow a court to modify a fee-shifting clause? I don't know if there is any case that has ever ruled on this issue, but I think the argument has some intuitive appeal. In my mind, a lot would depend on the breadth of the restrictions, the parties' bargaining power, and the governing state's policy on reformation of covenants.

Because non-compete agreements implicate public policy unlike other commercial contracts, a higher degree of scrutiny of one-way fee provisions logically should apply. Whether a court actually will be open to this argument is something I have not yet seen.

Amendment Introduced to Proposed Illinois Covenants Not to Compete Act

As I wrote back in January, House Bill 16 in the Illinois General Assembly introduces a statutory framework for non-compete agreements in the State of Illinois. Though it is unlikely to work its way to the required "Third Reading" during the General Assembly's regular session for 2011, the bill has drawn a significant number of co-sponsors.

Rep. Rosemary Mulligan is back as Chief Sponsor. Even if the bill gains some traction (likely next year), there will be several changes. This week, an amendment was added to make clear that the Act does not apply to "news media." Readers of this blog are aware that Illinois is one of many states that exempt broadcast industry employees from post-termination non-compete agreements. The amendment offered likely only clarifies this exemption.

Other changes likely will concern the two-week notice provision for employees who are asked to sign a non-compete agreement. The recent Oregon law contains a similar requirement as House Bill 16.

I also would not be surprised to see some provision included in the bill that is specific to medical practices, perhaps along the lines of what the Texas Covenant Not to Compete Act provides. In addition to other criteria, the Texas statute provides that a physician must be allowed to buy out the covenant at a reasonable price. Non-compete disputes for physicians were the main impetus behind House Bill 16 and its predecessor.