Step-Down Clauses May Be Important In Blue-Pencil States (Team IA, Inc. v. Lucas)

Step-down clauses are not something I often see in non-compete agreements.

The basic premise is fairly easy to grasp. A step-down clause provides alternative restrictions if a court finds that one (that is, the more restrictive one) is too broad to be enforced. When would such a clause be appropriate to use? If your jurisdictions is a true blue-pencil state.

The blue-pencil rule provides that, though certain overbroad clauses can be stricken without invalidating an entire contract, a non-compete clause cannot be rewritten by a court to make it reasonable. That means that a restriction - usually a territorial one - runs the risk of being held overbroad, unenforceable and not salvageable.

A step-down clause is a creative way to avoid the sometimes strict impact of the blue-pencil rule. A recent South Carolina case, which upheld a step-down clause, illustrates how it can work in the context of a non-compete lawsuit. The employee's territorial restriction was nationwide, but also provided that in the event it was held overbroad, could be limited to four southeastern states.

The court struck down the nationwide restriction as overbroad but concluded the step-down clause, with a much narrower geographic territory, was valid and enforceable.

In equitable modification states (which allow for reasonable alterations to a non-compete to make them reasonable), using a step-down clause is not as critical. Still, it may provide the court an easy alternative. Many judges are hesitant to modify parties' contracts and may view a reasonable step-down clause as upholding the parties' bargain.

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Court: Court of Appeals of South Carolina

Opinion Date: 9/14/11

Cite: Team IA, Inc. v. Lucas, 2011 S.C. App. LEXIS 267 (S.C. Ct. App. Sept. 14, 2011)

Favors: Employer

Law: South Carolina

The Value of Business Information In a Nutshell

Having litigated and advised clients on issues related to non-competes for almost 15 years, I hear the terms "trade secret", "confidential information" and "proprietary information" every day. It can be a little numbing, and unfortunately, I think more about these terms of art than I should.

So I thought I would try to summarize, briefly, what they mean in practice. The terms are different and they are not at all interchangeable.

1. Trade Secret. A trade secret is the type of non-public business information afforded the highest legal protection. Essentially, a trade secret is a narrow subset of valuable commercial information. There are two keys to establishing the existence of a trade secret: (a) value; and (b) secrecy. But here is the catch for lawyers and clients alike. Something does not qualify for trade secret protection simply because it is valuable, or because it is secret. It must be valuable because it is kept secret. Put differently, if something publicly available provides you the same or similar value, it's not a trade secret. Also, courts scrutinize secrecy measures very carefully. You need to demonstrate affirmative steps were taken to protect the information.

2. Confidential Information. I hate this term. And I hate it because by itself it is meaningless and overused. The law treats confidential information differently than a trade secret. In Illinois, it means "particularized information which is unknown to others in the industry and gives an employer advantage over his competitors." Trying to differentiate this from the trade secret definition is not easy, but here is the best I can come up with. First, courts will be more lenient on the degree of specificity required in claiming something is confidential. Second, courts won't impose that high of a burden on employers to show what secrecy measures are employed. And third, it is not clear that an employer needs to show the information is valuable because of its confidentiality. Keep in mind that while breach of confidentiality likely has legal implications, the remedies available are not as sweeping as in a trade secrets case.

3. Proprietary Information. As much as I hate the term "confidential information", I hate this term more. It is a mistake to equate confidential information with proprietary information. If something is "proprietary", it simply means it is owned. A patent, or documents submitted in a patent application, can be and likely are proprietary, but when published they are neither secret nor confidential. Even the content of this blog is proprietary to me, because I have copyright in it. But again, it's not confidential (as evidenced by the fact you are reading this...). A form contract may be proprietary in the sense that a company developed it, but if customers have access to it without restriction, it probably is not confidential. Absent some breach of confidentiality, disclosure of "proprietary" information may not be problematic.

Does the Illinois Computer Crime Prevention Law Benefit Employers?

The Illinois Computer Crime Prevention Law (ICCPL) is a scaled back version of the federal Computer Fraud and Abuse Act. Effectively, it is a penal statute (contained entirely within the Criminal Code) that criminalizes improper computer conduct, such as hacking or improper access of a computer system.

It does contain one civil remedy, however, and that potentially gives employers another weapon to combat unfair competition. An increasing number of employment competition cases at least raise the specter of whether the employee transferred confidential data or information prior to his departure. Often, this can color a trade secrets or non-compete claim. It is more frequent that an employee's communications will tip off the employer what he or she is planning to do, and it may even reveal sensitive details of a future business opportunity.

Some departing employees, to be frank, are not that clever. They try to cover their tracks by wiping a hard-drive clean with off-the-shelf software like "Window Washer" or "Evidence Eliminator." (Yes, the program names are as sinister as they sound.) The ICCPL potentially gives employers a statutory claim if a departing employee installs and runs one of these programs which has the effect of deleting data from a work computer. This information could consist of stored e-mails or even a detailed competing business plan.

What does this ICCPL claim get an employer? Perhaps not much. I am not a huge fan of piling on claims just so I can see my own work product on paper. In my mind, the claim ought to give the client some other type of relief - injunction, attorneys fees, punitive damages - or an alternative path to victory.

The ICCPL allows for damages and discretionary fee-shifting, but an employer likely has those claims anyway. However, there may be an issue on the type of damages the ICCPL allows and which may not otherwise be recoverable. From a plain reading of the statute, the damages seemingly would have to relate to the lost data. Potential damages, therefore, could include time spent on a forensic examiner to assess and recover lost data. It theoretically could include indirect damages, such as the value of employee time spent recreating the substance of what was lost. This is not clear, but if so, this may be a potentially valuable add-on claim. I am not so sure the typical business tort or contract-based claims would allow for those types of damages.

As one might expect, there are virtually no cases under the ICCPL (certainly none of note). The ICCPL also contains several other provisions, none of which provide for a civil remedy.

Illinois Court Describes What Facts State Claim for "Inevitable Disclosure" (Mobile Mark, Inc. v. Pakosz)

Illinois is one of the many states which recognize the "inevitable disclosure" doctrine. As I have written before, the doctrine is a species of the Uniform Trade Secrets Act provision which allows "threatened" misappropriation to be enjoined. A few courts have noted the fine line between a threat of disclosure and the inevitability of such disclosure. Only lawyers would devote such time to parsing this distinction.

With the new heightened federal pleading standard, a trade secrets plaintiff must show facts that demonstrate inevitable disclosure is a plausible theory of misappropriation. In Mobile Mark, Inc. v. Pakosz, a federal district court in Chicago rejected a motion to dismiss on the grounds the plaintiff had not pled the inevitable disclosure claim with enough facts.

Here are some factors the court outlined that are critical to the inevitable disclosure theory:

(1) Evidence of copying the employer's confidential information (usually, this is alleged by way of suspicious downloading activity, e-mails to web-based accounts, unusual printing activity, or off-hours appearances on the employer's premises prior to departure);

(2) The level of competition between the new employer and the old employer;

(3) Whether the employee's position is comparable to the position s/he previously held;

(4) The employer's steps in protecting against the employee's use or disclosure of the prior employers' confidential information (as an example, courts look to warnings, covenants not to use such information in a new agreement, "firewalls" from sensitive projects or clients).

Prior inevitable disclosure cases seem to examine other factors, such as an employee's lack of candor about the new work assignment or shifting explanations about what job duties s/he will be assuming.

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

Opinion Date: 9/6/11

Cite: Mobile Mark, Inc. v. Pakosz, 2011 U.S. Dist. LEXIS 99865 (N.D. Ill. Sept. 6, 2011)

Favors: Employer

Law: Illinois

Orthodontics Sales Representative Prevails in Non-Compete Bench Trial (Thiesing v. Dentsply Int'l)

A former dental products sales representative of GAC International, who left to join American Orthodontics, has prevailed in a non-compete bench trial in the Eastern District of Wisconsin.

The case involving Tim Thiesing started out as a declaratory judgment action filed by him and his new employer, AO. GAC International countersued under a variety of theories. Eventually, the claims which proceeded to trial were based on Thiesing's 2-year non-compete agreement and a tortious interference claim against AO.

The non-compete was, in a word, strange.

For some reason, it did not simply bar Thiesing from selling orthodontics products in his former territory or to his former accounts. Rather, it inexplicably tied his sales activity to the incorporation of confidential information belonging to his former employer, GAC, into products sold by his new employer.

Effectively, this meant that the employer not only had to prove a non-compete case, but it also had to demonstrate a breach of confidentiality as well. This is exactly what an employer should not have to do. The non-compete can protect well-established business interests such as client goodwill and relationships.

But by flipping the case around and tying everything (including solicitation of customers) to confidential information, the employer basically lost the benefit of a more easily established business interest. Stated another way, the court inevitably had to focus on whether certain information Thiesing had access to or used in his employment with GAC was truly confidential, and if it was, whether it was incorporated into his AO sales functions.

It wasn't.

As with many sales-oriented cases, the employer had a hard time establishing how the information alleged to be confidential - prices, contact names, product designs - was actually kept confidential. None of the claimed categories of information appeared to be anything more than ordinary commercial information that a customer would expect to receive in a sales solicitation and, of course, free to use in bargaining with another potential supplier.

(As an illustration, my wife and I are putting in a fence. We had four companies come out and provide us quotes and plans. Those documents were left with us after the sales pitch. Were we able to use them to negotiate and get a better price? Of course. Are those confidential documents? Nope.)

The court appeared to have little trouble rendering a decision in favor of Thiesing and AO. Because the court did not find that Thiesing incorporated his old employer's confidential information into his new company's product offerings, there was no non-compete violation. In my mind, this is a classic case of an overlawyered contract. It makes no sense why an employer would complicate what should be a clear agreement with confusing definitions that make it harder to enforce its own document.

But that is why there are disputes, and ultimately trials. Incidentally, I followed this case and have to commend the work that the Godfrey & Kahn firm in Milwaukee did for both Thiesing and AO. The attorneys, William Duffin and Mark Schmidt, represented their clients very well, which is obvious from reading the filings. Their briefs and pre-trial submissions were first rate and go straight into my bank of sample documents.

I am not ashamed to admit that I will be block copying some of their analyses and arguments into my own cases.

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Court: United States District Court for the Eastern District of Wisconsin

Opinion Date: 9/7/11

Cite: Thiesing v. Dentsply International, Inc., 2011 U.S. Dist. LEXIS 101437 (E.D. Wis. Sept. 7, 2011)

Favors: Employee

Law: Minnesota

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

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

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

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

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

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

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Court: United States Court of Appeals for the First Circuit

Opinion Date: 8/26/11

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

Favors: Employee

Law: Massachusetts

Top Employment Law Blog? You Decide...

This blog has been nominated by LexisNexis as a Top 25 Labor and Employment Law Blog. Of the nearly 60 nominees, LexisNexis will be picking the Top 25 through reader comments (which apparently count as votes). The Labor and Employment Community at LexisNexis will then choose the top blog.

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If you don't want to go through the hassle of voting, I appreciate you stopping by to visit. And if you prefer to send along kind remarks for my blogging work over the past three years, feel free to e-mail me directly. I always appreciate hearing from you!

Finally, by clicking on the link above, you will find a list of the other nominees. There are a ton of great, interesting blogs out there on a wide range of employment law topics. Be sure to visit them and add them to your blogroll.

Bank Executive's Non-Compete Dispute Promises To Be Year's Most Interesting Case

John Kanas is a legendary figure within the New York banking community. Five years ago, he sold his highly successful North Fork to Capital One Financial. In the course of doing so, Kanas received a $200 million payout. Kanas stayed on with Capital One, but clearly the match was not working out. Capital One agreed to let Kanas resign earlier than his original contract called for.

Once he resigned, Kanas decided not to hit the country club circuit. Instead, he orchestrated an acquisition of BankUnited, a failed Florida bank that had been seized by the FDIC. Kanas did so with a private equity group featuring such prominent names as Wilbur Ross, who is known for restructuring failed companies in the steel and coal industries. In recent interviews, Kanas has made it clear he wants back into the New York market.

Problem: his Capital One non-compete has not yet expired. Under Kanas' reworked non-compete arrangement, he is prohibited from competing in consumer or commercial banking within New York, New Jersey, and Connecticut. The restrictions are set to expire August 7, 2012.

Capital One claims certain activity by Kanas through BankUnited rises to the level of unfair competition and has enlisted heavy-hitter Orin Snyder of Gibson Dunn & Crutcher to litigate the the non-compete case. Kanas, and co-defendant John Bohlsen, responded with perhaps the nation's best attorney, David Boies.

The suit is interesting on several levels. Capital One's claim really centers on four key facts which it claims constitutes a non-compete violation:

(1) BankUnited already had a banking portfolio which contained mortgages on New York and New Jersey properties at the time Kanas and Bohlsen acquired BankUnited.

(2) BankUnited has planned to construct and open branches in New York and has advertised for open positions at these locations.

(3) Kanas placed a bid for the Bank of Ireland's New York commercial banking portfolio on behalf of BankUnited. (Bank of Ireland has been forced by that country's financial regulators to sell off a significant percentage of its foreign loan portfolio, and many of the real estate properties are located in New York).

(4) BankUnited has entered into an agreement to acquire Herald National Bank, a commercial bank located in Manhattan specializing in small to mid-size commercial lending.

The defendants have answered the complaint and from their statements, it is clear they do not believe that alleged activity constitutes a non-compete violation. They are contesting the reasonableness of the agreements they signed and believe that they constitute unenforceable restraints of trade if they were interpreted as Capital One proposes.

Interestingly, there is no motion for preliminary injunction on file. The complaint does seek an extension of the non-compete period commensurate with the period of breach, which could be ongoing until next August - depending on what the Court views as a breach. Capital One also is seeking a disgorgement of consideration paid to Kanas and Bohlsen for signing the non-competes, but it's not clear if this would need to be some sort of prorated amount based on the time period each sat out. However, given the dollars paid to both Kanas and Bohlsen (who pocketed $100 million), the claim for disgorgement at least would be well into the 7 figures.

This is one of those cases where you can anticipate a discovery fight. The interpretation of the defendants' conduct, and how it fits into the non-compete contracts, will be front and center. That should mean high-stakes depositions and costly document production. It is unlikely that the court would view the non-competes signed in exchange for millions of dollars to be unenforceable restraints. More likely, if the defendants prevail, the court will have to find that Capital One's interpretation is incorrect. Other high-profile executive disputes, such as that involving involving Mark Hurd, have settled quickly, so perhaps all sides will determine that a confidential settlement is the best option.

Virginia law governs the non-compete contracts, so that state's blue-pencil rule could pose a problem for Capital One if the court finds that the contracts contain some overbroad terms. Virginia's Supreme Court has not approved of a blue-pencil rule, though the case law there is employee-friendly in many respects and courts "discourage" modification of overbroad covenants.

In Pennsylvania, Termination Only a Factor to Consider on Enforceability (Colorcon, Inc. v. Lewis)

Several years ago, a Pennsylvania court used sweeping language to deem a non-compete unenforceable against an employee who had been terminated without cause, allegedly due to poor performance. Since that time, the courts in Pennsylvania have pared back on any hint of a per se rule and have noted that termination is only "an important factor" to be considered in the overall reasonableness analysis.

A recent case out of Pennsylvania demonstrates, though, that courts are still skeptical of enjoining employees who have been terminated involuntarily for reasons other than cause. In Colorcon, Inc. v. Lewis, the court denied an employer's effort to enforce a non-compete against a terminated salesperson. After finding that her new employment did not even place her in breach, the court proceeded to analyze the enforceability question in light of her prior termination.

The court noted a couple of key factors in this fact-intensive inquiry:

(1) While the employee signed a severance agreement, she only obtained $21,000 severance pay. The court noted that pay was for more than just reaffirming her non-compete: she also released her employer from any and all claims against it.

(2) The employee and new employer took extra precautions to make sure she was in a different line of work than her previous job, and even avoided contacting certain customers that may have been problematic under the non-compete's language.

(3) The employee had searched for other employment and could not find anything outside her industry that did not require her to either take a substantial pay cut or relocate.

My experience has been that courts are sympathetic to employees who have been laid off, particularly when the non-compete agreement is broad and includes jobs that potentially are not in line with what they previously were doing. As always, courts will assess a wide range of fact specific hardship questions as well.

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Court: United States District Court for the Eastern District of Pennsylvania

Opinion Date: 5/31/11

Cite: Colorcon, Inc. v. Lewis, 2011 U.S. Dist. LEXIS 58637 (E.D. Pa. May 31, 2011)

Favors: Employee

Law: Pennsylvania

Does a Trade Secrets Defendant Have Insurance Coverage?

Trade secrets litigation can be very expensive. For the type of clients that I frequently advise - small business owners - the litigation can extend to significant document production, retention of experts, and complex damages analysis. Defense costs almost always are well into the six figures.

Clients often ask whether they have insurance for these types of claims. Like most things, the answer is "it depends." Usually, for trade secrets defendants, it is worth exploring whether a commercial general liability policy contains an advertising injury endorsement. If so, it is possible that there may be some coverage for defense and liability costs arising out of trade secrets misappropriation.

However, I caution clients not to get their hopes up. The newer advertising injury endorsements often contain exclusions for a wide range of intellectual property claims, including those arising under the law of trademark, trade dress, and trade secret. Even if there is no such exclusion, the opportunity for coverage may be limited. In these circumstances, counsel will need to examine whether the allegations of the complaint truly implicate "advertising" activity.

Advertising generally means the promotion of a product or service to the general public. It usually does not include customer solicitation. So, in the case where a trade secret is a customer list, and a defendant is improperly using that list to target key accounts, it would be much more difficult to claim that this injury is based on "advertising."

However, many types of trade secrets are included within products or services offered to the public. For instance, if a trade secret is used to design a consumer product, and that product is then marketed generally to the public, a claim that the misappropriation resulted in an "advertising" injury would seem to have more merit.

So to conclude, it is important to first look at your liability policy for endorsement and exclusion language that may directly touch upon trade secret claims. Absent such language, you will need to scour the allegations of the complaint to determine if there is a colorable argument that the injury resulted from an effort to sell to the public, not just certain targeted customers.