Case Law Update: Riding Circuit

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

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

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

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

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

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

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

A copy of the opinion is available here.

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

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

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

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

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

A copy of the opinion is available here.

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

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

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

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

A copy of the opinion is available here.

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

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

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

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

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

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

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

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

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

A copy of the opinion is available here.

California Choice-of-Law Rulings Strike Sensible Balance

Choice-of-law and -forum clauses are not only some of the most important issues in non-compete agreements, but they also are some of the most complex.

To step back, the clauses are just what they sound like. If you have a restrictive covenant agreement, look to the back and you'll find what many normal people call "boilerplate" terms. A choice-of-law clause says what State's law will govern the agreement. And a choice-of-forum clause will tell you where the case can, or even must, be heard.

These clauses take on added importance for employees who work for larger enterprises, because often the employee's place of citizenship will differ from the corporate nerve center. A valued sales employee may have selling responsibility only on the west coast, but her company may be situated in New York or Florida. This is extremely common, and employees often don't quite know what to do when their place of residence is different than the law governing their agreements.

Red-flag States, such as California and Oklahoma, pose special problems because of clear public policy concerns that deal with non-compete law. In those States (and others), many restrictive covenants enforceable in States like Texas or Florida won't be reasonable at all. What to do, then, when a citizen of one of these States has an agreement governed by a State's law that embraces non-competes?

Let's walk through how to assess this.

Step 1: Determine the employee's place of citizenship. This should be easy, but we've seen cases where employees move in order to take a new job in a State that is somewhat hostile to non-competes. Can this move aid the employee, or is it irrelevant?

Step 2: Find out if the employee's home State poses special enforcement problems. Those States are California, Oklahoma, North Dakota, Louisiana, and Wisconsin. There may be others, too, but for certain an employee's citizenship in one of these States should cause counsel to engage in a deep enforceability analysis.

Step 3: Ascertain whether suit in State or Federal court is likely. If there is a possibility of a suit in Federal court, then the Supreme Court's case of Atlantic Marine in 2013 will be important to consider. But, that is only if the contract contains a choice-of-forum clause.

Step 4: Review State choice-of-law rules. Most States adopt the analysis from Section 187 of the Restatement (Second) of Conflicts of Laws. If the parties select a State's law to apply, it will be given effect unless one of two conditions is met: (a) the selected State has no substantial relationship to the parties or the transaction; or (b) application of the chosen State's law would be contrary to the public policy of a State that has a materially greater interest and whose law would apply absent the choice-of-law clause.

Step 5: Apply the choice-of-law rules. Often, the first exception noted above won't apply, unless you encounter the totally bonkers situation where an employer gratuitously picks the most authoritarian State even though that State has nothing to do with the employment relationship. Or, perhaps, the employer picks Delaware when the only connection to Delaware is that the company chose to be incorporated there. That may fall within exception (a).

More likely, you'll need to do a deep dive on exception (b), which often applies when an employee has little connection to the forum State. Again, consider my example where an employee sells only in Oklahoma and has no job responsibilities in New York where the company home is. Very common fact pattern.

Step 6: Assuming you have a scenario involving exception (b), consider the nature of the public-policy at stake. Do you have a California problem, where non-competes are totally off-limits? Or do you have a State with marginal deviations to the general rule of reason, like a Nebraska which does not allow overbroad non-competes to be enforced? Sometimes these small deviations can be outcome-determinative in a particular dispute, but is that enough to qualify as a "public policy"? Debatable, to be sure.

Step 7: See if some other limiting condition applies. That is, does a State have a particular rule about choice-of-law or -forum clauses that applies to employees? Some States do by statute.

There are a few recent illustrations that involve some or all of these steps. The first comes from the redundantly-named Supreme Judicial Court of Massachusetts in a case called Oxford Global Resources, LLC v. Hernandez, in which the SJC held that a Massachusetts court would not enforce choice-of-law and -forum clauses that both selected Massachusetts against a former employee residing in California. Of particular note, that employee had job responsibilities only in California. The deciding factor was California's strong public policy that I have discussed often, which bars non-competes for employees.

Conversely, the Delaware Court of Chancery addressed a slightly different question in NuVasive, Inc. v. Miles. There, an employee in California entered into an employment contract that specified Delaware law and venue. But that agreement was entered into after California amended its Labor Code, Section 925. That section was generally intended to deepen the public policy interest against non-competes by preventing circumvention of California law through choice-of-law clauses. But Section 925 also carved out contracts where the employee's counsel negotiates the choice-of-law provision. As the Delaware court found, that carve-out balanced an overriding public policy interest in favor of free competition with a countervailing interest in the freedom to contract. As such, the choice-of-law clause was valid.

These issues are extremely important, and sometimes the case law can be confusing. That is more so with venue clauses than with choice-of-law provisions. But an employee and counsel must be attuned to the importance of both when it appears they can have an impact on the agreement.

California Dreamin'

I often think of living in California.

The warm weather, the fact that the air just somehow feels different. The sand running through your toes as you soak it all. And of course, the punishing taxes and regulations...but still.

And of course I think of what it would be like to be a non-compete attorney in California, because man would it be weird. You'd almost have to reverse most of your instincts. You wouldn't have to hedge when you talk to clients. You could actually dispense advice without the maddening qualifiers like, "well maybe a court would do this, but hey maybe not. Good luck!"

The reason, of course, is that California is pretty hostile to most types of restraints on trade, due to Section 16600 of the Business and Professions Code, which states that "every contract" in which one is restrained from engaging in a lawful profession, trade, or business is void. That's strong stuff. But despite attorneys' ability to give somewhat clearer answers than we can give in say Illinois, some nuance still remains.

Take no-hire clauses, which bar employees from soliciting co-workers for a reasonable period of time post-employment. Those are often far less controversial than non-competes and customer non-solicitation covenants because they don't really tend to limit one from working. Except, though, recruiters.

Recruiters are basically salespersons, but they specialize in placing people (sometimes consultants, sometimes other employees) with clients. Their relationships, which restrictive covenants try to protect, thus cross over into two different areas of the distribution chain. And so recruiters more than any group of employees feel restrained by no-hire clauses.

The California courts haven't been as troubled by no-hire clauses as the more common and restrictive form of post-employment covenants, with some courts allowing them. But that rule now appears in doubt after AMN Healthcare, Inc. v. Aya Healthcare Services, Inc. There, the Fourth District Court of Appeal held void under Section 16600 a garden-variety no-hire clause in the travel nurse staffing business.

The employees impacted by the no-hire were travel nurse recruiters of AMN Healthcare, who had signed no-hire clauses of either a year or 18 months that limited their ability to solicit co-workers to leave AMN. Those recruiters then left and contacted various travel nurses, who typically were placed at health care facilities on 13-week assignments.

The Court of Appeal found the no-hire clauses void as a matter of law, thus casting doubt about older case that lawyers typically relied upon to enforce those clauses. The gist is that those older cases pre-dated a significant Supreme Court of California decision in a case called Edwards v. Arthur Anderson LLP, which generally disapproved of a narrow-restraint exception to Section 16600. As a result of Edwards, Section 16600 still applied when a post-employment covenant restricts only a limited part of an employee's profession, such as solicitation of clients.

The Court of Appeal in AMN Healthcare found Edwards controlling. As applied to the travel nurse recruiter scenario, the court had little trouble concluding that the no-hire clause was a void restraint. In particular, it focused on the nature of the recruiting business (which makes no-hire clauses much more significant than in other industries), the impact on recruiters' compensation if restrained from soliciting nurses for work, and the temporary nature of the travel-nurse assignments.

Despite all that, it's hard not to see AMN Healthcare as a significant shift in how courts evaluate no-hire clauses. A copy of the decision is available here.

Cleaning Up the Janitorial Mess

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

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

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

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

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

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

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

***

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

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

The Janitor Non-Compete, This Time for Real

The janitor hypothetical is one of the most timeless aspects of non-compete cases. That is, when illustrating how broad a non-compete is, courts and lawyers alike often resort to a sometimes absurd hypothetical. It often contains some variation of "this non-compete is so broad it would restrict [insert poor sap stuck in litigation] from being a janitor." Feigned outrage and chuckles then ensue.

Only this time, no absurd hypothetical. Enter the combatants. On one side is C&W Facility Services, which provides maintenance services to commercial property owners. On the other side is UG2, a competitor. In the middle sits poor Sonia Mercado, a non-exempt "janitorial supervisor" making $18 per hour at C&W.

C&W is faced with a contract renewal to provide maintenance services at some outfit called Lonza Biologics, a life sciences company. Apparently, Lonza put the maintenance contract out to bid and lost it to UG2. Mercado worked for C&W on-site at Lonza. From her Declaration (unrebutted), she describes her job like this:

"As a supervisor, my job responsibilities differed from clearness only in that I helped to train new staff in how to clean. Otherwise, I was a cleaner. My English is better than some of the other cleaners, and I believe this is why I was made a supervisor."

She continues, again without rebuttal:

"I cleaned in the Carpet World. The Carpet World cleaners, including myself, did vacuuming, cleaning rugs, dusting, emptying trash cans/recycle bins, and periodically washing windows. We had a small room with cleaning supplies." She went so far as to attach a goddamned picture of the room with cleaning supplies."

After C&W loses the services contract to UG2, it presents Mercado with a two-year non-compete agreement. The upshot of the agreement is that Mercado, under the agreement, could not provide services at Lonza for another maintenance company. Mind you, by this time, C&W has lost the agreement and Mercado had no involvement in that process whatsoever.

The circumstances under which Mercado signed the restrictive covenant are questionable. From her affidavit, Mercado says that C&W informed Mercado and others that they would be placed at a new facility (Lindt chocolate...overrated, by the way). Apparently, C&W felt that UG2 would have trouble handling the job and told Mercado that she would be back at Lonza in no time. Weird, but plausible.

Mercado then signs the restrictive covenant along with a bonus agreement, most of which she ultimately returns. She ends up back at Lonza working for UG2, which should have surprised no one.

C&W then takes the inexplicable step of suing Mercado to enforce the agreement. The Verified Complaint is the typical sort of canned pleading we've come to hate, playing up what a total fucking disaster it would be for the company's confidential information to be lost. Mercado had no access to any such information, but the point seems to have been lost on C&W. In fact, the so-called protectable interest allegations, to me, do not pass the smell test. If believed, Mercado's responsibilities as a janitorial supervisor are on par with Lonza's head of operations.

The district court then enters an order of injunctive relief, enforcing the non-compete for four months (not two years) and ordering C&W to pay Mercado a portion of the bonus she returned to C&W. In effect, the court told C&W its non-compete was overbroad, required some modified form of "garden leave," and then struck as unreasonable the fee-shifting clause. The ruling preserved some semblance of sanity, though the court made a grave error. It should have denied the injunction outright.

The overarching problem is the court's complete lack of engagement with the protectable interest requirement. In other words, what was C&W hoping to achieve by preventing a custodian from working for another service provider after C&W already had lost the service contract? The court never says, beyond some unconvincing reference to training costs.

This is a problem in non-compete cases. Judges must be engaged with the facts to understand the rationale behind enforcing the restriction. Too often, plaintiffs get a free pass because they lodge vague generalities about threatened injury that sound just fine on paper, but fall apart in practice. It is unclear where C&W possibly could go from here. This case won't get any better. It's likely to get far worse.

A final word. It seems pretty clear to me that C&W is using Mercado as a pawn in much larger tactical battle with UG2. C&W could care less about her - that much is clear from the mere filing of the suit. Companies that use ex-employees in this way, as well as the "lawyers" representing them, do grave damage to the labor market and the use of human capital. This particular dispute sucks, and it's a total waste of time. C&W doesn't care. No one at UG2 is likely losing sleep. But I guarantee you Mercado cares.

I know people like her. I see them at night when I am working late. I make a point to get to know them and let them know they're appreciated. They work hard, for not much money, and people take them for granted. When my father was a school superintendent, he knew each custodial worker in my high school. He knew them by name. He gave them little things, an old TV comes to mind, knowing how much they'd appreciate it. That always has stuck with me.

Ultimately, it is C&W that will suffer the consequences of this inane and utterly pathetic lawsuit. It will be used as exhibit A for non-compete abuse. It ought to be used as a justification by some future client of C&W to not hire C&W at all.

C&W Facility v Mercado by Ken Vanko on Scribd

Legislative Reform, Non-Compete Agreements, and the Contracts Clause

With increasing frequency, we see state legislatures wade into the hot topic of non-compete reform. Over the past several years, we've seen the States enact laws that govern employee non-compete arrangements in myriad ways.

Below is just a sampling:

• Illinois enacted the Freedom to Work Act, which banned non-competes for employees below a salary threshold;
• New Mexico and California established laws that restrict the use of choice-of-law and choice-of-forum clauses;
• Idaho repealed a statutory rule that created a rebuttable presumption of irreparable harm for certain employees who were subject to non-compete clauses;
• Colorado limited remedies for certain physician non-compete arrangements;
• Hawaii banned non-competes for technology workers; and
• Massachusetts totally revamped its entire law on non-competes at the end of July.

One inevitable feature of these legislative reforms is the prospective application of the new law. For instance, California's amendment to its Labor Code specifically provides that the bar on foreign choice-of-law/choice-of-forum clauses do not apply to any contract entered into before January 1, 2017. The new Massachusetts non-compete bill is basically the same, as it only impacts contracts signed on or after October 1, 2018.

This "prospective application only" obviously requires lawyers to evaluate potentially two different sets of non-compete law, depending on the breadth of the legislative reform. But why do have to worry about this at all? I have had several clients, for instance, who live in California but have Illinois choice-of-law and -forum clauses perplexed at why the legislative reform would just target new contracts, instead of existing ones.\

The answer lies in the U.S. Constitution's Contracts Clause (Art. I, § 10, cl. 1), which provides that no State shall pass any law impairing the obligation of contracts.

Relatively simple language has spawned an impairment test that is anything but easy to apply, however. Not all laws that affect pre-existing contracts violate the Contracts Clause. Instead, courts must look first at whether the state law has "operated a substantial impairment of a contractual relationship." To answer that question, courts consider the extent to which a law undermines a contractual bargain, interferes with a party's reasonable expectations, and prevents a party from safeguarding its rights. Assuming a party can demonstrate this substantial impairment, courts then ask whether the state law is drawn in a reasonable way to advance a significant and legitimate public purpose.

The recent rash of non-compete reform, both big and small, raises the question of just how far States could go to alter contractual rights retroactively if they so choose. For instance, Alabama enacted its Restrictive Covenants Act effective January 1, 2016, but nothing in the Act says anything about prospective application. Indeed, the language of the Act suggests it applies to everything.

Alabama actually serves as a good starting point for analysis. The new law changed some stuff, but perhaps not in a way that impaired existing non-competes in a constitutional sense. For instance, it now lists presumptive periods of reasonableness, but it does not say for instance that a three-year non-compete is void against public policy. Alabama also puts the burden on an employee to prove that a covenant will impose an undue hardship on her, a deviation from prior law that is somewhat significant. But the statute still allows for presentation of the defense (as distinguished from Florida law, which does not).

On the other side of the equation, Hawaii's law banning non-competes for technology workers would constitute the sort of substantial impairment that the Contracts Clause prohibits. So too, Massachusetts now bans non-competes unless they meet a rash of substantive and procedural requirements (including garden-leave pay). No doubt, that law could not be given retroactive application.

But we can imagine tougher calls. Laws that address choice-of-law and choice-of-forum clauses do not necessarily impact contractual rights, but could place a burden on obtaining a contractual remedy. A law that allocates burdens of proof similarly would not constitute a substantial impairment. By the same token, a law that shortened the statute of limitations for enforcement or even for asserting damages claims still would preserve the underlying right. But those that establish a maximum non-compete period, categorically, likely would be unconstitutional because they would invalidate a whole class of agreements.

Prospective application of the law is sort of a bedrock principle of statutory construction. The Contracts Clause was supposed to harden that into a rigid mandate. Like much of constitutional law, the contours of the clause are now a bit fuzzy. Non-compete law, in most states, suffers from the same problem.

Ninth Circuit Expands Reach of Section 16600 in Golden II

Three years ago, I wrote a lengthy blog post on the case of Golden v. California Emergency Physicians, a Ninth Circuit case that I felt was a bit of an oddity. It addressed California's well-known statute, Section 16600 of the Business and Professions Code, which generally bars non-compete agreements.

The problem in Golden I was that the provisions at issue weren't really non-compete covenants at all, and so the application of Section 16600 was a little confusing. Though I punt to my 2015 post for a factual run-down of Golden I, summarized briefly the case involved this scenario. Am emergency physician had an employment dispute with a staffing company. As part of a settlement, the company required him to agree not to work at any facility where the company had a staffing contract. It further provided that if the company later acquired a staffing contract at another facility, it could and would terminate the physician.

So how does this implicate Section 16600? Golden I didn't necessarily address that question and remanded for fact-finding about how this covenant impacted Dr. Golden. I wrote three years ago that I didn't understand the fact-finding rationale at all. I still don't. But the Ninth Circuit now has addressed the application of Section 16600 and what the district court did on remand.

To start with, the Ninth Circuit says Section 16600 covers all contractual provisions that impose "a restraint of a substantial character." That means, the provision cannot "significantly or materially" impede a person's lawful profession, trade, or business. According to the California decisions summarized in Golden II, restraints that meet this definition include:

1. Restrictions on working for a competitor;
2. Restrictions on soliciting customers;
3. Clauses that impose a monetary penalty for engaging in competitive conduct.

What won't meet the definition? A limited provision allowing for a company to recoup training program costs when an employee leaves.

The no-employment clauses at issue in Golden I and Golden II don't fit neatly into any of these boxes. Instead, they make clear that Dr. Golden won't work where CEP is contracted to provide services, now or in the future. The Ninth Circuit concluded that a clause pertaining only to Dr. Golden's employment at CEP wasn't problematic and was so limited that it didn't meet the "significantly or materially" impeding test it created.

The other provisions in the draft settlement agreement, however, were void under Section 16600. Those prohibited his current and future employment at CEP-contracted facilities. The court's analysis suggested that it was focused more on results and less on methodology. For instance, it emphasized CEP's expansive reach into California medical facilities. But it also downplayed Dr. Golden's admissions concerning his medical specialties, which suggested that the restraint in practice might not be that onerous.

To be sure, it's hard to make much of this case. I suspect that it's so factually goofy that any other case that deals with obliquely limited clauses having some peripheral impact on employment will easily be able to navigate around the court's rationale. About all the case may do for practitioners is reinforce the reach of Section 16600 and solidify that true covenants against competition are almost certain to fail, even if those covenants are very specific and narrow. 

Back from Hiatus (Part II): State Law Updates

Last week, I discussed three examples of Illinois courts analyzing similar non-compete issues in very different ways, a post that amply illustrates how difficult it is for lawyers to predict outcomes for clients. It also reminded me of a famous Abraham Lincoln quote: "Discourage litigation. Persuade your neighbors to compromise whenever you can. Point out to them how the nominal winner is often a real loser - in fees, expenses, and waste of time. As a peacemaker the lawyer has a superior opportunity of being a good man. There will still be business enough."

But to be sure, many people ignore Lincoln and litigate anyway - often with profoundly silly reasons motivating them.

So because we have litigation, we have legal developments and I therefore have a blog that continues to chug along. And you continue to read, meaning I must update you with some new rulings over the past several months.

California:

The infamous, long-running case involving ex-Korn/Ferry International executive David Nosal may have reached its end, with the Supreme Court declining a cert petition and the District Court now having finally decided on the scope of Nosal's restitution to KFI. United States v. Nosal is the most notable case under the Computer Fraud and Abuse Act, which generally criminalizes unauthorized access to protected computers. Nosal had its roots as a garden-variety trade secret case, but it was a criminal prosecution and tested the CFAA's limits.

Ultimately, Nosal secured some victories along the way. But still he will serve a year in prison and pay restitution to KFI. As to the scope of restitution, KFI sought about $1,000,000 in legal fees incurred to assist the Department of Justice investigation. After the Ninth Circuit weighed in KFI, will have to settle for less: $164,000. Still a heavy price to pay for Nosal, who probably deserved a civil suit but definitely does not deserve to spend a year in prison.

Connecticut:

The case of Datto, Inc. v. Falk discussed whether a forfeiture-for-competition clause was reasonable and enforceable. A minority of jurisdictions apply the same, or at least a similar, non-compete standard to these clauses, which (as one might expect) enable an employer to clawback certain benefits if an employee leaves to compete.

Forfeiture clauses range in scope, frequently calling for the forfeiture of unvested stock options but sometimes also calling for the employee to pay back income earned from the exercise of a grant within a certain period before the end of employment. Datto involved a dispute as to whether the cancellation of certain stock options were void because Falk (an ex-Chief Revenue Officer) accepted a position with a competitor.

The court was bound to apply Delaware law on the question of reasonableness, and that law in my view is somewhat confusing. Precedent, in effect, equated true non-competes with forfeiture clauses, finding they accomplished the same results. That's not necessarily true. A forfeiture clause may incent future performance, while a non-compete unquestionably tries to protect a separate economic interest beyond employee loyalty.

Datto illustrates the confusion in its analysis, though the district court judge admittedly was bound by controlling law. He noted, for instance, that the forfeiture clause was reasonable because "[t]his is not a case of an employee who is barred altogether from working for the competition anywhere in the world."

In my opinion, courts ought to use varying levels of scrutiny when examining restraints, similar to the current First Amendment jurisprudence. Specifically, I think that for employment-based non-competes, courts should use the strict scrutiny test (which by and large, they say they do), and for sale-of-business non-competes, they should examine them under a rational basis inquiry.

For mid-tier restrictions, like franchise non-competes and forfeiture clauses like that in Datto, I would use intermediate scrutiny. That test would require courts to determine whether the restrictive means used (e.g., the scope of the event triggering the forfeiture) are substantially related to the interest the restraint is designed to protect. This test, though it may not be perfect, would at least provide courts with a flexible, coherent way to analyze less problematic covenants that lack adhesive properties.

New York:

The New York Court of Appeals answered a significant question of damages related to trade secrets claims in the case of E.J. Brooks v. Cambridge Security Seals. The Court held that a plaintiff's damages cannot be measured by the costs the defendant avoided due to unlawful activity.

If a principal goal of trade secret law is to encourage innovation, then a cost-avoidance theory of damages seems to be a logical means to further that goal. Stated another way, if the misappropriation shortens a product-development cycle and enables X to bring a product to market more efficiently, then X is unjustly enriched by not incurring research-and-development expenses.

In the Court's view, cost-avoidance is inconsistent with a compensatory theory of damages. And under New York law, only the plaintiff's losses count. Cost-avoidance theory resembles unjust enrichment, but because New York has not adopted some variation of the Uniform Trade Secrets Act -- which specifically allows for unjust enrichment-type damages -- the theory is not viable.

The holding, predictably, spurred a long and persuasive dissent. It summarized the pragmatism and utility of cost-avoidance damages, noting that they are "generally much simpler than, and less subject to challenge than, lost-profit damages, which makes them an attractive alternative for plaintiffs who are willing to forego a potentially larger recovery in favor of a smaller, more certain one." (The assumption of a "smaller" recovery reasonably invokes the principle that a developer does not spend X to recover X. Normally, a rational economic actor would spend X to recover some multiple of X.)

A link to E.J. Brooks is available here. I emphasize again that I view this as a distinctly New York rule of law, and not one likely to be adopted across jurisdictions that have embraced a more flexible approach to damages.

South Carolina:

In Hartsock v. Goodyear Dunlop Tires North America, Ltd., the Supreme Court of South Carolina recognized an evidentiary privilege for trade secrets, but held the privilege was "qualified." That means it is different than, say, an attorney-client privilege or one barring self-incrimination. By "qualified," the Court held that a party seeking the disclosure of trade-secret material must show a "substantial need" for it that is relevant to the specific issues involved in the litigation. If a proponent makes that showing, the trade-secret holder still can gain the benefit of a protective order over the compelled disclosure.

The decision is, to be certain, a weird one. This is not really a privilege rule, but rather a rule of discovery that calls upon courts to make a balancing decision. If anything, this rule will create confusion where none should exist.

Texas:

Everything is bigger in Texas, including damages and attorneys' fee judgments. In the long-running case of Quantlab Technologies v. Godlevsky, a federal district court awarded the plaintiff its attorneys' fees in a trade secrets suit for what the court called defense behavior that was "so acrimonious, vexatious, and indefensible that...[it] exceeds any that this judge has seen in his nineteen years on the bench." The case involved stolen technology in the high-frequency trading industry, and the court at various times had sanctioned the defendants for destroying or failing to preserve evidence.

The price for that behavior was a fee judgment of $3,220,205 against each individual defendant.

The plaintiff didn't fare so well in GE Betz v. Moffitt-Johnston. There, the Fifth Circuit held that under Texas law, a company failed prove than ex-employee breached a customer non-solicitation covenant. The employee succeeded despite "highly suspicious" computer activity, including the mass download of data to an external device. But the company couldn't prove that any contacts with customers amounted to solicitation of business, rendering the contract claim unsupportable.

The Fifth Circuit did, however, vacate a large fee award for the ex-employee. Texas law allows an employee sued on a non-compete violation to obtain fees if the employer knows the agreement is overbroad and sues to enforce the agreement to an extent greater than necessary to protect the employer's interests. That's a hard standard to meet, absent some damaging admission or a truly terrible agreement. And the employee here didn't do so. 

Back from Hiatus (Part I): Illinois Case Law Update

I've been uncharacteristically quiet about the subject of restrictive covenants, consumed (somewhat mercifully) by other cases in other areas of the law.

But the flow of non-compete decisions does not stop for those who venture astray, and so it appears I have some catchin' up to do.

I'll start with my home State (for now) of Illinois, where we have high taxes and a high output of non-compete cases. The federal district courts in Illinois churn out a lot of interesting non-compete cases. Those decisions, too, tend to be influential. For instance, most Illinois courts have decided to break from appellate case law on the employee at-will consideration rule that has generated some buzz (and some appellate work for yours truly).

Non-Competition Covenants and Motions to Dismiss

One example of this independence from the federal bench is the case of Medix Staffing Solutions Inc. v. Dumrauf. Judge Sara Ellis granted a motion to dismiss a non-compete claim that Medix brought again a former Director of Business Operations. The decision was notable - and fairly bold - since Illinois courts have suggested that enforceability and overbreadth questions generally are unsuitable for motions to dismiss. True, you see these teed up more often at summary judgment or even through preliminary injunction rulings. But infrequently, the propriety of a motion to dismiss in the context of non-competes appears in the case law.

The court in Dumrauf found that the employer's non-compete was extreme and facially unenforceable when it barred the employee from working within 50 miles of any Medix office for any business that competed with Medix or that offered a product or service in competition with Medix. Of central concern to the court was the non-compete's prohibition on Dumrauf's work in any capacity for a competing enterprise. The case demonstrates the importance of drafting non-competition agreements with a reasonable scope limitation that is roughly commensurate with the type of job the employee performed at the company (or perhaps one that, if not comparable, would threaten the same type of legitimate business interest).

Judge Ellis lastly declined to modify, or blue-pencil, the non-compete, as is typical of most (but not all) Illinois courts. The deciding factor is usually how close the employer came to being reasonable. But here, the non-compete failed terribly so Judge Ellis said no to rewriting it.

Non-Solicitation Covenants and Motions for Summary Judgment

The employer didn't fare a whole lot better in Call One, Inc. v. Anzine, but the case does show that blue-penciling is not always a pipe dream.

The non-solicitation covenant in Anzine had all the hallmarks of a crapshow. It was (a) not limited to the employee's particular accounts, and (b) included something called "prospective" customers, which unhelpfully covered accounts the company solicited or "had plans to solicit."

Judge Matthew Kennelly found the covenant unenforceable, noting along the way that Illinois precedents in the non-compete field are of "less than usual value." This could mean either that the cases are too fact-specific to be helpful in a subsequent case, or that Illinois state appellate courts are not helpful as a general proposition. Or both.

But Judge Kennelly looked to a reformation clause in the underlying agreement, which contemplated that a court could make an invalid clause valid. Many changes skim over that clause for reasons that are obvious. As a result, he fixed some (but in my opinion not all) of the problems in the non-solicitation clause, such that Anzine was still barred from soliciting company customers (and active prospects as of the date she was terminated) and customers for which she had sales responsibility.

One other observation on this case. Anzine sent a couple of work spreadsheets to her personal email account, but Judge Kennelly found that no jury could find that this rose to the level of "misappropriation" of a trade secret. The self-emailing phenomenon is not new, but in and of itself it is no panacea for a trade secrets claim. Here, Anzine appeared to have plausible reasons for what she did, and the e-mailing didn't occur under suspicious circumstances (like, for instance, a forwarding of documents after notice and before departure). The court's discussion of this is worth a read for practitioners who've dealt with this set of facts before.

Non-Competition Covenants, Non-Solicitation Covenants, and Motions to Dismiss (Redux)

And on the opposite end of the spectrum (somewhat), we have American Transport Group v. Power. There, the court denied the defendant's motion to dismiss a restrictive covenants claim even when problems with those covenants were clearly apparent. The theme running through this case was nearly the opposite of Dumrauf, as Judge Virginia Kendall repeatedly noted that the employer must have the opportunity to develop the record on the question of reasonableness.

The non-compete precluded a freight broker's salesman from working for any competitor for three months, regardless of geographic location. I have a lot to say about the freight brokerage business, but that's beyond the scope of this. It is true, however, that geography seems to matter very little for sales people who work the phones contacting shippers (that is, customers) and arranging carriers. So I wasn't terribly bothered by the three-month clause or the lack of a geographical limit, as much as I am bothered by the use of non-competes in this industry entirely.

The non-solicitation clause though was a problem, and I think Judge Kendall should have found it unenforceable. It barred Power, for one year, from soliciting or diverting any customer or carrier of his employer. The court provided little analysis here, but I am uncertain how ATG ever could restrict the employee's use of a carrier (in effect, a supplier) when freight brokers all deal with the same carriers. Seems gratuitous.

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So what lessons did we learn today? Judges reach different holdings on similar facts. Companies still have a lot to learn when drafting agreements. Lawyers will keep getting business because this stuff ain't going away. And your author can't take a month off again, because the cases keep piling up.

Justice Thomas and Questions About Severability

A lot can be said about Justice Clarence Thomas. Some of it bad, but much of it quite good. For those who assert he is one of the worst Supreme Court justices of all time, take that for what it is good. Toxic political commentary and sheer uninformed drivel.

The best of Justice Thomas comes out in the now-familiar lone-wolf opinion, whether concurring or dissenting. His unique views span a wide range of the legal landscape, from the Eighth Amendment to the collateral-order doctrine to qualified immunity. Whether you agree with those views or not, they spark discussion and offer an idiosyncratic viewpoint that often makes a great deal of sense.

He expressed another one of these views again last week in Murphy v. NCCA on the issue of severability, which comes up in the Court's constitutional jurisprudence from time to time.

Put simply, the severability doctrine arises when the Court strikes at least part of a statute as unconstitutional. The question then becomes whether the Court should "sever and excise" the offending parts while saving the remainder.

Justice Thomas would like to reexamine that doctrine and has doubts that it is an appropriate part of constitutional analysis for two reasons: (1) it does not follow statutory interpretation principles, because by definition it requires courts to determine what a legislature would have done had the unconstitutional parts of the statute never been enacted at all; and (2) it requires courts to render an advisory opinion on issues the parties aren't fighting over.

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You may be asking: what the hell does this have to do with non-compete agreements, which is after all sort of the point of this blog.

The connection, however loose or attenuated, is that non-compete law has its own severability principle and it's not all that dissimilar from what Justice Thomas discussed.

In Illinois, the general rule on contract severability is this: a court may enforce the valid parts of an agreement "in favor of a party who did not engage in serious misconduct if the performance as to which the agreement is unenforceable is not an essential part of the agreed exchange." That framework generally parrots the Restatement (Second) of Contracts, Section 184. And to further clarify the rule, whether an unenforceable term is an "essential part" of the contract depends on the relative importance of the term in light of the entire agreement between the parties.

The black-letter formulation of this rule thus invokes some of the concerns Justice Thomas outlined in his Murphy concurrence. Assume the following very realistic hypothetical scenario:

• Employee signs agreement containing broad non-compete clause and narrow non-solicitation of customers clause.
• Employer focuses its case on customer solicitation, but appears to agree that employee can work for competitor despite the nominal presence of the non-compete in the contract.
• Employer is generally successful in showing actual solicitation and that the circumstances render the non-solicitation enforceable.
• Employee proves that the facts make the non-compete gratuitously overbroad.

In such a circumstance, what do we make of the severability rule? It is clear in my hypothetical that part of the agreement is unenforceable, but does that doom the non-solicitation covenant? Under Illinois law, the employee may have a winning argument if circumstances show that the non-compete was integral to the overall contract formation. For instance, she could show the following:

• Employer insisted that it be included, despite the employee's objections to the broader non-compete.
• The contract recitals suggest all provisions of the agreement work in unison, are all needed to protect confidential information, or are each integral to the contract.
• The Employer threatened to enforce the non-compete in an early cease-and-desist letter.

At least if we apply Justice Thomas' reasoning, the severability principle may be a big distraction if the employer isn't attempting to enforce it in court. In other words, the defendant would be addressing a counterfactual: yes, your Honor, but if Employer did try to enforce it, it would lose. Depending on the facts, though, Justice Thomas' stated concerns over an advisory opinion may be overstated. 

The prevailing law on severability then diverges a bit from Justice Thomas' analysis and focuses less on whether the employer would have entered into the agreement with the employee if it had known the non-compete wouldn't have been enforceable and instead more on whether the offending non-compete covenant was an essential part of contract formation. On this score, the analysis does not seem to raise the judicial power concerns Justice Thomas discusses in Murphy and rather focuses on the circumstances at signing. 

The arguments for and against severability are not easy to resolve. Justice Thomas' opinion, though, clarifies in a very straightforward way the tension surrounding them.