Executive's Ambiguous Acceptance of Non-Compete Prevents Enforcement by IBM (IBM v. Johnson)

Non-compete disputes almost always turn on whether the agreement is reasonable or supports a legitimate business interest.

Rarely do they depend on whether the contract was signed in the first place. But that was in fact the principal issue in another case involving IBM and a high-level executive. This case involved the departure of David Johnson, IBM's former Vice-President of Corporate Development, who left IBM earlier this year to take a position as Senior Vice-President of Strategy with Dell, Inc.

IBM immediately filed suit seeking preliminary injunctive relief against Johnson for breach of a non-competition agreement that was purportedly signed back in 2005. Johnson defended on the basis that he never properly signed the contract - and never intended to be bound to the same. The district court agreed and denied IBM's request for injunctive relief, opining that IBM faced a near insurmountable case at a trial on the merits.

Johnson, a highly paid and long-time IBM employee, was clearly reticent to sign a non-compete agreement for one overriding reason: he had foregone an opportunity to become a general manager at another technology company in reliance on assurances he received that a similar opportunity would be made available to him at IBM. That opportunity never came to pass.

In 2005, IBM began requiring its executive to sign non-compete agreements as a condition of receiving equity grants. Johnson attempted to buy as much time as possible and delayed signing his contract. Eventually, he pulled what turned out to be a brilliant move - he signed the agreement on the line designated for IBM.

Johnson returned the document to IBM, and it was clear this caused a great deal of confusion among human resources employee and in-house lawyers. In reality, Johnson's move could have backfired because, as the court noted, his ambiguous "acceptance" of the non-compete agreement meant that he assumed the risk of how IBM responded. Put differently, IBM's reaction was critical to determining whether the agreement had ever been truly accepted as a matter of New York contract law.

So what did IBM do? They repeatedly tried to get Johnson to sign his agreement again, imploring him on several occasions to return a properly executed contract and threatening to withhold equity grants. In short, IBM clearly believed Johnson had not intended to be bound when he signed the non-compete on the wrong line.

Johnson himself testified he did this simply to buy more time. IBM's general counsel even told Johnson to save any documentation from human resources about its efforts to get him to sign another contract. The facts demonstrated that IBM's reaction to Johnson's ambiguous acceptance was clear. No one believed he had intended to be bound by the non-compete, and no one believed his clever misdirection created a binding contract.

--

Court: United States District Court for the Southern District of New York
Opinion Date: 6/26/09
Cite: IBM v. Johnson, 629 F. Supp. 2d 321 (S.D.N.Y. 2009)
Favors: Employee
Law: New York

"Management Personnel" Exception to Colorado Non-Compete Statute Accorded Plain Meaning (DISH Network v. Altomari)

Last week, I wrote on one of the several exceptions contained in Colorado's non-compete statute, which presumptively voids restrictive covenants. That exception permitted reasonable non-competes to protect trade secrets, a curiously worded exception which could swallow the entire rule with some artful contract drafting.

Today, I review a case addressing a more sensible exception, one which finds parallels in other states' non-compete laws. The particular carve-out allows reasonable non-competes for "executive and management personnel and officers and employees who constitute professional staff to executive and management personnel." (As a grammatical aside, never underestimate the power of a group of hack legislators to forget basic comma usage norms.)

At issue in DISH Network v. Altomari was a trial court's ruling which refused to apply this exception to a communications director for DISH Network who supervised about 50 employees. Altomari signed a non-compete in connection with the issuance of stock options and sought to leave for DirecTV, a competitor specifically named as a prohibited entity in the non-compete clause.

The trial court made certain factual findings that Altomari was a mid-level manager and that he had definite management responsibilities. However, it found that he was not the type of management personnel contemplated by the statute.

The Court of Appeals of Colorado reversed, finding the trial court erred by not applying the plain meaning of the legislative exception. The court noted that the General Assembly chose not to define the term "management personnel", and that this required it to apply the term according to its plain meaning. The court then concluded that because the trial court found Altomari to be a mid-level manager vested with decision-making autonomy, he qualified as "management personnel" under the statute.

Other states have gone further than Colorado in defining key employees who are otherwise subject to non-compete arrangements, though sometimes this seems to add to the confusion. In Altomari's case, DISH Network showed he had enough autonomy and controlled enough decisions to fall within the legislative exception.

--

Court: Court of Appeals of Colorado, Division One
Opinion Date: 6/25/09
Cite: DISH Network Corp. v. Altomari, 2009 Colo. App. LEXIS 1178 (Colo. Ct. App. June 25, 2009)
Favors: Employee
Law: Colorado

Drafting Non-Competes In Colorado Poses a Different Challenge (Haggard v. Synthes Spine)

In Illinois and many other states, non-competition covenants are often wrapped into broader employment agreements with little risk that this would pose any sort of hurdle to enforcement. But because non-compete law varies so significantly from state to state, this common practice may not be a great idea elsewhere.

Colorado, for instance, is one state where non-competes are regulated by state statute. The governing law generally consideres covenants void unless they meet one of four specific exceptions. Sale of business covenants generally are valid if reasonable, and courts also will uphold covenants given by "executive and management personnel." For salespersons who do not qualify as a key employee under this latter, fact-intensive exception, a covenant still may be valid if it is "for the protection of trade secrets."

Courts in Colorado generally require the purpose of the covenant to be trade secret protection. A recent case involving a dispute between a salesperson and a medical device company illustrates the importance of good, careful drafting. The court in Haggard v. Synthes Spine found that a non-compete met the purpose test in Colorado, noting specifically that the non-compete agreement carefully spelled out the exact type of information the employer sought to protect. The employer also deemed it important that the contract did not contain other provisions related to job responsibilities, pay or salary, or other incidents of the employment relationship.

This rule seems a bit technical, suggesting that a comprehensive employment agreement containing covenants and other promises regarding employment may not satisfy Colorado's statute. In other words, for a non-management employee, an employer may be better off drafting two separate agreements - one focused entirely on trade secrets and any covenants against competition intended to protect those secrets.

The opinion in the Haggard case itself was somewhat simplistic regarding the specific "trade secret" information to which the ex-employee had access. The court, like many, sort of assumed that product knowledge and customer data (e.g., contact persons, preferences) were trade secrets, though opinions are all over the map on this issue with the better reasoned approach being that employers ought to really show this information is more than just "confidential" or general knowledge learned during the course of employment. In view of its conclusion, the court enforced both a client non-solicitation and industry non-compete covenant.

Of course, the type of operational information in Haggard could be considered confidential, given its obvious importance but relatively fleeting lifespan (a fact admitted to by the employer in Haggard), and this may very well justify a covenant not to compete. But the statute requires protection of actual trade secrets - not confidential information - and so an analysis basically assuming that every bit of data about customers or products in development is a trade secret seems overly succinct and kind of silly.

--

Court: United States District Court for the District of Colorado
Opinion Date: 6/12/09
Cite: Haggard v. Synthes Spine, 2009 U.S. Dist. LEXIS 54818 (D. Colo. June 12, 2009)
Favors: Employer
Law: Colorado

Missouri Decision Summarizes Difference Between Trade Secret and Confidential Information (Brown v. Rollet Bros. Trucking)

In assessing the validity of a non-compete agreement, courts are frequently called upon to assess whether an employer has a legitimate business interest in need of protection. Most states classify trade secrets and customer contacts as protectable interests, and Missouri is no exception.

The recent Missouri appellate decision Brown v. Rollet Bros. Trucking is notable in at least one respect. In affirming the trial court's declaration that a commercial trucking dispatcher's non-compete was invalid, the court examined whether the employee's access to a rate sheet and other pricing information implicated trade secrets concerns.

The court made a distinction between access to an actual trade secret and less valuable confidential information, the latter not amenable to protection through a non-compete. In Brown, the dispatcher was given access to a rate sheet listing his ex-employer's shipping rate and fuel surcharges. That sheet was adjusted at various times - sometimes monthly, sometimes annually. Relying on long-standing Missouri precedent, the court found that this type of confidential information was not a trade secret.

In so holding, the court specifically noted the key difference between the two legal concepts: confidential information is generally limited to a single or ephemeral event in the conduct of a business, whereas a trade secret is a process or device for continuous use in the operation of a business. With respect to pricing out a customer job, a trade secret can be found if the employer uses a specifically developed code or formula to churn out bids. However, as in the Brown case and in countless other fields, pricing information is often fleeting with sales managers given vast discretion to match a competing bid or adjust prices based on a fluctuating cost of materials.

When assessing whether information is truly a trade secret, or merely confidential, attorneys ought to consider whether the information is fleeting and subject to becoming outdated relatively quickly. A set of engineering diagrams, manufacturing processes or other formulas used consistently in the operation of a business differ markedly from rapidly evolving operational information which can become useless after even a short period of time.

--

Court: Court of Appeals of Missouri, Eastern District, Division Four
Opinion Date: 6/16/09
Cite: Brown v. Rollet Bros. Trucking Co., Inc., 291 S.W.3d 766 (Mo. Ct. App. 2009)
Favors: Employee
Law: Missouri

Choice of Law Ends Inevitable Disclosure Case Between Consumer Products Titans (Clorox Company v. S.C. Johnson & Son)

The most interesting inevitable disclosure cases tend to involve the migration of key executives from one direct competitor to another. The cases involving Bill Redmond and Mark Papermaster, among others, have served as influential precedents and will continue to do so for many years.

Another recent executive defection, this time between two well-known consumer products companies, ended with somewhat of a thud.

S.C. Johnson & Son - makers of Ziploc, Drano and Nature's Source - hired away Timothy Bailey to serve as Vice-President of Product Supply. Formerly, Bailey worked in a similar position with Clorox Company, makers of Glad bags, Liqui-Plumr and GreenWorks. Clorox filed suit in Wisconsin against SCJ only, contending that its hiring of Bailey resulted in trade secrets misappropriation. The gist of Clorox's complaint relied on the inevitable disclosure theory of misappropriation, though there were enough conclusory allegations of threatened misappropriation to withstand a motion to dismiss.

The case hinged on choice of law. Clorox chose not to sue Bailey for obvious reasons - the PepsiCo v. Redmond case. Since Clorox and Bailey were California residents, adding him would have destroyed diversity of jurisdiction and Clorox would not have been able to sue in a district court within the Seventh Circuit where PepsiCo remains a significant precedent. It could have sued in Wisconsin state court, but convincing a state court to apply a Seventh Circuit case, which itself applied llinois law, would have been much more of a challenge. And Wisconsin has not adopted the inevitable disclosure theory, so Clorox really had to hinge its case on PepsiCo.

SCJ predictably argued California law applied, and the court agreed. Because of the vague nature of the allegations concerning threatened misappropriation of trade secrets, Clorox lost the injunction motion. In finding California law applied, the court considered a number of important factors, among them the following:

(1) Clorox and Bailey entered into an employment relationship in California, and Bailey apparently executed a confidentiality agreement governed by California law;

(2) California had a significant interest, given its hostility to non-compete agreements and refusal to recognize a closely related doctrine - the inevitable disclosure claim;

(3) The law concerning inevitable disclosure under California law was clear, whereas no Wisconsin case addressed the issue.

The court did mention that the trade secrets which Clorox would have to disclose must have been developed or maintained in California.

--

Court: United States District Court for the Eastern District of Wisconsin
Opinion Date: 6/9/09
Cite: The Clorox Co. v. S.C. Johnson & Son, Inc., 627 F. Supp. 2d 954 (E.D. Wisc. 2009)
Favors: Employee
Law: California

Intellectual Laziness Threatens Most Liquidated Damages Clauses (Coffman v. Olson & Co.)

Two summers ago, I authored an article in the Illinois Bar Journal concerning liquidated damages provisions in non-compete agreements. My research at the time revealed that most provisions which courts voided as an impermissible penalty were the product of sloppy lawyering.

The black-letter law concerning liquidated - or agreed - damages clauses is fairly consistent from state to state. Actual damages must be difficult to calculate, and the fixed damages must be a reasonable forecast of the damages likely to occur. Failure to satisfy both conditions means the clause is an unenforceable penalty.

The exercise in drafting an enforceable liquidated damages clause is not rigorous, nor should it be. But judging by some of the clauses that end up getting litigated, one would think writing a legally compliant liquidated damages provision is a herculean challenge.

In Coffman v. Olson & Co., the Court of Appeals of Indiana found a liquidated damages clause in a non-compete agreement to be an unenforceable penalty. The case generally involved an accountant who breached a client non-solicitation provision in his employment agreement. That agreement contained a liquidated damages clause requiring the employee to pay the employer as fixed damages the sum of two times the previous year's billings for any client taken in violation of the non-compete. For some unknown reason, the clause trebled the amount if the employee failed to notify his ex-employer of the breach.

The court had little trouble in finding the clause was an unenforceable penalty. The reason: the shotgun clause increasing the damages from two times gross revenues to three times gross revenues bore absolutely no relationship to actual damages and was intended strictly to penalize the employee for a breach.

This is a common, though still inexcusable, mistake, and it's either the product of overlawyering or underlawyering a contract. Interestingly, the court cited a number of past Indiana cases where liquidated damages clauses were void when the fixed sum of damages did not vary with the type of breach. For instance, if the same damages penalty applies to both a breach of a client non-solicitation provision and a provision requiring an ex-employee not to contact former co-workers (clearly a less severe breach), then the clause is inherently punitive, not to mention nonsensical.

In my practice, I frequently review or litigate liquidated damages clauses where this problem occurs. The clause will relate to any breach of post-employment covenants, but will make no distinction between the type of breach. I have seen a capitalization of revenue clause similar to that in Coffman, which was intended to redress an improper client solicitation, apply with equal (and still quite unconvincing) force to a non-disparagement or non-disclosure covenant. Invariably, they defy logic.

Attorneys don't need to invest a lot of time to get this right, but few do. The result is that many types of liquidated damages clauses get thrown out.

--

Court: Court of Appeals of Indiana
Opinion Date: 5/18/09
Cite: Coffman v. Olson & Co., P.C., 906 N.E. 2d 201 (Ind. App. Ct. 2009)
Favors: Employee
Law: Indiana

Lack of Key Non-Compete Can Hurt Secured Creditors In Chapter 11 Valuation (In re Olio Dental)

In a Chapter 11 proceeding, a secured creditor may file a proof of claim valuing the business well above what the debtor believes is accurate. If the debtor intends to carry on the business in the normal course, the court must not look to liquidation value of the business' assets, but rather must examine the use value or fair market value of secured property.

In a recent bankruptcy case involving dental equipment business, HSBC took a security interest in the debtor's "general intangibles of every kind." When assessing the debtor's objection to the proof of claim it filed, the bankruptcy court noted that "the valuation must take into account the value of the business going forward."

However, the debtor's principal had no employment or non-compete agreement, and in the words of the court, "could walk away from this practice and open a new business across the street taking many of debtor's customers with him." Accordingly, the court had to examine fair market value considering the absence of any non-compete binding the debtor's principal.

The result: HSBC's proof of claim estimated the value of its collateral between $375,000 and $500,000. The court valued the secured collateral at just over $100,000 and held HSBC was unsecured as to the balance of its claim.

--

Court: United States Bankruptcy Court for the Southern District of Indiana
Opinion Date: 5/26/09
Cite: In re Olio Dental, Inc., 2009 Bankr. LEXIS 1248 (S.D. Ind. May 26, 2009)
Favors: N/A
Law: Federal

Proving Inevitable Disclosure No Easy Task Against Salesmen (American Airlines v. Imhof)

The "inevitable disclosure" theory is by no means a panacea. In my opinion, it is more a tactic than a theory. For those unfamiliar, the doctrine serves a proxy for the term "misappropriation" in a trade secrets case. Put differently, instead of proving that a defendant misappropriated a trade secret - which are the basic elements of the case - a plaintiff need only establish that it's inevitable he or she will do so.

Because application of the document can be tantamount to an implied non-compete, courts are understandably reluctant to apply it with any force.

Last year's dispute between IBM and Mark Papermaster was somewhat of an anomaly, and people forget Papermaster had a non-compete. The case wasn't just about inevitable disclosure. The doctrine helped aid enforcement of the agreement. The tougher cases involve employees who have no non-compete agreement, but who arguably have access to trade secret information.

Another New York case provides 2009's most significant inevitable disclosure case to date, and it yields another employee-friendly result. The case involved the resignation of Charles F. Imhof, a senior-ranking employee of American Airlines' New York Sales Division, who depared and left for Delta Airlines in a very similar capacity. Imhof had no governing non-compete agreement with American.

Not long before Imhof quit American, he e-mailed to a family account certain corporate documents, one of which was a 2008 sales presentation on Power Point. He also bought a personal digital assistant and transferred some of his business contacts to a personal hand-held device. Imhof's departure was, initially, far from acrimonious - even when he disclosed where he was going. However, when American found out he e-mailed himself business information, it made a demand to Delta that Imhof cease working altogether.

At this point, Delta did what most sophisticated entities are doing now in the face of such demands. It conducted a litigation trade secrets audit, which included the following:

(a) immediately disclaim any need for Imhof's American Airlines documents;
(b) facilitate destruction or complete return of the same; and
(c) conduct a thorough inspection of any digital medium to confirm no traces of the information.

Ultimately, those steps - along with the fact Imhof did not appear to have sent anything to Delta - ruined American's chances to succeed on the inevitable disclosure doctrine.

District Judge Kaplan issued an interesting, thorough opinion. Of particular interest were the following comments:

(1) He found Imhof was not a threat to disclose any corporate information of American because Delta demonstrated no interest in anything and because the litigation itself obviously was a strong deterrent from doing anything suspicious in the future;

(2) Though Imhof did copy and send to himself a few documents, he did not copy a lot, which suggested a less-than-nefarious intent;

(3) Imhof was a sales manager - albeit a highly positioned one - not, in the words of the court, a "food chemist privy to the secret formula for Coca-Cola. The document upon which American relied was a 2008 sales presentation that contained rote talking points about how good the company was or what ends it sought to achieve (which, presumably, someone in sales would want known to others).

The last point is, in my opinion, most important because the theory of inevitable disclosure as applied to salesmen is considerably more abstruse. Access to "sales strategies" or "customer information", for instance, may sound interesting in theory, but it's tough to apply and define as a trade secret.

Sales operational information tends to become stale quickly and may be widely known or publicly available (as was the case with Imhof). Furthermore, it's highly general. The following key passage from Judge Kaplan's opinion elucidates this point rather powerfully:

"The lack of detailed information concerning what Mr. Imhof allegedly knows and why it is both confidential and important means that American essentially asks me to accept the word of those of its personnel who have described these matters in the most general of terms for the proposition that the details, whatever they may be, in fact would be harmful to American if used against it by Mr. Imhof at Delta. But, at the risk of banality, the devil is in the details. Without them, it is extremely difficult for me to know exactly what information American fears that Mr. Imhof inevitably would retain in his memory..."

--

Court: United States District Court for the Southern District of New York
Opinion Date: 6/3/09
Cite: American Airlines, Inc. v. Imhof, 2009 U.S. Dist. LEXIS 46750 (S.D.N.Y. June 3, 2009)
Favors: Employee
Law: New York

Meaning of "Solicitation" Strictly Construed In Favor of Employee (Resource Associates v. Maberry)

Customer non-solicitation covenants tend to be the most commonly enforced restraints of trade. The general rule is that this type of activity restraint is narrowly tailored to prevent an employee from capitalizing on her ex-employer's client goodwill, while still allowing that employee to ply her trade.

Still, non-solicitation covenants are restraints of trade and will be strictly construed against the employer. One issue that often arises concerns the meaning of the term "solicitation." Generally, courts will examine the employee's intent in contacting a client to determine whether a solicitation has in fact occurred. Employees frequently claim that the client approached them first, and that no solicitation occurred.

That was the issue in Resource Associates v. Maberry, and the court held that a non-solicitation clause which only prohibited the employee from "approaching" customers of the business did not include passive acceptance of work when those clients sought out the employee. Of particular importance to the court was the fact that the following paragraph - an employee no-hire clause - used broader terms such as "solictation" and "enticement." These terms may be synonymous, but the court found that the intent of the client non-solicitation covenant was quite limited.

Attorneys drafting non-solicitation clauses for business clients can easily avoid a problem like this and provide that an employee cannot "solicit, contact, take away, or accept business from" a defined list of the employer's clients.

--

Court: United States District Court for the District of New Mexico
Opinion Date: 4/23/09
Cite: Resource Associates Grant Writing and Evaluation Services, LLC v. Maberry, 2009 U. S. Dist. LEXIS 45666 (D.N.M. Apr. 23, 2009)
Favors: Employee
Law: New Mexico

Grant of Stock Options Not Sufficient Consideration for Non-Compete Agreement (Marsh USA v. Cook)

The best way to predict the outcome of a Texas non-compete dispute is to take every instinct you have as an attorney and do the opposite.

Texas is notoriously employer-friendly, and courts hand out injunctions like garage band flyers. But the Texas Supreme Court has interpreted one aspect of the Covenants Not to Compete Act fairly narrowly. That provision requires a covenant to be ancillary to an otherwise enforceable agreement. The Court has interpreted that phrase to mean that the covenant must "give rise to the employer's interest in restraining the employee from competing." Generally, employers are able to satisfy this requirement by agreeing to provide employees with confidential or proprietary business information. According to Texas courts, this is intrinsically related to the restraint, because the covenant protects potential use or disclosure of confidential information.

The odd part of this rule, however, is that financial consideration does not "give rise to" the interest in preventing competition. In Marsh USA v. Cook, the Court of Appeals held that an employer's covenant not to compete was invalid when the employee's consideration was a grant of stock options.

Most states would hold the opposite - that financial consideration is indeed valuable enough to support a non-compete. Even employee-friendly states such as Illinois would not invalidate a covenant on grounds of inadequate consideration if the employee was given stock options. In fact, giving an employee an equity stake in exchange for a non-compete is generally viewed as far less problematic when assessing the reasonableness of the covenant.

But, alas, Texas goes its own way again. At least we haven't heard all that secession talk of late.

--

Court: Court of Appeals of Texas, Fifth District, Dallas
Opinion Date: 5/26/09
Cite: Marsh USA, Inc. v. Cook, 287 S.W.3d 378 (Tex. Ct. App. 2009)
Favors: Employee
Law: Texas