Post-Reliable Fire, Illinois Courts Are Really All Over the Place

When the Supreme Court of Illinois rendered its decision in Reliable Fire Equipment Co. v. Arredondo, I really didn't think much had changed. Though I suspected courts would be less susceptible to motions to dismiss, Reliable Fire really did not set forth any hard-and-fast rules - even if it did broaden the types of interest a company can protect through a non-compete agreement. In essence, I thought employers might have a slightly easier time enforcing contracts than in the past.

Less than a year later, courts continue to struggle with Reliable Fire in application. The problem continues to be that each judge views non-competes differently, and that very few generalist judges are in the position of reading the 150 or so Illinois decisions to try and reconcile cases all over the map. Further, there are very few areas of commercial litigation that call upon courts to make policy judgments and to resolve tensions with significant public interests at stake.

But non-compete litigation poses a number of challenges for litigants, attorneys, and judges. For instance, it's widely assumed - rightfully so - that only the most extreme non-competes will be tossed before discovery. This is what Judge Holderman held a week or so ago in Instant Technology, LLC v. DeFazio, 2012 U.S. Dist. LEXIS 90911 (N.D. Ill. June 26, 2011). That case involved a three-year non-solicitation covenant in the IT staffing business - one of my top three markets for non-compete litigation (insurance agents and medical device sales run a solid one and two). Citing Reliable Fire, Judge Holderman noted that the three-part reasonableness test requires a court to balance the totality of the circumstances to determine whether a covenant is enforceable.

But the Appellate Court of Illinois looked at the issue differently in Kairies v. All Line, Inc., 2012 IL App (2d) 111027-U, when it affirmed a circuit court's order granting judgment on the pleadings in a non-compete case. That dispute involved a declaratory judgment claim brought by an employee who was bound to a two-year non-solicitation/non-compete covenant. The court found that the non-solicitation covenant was unenforceable on its face because it extended to all of the company's customers - not just those the employee contacted or developed. The non-compete proved an easier analysis, because it was an outright prohibition on competition anywhere (though, for some reason, the court never notes the absence of a geographic term).

The really screwy part of this is that the Kairies court held Reliable Fire was of limited impact, since the "principles governing the determination" of the non-solicitation covenant's reasonableness were "well settled and predate Reliable Fire." Essentially, Kairies seems to suggest Reliable Fire only deals with determining the existence of a legitimate business interest, and that prior cases concerning reasonableness were undisturbed.

But this can't be right. If Reliable Fire requires consideration of the totality of the circumstances, and indeed says that the "identical contract and restraint may be reasonable and valid under one set of circumstances...and invalid under another set" then a court must look at the protectable interest and the covenant's language together, with the unique facts of each case.

As an example, a customer non-solicitation covenant may not have the necessary tie in to the employee, which the agreement in Kairies did not. But what if the facts show that the company was small and that all employees had access to, or worked on, all customers' accounts? Or what if the employee was a manager, such that he had indirect contact with (but extensive knowledge of) a wide range of customers?

This is not to say that some agreements are so patently overbroad that a pre-discovery motion is never a useful tool to dispose of a case. But there is no way that the Supreme Court intended for Reliable Fire to be interpreted so narrowly.

It's hard to say whether Kairies will be revisited on a motion to reconsider. It has a shaky foundation. At this point, it's non-precedential (why, I don't know...) under Rule 23. For lawyers, the case is a continuing reminder that they must be careful advising clients on enforceability. Courts just continue to miss significant legal issues.

A final word. I am not defending the contract provisions in Kairies. They weren't the greatest, and perhaps the employer deserved its fate. The policy rationale, and the potential impact, for future cases, though, is of real concern.

New Hampshire Employer Alert: Notice Required for Non-Compete Agreements

A few years ago, Oregon enacted legislation requiring that employers give employees notice they will have to sign non-compete agreements. New Hampshire has just followed suit.

In a statute passed May 15 - to take effect July 14 - employers in New Hampshire must provide a copy of any "non-compete or non-piracy agreement" to an employee or potential new hire. The terms are not defined, but it seems obvious any restriction on competitive conduct or solicitation (or employees or customers) would fall within the statute. Less certain is whether a non-disclosure agreement would, though the text of the agreement suggests it wouldn't.

The statute also applies to a "change in job classification." As Seyfarth Shaw's blog points out, this too is not defined and could include a promotion, demotion, or lateral move. I doubt it would include a change in pay, since that doesn't seem to alter how one is classified.

The law is vague enough that crafty lawyers will soon litigate over its meaning.

I don't think it's worth reading too much into this, though. Smart employers should provide a copy of a non-compete to a new hire with reasonable notice. This helps mitigate any consideration defense, to be sure. But it also is a sound business practice. Experience shows that employees are more satisfied and less likely to leave if they feel as though they have been treated fairly by their employers.

Case Update...The Trade Secrets Edition

I've come up with a better way to differentiate between trade secrets (protected nearly everywhere by statute) and confidential information (somewhere protected by the common law; more often, by contract). I may be totally off-base on this, but here goes.

A trade secret is a form of intellectual property whose value can be monetized like a patent or trademark. Confidential information is information that generally is not available to outsiders but which lacks independent value as a firm asset.

(I actually thought of this yesterday while changing a diaper.)

We're in the dead of summer, but the law continues to churn out interesting cases for us nerds to ruminate over.

Inevitable Disclosure in Massachusetts

A preliminary injunction ruling out of the District of Massachusetts rejected a rather expansive view of the inevitable disclosure doctrine. U.S. Elec. Svcs., Inc. v. Schmidt, 2012 U.S. Dist. LEXIS 84272 (D. Mass. June 19, 2012), involved the departure of a national accounts manager who did not have a non-compete agreement with the plaintiff (he actually left to work for a subsidiary two years prior). When a project coordinator followed the manager to a competing electrical distributor, the distributor sued under a variety of theories. Surveying Massachusetts' interpretation of the inevitable disclosure rule, the district court held that the rule is best applied to establish irreparable injury - basically, a protectable interest - supporting a non-competition agreement. It did not approve of using the theory as the foundation for a trade secrets claim. Factually, the claim appeared to be a stretch since the manager had not dealt with the key customer at issue - Dollar Tree Stores - for over two years.

Royalty Damages for Misappropriation

Royalty damages are the back-up plan for victims of trade secrets theft who can't prove lost profits or gains the misappropriator realized. This is a derivative of patent law, and it seeks to figure out a hypothetical licensing price that the misappropriator would pay for the privilege of using the information taken from the owner.

An Arizona court has held that a trade secret owners license fees for other patents and investment costs in developing the trade secret can provide a basis for a royalty award. It also rejected the argument that because a product may never be brought to market - the product involved an intestinal sleeve to treat morbid obesity - damages were inherently speculative. Using corporate finance theory, the court stated that a risky future cash flow is simply discounted with a risk-adjusted rate. The case is W.L. Gore & Assocs., Inc. v. GI Dynamics, Inc., 2012 U.S. Dist. LEXIS 75055 (D. Ariz. May 30, 2012).

Attorneys' Fees In Non-Compete Agreements

What happens when an employee wins a non-compete case and tries to recover attorneys' fees he never was obligated to pay? In my experience, new employers pay the freight on non-compete suits about 1/4 of the time, depending on the employee's value and position within the company. (An executive, for instance, likely will be able to negotiate this as part of his employment agreement.)

In Rogers v. Vulcan Mfg. Co., 2012 Fla. App. LEXIS 8793 (Fla. Ct. App. June 1, 2012), the Court of Appeal of Florida reversed a $0 attorneys' fee award to the employee after he prevailed on the employer's non-compete claim. The fee-shifting clause provided the employee could recover fees "incurred to enforce any term, condition, or provision" of the contract. The court found the clear intent of the clause was that "the loser pays, and the winner does not." It did not matter who the source of the funds was, because the language in the fee provision was passive.

And who said never to use the passive voice??

The "Weekly" Posner, Starring Judge Easterbrook

A few years ago in Hess Newmark Owens Wolf, LLC v. Owens, Judge Frank Easterbrook of the Seventh Circuit explained in simple terms that the law's grudging attitude towards restrictive covenants is best explained by the fact employees often are tricked into signing, or feel compelled to sign, agreements that later turn out to be disabling.

There's good reason to cite to Posner and Easterbrook opinions, and it doesn't require lawyers to subscribe to a particular brand of law-and-economics analysis. Judge Easterbrook's affirmance rate by the Supreme Court is twice that of the average circuit court judge. And measuring a circuit judge's effectiveness by how often he or she is cited by other circuit court judges, Posner and Easterbrook rank 1 and 2 respectively - by a wide margin.

Plus, they just make sense.

The reason I bring up the Owens case is that it helps coalesce the various reasonableness factors into a very simple, straightforward analysis. In my previous discussion of the Capital One v. Kanas case, Judge Liam Grady in Virginia took special pains to differentiate that John Kanas was hardly the novice when signing a covenant he later challenged as unreasonable. Though it's sometimes hard to figure out where in the compartmentalized analysis this factor fits, it permeates the reasonableness test. In Kanas (as in Owens, for that matter), the individual signing the covenant was sophisticated and gained more than just a mere job opportunity in exchange for signing the restriction. It was hard for Judges Grady and Easterbrook to conclude either defendant was the type of individual the law meant to protect from disabling restrictions.

The Easterbrook formulation is helpful, too, to assess covenants from the employee's perspective. I think it's fair to say that when an employee signs a non-compete she may have a layman's understanding of what it means. For a sales person, the thought process likely is "stay away from my accounts." But she may not anticipate the actual scope of the restrictions beyond this, particularly if the covenant is written in dense legalese. A non-lawyer is not trained to think in hypotheticals, so the sales person may not appreciate what type of competition the covenant actually prohibits beyond what is foremost in her mind at the point of signing.

The overall point is this. Assessing reasonableness does not need to be highly fragmented, and lawyers don't have to always fit the facts into the little black boxes of three-part tests. Sometimes, as Judge Easterbrook points out, it is enough to hone in on the purpose of the law and argue your case around that.

John Kanas, What's In Your Wallet ($24M in Restricted Stock...)

Last year, I wrote about the non-compete case involving high-profile New York banker, John Kanas. Along with his associate, John Bohlsen, Kanas sold North Fork Bancorporation to Capital One Financial in 2006 for $13.2 billion. Along the way, Kanas pocketed $24 million in restricted stock (Bohlsen received $18 million).

Not long after the business deal closed, Kanas and Bohlsen - who had agreed to remain employed by Capital One for three years - split under a Separation Agreement. That agreement narrowed the non-competes in the restricted stock agreement to prohibit work in a competitive business only in New York, New Jersey, and Connecticut.

When Kanas and Bohlsen formed BankUnited in 2011, Capital One claimed a breach of the covenants. I described in a previous post the facts underlying Capital One's claim. Kanas and Bohlsen moved for summary judgment, requesting a federal court in Virginia to void the non-competes.

The court, in a very well-written opinion by Judge Liam O'Grady, found the agreements reasonable. He found the case highly unique, given the extraordinary amount of consideration the defendants received out of the North Fork acquisition and because they were highly sophisticated businessmen.

The interesting aspect of the case involved Capital One's claim that the covenants should be examined under the more lax sale-of-business standard. They weren't, as the court found two factors dispositive of that claim: (1) the covenants were triggered by the end of employment, not the closing date of the transaction; and (2) the covenants were not a condition to the North Fork acquisition. The points are debatable given that the covenants were, in effect, replacements for those that did get signed at the deal's closing. But the court was correct in that the terms of the contract were tied more towards the employment of Bohlsen and Kanas.

The court was tempted to apply the sale-of-business standard, but stated that "policy considerations, such as the bargaining power of the parties, are more properly considered as part of the Court's analysis of enforceability." For a long time, I have been saying that the sale-of-business/employment framework simply does not account for a lot of cases that fall within the two extremes. Cases that are more difficult to assess include covenants between:

(1) franchisor and franchisee;

(2) commercial transactions short of a sale of business (for instance, a staffing agreement); and

(3) executive employment contracts.

Often times you see courts apply a sale-of-business standard to situations where sale-of-business precedents don't fit. It would be far preferable if courts considered such factors as negotiations, bargaining power, commercial realities, and monetary benefits conferred on the promisor when examining restrictions under the traditional reasonableness test. Judge O'Grady's opinion did that, discounting the framework used and focusing more on the public policy aspects of what he was deciding.

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Court: United States District Court for the Eastern District of Virginia
Opinion Date: 5/17/12
Cite: Capital One Fin. Corp. v. Kanas, 2012 U.S. Dist. LEXIS 69385 (E.D. Va. May 17, 2012)
Favors: Employer
Law: Virginia

New Hampshire Takes Broad View of Trade Secrets Preemption

Courts interpreting the Uniform Trade Secrets Act interpret the preemption provision either narrowly or broadly. The narrow view does not limit similar claims for misappropriation based on lesser-protected confidential information, while the broad view does.

New Hampshire is one of the adherents to the broad view, along with a number of other states including Ohio. As explained in the recent unreported case of Wilcox Indus. Corp. v. Hansen, 2012 U.S. Dist. LEXIS 63668 (D.N.H. May 7, 2012), broad view preemption eliminates "other tort causes of action founded on allegations of misappropriation of information that may not meet the statutory standard for a trade secret." Put another way, there are two classes of information - trade secrets (defined by statute, interpreted by cases) and general knowledge (always unprotected). Something in between won't cut it.

Except if you have a contract claim. The cleanest way to assert a claim for misappropriation or improper use of confidential information is to show a breach of some non-disclosure covenant. That won't be preempted by trade secret law, and an employer need not worry about establishing the standards of secrecy applicable to UTSA claims.

In the Hansen case, the preempted claims were unjust enrichment and breach of fiduciary duty. Conversion claims and those based on common law unfair competition often suffer a quick demise at the hands of the preemption clause.

Non-Compete Case Law Update (And a Tip for Clients)

I've been absent the last several days, so I feel I have some catching up to do. And there have been some really interesting cases and legal issues to report on.

First, though, a practical tip to clients, particularly employees who have to deal with non-compete issues. Assemble your documents. That sounds easy, but apparently it's not. If you leave and stay in the same industry or compete with your former employer, you need to have a handle on your obligations. Those obligations may exist outside of an employment agreement. Here generally are the sources of where you can find documents outlining restrictions or post-termination obligations:

(1) Employment Agreement (including older ones that may (or may not) be superseded)
(2) A separate Confidentiality Agreement (yes, many employers keep them separate)
(3) A Severance or Separation Agreement, which likely applies only if you've been terminated
(4) Any agreement you have to sign to participate in an equity incentive plan (these sometimes contain forfeiture-for-competition provisions, if not outright covenants not to compete)
(5) Employee handbooks

Okay, onto some new decisions of interest...

Non-Competes and the Ohio Merger Statute

I could have woken up at 2 am to write and John Marsh of Hahn Loeser in Columbus still would have beaten me to the punch. The Supreme Court of Ohio held this week, in Acordia of Ohio v. Fishel, 2012 Ohio 2297, that covenants not to compete are not automatically assigned in the context of a statutory merger. Practically speaking, the merger statute - which is common and similar to other business corporation laws, in that all assets and obligations of the merged entity vest in the assigned entity - has to give way to the plain language of the covenant.

This 4-3 decision surprised me. Marsh's post here contains a more extensive discussion. A PDF of the court's slip opinion can be found here.

Wisconsin Kicks Out 3-Year Non-Compete Covenant

Litigating non-competes in Wisconsin is no bargain for employers. And just as Share Corporation had a restrictive covenant tossed last year on a Rule 12(b)(6) motion, so too did the employer in Priority Int'l Animal Concepts, Inc. v. Bryk, 12-cv-150 (E.D. Wisc). The covenant in that case lasted three years and contained no territory or activity limitation, rendering it unenforceable under Wisconsin's restrictive covernant statute, Section 103.465. That statute is highly favorable to employees and often can result in dismissal of contract actions before discovery even begins. The choice-of-law analysis in that case proved fatal, as the employer had argued Ohio law applied and did not appear to contest the fact the agreement was unenforceable under Wisconsin law.

Flat Fee Liquidated Damages Clause - Penalty or No?

I have written a lot about liquidated damages clauses in non-compete agreements, both here and in my home state's bar journal. My recommendation to employers has never been to take the easy route and use a fixed, or flat, fee for computing liquidated damages. They're not per se unreasonable, as the district court's opinion in Kadant Johnson, Inc. v. D'Amico, 2012 U.S. Dist. LEXIS 64237 (E.D. La. May 8, 2012), indicates.

The court, applying Michigan law, held that such a clause - providing for $250,000 upon violation of a non-compete - could be reasonable, or at least was "not unreasonable as a matter of law." This was despite testimony from the CEO of the Plaintiff who stated that it was a "penalty", "a good deterrent", and that there was "no real reason" to choose that number. Honestly, I think the plaintiff got away with one - sounds like the plaintiff admitted it was a penalty.

***

Next up, another trade secrets preemption case extensive discussion on the high-profile case of Capital One Financial v. Kanas. Then we'll get to Capital One v. Kanas.

Supreme Court of Wyoming: Continued Employment Is Sufficient Consideration for Invention Assignment Agreement

Invention assignment agreements are often important for employees who work in a highly technical field, creating patentable or trade secret material used to give a company a competitive advantage. As long as that technology is within an employer's line of business, that employer should have every expectation that the employee's invention will become the employer's property. That is, after all, what the employer is paying a good wage for.

Assignment clauses are part and parcel of most confidentiality agreements. If they are a species of a non-compete, they're not a particularly onerous one. Still, they do give rise to some litigation, most frequently when an invention falls within a so-called "trailer" clause - a clause extending the assignment for a short period of time past the end of employment.

In Preston v. Marathon Oil, the Supreme Court of Wyoming answered a certified question from the United States Court of Appeals for the Federal Circuit on invention assignment clauses. The Court held that an employee's continued employment is sufficient consideration for such a clause, even though Wyoming is in that group of states holding that continued employment is not sufficient consideration for a covenant not to compete. The court had little trouble differentiating the types of contracts, reasoning that the continued employment rule in the non-compete context clashed with an employee's right to earn a living.

Keep in mind that in the absence of an express assignment, an employer still has a shop right to an employee's inventions - in effect, a paid-up, royalty-free license to use it - but the employee is still the owner. Illinois also has a statute which technically requires an assignment clause to carve-out certain classes of inventions, essentially those having nothing to do with the employer's line of work or R&D. I am not aware of any case addressing the consequences, though, of a non-compliant assignment clause in Illinois.

A copy of the Preston opinion can be found here.

The Weekly Posner (Nos. 3 and 4)

Revisiting Judge Posner's Dissent in Outsource Int'l v. Barton

About 12 years ago, the Seventh Circuit decided Outsource Int'l v. Barton, one of only a handful of employee non-compete cases it has heard. The case arose in the staffing industry and involved a fairly limited customer non-solicitation covenant and a 25-mile non-compete. As with many non-compete disputes, the case centered on reasonableness - not actual breach, because there was not dispute Barton did.

The Seventh Circuit affirmed the district court's grant of injunctive relief, which prompted a dissent from Judge Richard A. Posner who remarked that Illinois courts would not enforce Barton's non-compete. The dissenting opinion was interesting in the sense that Posner agreed with the outcome, at least in terms of whether the result was substantively fair, but disagreed with the application of the law. He felt that Illinois courts were too hostile to the contract to enforce it, particularly under the then-applicable legitimate business interest test.

The dissent prompts me to wonder if Judge Posner would now view courts as hamstrung, given that Reliable Fire Equipment v. Arredondo has replaced the test which he felt doomed the employer's chances in Barton. I think he would now feel that judges were not so constrained.

There are a few interesting nuggets from that case, which are great for lawyers to keep in mind. To be certain, Judge Posner believes in the notion of freedom of contract, such that I don't think he views the prevalent reasonableness test as anything but outdated and paternalistic. He would, in my mind, be open to viewing particularly onerous covenants that really don't protect much of anything (say, for a low-level employee with no skills to move customers) as subject to a defense of unconscionability or fraud. I'm not one for affirmative defenses, but perhaps employees need to be thinking about fitting their theory into a traditional contract defense rather than resting on the employer's inability to prove reasonableness.

Judge Posner feels that the foundation for judicial hostility to covenants has collapsed. This may be so, as an array of employment laws fairly well undercut the idea that employees are subject to the abusive whims and caprices of their masters. Too, the vast choices of employment attorneys has reduced the cost for employees to seek and obtain legal advice before signing a covenant. This says nothing of the amount of free information available to employees on the internet who resort to self-help. Such as the tidbits provided on this blog...

"Duck, Bluff, Weave and Change the Subject"

Those are Judge Posner's words, apparently uttered at the Seventh Circuit Bar Association's annual dinner. Apparently not directed at some of my opponents, they were meant to describe how judges grapple with increasingly complex subjects before them. Judge Posner is sitting as trial judge on an upcoming patent case, so he may be particularly motivated to discuss this topic now. He is an advocate of independent, court-appointed experts to help sift through the battle of retained experts and cut through some of the technical jib-jab at trial. That should do plenty to scare the hell out of lawyers, but it makes sense. In the non-compete world, many covenants are enforced to protect trade secrets - and trade secrets (like patents) can be highly technical. This may be an area district judges explore, particularly in cases involving source code, financial derivatives, or biotechnology.

A link to the article on Judge Posner's speech from the Chicago Tribune can be found here.

Case Law and Non-Compete News Update

Some interesting news stories and cases to report on this week.

News Stories


A couple of years ago, FLIR Systems engaged in an ill-advised trade secrets action in California which resulted in a substantial fee award to the defendants under a theory of bad faith. Now, the defendants are going after FLIR's counsel in that case, Latham & Watkins, on a malicious prosecution theory of liability. Apparently, the genesis of the claim against L&W arose when the plaintiffs (that is, the defendants in the original trade secrets case) discovered FLIR was invoking the "advice of counsel" defense. There a number of interesting procedural issues which could come out of this, including the possibility that L&W may have a SLAPP defense under California law. Epstein Becker & Green discusses the case.

In this author's opinion, counsel should not be granted an absolute privilege for bad faith or malicious litigation if they act as a mere instrumentality for their client.

John Marsh discusses the high-profile dispute between sports agent Aaron Mintz and Priority Sports Entertainment, a battle taking place in California over a non-compete apparently governed by Illinois law. Given California's clear public policy on non-competes, there certainly will be questions whether the choice-of-law clause is valid. Mintz joined CAA, which represents NBA stars LeBron James, Chris Bosh, Dwyane Wade, Carmelo Anthony and others. Priority Sports is headed by Mark Bartelstein, a graduate of the University of Illinois and a resident of suburban Chicago. Some salacious details of the suit can be found here.

Reported Cases


The Tennessee case of ProductiveMD, LLC v. 4UMD, LLC, 821 F. Supp. 2d 955 (M.D. Tenn. 2011), contains a good discussion of the "same proof" standard to determine trade secrets preemption. This standard essentially examines whether proof of a non-trade secrets claim would also establish a claim for misappropriation of trade secrets. If the answer is yes, the claim is preempted. Most frequently, the same proof test will jeopardize claims of common law unfair competition, unjust enrichment, breach of the duty of loyalty (at least in part), and civil conspiracy. To my knowledge, Hawaii is the only other state which has adopted the "same proof" test of preemption.

Grace Hunt IT Solutions, LLC v. SIS Software, LLC, 2012 Mass. Super. LEXIS 40 (Sup. Ct. Feb. 14, 2012), discusses the Massachusetts rule which voids non-compete agreements if there has been a "material change" in the employment relationship. The rationale for this rule is that a material change equates to a brand new employment relationship, which requires a new non-compete to be signed. An example of a material change would be a reduction in compensation. Interestingly, in the Grace Hunt case, the court discounted the employer's point that the reduced compensation could be made up through bonuses, because the evidence equivocated over whether those bonuses could realistically be achieved.

Franchise non-competes are usually enforced, as demonstrated by Outdoor Lighting Perspectives Franchising, Inc. v. OLP-Pittsburgh, Inc., 2012 U.S. Dist. LEXIS 53583 (W.D.N.C. Apr. 17, 2012). As I have noted on this blog before, the interests to be protected under franchise covenants are different than those in an employment contract, even though most franchise covenants are non-negotiable. The interest is not only business goodwill, but protection of the franchise system itself. Often times, the court will examine the interests of third-parties, other franchisees, who need protection. The case was interesting in one respect, however. The non-compete extended to a 100-mile buffer around the ceded franchise territory and other franchisees' territories. This was too broad, almost by definition, and the court cut it back to eliminate the 100-mile buffer language. However, the court did state that the restriction on competition within other franchisees' territories was reasonable.