The unfortunate reality of many non-compete lawsuits is that the parties face a vast asymmetry in legal resources. While individuals suing companies in court is hardly a novel concept, an individual usually stands something to gain - money - if she wins. A non-compete defendant is in no such similar position.
As a result, bankruptcy looms as a potential "option" for defendants in a good percentage of non-compete cases. Most defendants don't realize that there's a significant chance that a damages award may not even be dischargeable, though this depends on a host of factors. Blanket statements or conclusions can't be made.
Another vexing issue is a company's ability to pursue injunctive relief to protect customer goodwill or confidential information, even if a non-compete defendant has filed a bankruptcy petition. The most obvious step for companies to take is to file a lift-stay motion. This refers to the fact that all litigation against a debtor is "stayed" (or halted) once he or she files a petition.
Bankruptcy laws serve to relieve an honest debtor from the weight of his financial obligations and give him a fresh start in business life. Injunctive relief, though, is not a matter that impacts the administration of a bankruptcy estate, so courts often confront a company's attempt to lift the stay so that it may seek to pursue an injunction and protect against the loss of customers or trade secrets. Because damages are difficult to prove, injunctive relief still is the preferred remedy for most non-compete plaintiffs.
Since bankruptcy laws do not give a debtor a shield to misappropriate assets or customer relationships, under what circumstances will a court grant an employer's lift-stay motion and allow it to proceed forward with its case outside of bankruptcy?
There are several factors courts have examined in the past, though there is no uniform set of rules:
(1) Likelihood of success - This seems rather obvious, but it poses serious challenges for bankruptcy judges. If a bankruptcy judge weighs in on the merits (even if it's not a decision or judgment), then there is a substantial risk that the court hearing the underlying dispute will be influenced by another judge's thoughts. This is a particularly acute concern when the non-compete case is in state court.
(2) Prejudice to debtor - The most obvious hardship is the cost of litigation. However, in the past, bankruptcy courts haven't found that this practical reality is a significant prejudice factor that would justify a denial of relief.
(3) Prejudice to the estate - In a garden-variety employee matter, the bankruptcy estate rarely has an interest in the non-competition covenant. Put another way, the contract is not an estate asset.
(4) Harm to the moving party - In the decisions addressing lift-stay motions, most courts find that the potential harm to the ex-employer (i.e., loss of customers or impairment of trade secret rights) is the most important factor to consider. Courts seem receptive to the notion that it is impermissible to use the bankruptcy laws offensively to continue violating unexpired restrictive covenants.
It also is important to keep in mind that considerations of lifting a stay are different in Chapter 11 or 13 cases when enforcement of a covenant not to compete may affect a debtor's ability to reorganize and earn income. However, in a typical Chapter 7 case, a bankruptcy court is unconcerned with a debtor's ability to generate post-petition earnings because those earnings are not estate property.
Monday, June 9, 2014
Wednesday, June 4, 2014
An Illinois Federal Court Now Pivots Towards Supporting Fifield
I wrote previously about the hostile reception Fifield v. Premier Dealer Services, Inc. had received in Illinois federal courts, which is set forth in my March 6 post "Fifield, Federal Style." Since that time, I have presented at two seminars in which I predicted that a fissure between how state and federal courts perceived the Fifield consideration rule may encourage the Supreme Court of Illinois to take the issue up when it inevitably resurfaces.
Perhaps, I am wrong.
One federal judge in Chicago has disagreed with his federal court counterparts and endorsed Fifield. The case is Instant Technology, LLC v. DeFazio, No. 12-cv-491. Judge Holderman declined to follow the lead of Chief Judge Castillo in Montel Aetnastak, Inc. v. Miessen (and Judge Feinerman in another case) and found that the Supreme Court of Illinois would, indeed, follow the two-year consideration rule from Fifield.
As readers of this blog know all too well by now, Fifield holds that for at-will employees new or continued employment must last at least two years for the employment to serve as consideration supporting a non-compete agreement. It's clear from Fifield that this two-year rule applies to both non-compete and non-solicit covenants, but it almost certainly does not extend to confidentiality restrictions.
Judge Holderman relied on Judge Posner's opinion in Curtis 1000, Inc. v. Suess to justify why Fifield represents the law in Illinois. That case discussed the fact that employment in the at-will context often is illusory because the employer retains full discretion to take away the consideration without fear of liability. Also important to Judge Holderman's analysis were two recent Illinois circuit court decisions that appeared to endorse Fifield. It's rather unusual to see a federal court rely on and cite to unreported trial court cases as support for a ruling. But such is the terra (in)firma that Fifield graced us with.
As I recently wrote, the Supreme Court of Wisconsin is addressing an important question of law concerning consideration for non-competes in the at-will employee context.
Perhaps, I am wrong.
One federal judge in Chicago has disagreed with his federal court counterparts and endorsed Fifield. The case is Instant Technology, LLC v. DeFazio, No. 12-cv-491. Judge Holderman declined to follow the lead of Chief Judge Castillo in Montel Aetnastak, Inc. v. Miessen (and Judge Feinerman in another case) and found that the Supreme Court of Illinois would, indeed, follow the two-year consideration rule from Fifield.
As readers of this blog know all too well by now, Fifield holds that for at-will employees new or continued employment must last at least two years for the employment to serve as consideration supporting a non-compete agreement. It's clear from Fifield that this two-year rule applies to both non-compete and non-solicit covenants, but it almost certainly does not extend to confidentiality restrictions.
Judge Holderman relied on Judge Posner's opinion in Curtis 1000, Inc. v. Suess to justify why Fifield represents the law in Illinois. That case discussed the fact that employment in the at-will context often is illusory because the employer retains full discretion to take away the consideration without fear of liability. Also important to Judge Holderman's analysis were two recent Illinois circuit court decisions that appeared to endorse Fifield. It's rather unusual to see a federal court rely on and cite to unreported trial court cases as support for a ruling. But such is the terra (in)firma that Fifield graced us with.
As I recently wrote, the Supreme Court of Wisconsin is addressing an important question of law concerning consideration for non-competes in the at-will employee context.
Monday, May 19, 2014
Supreme Court of Wisconsin to Address Key Consideration Issue
The Court of Appeals of Wisconsin certified an important question to the state Supreme Court concerning restrictive covenant law:
Is consideration in addition to continued employment required to support a covenant not to compete entered into by an at-will employee?
The case is Runzheimer Int'l Ltd. v. Friedlin, 2014 Wisc. App. LEXIS 342 (Ct. App. Apr. 15, 2014). The question, to be sure, is a recurring one across the states. This is for a few reasons.
The policy rationales for and against a consideration rule lie in tension with one another. On the enforcement side, employers say that because they can terminate at-will employees without liability, there's no true distinction between a covenant signed at the start of employment and those signed mid-stream (or, as an afterthought). Conversely, employees legitimately can argue they face a disparity in bargaining power and feel serious economic pressure to sign a contract just to keep their job.
Wisconsin courts haven't really addressed this issue head-on, which is surprising given that state's volume of non-compete disputes and its well-known pro-employee bent. The few cases - none directly on point - push courts in opposite directions, which is reflective of the policy tension I just discussed. Decisions from other states aren't helpful, because there's no uniform rule. The pro-employee cases make just as much sense as the pro-employer cases. (Not surprisingly, the Court of Appeals did not discuss the analysis from Illinois' much-maligned Fifield decision, probably since there is no analysis in that case to rely on.)
From my perspective, it's a bit myopic to say no consideration is required simply because the at-will relationship is fluid and starts anew each day. This is a theoretical argument and ignores a couple of realities.
First, it assumes freely terminate people when they view them as valuable. There's no empirical support for this. I am not aware of employers firing employees en masse only to rehire them with a non-compete. Not only would such a practice impair goodwill, but it actually would raise the specter of liability for unemployment costs. The pro-employer theory neglects to consider marketplace realities and the intangible harm to reputation that could arise.
Second, an employee may accept a job with Company X in reliance on the fact X never asked him to sign a restrictive covenant. Presumably, that impacted his decision to forego other jobs. Those lost (irretrievably) opportunities should be accounted for at least to the same degree as the theoretical "fire-rehire" justification.
In the final analysis, I'm not a huge fan of "continued employment" as a consideration theory. It seems wishy to me, and employers ought to come up with something better - a promotion, a new commission opportunity, a bonus - to justify binding an employee to a significant work restriction.
Is consideration in addition to continued employment required to support a covenant not to compete entered into by an at-will employee?
The case is Runzheimer Int'l Ltd. v. Friedlin, 2014 Wisc. App. LEXIS 342 (Ct. App. Apr. 15, 2014). The question, to be sure, is a recurring one across the states. This is for a few reasons.
The policy rationales for and against a consideration rule lie in tension with one another. On the enforcement side, employers say that because they can terminate at-will employees without liability, there's no true distinction between a covenant signed at the start of employment and those signed mid-stream (or, as an afterthought). Conversely, employees legitimately can argue they face a disparity in bargaining power and feel serious economic pressure to sign a contract just to keep their job.
Wisconsin courts haven't really addressed this issue head-on, which is surprising given that state's volume of non-compete disputes and its well-known pro-employee bent. The few cases - none directly on point - push courts in opposite directions, which is reflective of the policy tension I just discussed. Decisions from other states aren't helpful, because there's no uniform rule. The pro-employee cases make just as much sense as the pro-employer cases. (Not surprisingly, the Court of Appeals did not discuss the analysis from Illinois' much-maligned Fifield decision, probably since there is no analysis in that case to rely on.)
From my perspective, it's a bit myopic to say no consideration is required simply because the at-will relationship is fluid and starts anew each day. This is a theoretical argument and ignores a couple of realities.
First, it assumes freely terminate people when they view them as valuable. There's no empirical support for this. I am not aware of employers firing employees en masse only to rehire them with a non-compete. Not only would such a practice impair goodwill, but it actually would raise the specter of liability for unemployment costs. The pro-employer theory neglects to consider marketplace realities and the intangible harm to reputation that could arise.
Second, an employee may accept a job with Company X in reliance on the fact X never asked him to sign a restrictive covenant. Presumably, that impacted his decision to forego other jobs. Those lost (irretrievably) opportunities should be accounted for at least to the same degree as the theoretical "fire-rehire" justification.
In the final analysis, I'm not a huge fan of "continued employment" as a consideration theory. It seems wishy to me, and employers ought to come up with something better - a promotion, a new commission opportunity, a bonus - to justify binding an employee to a significant work restriction.
Tuesday, April 22, 2014
Supreme Court of Wyoming Issues Important Trade Secrets Decision Related to Fracking
One of the hot new frontiers in trade secrets law involves an industry, not a legal question. There is no question the fracking industry is controversial. On the one hand, state legislatures view hydraulic fracturing as a potential boon to local economies. On the other, the very nature of this process causes much hand-wringing and cause for concern among environmental advocacy groups.
Hydraulic fracturing occurs when operators inject pressurized fluids into rock layers to release petroleum or natural gas. Fracking companies often believe the chemical compounds used in the fluid injection process are trade secrets. This causes a natural tension when public interest groups seek to discover what kind of chemicals are being inserted into local aquifers.
The case law applying trade secrets concepts to fracking is new and largely undeveloped. In the most significant decision to date, the Supreme Court of Wyoming addressed what trade secret definition should apply to a request for disclosure of an operator's chemical compounds. In Powder River Basin Resource Council v. Wyoming Oil and Gas Conser. Comm'n, the Court held that the most stringent trade secrets definition should apply. (The opinion is contained below.)
It considered three alternatives:
(1) The Uniform Trade Secrets Act definition, with its now ubiquitous two-part formulation;
(2) The Restatement (Third) of Unfair Competition definition, found in Section 39, which generally is viewed as less rigorous than the UTSA standard; and
(3) The federal Freedom of Information Act definition.
The Court ultimately chose the FOIA definition. It defines trade secret as "[a] secret, commercially valuable plan, formula, process, or device that is used for the making, preparing, compounding, or processing of trade commodities and that can be said to be the end product of either innovation or substantial effort."
The italicized clause limits trade secrets to the productive process and would exclude a wide range of commercially valuable information that often times is at issue in competitive disputes. The Court's justification makes some sense. The broader UTSA and Restatement definitions are geared towards providing a remedy for unfair competition in private disputes. And a more definition would render meaningless the protection FOIA affords "commercially valuable" information.
The FOIA definition, which should lead to more disclosure, is meant to balance ownership of a true trade secret with the public's right to access documents affecting matters of public interest. In those states with fracking laws and regulations, operators normally have the chance to show administrative agencies that their chemical compounds or formulas are trade secrets. The decision in Powder River Basin will provide appropriate guidance to other courts that are called upon to evaluate a challenge to any administrative decision that favors fracking operators.
Hydraulic fracturing occurs when operators inject pressurized fluids into rock layers to release petroleum or natural gas. Fracking companies often believe the chemical compounds used in the fluid injection process are trade secrets. This causes a natural tension when public interest groups seek to discover what kind of chemicals are being inserted into local aquifers.
The case law applying trade secrets concepts to fracking is new and largely undeveloped. In the most significant decision to date, the Supreme Court of Wyoming addressed what trade secret definition should apply to a request for disclosure of an operator's chemical compounds. In Powder River Basin Resource Council v. Wyoming Oil and Gas Conser. Comm'n, the Court held that the most stringent trade secrets definition should apply. (The opinion is contained below.)
It considered three alternatives:
(1) The Uniform Trade Secrets Act definition, with its now ubiquitous two-part formulation;
(2) The Restatement (Third) of Unfair Competition definition, found in Section 39, which generally is viewed as less rigorous than the UTSA standard; and
(3) The federal Freedom of Information Act definition.
The Court ultimately chose the FOIA definition. It defines trade secret as "[a] secret, commercially valuable plan, formula, process, or device that is used for the making, preparing, compounding, or processing of trade commodities and that can be said to be the end product of either innovation or substantial effort."
The italicized clause limits trade secrets to the productive process and would exclude a wide range of commercially valuable information that often times is at issue in competitive disputes. The Court's justification makes some sense. The broader UTSA and Restatement definitions are geared towards providing a remedy for unfair competition in private disputes. And a more definition would render meaningless the protection FOIA affords "commercially valuable" information.
The FOIA definition, which should lead to more disclosure, is meant to balance ownership of a true trade secret with the public's right to access documents affecting matters of public interest. In those states with fracking laws and regulations, operators normally have the chance to show administrative agencies that their chemical compounds or formulas are trade secrets. The decision in Powder River Basin will provide appropriate guidance to other courts that are called upon to evaluate a challenge to any administrative decision that favors fracking operators.
Friday, April 18, 2014
Contention Interrogatories In Trade Secret Cases Demand Strict Compliance
Yesterday, I gave a lengthy presentation to the American Intellectual Property Law Association's Trade Secrets Committee. The bulk of my presentation dealt with the knotty issue of properly identifying trade secrets in litigation.
Many trade secrets cases stall out due to deficient identifications. Since trade secrets are unlike other forms of intellectual property in that they are not listed in the public record, a plaintiff controls the identification of its property. In litigation between competitors, a plaintiff frequently will attempt to hide its secrets - yes, the crux of the claim itself - from the defendant. This leads to many disputes over whether the plaintiff properly is identifying its trade secrets in discovery. Sometimes the dispute occurs quite early, but other times it can take months or years before the identification issue reaches an inflection point.
As I was preparing for my presentation yesterday, I took a scan through some recent cases on the identification question. If you're looking for a fertile area of legal research, this is it. The federal district courts seem inundated with questions about whether a plaintiff is properly identifying its trade secrets during litigation. And the cases yield few hard-and-fast rules.
But, as I am sometimes prone to do, I found a case on the identification question that I hadn't seen before. The case, Safety Today, Inc. v. Roy, 2014 U.S. Dist. LEXIS 17116 (S.D. Ohio Feb. 11, 2014), addressed a plaintiff's attempt to answer a customer trade secrets identification interrogatory by referencing documents produced in the case. This sometimes is permitted under Federal Rule of Civil Procedure 33(d).
But the Safety Today court said no, a plaintiff could not use the Rule 33(d) mechanism to "identify" its trade secrets in response to a contention interrogatory. It did say that in some unusual cases a court could permit this approach. For instance, if the trade secret is entirely contained within a document - say a customer list, or an engineering drawing - then a Rule 33(d) reference may be appropriate. The secret, though, would have to be really narrow.
The case dealt with an entirely different factual matrix that did not lend itself to a bald document reference. In fact, the court called it a "typical case" involving ex-employees and stated specifically:
"Only the employer will know what portion of that myriad information known to its employees can legitimately be claimed as a trade secret, and no amount of record production can provide the appropriate answer to the question."
The court examined a largely undifferentiated set of documents the parties produced and noted that it was not at all apparent from the production what was secret and what was not. In other words, the defendant still would have to guess at what bits of information the plaintiff claimed as trade secrets. It was, indeed, the typical case where the trade secrets are not evident to anyone from the face of a particular document.
This illustrates the burden a plainitff in a trade secrets case usually will face. When answering an interrogatory, it is essential to take that obligation seriously and not reflexively punt to documents the parties otherwise produce. This approach may just raise more questions and do more harm than good.
Ultimately, a plaintiff ought to be under a strict burden to do its homework and prepare its case for trial. If it cannot grasp its own trade secrets and is not willing to put the time in to do so, that usually portends a much larger, strategic problem.
Many trade secrets cases stall out due to deficient identifications. Since trade secrets are unlike other forms of intellectual property in that they are not listed in the public record, a plaintiff controls the identification of its property. In litigation between competitors, a plaintiff frequently will attempt to hide its secrets - yes, the crux of the claim itself - from the defendant. This leads to many disputes over whether the plaintiff properly is identifying its trade secrets in discovery. Sometimes the dispute occurs quite early, but other times it can take months or years before the identification issue reaches an inflection point.
As I was preparing for my presentation yesterday, I took a scan through some recent cases on the identification question. If you're looking for a fertile area of legal research, this is it. The federal district courts seem inundated with questions about whether a plaintiff is properly identifying its trade secrets during litigation. And the cases yield few hard-and-fast rules.
But, as I am sometimes prone to do, I found a case on the identification question that I hadn't seen before. The case, Safety Today, Inc. v. Roy, 2014 U.S. Dist. LEXIS 17116 (S.D. Ohio Feb. 11, 2014), addressed a plaintiff's attempt to answer a customer trade secrets identification interrogatory by referencing documents produced in the case. This sometimes is permitted under Federal Rule of Civil Procedure 33(d).
But the Safety Today court said no, a plaintiff could not use the Rule 33(d) mechanism to "identify" its trade secrets in response to a contention interrogatory. It did say that in some unusual cases a court could permit this approach. For instance, if the trade secret is entirely contained within a document - say a customer list, or an engineering drawing - then a Rule 33(d) reference may be appropriate. The secret, though, would have to be really narrow.
The case dealt with an entirely different factual matrix that did not lend itself to a bald document reference. In fact, the court called it a "typical case" involving ex-employees and stated specifically:
"Only the employer will know what portion of that myriad information known to its employees can legitimately be claimed as a trade secret, and no amount of record production can provide the appropriate answer to the question."
The court examined a largely undifferentiated set of documents the parties produced and noted that it was not at all apparent from the production what was secret and what was not. In other words, the defendant still would have to guess at what bits of information the plaintiff claimed as trade secrets. It was, indeed, the typical case where the trade secrets are not evident to anyone from the face of a particular document.
This illustrates the burden a plainitff in a trade secrets case usually will face. When answering an interrogatory, it is essential to take that obligation seriously and not reflexively punt to documents the parties otherwise produce. This approach may just raise more questions and do more harm than good.
Ultimately, a plaintiff ought to be under a strict burden to do its homework and prepare its case for trial. If it cannot grasp its own trade secrets and is not willing to put the time in to do so, that usually portends a much larger, strategic problem.
Friday, March 21, 2014
"Embedded Knowledge" and the Trade Secret Gap
For anyone (lawyer or otherwise) interested in the tensions associated with employee mobility, a truly must-read is Talent Wants to Be Free, by Orly Lobel.
Professor Lobel discusses a wide range of issues associated with talent and knowledge flows, and she incorporates thoughts that transcend the law and devolve into economics and sociology. The book is, to say the least, thought-provoking even for those who may choose to disagree with some of her conclusions. There's a particular issue that Professor Lobel discusses that touches upon one of competition law's great tensions.
In my judgment, one of the most difficult areas of the law for lawyers, judges, and clients is drawing a distinction between two concepts: general skill and knowledge (which is not protectable) and a trade secret (which is). Consider the following from an Illinois decision some twenty years ago:
"General skills and knowledge acquired in the course of employment...are things an employee is free to take and to use in later pursuits, especially if they do not take the form of written records, compilations or analyses." Passage quoted from Colson Co. v. Wittel, 569 N.E.2d 1082, 1087 (4th Dist. 1991).
This is somewhat (largely?) unhelpful for two reasons. First, it's so obvious that we shouldn't feel the need to use it as a guidepost or legal marker. Second, the notion of "general skills and knowledge" suggests a disconnect from experiential information or data the employee may have obtained by reason of his or her employment with a business. Put another way, GSK sounds like information an employee may acquire just by virtue of being in a particular field and that generally may be available to anyone, but not of any real use to people who are engaged in other occupations.
This disconnect is troubling when trying to parse out what kinds of information a business can protect by contract or through assertion of a trade secret right. A passage in Chapter 4 of Professor Lobel's book gets closer to solving the disconnect and bridging the ideas of general skill and knowledge, on the one hand, and trade secrets, on the other.
She talks of "embedded knowledge." Here's how she puts it in context:
"Knowledge that is embedded comes from experience, from learning by doing or observing; this kind of knowledge is difficult to codify and write down. Embedded knowledge (also known as tacit knowledge) is learned informally through direct and repeated contacts."
This formulation actually gets us closer to determining what is protectable and what is not, but only if we say embedded knowledge is something only an enforceable non-compete can safeguard. In other words, we should be careful not to lump in embedded knowledge with the amorphous (some might say rudderless) definition of a trade secret.
Examples of embedded knowledge likely include a person's familiarity with key contacts and customer requirements or buying habits. It also may include the odd concept of "negative know-how" (that which isn't effective). It certainly includes pricing patterns or strategies. Perhaps, too, it encompasses knowledge of which particular vendors are reliable or can lead to efficient sales distribution. To be sure, this will be company-specific data; they're not "general" in the fair sense of the word.
Professor Lobel also makes the point that "embedded knowledge" doesn't spread with great accuracy. Again, from Chapter 4:
"As you can imagine by now, the way tacit knowledge spreads depends on the shape of the network and the complexity of the information being diffused. When knowedge is transmitted, it usually does not diffuse accurately and flawlessly across companies."
This is another way of saying that embedded knowledge can be (and likely is) fleeting or ephemeral; it changes, in other words.
Consider this example. An employee is charged with developing a new product and has his hands in various business units that may impact the development of the good before it's rolled out publicly. If that employee leaves, he may have knowledge that his former company still is rolling out the product. But much likely has changed since his departure. Perhaps the company switched vendors, changed chemicals that go into the product formulation, or had to purchase new equipment (thereby decreasing the amount of months it would take to generate a positive return on investment).
It is entirely reasonable that the employee would not know anything about these developments, even if he had day-to-day involvement in the product for a long time while he was there. To Professor Lobel's point, if he then used his prior information about the product (his embedded knowledge) in a new position with a new company, it's likely to be inaccurate. That is to say, the passage of time and fluidity of useful information reshapes the employee's knowledge in such a way as to render it less valuable and even counterproductive to a competitor.
A trade secret, by contrast, shouldn't face the diffusion problem. The central point of a trade secret is that it's a patent substitute. An owner achieves an economic advantage (possibly in perpetuity) by keeping the information secret, rather than gaining a limited monopoly through the patent system. If that's the case, then the trade secret should be something the firm can monetize. Embedded knowledge, by contrast, is that which shifts and is not capable of monetization.
An alternative way for lawyers and judges to look at whether something meets the definition of a trade secret may be to get away from the mutli-factored standard that yields more questions than answers and determine whether, in Professor Lobel's words, it can "diffuse accurately and flawlessly across companies."
Professor Lobel discusses a wide range of issues associated with talent and knowledge flows, and she incorporates thoughts that transcend the law and devolve into economics and sociology. The book is, to say the least, thought-provoking even for those who may choose to disagree with some of her conclusions. There's a particular issue that Professor Lobel discusses that touches upon one of competition law's great tensions.
In my judgment, one of the most difficult areas of the law for lawyers, judges, and clients is drawing a distinction between two concepts: general skill and knowledge (which is not protectable) and a trade secret (which is). Consider the following from an Illinois decision some twenty years ago:
"General skills and knowledge acquired in the course of employment...are things an employee is free to take and to use in later pursuits, especially if they do not take the form of written records, compilations or analyses." Passage quoted from Colson Co. v. Wittel, 569 N.E.2d 1082, 1087 (4th Dist. 1991).
This is somewhat (largely?) unhelpful for two reasons. First, it's so obvious that we shouldn't feel the need to use it as a guidepost or legal marker. Second, the notion of "general skills and knowledge" suggests a disconnect from experiential information or data the employee may have obtained by reason of his or her employment with a business. Put another way, GSK sounds like information an employee may acquire just by virtue of being in a particular field and that generally may be available to anyone, but not of any real use to people who are engaged in other occupations.
This disconnect is troubling when trying to parse out what kinds of information a business can protect by contract or through assertion of a trade secret right. A passage in Chapter 4 of Professor Lobel's book gets closer to solving the disconnect and bridging the ideas of general skill and knowledge, on the one hand, and trade secrets, on the other.
She talks of "embedded knowledge." Here's how she puts it in context:
"Knowledge that is embedded comes from experience, from learning by doing or observing; this kind of knowledge is difficult to codify and write down. Embedded knowledge (also known as tacit knowledge) is learned informally through direct and repeated contacts."
This formulation actually gets us closer to determining what is protectable and what is not, but only if we say embedded knowledge is something only an enforceable non-compete can safeguard. In other words, we should be careful not to lump in embedded knowledge with the amorphous (some might say rudderless) definition of a trade secret.
Examples of embedded knowledge likely include a person's familiarity with key contacts and customer requirements or buying habits. It also may include the odd concept of "negative know-how" (that which isn't effective). It certainly includes pricing patterns or strategies. Perhaps, too, it encompasses knowledge of which particular vendors are reliable or can lead to efficient sales distribution. To be sure, this will be company-specific data; they're not "general" in the fair sense of the word.
Professor Lobel also makes the point that "embedded knowledge" doesn't spread with great accuracy. Again, from Chapter 4:
"As you can imagine by now, the way tacit knowledge spreads depends on the shape of the network and the complexity of the information being diffused. When knowedge is transmitted, it usually does not diffuse accurately and flawlessly across companies."
This is another way of saying that embedded knowledge can be (and likely is) fleeting or ephemeral; it changes, in other words.
Consider this example. An employee is charged with developing a new product and has his hands in various business units that may impact the development of the good before it's rolled out publicly. If that employee leaves, he may have knowledge that his former company still is rolling out the product. But much likely has changed since his departure. Perhaps the company switched vendors, changed chemicals that go into the product formulation, or had to purchase new equipment (thereby decreasing the amount of months it would take to generate a positive return on investment).
It is entirely reasonable that the employee would not know anything about these developments, even if he had day-to-day involvement in the product for a long time while he was there. To Professor Lobel's point, if he then used his prior information about the product (his embedded knowledge) in a new position with a new company, it's likely to be inaccurate. That is to say, the passage of time and fluidity of useful information reshapes the employee's knowledge in such a way as to render it less valuable and even counterproductive to a competitor.
A trade secret, by contrast, shouldn't face the diffusion problem. The central point of a trade secret is that it's a patent substitute. An owner achieves an economic advantage (possibly in perpetuity) by keeping the information secret, rather than gaining a limited monopoly through the patent system. If that's the case, then the trade secret should be something the firm can monetize. Embedded knowledge, by contrast, is that which shifts and is not capable of monetization.
An alternative way for lawyers and judges to look at whether something meets the definition of a trade secret may be to get away from the mutli-factored standard that yields more questions than answers and determine whether, in Professor Lobel's words, it can "diffuse accurately and flawlessly across companies."
Friday, March 7, 2014
The Janitor Analogy, Once Again
"The agreement is so broad that it would prohibit my client from working for his new company even as a janitor!"
- Comment attributed to every defense attorney in every non-compete case, generally accompanied by arms flailing up and down violently.
***
Despite my sarcasm, this isn't a terrible argument.
In fact, it's made repeatedly with great success. And the analogy has managed to work its way into one court opinion after another.
The cases in which you see this generally involve a broad non-compete agreement, as opposed to a more limited non-solicitation of customers restraint. The argument never works for a high-level executive because courts generally assume such executives have pervasive access to confidential information of their former employer, such that a tightly defined job-scope limitation isn't required based on the interest the company is trying to assert.
However, the argument has appeal when a mid-level sales person has a restrictive covenant that goes beyond his or her ability to service or solicit clients and that extends to a broader restriction more appropriate for those that develop products or manage the flow of confidential information. So the argument goes, the broad market-based covenant is not narrowly tailored to protect the interest (customer goodwill) the employee can impair.
Two North Carolina appellate decisions discuss broad non-competes in this context, and both came out in favor of the ex-employee. The cases are Horner Int'l Co. v. McKoy, No. COA13-964 (March 4, 2014), and CopyPro, Inc. v. Musgrove, No. COA13-297 (Feb. 4, 2014). Neither case breaks new ground, but they serve as strong illustrations of how courts examine broader covenants as applied to salespersons. Prohibitions on employment altogether for this class of employees will raise major red flags. The problems easily can be cured with more reasonably drawn non-solicitation of customers provisions.
On this score, though, there's a further problem percolating underneath the surface in restrictive covenant law. Too much, generally, is made of the need for a geographic limitation. While some businesses still are hyper-local, many aren't. As the economy continues to evolve and individual spheres of influence extend beyond particular geographic borders, courts are going to have to reformulate their enforceability tests to move away from a geographic analysis. The short concurrence in the McKoy case makes this point.
Changes to our economy pose a special challenge for lawyers who draft agreements for their employer clients. We have to begin paying more attention to scope limitations in non-competes contracts and tailoring contracts to the particular employee. This is an issue separate and apart from the utility of any geographic restraint. More and more, I am reviewing non-competes that have no real meaningful geographic restriction but which are more carefully defined in the type of role the employee would be restricted from assuming after his or her departure.
It's encouraging that drafting seems to have evolved in this respect. But as the North Carolina cases show, there still frequently is a large disconnect between the employee's activities and the employer's business, on the one hand, and the practical impact of the covenant language, on the other.
Thursday, March 6, 2014
Fifield, Federal Style
"The law is an ass. But it's not that big of an ass..."
U.S. District Court Judge - Northern District of Illinois on March 5, 2014, discussing holding of Fifield v. Premier Dealer Services.
***
In the past several weeks, two federal district court judges have declined to follow Fifield's bright-line, 2-year continued employment rule for enforcement of non-compete agreements. As readers of this blog know, Fifield generated enough controversy that - at least among lawyers in Illinois - it's now a noun ("I have a Fifield hearing at 2 pm"), a verb ("The judge just Fifield-ed me."), and an adjective ("That ruling had a crummy, Fifield-ish quality to it.").
Surprisingly, neither judge in the Northern District of Illinois cited my dissenting opinion in Fifield (available here). But the gist of both rulings is the same and, remarkably, somewhat similar to what I laid out last year in my beer-induced missiv:
(1) There has to be some latitude in the consideration rule for a particular employee's position within the company;
(2) The closer the employee bumps against the 2-year window, the less relevance the rule has;
(3) The method of termination - voluntary or involuntary - has to be relevant (if not dispositive).
The Fifield decision has caused a fairly wide rift. It's now a federalism issue. Federal courts, under the Erie doctrine, must determine how the Supreme Court of Illinois would look at the issue of consideration. The court yesterday in my case found that the Supreme Court would not adopt Fifield and that under Erie, the two-year rule was not in fact the law in Illinois.
We continue to see a proliferation of trade secrets and non-compete disputes make their way into federal court under diversity rules or as adjuncts to Computer Fraud and Abuse Act claims. This only will continue in light of recent rulings, and it may spur on plaintiffs to add CFAA claims where they otherwise wouldn't.
It's also only a matter of time until another district within the Appellate Court of Illinois (there are five) confronts a Fifield issue, which may give the Supreme Court a second chance to clarify this unacceptably confusing area of the law.
All the while, lawyers will continue hedging their advice with multiple disclaimers. Which, of course, clients love.
U.S. District Court Judge - Northern District of Illinois on March 5, 2014, discussing holding of Fifield v. Premier Dealer Services.
***
In the past several weeks, two federal district court judges have declined to follow Fifield's bright-line, 2-year continued employment rule for enforcement of non-compete agreements. As readers of this blog know, Fifield generated enough controversy that - at least among lawyers in Illinois - it's now a noun ("I have a Fifield hearing at 2 pm"), a verb ("The judge just Fifield-ed me."), and an adjective ("That ruling had a crummy, Fifield-ish quality to it.").
Surprisingly, neither judge in the Northern District of Illinois cited my dissenting opinion in Fifield (available here). But the gist of both rulings is the same and, remarkably, somewhat similar to what I laid out last year in my beer-induced missiv:
(1) There has to be some latitude in the consideration rule for a particular employee's position within the company;
(2) The closer the employee bumps against the 2-year window, the less relevance the rule has;
(3) The method of termination - voluntary or involuntary - has to be relevant (if not dispositive).
The Fifield decision has caused a fairly wide rift. It's now a federalism issue. Federal courts, under the Erie doctrine, must determine how the Supreme Court of Illinois would look at the issue of consideration. The court yesterday in my case found that the Supreme Court would not adopt Fifield and that under Erie, the two-year rule was not in fact the law in Illinois.
We continue to see a proliferation of trade secrets and non-compete disputes make their way into federal court under diversity rules or as adjuncts to Computer Fraud and Abuse Act claims. This only will continue in light of recent rulings, and it may spur on plaintiffs to add CFAA claims where they otherwise wouldn't.
It's also only a matter of time until another district within the Appellate Court of Illinois (there are five) confronts a Fifield issue, which may give the Supreme Court a second chance to clarify this unacceptably confusing area of the law.
All the while, lawyers will continue hedging their advice with multiple disclaimers. Which, of course, clients love.
Friday, February 14, 2014
The Yardstick Method and Non-Compete Damages
One of the most difficult tasks for a plaintiff in non-compete litigation is the need to focus on a remedy. I was reading an interview Judge Richard Posner gave to Stout Risius Ross recently concerning patent litigation, and some of his comments and criticisms about that type of suit ring true with respect to non-compete and trade secrets claims.
Judge Posner was highly critical of the plaintiff's bar for its laser-like focus on establishing liability. He said - and I agree wholeheartedly - that when it comes time to assessing the viability of a remedy, the plaintiff tends to lose steam. Normally, this isn't much of a problem at the injunction phase. My experience is that plaintiff's counsel generally has a decent handle on what it wants for interim, injunctive relief.
The problem is the next step.
Several years ago, I wrote a law journal article emphasizing the need for businesses to consider using liquidated damages clauses in non-compete agreements for this very reason. I tend to think most lawyers do a really bad job at figuring out damages issues. There are two main factors at force here. For starters, an increasing number of lawyers have very little business or economics background. They're more comfortable proving historical facts - did X solicit the business from Y? - than they are modeling an economic picture of lost profits that has even a basic degree of smarts behind it. And just as important, lost profits require effort - real effort, not just poring over documents. Just deriving a theory can be a tough task to undertake.
There are a number of different methodologies for proving lost profits. Say a non-compete defendant has undoubtedly competed and taken business away. Even if a plaintiff sustains a claim for injunctive relief, that may not be enough to mollify his or her client. There's real economic loss. But how to prove it, that's the challenge.
Modeling is complex stuff, and even settling on an accepted method only solves part of the problem. Take the "yardstick" method of showing lost profits. This method, widely approved and used in
antitrust cases (overall a good analogy for non-compete claims), measures the plaintiff's financial performance against a substantially similar business (this comparator being the "yardstick"). Based on that comparison, the plaintiff should be able to draw inferences about how its business would have performed but for the contract breach (the use of a customer list, diversion of clients, and the like).
But gauging the appropriate yardstick - in essence, data sampling - is the trick. Suppose the defendant raids a branch office of the plaintiff. It takes its top three sales employees, steals the customer list associated with that branch office, and causes widespread disruption in the branch's ability to operate day-to-day. The yardstick approach may be a viable candidate to model damages as long as the plaintiff can find a comparison point. But the plaintiff has a lot of work to do to select the right yardstick.
What can go wrong? Several factors. Assume the plaintiff chooses to pick the financial performance of one of its other branch offices that wasn't raided. Presumably it will pick one that is doing very well. The selected yardstick may not be comparable or provide a reliable indicator of damages. The experience of its employees may be different. The yardstick location may have a super-competent branch manager. It may operate in a geographic location with different organic growth levels. The yardstick location may face a lower level of competition.
The plaintiff would have to run a very intense analysis to show how the comparable location is truly similar in most material respects to the one impacted by the unfair competition. This is no easy task and requires the plaintiff to tease out a lot of factors that may cause it to present an inaccurate, unreliable financial picture during a damages presentation.
My personal preference is to avoid the yardstick method in most non-compete cases. I think that it has some applicability as long as you can draw a reliable comparison, but it is very easy for a defendant to question the data assumptions and point to other yardsticks that may be more appropriate. On that score, it tends to make discovery very expensive.
Friday, February 7, 2014
When Do I Have to Turn Over My Devices?
Defendants in competition cases quickly realize that the discovery battlefield often sits in the land of electronic information. Devices such as smart-phones, laptops, tablets, thumb drives, and cloud storage programs potentially contain relevant information that may bear upon both liability and damages issues. Many times in these types of disputes, an employee's retention of actual paper is minimal, so that discovery may not appear at first blush to be that much of a burden on the employee and its counsel.
However, when an employer requests access to devices, the landscape changes. Employers - often rightly so - are suspicious that an employee has kept information electronically and may not have the digital footprint to track data to a particular device. An employee often reacts viscerally and may be surprised that such a request is even proper.
So under what circumstances will courts order the inspection of devices?
There are some important groundrules and principles to consider. Let's start with the basics, which tend to favor (at least initially) an employee's resistance to turning over devices for inspection:
(1) Many courts find that imaging and production of devices is an exercise that should be undertaken sparingly.
(2) Courts will deny requests for inspections where the request is too broad.
(3) If the employer does not make a connection between the device and the factual underpinning of the claim, then a court will be hesitant to order imaging of the device and inspection.
(4) Courts will frequently put in place protocols to ensure an employee's personal records are kept private and not otherwise exposed (for instance, to protect disclosure of personal photos, financial information, or tax records).
(5) Absent bad faith, employers bear the cost of the imaging.
So with that general landscape in mind, under what circumstances will a court likely order some production of devices for inspection?
(1) There is specific evidence tying a misappropriation of records to the particular device. An employer may, for instance, learn through an examination of a work computer that an employee inserted an external hard-drive the day she left. This would likely justify an inspection of the device by a third-party expert.
(2) An employee has destroyed information in violation of a court order or a duty to preserve evidence. For instance, if an employee admits tossing out a stolen customer list after receiving a summons, a court likely won't have much sympathy for any objection to a device inspection request. The Court would seem to have the inherent authority to order the inspection to see if other vestiges of the list remain somewhere.
(3) An employee's document production has been inadequate. If an employee obfuscates during discovery, then an employer legitimately could claim that the only way to ensure a complete production is to inspect devices to see if the employee has sent information elsewhere that he has failed to account for.
Having considered these general principles, what are the best practices for an employer to obtain an inspection of devices?
(1) Try to learn specific facts tying the claim to a device.
(2) Propose a fair, even-handed protocol for inspection that accounts for an employee's privacy concerns. Attach a draft protocol and order to a motion seeking such an inspection.
(3) Follow the discovery rules. A request for inspection is nothing more than a discovery request. Don't short-circuit the process by filing a motion. Understand - and follow - procedures for resolving discovery disputes (including meet-and-confer efforts with opposing counsel).
(4) Keep the request narrow. Don't ask for all devices kept within the employee's control or possession. A court won't order the production of a 12 year-old's iPod.
(5) Learn other facts first. Often times, the best approach is to take an employee's deposition first to lock him or her into testimony about how a particular device may have been used or what it may contain. At that point, the employer will be on stronger factual footing to request an inspection with specific admissions and testimony backing up the reasonableness of the request.
However, when an employer requests access to devices, the landscape changes. Employers - often rightly so - are suspicious that an employee has kept information electronically and may not have the digital footprint to track data to a particular device. An employee often reacts viscerally and may be surprised that such a request is even proper.
So under what circumstances will courts order the inspection of devices?
There are some important groundrules and principles to consider. Let's start with the basics, which tend to favor (at least initially) an employee's resistance to turning over devices for inspection:
(1) Many courts find that imaging and production of devices is an exercise that should be undertaken sparingly.
(2) Courts will deny requests for inspections where the request is too broad.
(3) If the employer does not make a connection between the device and the factual underpinning of the claim, then a court will be hesitant to order imaging of the device and inspection.
(4) Courts will frequently put in place protocols to ensure an employee's personal records are kept private and not otherwise exposed (for instance, to protect disclosure of personal photos, financial information, or tax records).
(5) Absent bad faith, employers bear the cost of the imaging.
So with that general landscape in mind, under what circumstances will a court likely order some production of devices for inspection?
(1) There is specific evidence tying a misappropriation of records to the particular device. An employer may, for instance, learn through an examination of a work computer that an employee inserted an external hard-drive the day she left. This would likely justify an inspection of the device by a third-party expert.
(2) An employee has destroyed information in violation of a court order or a duty to preserve evidence. For instance, if an employee admits tossing out a stolen customer list after receiving a summons, a court likely won't have much sympathy for any objection to a device inspection request. The Court would seem to have the inherent authority to order the inspection to see if other vestiges of the list remain somewhere.
(3) An employee's document production has been inadequate. If an employee obfuscates during discovery, then an employer legitimately could claim that the only way to ensure a complete production is to inspect devices to see if the employee has sent information elsewhere that he has failed to account for.
Having considered these general principles, what are the best practices for an employer to obtain an inspection of devices?
(1) Try to learn specific facts tying the claim to a device.
(2) Propose a fair, even-handed protocol for inspection that accounts for an employee's privacy concerns. Attach a draft protocol and order to a motion seeking such an inspection.
(3) Follow the discovery rules. A request for inspection is nothing more than a discovery request. Don't short-circuit the process by filing a motion. Understand - and follow - procedures for resolving discovery disputes (including meet-and-confer efforts with opposing counsel).
(4) Keep the request narrow. Don't ask for all devices kept within the employee's control or possession. A court won't order the production of a 12 year-old's iPod.
(5) Learn other facts first. Often times, the best approach is to take an employee's deposition first to lock him or her into testimony about how a particular device may have been used or what it may contain. At that point, the employer will be on stronger factual footing to request an inspection with specific admissions and testimony backing up the reasonableness of the request.
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