Texas Court Predicts Pennsylvania Will Adopt Inevitable Disclosure Doctrine (Industrial Insulation v. Sproule)

The "inevitable disclosure" theory of trade secrets misappropriation continues its journey through the courts, this time making a stop in Pennsylvania.

Actually, the stop was in Texas, but the court decided to apply Pennsylvania law. In this particular case, Industrial Insulation Group v. Sproule, the dispute arose out of a business sale that occurred over 20 years ago in the business of perlite pipe coverings. At the time, Gary Sproule's company was the only U.S.-based manufacturer of perlite pipe insulation. He sold the assets of his company to Calsilite Manufacturing (later succeeded by Industrial Insulation) and transferred all intellectual property to Calsilite in the sales agreement.

Sproule also received a license back to use the transfered IP for his pipe fitting cover business. The parties entered into various restrictive covenant agreements, none of which is relevant to the case.

In 2008, a competitor of Industrial Insulation, ITW Insulation Systems, issued a press release announcing a strategic alliance with Sproule to construct a perlite facility in Texas. Immediate concerns arose within the IIG ranks about the affiliation. ITW had just acquired two facilities overseas.

IIG filed a motion for preliminary injunction, contending that Sproule could not consult with ITW without disclosing trade secret information sold to IIG many years back. In granting the injunction, the court noted that the application of the inevitable disclosure theory of misappropriation was unclear in Pennsylvania. Still, it determined that, based on prior cases, courts there would apply the doctrine.

The court held that even though certain aspects of the perlite manufacturing process were known by some in the industry and were in the public domain, the totality was not. This is the "unified process" theory of trade secret protection that many courts have spoken of in rejecting similar defense arguments. The court stated: "Although portions of both the formula and the process may be publicly accessible at this time, the combination of the formula and the process which enables the producer to consistently manufacture ... perlite remains a valuable trade secret."

Because ITW was attempting to develop similar perlite technology, and sought to hire Sproule in a research and development capacity, an injunction was proper under the inevitable disclosure theory.

The case illustrates the difficulty of applying inevitable disclosure. Generally, four approaches are taken by courts in applying the rule: (a) a fact intensive inquiry; (b) bad faith of the employee; (c) the level of technical skill required of the position; and (d) an objective look at the position and nature of the competition. The approach in this case clearly fell within (c) - the technical skill of Sproule had to be the determining factor.

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Court: United States District Court for the Southern District of Texas
Opinion Date: 1/28/09
Cite: Industrial Insulation Group, LLC v. Sproule, 2009 U.S. Dist. LEXIS 5746 (S.D. Tex. Jan. 28, 2009)
Favors: Employer
Law: Pennsylvania

Pennsylania Court Enforces Non-Compete Agreement Against Pyrotechnics Designer (Zambelli Fireworks v. Wood)

Cases with interesting facts usually produce interesting results, and a recent decision out of Pennsylvania demonstrates this. The case of Zambelli Fireworks v. Wood involved the defection of a pyrotechnics designer from his long-time employer to a direct competitor. At issue in the case was the reasonableness of a nationwide covenant not to compete that barred Matt Wood from working in the pyrotechnics business in any capacity for a total of two years.
The court's findings of fact were extensive, and I'll try and summarize the most critical of those here:

(1) Wood worked in several job capacities for Zambelli, primarily involving choreography and design of high-profile fireworks shows. However, he also had customer contacts and was responsible for preparing business proposals.

(2) Wood had customer responsibility throughout the United States and was not assigned a specific geographic territory.

(3) In 2007, after Wood signed his second non-compete with Zambelli, the family-owned business went through a major restructuring, whereby an outside investor group bought 50 percent of the stock from the family. Two daughters in the family business were pushed out in favor of Doug Taylor, who had no experience in the fireworks business.

(4) Wood was contacted by Pyrotechnico, a close (and apparently friendly) competitor with Zambelli, in late 2007. He negotiated with them through the beginning of 2008, eventually resigning in February. Wood prepared a list of items that he returned to Zambelli on his departure and received a verification from Zambelli that key documents were returned or deleted.

(5) After he began working at Pyrotechnico, Wood refrained from customer contact and tried to minimize competitive activity that would constitute a breach of his Zambelli agreement.

There were several issues discussed by the court in granting an injunction in favor of Zambelli. By way of background, Pennsylvania appears to have a pro-employer bent, due in large part to two factors: (1) the range of protectable interests that a non-compete can support; and (2) its willingness to modify or rewrite covenants to make them reasonable. Both issues were on display in the court's ruling.

First, the court noted that Pennsylvania will recognize a protectable interest in an employee's "specialized training or skills." This is an increasingly popular interest courts deem worthy of protection, notable in New York for its widespread use. Still, it is unavailable for employers to assert in many jurisdictions. In this case, Wood clearly had been trained and had a unique skill in a very narrow, specialized industry - pyrotechnics choreography.

Second, the court found that the lack of geographic restriction on Wood's non-compete was not fatal to the reasonableness inquiry. It was patently clear from the testimony Wood had customer contact throughout the United States, and that he could choreograph shows from his home computer for any customer wherever it may be situated.

Third, the court found the total ban on any competitive activity far too broad, stating that it "would literally prevent [Wood] from engaging in his chosen profession." Accordingly, the court modified and rewrote the contract to make it reasonable. The injunction contained two key components. First, Wood could not contact those customers with whom he developed a business relationship during his employment with Zambelli. Second, Wood's activity restriction was modified so that he could not design or choreograph aerial pyrotechnic dsiplays - the specific expertise he developed at Zambelli.

Finally, the court rejected a novel defense raised by Wood, although it appeared to be a close call. In essence, Wood claimed that the change in job conditions following the stock sale resulted in a new Zambelli and that this was an unauthorized assignment of a non-compete. Though the court called Wood's argument "weighty", it ultimately was not able to rely on any authority for the defense.

Because the company's stock was sold, Wood's non-compete was never assigned. Had Zambelli sold its assets without an express assignment provision in Wood's non-compete, the result may have been different.

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Court: United States District Court for the Western District of Pennsylvania
Opinion Date: 1/21/09
Cite: Zambelli Fireworks Mfg. Co., Inc. v. Wood, 2009 U.S. Dist. LEXIS 3974 (W.D. Pa. Jan. 21, 2009)
Favors: Employer
Law: Pennsylvania

Minnesota Court Refuses to Enter Headstart Injunction In Absence of Non-Compete Agreement (Cenveo Corp. v. Southern Graphic Systems)

There are generally three ways an employer can prevent an ex-employee's post-termination competitive activity: (1) breach of a valid non-compete agreement; (2) breach of a fiduciary duty of loyalty; and (3) misuse of trade secrets or other confidential information. In the case of the last two theories, the scope of injunctive relief is always the subject of vigorous debate. Specifically, in the case of egregious pre-termination wrongful conduct or extensive trade secret theft, a court may deploy its power of equity to order what in effect is a non-compete remedy.

However, almost always, the employer needs a factually compelling case, and not mere isolated tidbits of circumstantial evidence. To illustrate, a Minnesota court last week denied an employer's motion for preliminary injunction, which sought to prevent several ex-employees from servicing its customers. None apparently had a non-compete agreement. But the dispute arose out of a mass exodus from one direct marketing firm to another, and there appeared to be some pre-termination competitive activity as well as limited disclosure of one business document.

The court, though granting the injunction to protect disclosure of some of the identified information, denied the relief pertaining to client solicitation. In particular, the court noted that ordering the defendants to stay away from certain clients would change the status quo, since the competitive activity took place while they were still employed by Cenveo several months earlier. Courts have gone either way on this issue, with Illinois one of the states a bit more flexible on the status quo issue and more willing to grant a so-called "headstart" injunction. That type of injunction can enable the plaintiff to recapture some of the headstart gained by unfair competitive activity. In this case, the Minnesota court found that a legal remedy of damages would be adequate, and it never addressed the propriety of a headstart injunction.

Additionally, the court noted the potential harm to third-parties - the customers themselves - from being denied the opportunity to work with a vendor of their choosing. This, too, is a fact with undetermined relevance. The cases come out both ways, with some placing more importance on third-party preferences than others.

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Court: United States District Court for the District of Minnesota
Opinion Date: 1/22/09
Cite: Cenveo Corp. v. Southern Graphic Systems, Inc., 2009 U.S. Dist. LEXIS 4542 (D. Minn. Jan. 22, 2009)
Favors: Employee
Law: Minnesota

Michigan Case Illustrates Breadth of Legitimate Employer Interests (Edwards Publications v. Kasdorf)

Michigan traditionally is a state which readily enforces non-competes. A recent dispute involving competitors in the advertising circular business demonstrates the broad array of legitimate business interests which will support an otherwise reasonable non-compete in Michigan.

Tracy Kasdorf was a sales representative for Edwards Publications, who left to take a similar position with Bilbey Publications. From the court opinion, there is no indication what the exact wording of Kasdorf's non-compete restricted in the way of competitive activity. That said, it was clear she was working in direct competition with Edwards to solicit businesses for the placement of advertisements in a free circular distributed to shoppers.

In 1985, Michigan enacted a new non-compete statute as part of the Michigan Anti-Trust Reform Act. The statute has been interpreted broadly, conferring upon the courts the ability to recognize a fairly wide range of legitimate business interests which can support a non-compete agreement. (In most states, an employer must not only demonstrate that the covenant is reasonable, but also that it is used to protect something - a legitimate business interests - the law deems acceptable.)

In reversing a summary disposition for Kasdorf on the non-compete agreement, the court noted as follows:

"By going to work for Bilbey, where Kasdorf's accounts would be with many of those same customers or where those customers would be subject to not-so-cold cold calls, Kasdorf would be gaining and taking an unfair advantage in competition with Edwards after years of acquiring a unique insight into various business operations thanks to her employment with Edwards."

The court went on to emphasize the "goodwill and strong personal relationships" developed by Kasdorf with accounts. In this sense, Michigan is more expansive in its recognition of a legitimate business interest than some other states. While states, such as Illinois, tend to disfavor covenants involving sales of ordinary goods or services, Michigan makes no such distinction. It also will recognize the amorphous term of "goodwill" as a protectable interest in the employment context - a concept amenable to use by any creative attorney.

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Court: Court of Appeals of Michigan
Opinion Date: 1/20/09
Cite: Edwards Publications, Inc. v. Kasdorf, 2009 Mich. App. LEXIS 109 (Mich. Ct. App. Jan. 20, 2009)
Favors: Employer
Law: Michigan

Kansas Court Sides With Narrow Application of Computer Fraud and Abuse Act (Us Bioservices v. Lugo)

Another court has weighed in on whether the federal Computer Fraud and Abuse Act can be applied to essentially federalize trade secrets claims. The answer, in the case of US Bioservices v. Lugo, was a resounding "no."

In granting the defendant's motion to dismiss the CFAA claim, the court adopted a narrow reading of the predicate act giving rise to liability under the statute. Though the CFAA has a number of different provisions, the touchstone of liability is that a defendant must use a protected computer without authorized access or in a manner which exceeds the access granted to him.

The Lugo case is based on a fairly typical of fact-pattern under the CFAA. An ex-employer claims that an employee downloaded or accessed confidential business information while on her work computer, e-mailed that to another location (usually a home account), and then permitted a new employer to use or obtain the benefit of the stolen data.

Does this activity equate to unauthorized access?

Lugo held no, noting along the way that federal courts are split on the issue. There are a number of factors supporting this narrow reading of the authorization language:

(1) the CFAA is at heart a criminal statute, and the rule of lenity applies
(2) "without authorization" is not defined but means, basically, "without permission" and there was no dispute that the employee had permission to access the information, irrespective of whether she misused it later
(3) the focus of the CFAA is wrongful procurement of data, not wrongful use of it

The court rejected the reasoning applied in other jurisdictions that principles of agency law can be grafted onto the CFAA. Under cases like the influential Citrin decision from the Seventh Circuit, an employee's "access" to his work computer ends when he is in breach of a duty of loyalty. Therefore, in those jurisdictions where Citrin is the prevailing rule, it is much easier to state a claim under the CFAA for cases involving misuse of data.

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Court: United States District Court for the District of Kansas
Opinion Date: 1/21/09
Cite: Us Bioservices Corp. v. Lugo, 595 F. Supp. 2d 1189 (D. Kan. 2009)
Favors: Employee
Law: Federal

California Appellate Court Rules Liquidated Damages Clause Unreasonable (Nissanoff v. Balikian)

Any California case involving a covenant not to compete has a fairly predictable outcome. The recent unpublished decision in Nissanoff v. Balikian is no different.

The case involved an attempt by Philip Balikian to become affiliated with an orthopedic practice in California after a relocation from Kentucky. Unfortunately for Balikian, he seemed to run into Jonathan Nissanoff wherever he looked. At first, Balikian went through a headhunter and discussions ensued with respect to Balikian joining that practice. The deal fell apart when Nissanoff balked to working with the headhunter, presumably because of the fees involved.

Then, in an unrelated transaction, Balikian found a listing for a medical practice - which turned out to be Nissanoff's. Eventually, Balikian signed a non-disclosure clause to conduct some due diligence about Nissanoff's practice. The NDA contained an end-around non-compete and a liquidated damages clause. As a fairly transparent way to circumvent California's statute against non-compete agreements, Nissanoff's contract with Balikian provided that it would be a breach of the confidentiality clause if, after reviewing Nissanoff's so-called proprietary information, Balikian opened up a medical practice for orthopedic surgery within 25 miles of Nissanoff's office within one year from signing the NDA.

The agreement contained a liquidated damages clause of $300,000 and a $1,000 per day violation every day thereafter for breach. (It is entirely unclear how a $1,000 per day penalty could be applied for breach of confidentiality, but that academic issue was not addressed).

Eventually, Balikian continued his search and ran into another physician who asked if he had looked at other options. Balikian remarked that he "had interviewed with Nissanoff." The same physician then asked Nissanoff if he was planning to leave San Diego. Apparently, Nissanoff concluded Balikian breached the confidentiality provision and demanded $300,000 and $1,000 per day. Balikian declined to pay.

Balikian then accepted a job with another orthopedic surgery center and found himself sued by the disgrunted Nissanoff.

Not surprisingly, the court had little trouble disposing of the case in favor of Balikian. In terms of the liquidated damages clause, the court of appeals affirmed the ruling that it constituted an unenforceable and unreasonable penalty under California's statute governing liquidated damages.

Key to the court's ruling were a couple of factors: (1) that there was no discussion whatsoever between the two surgeons about potential damages which might arise from a breach; (2) that there was no effort by either party to ascertain what damages might arise from a breach of the covenants; (3) that the agreement referred to the $1,000 per day amount as a "penalty."

Generally, liquidated damages clauses that are fixed fee or flat sum amounts are unreasonable and unenforceable. They are inherently arbitrary, and courts will not uphold damages clauses which are not a reasonable estimate of the damage likely to occur.

Though Balikian may have regretted his decision to relocate, he had the last laugh. He obtained over $76,000 in attorneys' fees from his opponent.

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Court: Court of Appeal of California, Fourth Appellate District
Opinion Date: 1/20/09
Cite: Nissanoff v. Balikian, 2009 Cal. App. Unpub. LEXIS 425 (Cal. App. Ct. 4th Dist. Jan. 20, 2009)
Favors: Employee
Law: California

Massachusetts Court Finds Successor Company Cannot Enforce Non-Compete (Randstad Professionals v. Wilson)

I wrote yesterday regarding the law of assignment and how it pertains to non-compete obligations of employees. Though approaches vary from one state to the next, assignments of covenants not to compete are generally permitted and may even be implied if the contract is silent.

Of course, nothing precludes a contract from prohibiting assignment altogether, as a recent Massachusetts decision illustrates. In the case of Randstad Professionals v. Wilson, the defendant signed an employment contract with a professional staffing agency, New Boston Select Group, Inc., which contained an 18-month, 100 geographic mile non-compete and a customer non-solicit clause. Several years after he started, New Boston was sold to Placement Pros. In 2008, the plaintiff - Randstad - took over Placement Pros. When it became apparent that Randstad would be Wilson's new employer, he quit.

Randstad sued to enforce the non-compete when Wilson defected and joined a direct competitor. The court had little trouble denying Randstad's motion for a preliminary injunction, holding that a specific provision of the non-compete agreement provided that "Employee's obligations ... may not be assigned."

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Court: Superior Court of Massachusetts at Worcester
Opinion Date: 12/26/08
Cite: Randstad Professionals US, LP v. Wilson, 2008 Mass. Super. LEXIS 405 (Mass. Super. Ct. Dec. 26, 2008)
Favors: Employee
Law: Massachusetts

Assignment of Non-Compete Agreements In Ohio Continues To Be Fact-Specific (Michael's Finer Meats v. Alfery)

One technical defense frequently raised by employees looking to break a non-compete agreement has to do with a change in ownership of the business. During the course of a business sale, the buyer conducts extensive due diligence regarding employee agreements and the availability of non-compete contracts, particularly as to key sales and executive employees.

The lack of valid non-compete agreements can impact the goodwill purchased in the transaction. Similarly, if those agreements are not assignable, the buyer's ability to protect customer relationships, and concomitantly a stream of sales revenue, will be detrimentally impacted. With that reality in mind, courts generally favor the assignment of non-compete covenants from a seller to a buyer. The rule is not absolute. Pennsylvania, for instance, requires a non-compete agreement to have an express assignment clause permitting the transfer.

Ohio is a more fact-specific state. Assignment of a covenant is not governed by a per se rule for or against the transfer. Rather, courts there continue to examine the facts bearing on the assignment if the non-compete agreement is silent on the issue. The precedents from Ohio are mixed.

In Michael's Finer Meats v. Alfery, the court sided with the employer on the assignment issue. Alfery began work as a sales representative with Michael's when it was a corporation owned entirely by Michael Bloch. Subsequently, Bloch merged the corporaton into a limited liability company with a Utah investor group. Bloch maintained a minority ownership interest. The merger was effectuated under Ohio law, and a certificate of merger was filed with the State pursuant to governing statute.

The court analyzed the facts and determined that the assignment was permissible for three main reasons: (1) the Bloch family remained in charge of day-to-day operations such that Alfery's line of reporting did not change significantly, (2) Alfery's job duties and sales responsibilities were not impacted significantly, and (3) assignment was necessary to protect the goodwill of the seller in the business transaction. In particular, the court stated: "nothing in Defendant's salary structure, his territory, his supervision or sales targets changed as a result of the sale of business."

Additionally, the court found that Alfery's non-compete was overbroad as drafted. It barred him from competing with Michael's for a one-year period, but the geographic term was silent. Under Ohio's liberal modification doctrine, the court rewrote the contract to prohibit Alfery from making sales of competitive products within one county around Pittsburgh, where he was the "face of the company." Assisting the court was clear evidence that Alfery did in fact make such sales to his former accounts in violation of the covenant.

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Court: United States District Court for the Southern District of Ohio
Opinion Date: 1/13/09
Cite: Michael's Finer Meats, LLC v. Alfery, 649 F. Supp. 2d 748 (S.D. Oh. 2009)
Favors: Employer
Law: Ohio

Louisiana Appellate Court Affirms Finding That No-Hire Clause Is Overbroad (Bell v. Rimkus Consulting Group)

The Louisiana case of Bell v. Rimkus Consulting Group has a long and tortured history, and generally speaking, appears to substantially favor the departing employees who sued their former firm seeking to have their rights under a customer non-solicitation clause declared invalid.

A recent ruling by the Court of Appeal of Louisiana further favors the employees and strictly applies an employee non-solicitation, or "no-hire" clause. These types of restraints of trade are receiving increased judicial scrutiny as employers attempt to prevent the poaching away of key employees. Courts have taken a number of different approaches in analyzing no-hire clauses. The general rule appears to be that, while the same are restraints of trade, they are not necessarily subject to the same rigorous analysis as customer non-solicitation or general non-compete covenants.

In the Bell case, the court upheld a trial court ruling, however, that a no-hire clause was invalid due to its overbreadth. The clause provided that Bell, following his termination, "will not, directly or indirectly, solicit, employee, or in any other fashion, hire persons who are, or were, employees, officers, or agents of the Company, until such person has terminated his employment with the Company for a period of eighteen (18) months."

The overbreadth of the no-hire clause was fairly obvious: it had no temporal limitation at all on Bell's conduct. As an illustration, if Bell waited ten years to approach a Rimkus employee for a new position, he would be barred from soliciting that person until he or she had left Rimkus' employment and was gone for at least 18 additional months. Put another way, the temporal limit was tied not to Bell, the party seeking to hire the employee, but rather to the employee being solicited.

The Louisiana court appeared to apply a conventional restrictive covenants analysis to the no-hire clause.

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Court: Court of Appeal of Louisiana, Fifth Circuit
Opinion Date: 1/13/09
Cite: Bell v. Rimkus Consulting Group, Inc., 2009 La. App. LEXIS 48 (Ct. App. La. Jan. 13, 2009)
Favors: Employee
Law: Louisiana

Illinois District Court Issues Partial TRO In Employee Competition Dispute (Hal Wagner Studios v. Elliott)

A federal district case out of Southern Illinois illustrates the difficulty employers face in attempting to enforce restrictive covenants - even those reasonably drafted.

The case of Hal Wagner Studios v. Elliott arises out of the school photography business. HWS provides yearbook and portrait services to schools in the Southern Illinois area. At the end of 2008, several of its key employees defected to a competitor, Herff Jones, and immediately began soliciting key HWS accounts. HWS also produced substantial evidence that certain of the employees misappropriated a substantial number of corporate documents. To its credit, HWS listed the specific documents missing, produced logs indicating suspicious copying and printing activity, and outlined for the court how it would be harmed by the defendant's use of those documents.

HWS also produced a non-compete agreement with the lead defendant, Kris Elliott. The non-compete was well-drafted and reasonably tailored; it only barred Elliott from soliciting school photography accounts which were in his defined territory or which he produced for HWS. (A separate aspect of the non-compete further barred Elliott from engaging in other competition with respect to those accounts, but the reasonableness of this clause was not discussed.)

HWS immediately filed suit and moved for a TRO on both the non-solicitation covenant and on several common-law claims seeking return of the information taken by the defendant group around the time of their mass exodus. The court denied HWS' effort to prevent Elliott from soliciting clients, but granted an affirmative injunction mandating return of documents.

In denying relief on Elliott's non-solicitation covenant, the court found that it was of questionable applicability under Missouri law because HWS had failed to pay Elliott commissions for a period of time. Though HWS claimed it adjusted Elliott's salary instead, the court found that a provision of the contract requiring modifications or amendments to be in writing doomed HWS' explanation. As such, and even though the court warned Elliott about the risks of further solicitation, the court could not issue a TRO in light of the likelihood HWS would not prevail on the merits.

The issue regarding return of documents proved easier for the court. Under a fiduciary duty theory, the court exercised its power of equity to demand immediate return and an accounting of documents HWS identified as missing. Key to this finding was the balance of harms analysis. Not only was HWS likely to prevail on the merits, but HWS was in a far worse position from not retrieving its documents than the defendants were from having unlawful continued access to them.

To its credit, the court issued a very specific TRO outlining by document name what should be returned and how the documents needed to be accounted for. Frequently, courts issue overbroad TROs without any degree of required specificity.

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Court: United States District Court for the Southern District of Illinois
Opinion Date: 1/15/09
Cite: Hal Wagner Studios v. Elliott, 2009 U.S. Dist. LEXIS 2778 (S.D. Ill. Jan. 15, 2009)
Favors: Employee
Law: Missouri, Illinois