Trade Secret | Noncompete – Issues and Cases in the News – October-November 2012

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Once again, this installment of “Trade Secret | Noncompete Issues and Cases in the News” is my vacation readings update. There is again a lot here! Enjoy…

Federal/Antitrust: In October 2009, Computerworld published an article of mine entitled, “No-poach agreements: A new generation of restriction.” The article discussed a no-poach agreement used by several large high tech companies (Adobe Systems, Inc., Apple Inc., Google Inc., Intel Corp., Intuit Inc. and Pixar) to refrain from soliciting the other’s employees. As I (here) and many others discussed at the time, this agreement led to an antitrust settlement with the DOJ in 2010. Now, as reported by CBS, the DOJ is at it again: “Justice Department sues eBay over non-compete agreement.” A copy of the DOJ complaint is here.

Federal/CFAA: As expected, there is finally a petition to the United States Supreme Court about the scope of the Computer Fraud and Abuse Act. Following the 4th Circuit’s decision in WEC Carolina Energy Solutions LLC v. Miller, two circuits (the 4th and 9th) have employed a narrow interpretation of the CFAA, while four other circuits (the 1st, 5th, 7th, and 11th) have taken a more broad approach.

Federal/ERISA: Occasionally, ERISA issues pop up in noncompete cases. That is exactly what happened in Pactiv Corp v. Rupert, in which the United States District Court for the Northern District of Illinois held that a noncompete agreement sought to be imposed to receive severance benefits was not required by the ERISA severance plan and therefore the former employee was entitled to the benefits. For more reading, see “ERISA Severance Plans and Non-Compete Agreements Must Work Together,” by Peter Land.

California:

Georgia: The Georgia Court of Appeals granted summary judgment in Contract Furniture Refinishing & Maintenance Corp. v. Remanufacturing & Design Group, LLC, reminding practitioners how difficult it can be to show actual proof of trade secret misappropriation. For more reading, see Burr & Forman’s post, “The Difficulty of Proving Trade Secret Violations.”

Illinois: How far can you go when investigating the conduct of a former employee suspected of breaching his noncompete? That answer just got a bit more complicated in Illinois, which, in Lawlor v. North American Corporation of Illinois (October 18, 2012), has now recognized a claim for intrusion upon seclusion (basically an invasion of privacy claim). Long-time noncompete blogger, Ken Vanko, discusses the case here: “Supreme Court of Illinois Recognizes Intrusion Upon Seclusion Tort in Non-Compete Investigation.”

Massachusetts:

  • About a year and a half ago, I posted about a hairstylist who was enjoined from competing with his former employer-hair salon, Zona Corp. (See “Hairdresser Takes a Haircut”.) Last month, however, a different Massachusetts judge went the other way in Invidia, LLC v. DiFonzo, raising the very question that I (and many others) were asking about the Zona Salon case: Who owns the goodwill in the context of a hairstylist? The Invidia Court determined that the employer failed to show that it was its goodwill. For more, see “Engaging Facebook Friends Doesn’t Violate Non-Solicitation Clause.”

Michigan: What happens when you have the following facts: A nondisclosure agreement; no noncompete; an employee who acts properly upon departure (returning all information, etc.); and a decrease in your business? Nothing.  Well, at least according to a recent decision by the Court of Appeals of Michigan in Michigan One Funding, LLC v. MacLean (September 20, 2012). For more reading, see “Preventing an Employee From Working for a Competitor Unravels without an Enforceable Noncompete Agreement.”

Minnesota: When enforcing restrictive covenants, the difficulty is often obtaining evidence of a true risk of harm before discovery has taken place. In Sempris, LLC. V. Watson (D. Minn. Oct. 22, 2012), the federal District Court denied a temporary restraining order based on the plaintiff’s failure to provide evidence of an imminent threat, as opposed to speculative or remote future harm. For more reading, see Paul Freehling’s post, “Speculative Fears Insufficient for Non-Compete Temporary Restraining Order Against Former Employee.”

Missouri: Choice of law provision selecting Missouri (where plaintiff was located) over Oklahoma (which like California and North Dakota, bars employee noncompetes and where defendants were located and where most of the conduct occurred) was enforced by the United States District Court for the Eastern District of Missouri in TLC Vision (USA) Corp. v. Freeman (E.D. Missouri Nov. 2, 2012). For more reading, see “Non-Compete Cases and Choice of Law: A Recent Case From Missouri,” by Jonathan Pollard.

New York: In perhaps the first 2nd Circuit decision to directly “address[] when enforcement of a covenant restricting competition may irreparably injure a former employee,” the Court held that “[d]ifficulty in obtaining a job is undoubtedly an injury, but it is not an irreparable one” when “monetary damages will compensate [the plaintiff] adequately . . . .”  Hyde v. KLS Professional Advisors Group, LLC (October 12, 2012). Given the 2nd Circuit’s pronouncement that “irreparable harm [is] the ‘single most important prerequisite for the issuance of a preliminary injunction,’” this decision should have significant implications for noncompete cases in the federal courts in New York, Connecticut, and Vermont.

Oklahoma: Rarely do restrictive covenant cases or trade secret cases proceed much beyond the injunction stage. When they do, the fight can be over permanent injunctive relief, damages, or both. Even then, damages are typically lost profits or disgorgement of profits. Sometimes, however, damages can be a reasonable royalty. That was the case in Skycam, LLC v. Bennett. There, the United States District Court for the Northern District of Oklahoma found injunctive relief to be against public policy, given limited competition, and instead ordered royalty payments – an initial payment of $1,000,000 plus $5,000 per use for the 3.5 years it would have taken the defendants to independently create the misappropriated information.

Ohio: As you may recall, in the September 2012 issue of “Trade Secret | Noncompete – Issues and Cases in the News,” I noted that, on July 25, the Ohio Supreme Court issued a decision agreeing to reconsider its May 24 Acordia of Ohio, L.L.C. v. Fishel decision, which took a dim view of assignment of noncompete clauses. Well, the Court did review its decision. And it reversed it! Here is the new (presumably final) view of the Ohio Supreme Court: Acordia II (October 11, 2012), courtesy of my friend and prolific blogger, John Marsh.

South Carolina: In another trade secret trial, judgment entered for over $4.6 million against a former employee who was found to have misappropriated trade secrets and breached his fiduciary duties. See, “Greenville Businessman Ordered to Pay $4.6 Million for Taking Trade Secrets, Breaching Fiduciary Duty.”

Virginia: As the United States District Court for the Eastern District of Virginia recently made clear in JTH Tax, Inc. v. Noor (September 26, 2012), failure to comply with an injunction requiring the return of trade secrets can have significant consequences, including an extension of the injunction. (Thank you to Jim Irving, who posted a link to the case in the LinkedIn Noncompete Lawyers group.)

Wisconsin: What happens to a plaintiff’s claim for misappropriation of trade secrets when the secret becomes publicly known? Nothing – at least according to a decision by the Eastern District of Wisconsin denying a motion to dismiss in Encap v. The Scotts Company. Well, to be clear, “nothing” in the sense that the claim survives a motion to dismiss when the information constituted a trade secret at the time of the misappropriation.  There’s no real surprise here; the cause of action is assessed as of the time the cause accrues; the fact that the circumstances later change does not affect the existence of the cause of action. (Damages may be another issue – assuming, of course, that the misappropriator was not the party that publicly disclosed the information.)

Criminal:

  • It’s always big news when employees of large companies are indicted for trade secret theft, especially when China is somehow involved. But, rarely do people report when those cases fail. So, kudos to The Trade Secrets Vault, Bloomberg, HudsonHubTimes, Alison Grant (writing for Cleveland.com here) and several others, all of whom reported that the former Bridgestone employee (Xiaorong Wang) accused of misappropriating Bridgestone’s secrets for the benefit of a Chinese company has been cleared.
  • John Marsh has an in-depth post on the latest in the Kolon/DuPont trade secrets dispute, the title of which begins, “The Kolonoscopy Continues . . . .” (The title is perfect, as is John’s discussion of the status.)

Related Items of Interest:

Massachusetts Trade Secret Protections Are Given Big Boost

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There has been much uncertainty in Massachusetts about whether and under what circumstances a claim under G.L. c. 93A (for those not from Massachusetts, that’s our unfair competition statute, which provides for the recovery of multiple damages and attorneys’ fees) exists against an employee who takes his former employer’s trade secrets to a new venture and uses them there. A recent decision from the Massachusetts Appeals Court seems to open the door to such claims. (Unless you are a lawyer, you will probably want to stop here.)

The problem started in 1983 with a case from our highest court (the Supreme Judicial Court, or “SJC”) called Manning v. Zuckerman. In that case – which was not a trade secrets case – the SJC made it clear that 93A does not apply to disputes arising out of an employment relationship. That seemed clear enough.

But, the very next year, the Appeals Court decided Peggy Lawton Kitchens, Inc. v. Hogan. Hogan, an employee of the plaintiff, had taken the plaintiff’s secret recipe for cookies and left to start a competing business using the plaintiff’s recipe. From the moment you start reading the decision, you know exactly how the case is going to come out; the decision starts, “Nothing is sacred.” Of course, the court holds that the plaintiff’s 93A claims against its former employee (and his new company) are proper.

The court’s decision is important in two respects: First, as to the defendant company (which the former employee had started with the intent of competing with the plaintiff), the court concluded that, because the company was never an employee of the plaintiff, Manning v. Zuckerman did not apply and the claim under 93A could therefore proceed. Second, as to Hogan, the court says, “Hogan’s use of Kitchens’ trade secret was made when he was no longer an employee of Kitchens. Hogan’s argument crumbles.”

The distinction (that 93A could be applied to conduct that took place after employment ended) lasted about 12 years.

In 1996, the Appeals Court decided Informix, Inc. v. Rennell. There, the court held that it did not matter whether the conduct occurred during or after employment. In this regard, the court stated, “Manning held simply that any claim arising from the employment relationship was not actionable under c. 93A; it imposed no limitation that the employment relationship be ongoing.” Further, the Informix court distinguished Peggy Lawton Kitchens on the basis that the claim in Informix was based on a nondisclosure agreement, whereas there was no such agreement in Peggy Lawton Kitchens, and therefore the claim in Peggy Lawton Kitchens was independent of the employer/employee relationship.

One might wonder at this point why the Appeals Court in Informix did not simply deny the 93A claim based on the nondisclosure agreement, but then allow a claim based on the common law and statutory obligations of all persons (not just employees) not to misappropriate trade secrets – but it did not. Presumably, the court’s rationale was based on the procedural posture of the case and the fact that the claim was based “solely” on the parties’ contract.

Since then, trial courts have been wrestling with these two decisions and trying to square them.

For example, in Professional Staffing Group, Inc. v. Champigny (in 2004), the Superior Court reasoned as follows:

Informix conflicts with the decision of Peggy Lawton Kitchen’s, Inc. v. Hogan. The panel reasoned that no express confidentiality or noncompetition agreement existed between Peggy Lawton Kitchen’s, Inc. and Hogan. However no doubt arises from the Peggy Lawton Kitchens decision that the wrongful misappropriation of trade secret information arose from the employment relationship. . . . Moreover the absence of an explicit employment contract is not essential to impose duties of loyalty upon a former trusted employee. The Massachusetts common law implies a covenant or promise of the trusted employee not to divulge trade secret or proprietary information. See Jet Spray Cooler v. Crampton, 361 Mass. 835, 839 (1972), and cases cited.

Having disposed of the notion that the existence or absence of a contract is controlling, the court then came back to the temporal distinction:

The other ground of distinction [from Peggy Lawton Kitchens] asserted by the Informix panel is that the theft of trade secrets constitutes a wrong independently of an employment relationship and will be separately actionable under 93A. Nothing in the Peggy Lawton decision suggests such a special rule. Rather the Peggy Lawton panel concluded that the exemption from 93A for wrongdoing arising from an employment relationship was inapplicable for temporal reasons. “Moreover, Hogan’s use of Kitchens’ trade secret was made when he was no longer an employee of Kitchen’s.” Id. at 940 (emphasis added).

It is on that temporal basis that the Superior Court in Professional Staffing Group found that 93A can apply to an employee’s misappropriation of trade secrets: “[H]ere, we are addressing conduct occurring long after the termination of the employment relationship between the contesting parties.” The court then went on to conclude that “Informix is a mechanical overextension of Manning” and “appears to drift away from the anchoring principle of c. 93A . . . .” In the end, however, after offering a few public policy reasons for applying 93A to this type of claim, the court observed that, following trial, there will be a complete record so that the issue can be reviewed on appeal. However, no appellate decision followed.

Another oft-cited case addressing this issue is TalentBurst, Inc. v. Collabera, Inc. That case relies on yet another case (Intertek Testing Servs. NA, Inc. v Curtis-Strauss LLC from Judge Gants while in the Superior Court, now on the SJC) and concludes that the Professional Staffing Group decision was distinguishable on the ground that it involved a counterclaim by the employee (rather than a claim by the former employer).

Such was the state of affairs until recently.

Enter Specialized Technology Resources, Inc. v. JPS Elastomerics Corp. (November 23, 2011), an Appeals Court decision, perhaps shedding some additional light on its two prior rulings (Informix and Peggy Lawton Kitchens). The sum total of the court’s discussion of those cases and 93A is as follows:

Applicability of c. 93A. The defendants separately assert that c. 93A is inapplicable to [plaintiff’s] claim in the present case, as it arises out of an employer-employee relationship between [plaintiff] and [defendant] Galica. See Manning v. Zuckerman, 388 Mass. 8, 12-15 (1983); Informix, Inc. v. Rennell, 41 Mass. App. Ct. 161, 163 (1996). However, [defendant company] was never an employee of [plaintiff]. See Augat, Inc. v. Aegis, Inc. 409 Mass. 165, 172 (1991); S.C., 417 Mass. 484 (1994); Peggy Lawton Kitchens, Inc. v. Hogan, 18 Mass. App. Ct. 937, 940 (1984). More to the point, though Galica obtained the trade secret during his employment with [plaintiff] and was bound by a confidentiality agreement as part of his employment contract, his misappropriation of the trade secret was actionable independent of his contractual obligations and accordingly may support a claim under c. 93A. See Peggy Lawton Kitchens, Inc. v. Hogan, supra; Informix, Inc. v. Rennell, supra at 163 n.2. The former employer-employee relationship between [plaintiff] and Galica does not stand as a bar to [plaintiff’s] c. 93A claim against either Galica or [his new employer].

In short, it appears that the court’s rationale is that, while the misappropriation of trade secrets may constitute a breach of an employee nondisclosure agreement, which cannot serve as a predicate to a 93A claim, the same conduct can also constitute a separate and independent wrong (presumably because it violates trade secret laws – as opposed to the fiduciary duty of loyalty referenced in Professional Staffing Group) that is actionable under 93A.

It bears mention that the decision is also very interesting insofar as it holds that a judge may ignore a jury’s findings when deciding a 93A claim and allows two different injunctive remedies for the defendants’ misappropriation of trade secrets.

Massachusetts Noncompete Bill Refiled

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The bill in Massachusetts to codify, clarify, and modernize Massachusetts law relative to employee noncompetition agreements was re-filed today, with several significant changes from the prior version.  A copy will be available shortly (check back or see below).

Here is a summary:

(1) The bill, if enacted, will not apply retroactively (i.e., it would apply only to noncompete agreements that are entered into after the law becomes effective). Of course, lawyers being lawyers, will not let the inquiry end there. Lawyers seeking to help their clients avoid existing noncompete agreements will likely argue that the bill provides guidance that should be followed in interpreting existing agreements.

(2) The bill does not affect nondisclosure agreements, nonsolicitation agreements, anti-piracy agreements, other similar restrictive covenants, or noncompetition agreements outside of the employment context (for example, in the context of the sale of a business). Such agreements are specifically exempted from the scope of the bill.

(3) The bill codifies current law insofar as noncompetition agreements may be enforced if, among other things, they are reasonable in duration, geographic reach, and scope of proscribed activities and necessary to protect the employer’s trade secrets, other confidential information, or goodwill. Similarly, courts may continue to reform noncompetition agreements to make them enforceable and refuse to enforce such agreements in certain circumstances.

(4) The bill requires that noncompetes be in writing, signed by both parties, and, in most circumstances (i.e., if reasonably feasible), provided to the employee seven business days in advance of employment. If the agreement is required after employment starts, the employee must be provided with notice and “fair and reasonable” consideration (beyond just continued employment).

(5) The bill restricts noncompete agreements to one year, except in the case of garden leave clauses, which may be up to two years.

(6) The bill identifies certain restrictions that will be presumptively reasonable and therefore enforceable (if all other requirements are met).

(7) The bill requires payment of the employee’s legal fees under certain circumstances, primarily where the agreement is not enforced in most respects by the court or where the employer acted in bad faith. The bill does, however, provide safe harbors for employers to avoid the prospect of having to pay the employee’s legal fees, specifically, if the noncompete is no more restrictive than the presumptively reasonable restrictions (the safe harbors) set forth in the bill – or if the employer objectively reasonably tried to fit within the safe harbors. Similarly, an employer may receive its legal fees, but only if otherwise permitted by statute or contract, the agreement falls within the safe harbor, the noncompete was enforced, and the employee acted in bad faith.

(8) The bill rejects the inevitable disclosure doctrine (a doctrine by which a court can stop an employee from working for a competitor of the former employer even in the absence of a noncompetition agreement).

(9) The bill places limitations on forfeiture agreements (agreements that can otherwise be used as de facto noncompetition agreements).

The principal changes from the last bill are as follows:

(1) The requirement that a noncompete be housed in a separate document has been eliminated.

(2) The salary threshold has been eliminated. Instead, courts shall simply factor in the economic circumstances of, and economic impact on, the employee.

(3) Garden leave clauses have been added back in. Accordingly, if an employer needs a noncompete for more than one year, up to two years, it may – at its option – use a garden leave clause.

(4) The consideration for a mid-employment noncompete has been changed to simply that which is “fair and reasonable.” The presumption that 10 percent of the employee’s compensation is “reasonably adequate” (the old standard) has been eliminated.

(5) The circumstances in which an employer can avoid paying mandatory attorneys’ fees have been expanded to include when the lawyer objectively reasonably attempted (even if unsuccessfully) to fit within the applicable safe harbors.

(6) The rejection of the inevitable disclosure doctrine has been further clarified to ensure that employers can still protect themselves if an employee has disclosed, threatens to disclose, or is likely intentionally disclose the employer’s confidential information.

(7) The scope of restrictions place on forfeiture agreements has been limited. Incentive stock option plans and similar plans will have fewer requirements placed on them.

Other information:

Some people have expressed an interest in having other issues to be addressed by the bill, which have not been incorporated. Three facts are important in this regard: (1) additional changes may be made in the future; (2) the bill is the product of input reflecting many different points of view and strives to balance those needs in order to improve the state of the law as to all of those affected; and (3) the bill is not, nor is it intended to be, a substitute for proper drafting of a noncompete (or any other restrictive covenant, for that matter).

We will continue to provide close and timely coverage of the bill, so please feel free to do any or all of the following:

If you have any questions, please feel free to share them with us via email.  Also, you may wish to contact your local state senator or representative if you would like them to take a position.

Liquidated Damages in Restrictive Covenants

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When drafting restrictive covenants, including especially noncompetes and nonsolicitation agreements, companies should consider including a liquidated damages provision. Before the guffaws start, note that this only makes sense in jurisdictions, like Massachusetts, where the specification of monetary damages does not of itself affect entitlement to injunctive relief. However, in those states where injunctive relief is compatible with liquidated damages, the benefit of liquidated damages is three-fold.

First, a proper liquidated damages clause provides a substantial likelihood that damages will be provable, and therefore potentially recoverable. In the absence of such a provision, damages for breach of a noncompetition agreement are typically lost profits or disgorgement of profits. (No, they are not the same thing.) But, proving (and defending against) these types of damages can be quite difficult – and expensive. Although courts often give great latitude to the plaintiff when the difficulties in proving such damages arise from the defendant’s conduct, this latitude only makes a difficult task marginally less difficult. Also, courts can still refuse to enforce the liquidated damages provision (in whole or in part) on equitable or other grounds, for example, when the agreement specifies the forfeiture of earned retirement (which is unlawful for other reasons).

Second, it provides a degree of certainty in the amount of damages. For the employer, this comes at the expense of potentially being able to prove that the actual damages were greater than those specified. In contrast, for the employee, the opposite is true; the employee foregoes the argument that damages were less than the liquidated amount. This is not an unbounded agreement, however, as the stated amount must always be a reasonable estimate of what the likely monetary damages would be.

Third, it enables both parties to save a substantial amount of legal and expert fees insofar as they will not be embroiled in a battle over the amount of damages. (The fight will generally turn on the reasonableness of the estimate, which is a significantly less intensive analysis.)

One word of caution: although you should go back and review existing restrictive covenants, before making any changes, you need to consider the impact of changing the terms of an existing agreement – especially mid-employment. More on that later.

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