EBG Trade Secrets and Noncompete Blog : Non-Compete Lawyer & Attorney : Epstein Becker Green Law Firm : Trade Secrets & Confidentiality Agreements

The U.S. Court of Appeals for the Third Circuit recently held that a stock sale did not invalidate an employee’s non-compete. Zambelli Fireworks Manufacturing Co., Inc. v. Wood et al., Case No. 09-1526 (January 15, 2010).

In Zambelli, a company brought suit against a former employee to enforce his non-compete. The employee responded, in part, by arguing that the non-compete was invalid because, when a majority of the company’s stock had been sold, there was no specific assignment of the employee’s non-compete to the buyer of the stock.

Although this would not seem to be a novel question, the Third Circuit explained that it found no Pennsylvania appellate decisions which addressed “the impact of a stock sale on the enforceability of a non-compete agreement.” Nevertheless, relying on Pennsylvania cases holding that (a) “a stock sale, unlike a sale of assets, does not necessitate an assignment in order for the corporation to enforce an employment agreement” and (b) “the transfer of a corporation’s stock does not destroy the corporate entity” because its existence is “irrespective of, and entirely distinct from, the persons who own its stock,” the Third Circuit concluded “that the transfer of some or all of the stock of a corporation has no effect on its ability to enforce a non-compete agreement.”

Accordingly, the Third Circuit rejected the employee’s challenge to his non-compete based on the lack of an assignment agreement at the time of the stock sale. The Third Circuit added that if the non-compete was intended to be contingent on the company remaining a family-owned business, that should have been set out as a material condition to the agreement.
 

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On January 14, 2010, Berkeley HeartLab, Inc. filed suit against Health Diagnostic Laboratory, Inc., and several former employees for trade secret violations and breach of contract. The suit was filed two weeks after a mass departure in which five sales representatives resigned from Berkeley.

Berkeley claims that in October 2008 a former Senior Vice President founded Health Diagnostic in Richmond, Virginia with the alleged intent to compete with Berkeley by providing diagnostic clinical tests that target cardiovascular disease and disease management similar to Berkeley’s clinical programs. On January 1, 2010, five sales representatives resigned from Berkeley within thirty minutes of each other, and allegedly began working for Health Diagnostic soon thereafter. The complaint asserts that within the first two weeks of January, several health care providers, who had previously conducted business with Berkeley, had switched their business to Health Diagnostic, causing an approximate 35% decline in Berkeley’s sales volume from the previous year. The complaint further alleges that the former employees had signed a Proprietary Information and Invention Agreement intended to protect Berkeley’s confidential information and customer goodwill, and their pre-resignation conduct as well as subsequent employment at Health Diagnostic breached their agreements.

The lawsuit, filed in the Eastern District of Virginia (known as the “rocket docket” for its swift processing of cases), alleges state law claims of breach of contract, breach of fiduciary duty, tortious interference, conspiracy, unfair competition, as well as a federal law claim under the Computer Fraud and Abuse Act (CFAA). While unclear from the court papers, it appears that Berkeley’s support for its CFAA claim is its allegation that two individual defendants accessed their Berkeley work computers without authorization, or in excess of their authorization, while still employed by Berkeley, to remove data to benefit Health Diagnostic.

This case could be of interest to employers and attorneys alike who are following the split in the courts across the country as to whether computer access while an employee meets the statutory test for “without authorization” under CFAA. As we reported on this blog on September 17, 2009, the U.S. Court of Appeals for the Ninth Circuit recently split with the U.S. Court of Appeals for the Seventh Circuit over the meaning of “authorization” under CFAA. The Ninth Circuit adopted the narrow view that CFAA only reaches conduct by individuals who do not have any permission to access the computer system (e.g., a hacker or terminated employee). The Seventh Circuit has adopted the more expansive view that a statutory claim could be made whenever an employee accesses a computer with an adverse interest in breach of his duty of loyalty without the employer’s knowledge. The U.S. Court of Appeals for the Fourth Circuit has not weighed in on this legal split under CFAA yet, and the issue will likely have to be resolved by the U.S. Supreme Court.

Berkeley is seeking preliminary and permanent injunctive relief, including an order restricting the defendants from using or disclosing confidential or proprietary information, misrepresenting Berkeley’s ability to perform clinical tests, soliciting healthcare providers, and soliciting Berkeley employees. Berkeley is also seeking an order to prevent the individual defendants from working at Health Diagnostic, and $350,000 in punitive damages from each defendant.
 

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In a case applying Ohio law, the Indiana Supreme Court recently held that, for purposes of a non-competition agreement, competition with a subsidiary corporation also constituted competition with the parent.  Baker v. Tremco Incorporated, No. 29S02-0902-CV-00065 (Ind. 2009).

In Tremco, the parent corporation was a manufacturer of roofing-related products. It had a subsidiary which provided services related to roofing projects. The parent had one of its salespersons, who sold products for the parent and services for the subsidiary, sign a post-employment non-competition agreement which barred the employee from competing “in any aspect” of the parent’s business for 18 months.

The salesperson eventually left and started a new business which he conceded directly competed with the subsidiary. However, he argued that because he was not competing with the parent, he was not in violation of his non-competition agreement with the parent.

This argument was rejected by the Indiana Supreme Court, which noted that while the salesperson was employed by the parent, he sold for both the parent and the subsidiary and all compensation was paid by the parent, regardless of whether commissions were earned for selling the parent’s products or the subsidiary’s services. Thus, the Court held that competition with the subsidiary was competition with the parent.

Non-compete cases are always fact and language-specific; in this case, both weighed in favor of enforceability.
 

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Often in cases involving restrictive covenants and sometimes in cases in which there is no restrictive covenant, an employer will bring a claim that a former employee breached his/her duty of loyalty by engaging in competitive activities when he/she was still employed by the employer. Indeed, in the absence of a restrictive covenant, a claim that a former employee breached his/her duty of loyalty is likely to be one of the principal claims raised in such a case. Wisconsin cases addressing such claims in the employment context have differentiated between “key employees” who have a duty of loyalty to their employers and other employees who do not have such a duty.  However, a recent decision by the Wisconsin Court of Appeals – Infocorp, LLC v. Hunt, __ N.W.2d __, No. 2007 AP 2887, 2009 WL 4800140 (Wis. Ct. App. Dec. 8, 2009) – reminds us that the “key employee” doctrine is a fact-intensive inquiry and courts should not conclude that a lower level employee can never be a “key employee” with a duty of loyalty to his/her employer.

The trial court in Infocorp concluded that the following facts were undisputed: Hunt, a salesman for Infocorp, was an at-will employee; he did not have an employment contract, nor did he sign a non-compete or confidentiality agreement. In the summer of 2006, Hunt contacted a sales manager for Tierny Brothers (a direct competitor of Infocorp) and indicated an interest in working for Tierny Brothers. In mid-September 2006, Tierny Brothers interviewed and hired Hunt and Hunt resigned from Infocorp in early October 2006. However, in the month prior to his resignation, Hunt sought to divert specific sales to his new employer.

Based on the above facts, the trial court granted Hunt’s motion for summary judgment on the breach of fiduciary duty claim, reasoning that “Wisconsin cases clearly establish that employees are judged by a different standard and that only officers or policy making employees owe a duty of loyalty”. Thus, the trial court concluded, a salesman like Hunt owes no duty of loyalty to his employer.

The Wisconsin Court of Appeals reversed, holding that the duty of loyalty is not limited to only officers or policy making employees. Rather, in situations involving lower level employees, the determining factor is whether the alleged breach implicates the employee’s specific job duties. Infocorp, 2009 WL 4800140, at *3-4 (holding that evidence establishing that an employee acted directly contrary to his employer’s interest in the course of performing his specific duties is sufficient to support a finding that the employee breached a duty of loyalty to his employer). Specifically, the Infocorp court held that the evidence in that case “could support a finding that… Hunt, while still employed by [Infocorp], used his authority at [Infocorp] to divert business from [Infocorp] (by withholding customer orders until he joined Tierny Brothers), and to actively attempt to shift business [] from [Infocorp] to Tierney Brothers, thereby breaching his duty of loyalty.” Id. at *4.

In other words, because Hunt was a salesman for Infocorp, he had a duty of loyalty to conduct his sales activities in the best interest of Infocorp. Assuming that he diverted those sales opportunities to a new employer while he was still employed by Infocorp, a jury could conclude that Hunt breached his duty of loyalty to Infocorp. Even though he was not a high ranking executive, Hunt was a “key employee” in the context of sales.
 

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A recent New York case, Edelman v. Starwood Capital Group, LLC, 2009 NY Slip Op. 09309 (1st Dep’t December 15, 2009), relates to the issue of maintaining the confidentiality of proprietary materials. The case involved an unsuccessful attempt by an investor, Asher B. Edelman, to acquire a French company Société du Louvre (SDL) in 1999. Edelman claimed that pursuant to his attempt to acquire SDL in 1999, he conducted and compiled significant research to identify SDL as a valuable acquisition. Among other things, Edelman claimed that he researched and analyzed the finances, ownership structure and business operations of SDL. In conjunction with his desire to acquire SDL, Edelman retained a French company to arrange for the financing and to help him obtain a business partner which could help run the hotel operations of SDL that Edelman wanted to continue. This company solicited Starwood Capital Group, LLC ("Starwood") as a potential business partner. Starwood was provided with Edelman's business plans and information, which were all marked confidential, pursuant to the oral agreement between Edelman and the third party company to maintain confidentiality. Starwood declined the deal.

In 2005, pursuant to an auction, Starwood acquired SDL. Its post-acquisition plan allegedly matched the business plans which Edelman had put together and had shown to Starwood years earlier. Edelman claimed that Starwood improperly took and profited from the information he compiled. Edelman alleged claims of unfair competition, improper use of proprietary information and unjust enrichment.

The First Department found that Edelman's claim for the misappropriation of proprietary information failed because the allegations did not sufficiently allege that he took "sufficient precautionary measures to insure that the information remained secret..." Among other things, the Court pointed out that Edelman had failed to obtain a confidentiality agreement with Starwood, as the Court noted would have normally been expected. The Court also stated that the fact that the documents had a "confidential" stamp was, on its own, inadequate to protect them, especially for six years.

The case is another reminder that companies should take appropriate precautionary steps when dealing with confidential information.
 

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*Co-authored with Jake Schmidt.

As we noted in a blog post in October 2009, in Sunbelt Rentals, Inc. v. Ehlers, 333 Ill.Dec. 791, 915 N.E.2d 862 (Ill. App. Ct. 2009), an Illinois appellate court reexamined and rejected over thirty years of well-established precedent regarding the enforceability of restrictive covenants. Specifically, it rejected the “legitimate business interest” test long applied as a threshold issue by Illinois courts when deciding the enforceability of a restrictive covenant. At the time, we noted that the court either isolated itself from every other Illinois appellate court or took the first step in decreasing the traditional hostility with which Illinois courts treat restrictive covenants.

Although we expect that the reasoning of Sunbelt will be at issue in virtually every lawsuit seeking to enforce or invalidate an Illinois restrictive covenant, to date only one published decision, Aspen Marketing Services, Inc. v. Russell, No. 09 C 2864, 2009 WL 4674061 (N.D. Ill. Dec. 3, 2009), has cited Sunbelt. In that case, federal district court judge Robert Gettleman noted his awareness of Sunbelt and its rejection of the legitimate business interest test, but he applied the test anyway, noting that “[t]he Illinois Supreme Court, the United States Court of Appeals for the Seventh Circuit, and this court, however, have not rejected the applications of the legitimate business interest test.” Judge Gettleman did not otherwise elaborate on his decision to apply the legitimate business interest test.

We will continue to monitor this issue, as it has significant ramifications on the enforceability of restrictive covenants in Illinois.
 

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An article recently published in the New Jersey Law Journal reviews potential sources of information to be searched and procedures that can be followed by employers faced with a departing employee who may have misappropriated the the employer's information, client lists and know-how.

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* Co-authored with Kathryn T. McGuigan.

In Edwards v. Arthur Andersen, LLP, 44 Cal.App. 4th 937 (2008) the California Supreme Court adopted an expansive interpretation of California Business & Professions Code §16600, holding that §16600 prohibits employee non-competition agreements unless the agreement falls within a statutory exception which are non-competition agreements associated with certain business sales transactions, dissolution of partnerships, or termination of a member’s interest in a limited liability company. The Edwards Court specifically rejected the “narrow restraint” exception adopted by the Ninth Circuit and which no California court had endorsed, finding that even limited restraints on post-termination competition are unlawful under California law.

However, the Court was careful to note that its opinion did not invalidate restraints necessary to protect trade secrets, stating that it was not required to address the applicability of the so-called trade secret exception to section 16600 because it was not germane to the claims raised by the employee. Edwards, supra, 44 Cal.4th at 946, fn. 4.

On November 19, 2009, the California Court of Appeal in Dowell v. Biosense Webster, Inc., No. B201439, in refusing to enforce broad and expansive noncompete and nonsolicitation clauses in employment agreements, did not reach the trade secret exception issue either. The Dowell Court stated in dicta that it doubted the continued viability of the common law trade secret exception to covenants not to compete, but was not resolving the issue because the noncompete and nonsolicitation clauses in the agreements before it were not narrowly tailored or carefully limited to the protection of trade secrets, but were so broadly worded as to restrain competition. The Dowell Court left open the question as to whether or to what extent courts will enforce agreements more narrowly tailored to protect trade secrets.

Even if a court does not enforce a nonsolicitation covenant tethered to even a narrow definition of trade secrets, an employer will still have protection under common law and the California Trade Secrets Act if the employee is using trade secret information to solicit. Given the direction that the California courts appear to be headed, however, employers in California should weigh the value of including any nonsolicitation covenant against the risk created by the inclusion of such a covenant, which may violate public policy.
 

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*Co-authored with Kathryn T. McGuigan.

The recent case of Perlan Therapeutics v. Superior Court (California Ct App 11/04/2009) serves as a reminder that when litigating, the definition of the trade secrets at issue is important.

Perlan Therapeutics brought an action against two former employees claiming the employees had misappropriated its trade secrets. California discovery statutes require that a plaintiff bringing an action for misappropriation of trade secrets file a trade secret statement before commencing discovery related to the trade secrets. The statement must identify with "reasonable particularity" the purported trade secrets which allegedly have been misappropriated.” The trial court found that Perlan’s statement lacked the necessary particularity, and granted the defendant employees an order precluding discovery until Perlan provided sufficient identification of its claimed trade secrets. The Court of Appeal affirmed.

The appellate court pointed out that Perlan's trade secret statement lacked clarity, did not segregate its alleged trade secrets, did not clearly explain how its secrets differed from publicly available knowledge, included a large amount of "surplusage," such as legal objections, factual allegations, and reservations of rights, and referenced hundreds of pages of extra documents. While the court noted that some trial courts have requested too much particularity, it emphasized that trial courts have broad discretion under the California discovery statutes. In this case, the court did not abuse its discretion in requiring Perlan to produce a clear, non-evasive trade secret statement.

You will certainly want to protect your trade secret information when in litigation. This can be accomplished with a protective order, which was in place in Perlan. As the Perlan court noted, there has been much protracted litigation regarding the initial trade secrets statement. Consider drafting this all important statement prior to filing your complaint.
 

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