Trade Secrets & Noncompete Blog

Trade Secrets & Noncompete Blog

News & Updates On Developments in the Law of Restrictive Covenants, Unfair Competition & Trade Secrets

Bad Leaver Pays the Price

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A former California State judge in an arbitration awarded nearly $1.7 million to an employer against its former employee based primarily on his acts taken going out the door.  His joking email with a co-worker after recruiting three others, characterizing their resignations as “Three bullets to the back of the head” of his employer, was clearly shooting himself in the foot in the eyes of the arbitrator.  The Award is interesting for many reasons – – the interplay between fiduciary duties and non-solicitation of employees provisions, the allowable damages when such a fiduciary duty is breached by co-worker solicitation, and the overriding difference of treatment of bad leavers versus good leavers.

Michael Valentine, a corporate vice president of Fortinet, Inc., a California based network security company, left for a competitor, Sophos, in the end of 2013.  The arbitrator found that due to his recruiting of several subordinates, both before and after he resigned, he had breached his fiduciary duty as an officer of Fortinet and his contractual obligations not to solicit employees for one year after his employment ended.  Despite Valentine’s affirmative defense that the clause was barred by California’s public policy [see California Business & Professions Code 16-600, et seq. and Edwards v. Arthur Anderson LLP, cf. Loral Corp. v. Moyes], the arbitrator awarded significant damages for his recruitment activity based upon the breach of his fiduciary duties.

While it appears from the Award that much of the evidence of pre-resignation solicitation was purely inferential, the arbitrator viewed the efforts to cover up such evidence, and the sentiment expressed in the email as being a “despicable” act, such that it caused him to find liability for the recruitment of the three subordinates and to award punitive damages on top of both actual damages and general damages.

The arbitrator awarded actual damages, the amount expended to replace the employees based on the time spent by the executive who recruited the replacements, at his hourly equivalent salary rate, or $39,560.  The arbitrator found general damages of $150,000 based on the “intentional tortious breach of fiduciary duty” and attributed that to his sense of a reasonable amount of the loss of valuable employees causing harm to the employer for likely lost business caused by delays in performance and the start-up time for new employees.  Finally, based on Valentine’s willful and intentional breach of his fiduciary obligations causing direct harm to Fortinet, the arbitrator awarded $250,000 in punitive damages and attorneys’ fees pursuant to contract of $1.2 million plus costs, rendering the total Award to be in excess of $1.75 million.

Had Mr. Valentine not spoken with his co-workers about joining him before he resigned, had he not taken steps to cover up such evidence of solicitation, and, most importantly, had he not callously joked about his egregious breach of duty in such a vivid and morbid email, he may have gotten the benefit of California’s public policy disfavoring employee non-solicit agreements.  But when you are a bad leaver, judges and arbitrators are definitely more likely to find breaches of duties and contractual obligations and enforce such provisions to the fullest extent.

Pennsylvania Supreme Court Holds That Mere Continued Employment Is Not Adequate Consideration To Support A Restrictive Covenant

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Weighing in on an issue that is drawing attention nationwide, the Pennsylvania Supreme Court recently held, in Socko v. Mid-Atlantic Systems of CPA, Inc., that the mere continuation of employment is not sufficient consideration to support a restrictive covenant.  Rather, for there to be sufficient consideration, the Court held that the employee must receive “some corresponding benefit or a favorable change in employment status.”  As examples of such sufficient additional consideration, the Court cited “a promotion, a change from part-time to full-time employment, or even a change to a compensation package of bonuses, insurance benefits, and severance benefits.”   The Court did not, however, provide any detail as to the size of the additional consideration that must be provided; it merely gave examples of types of additional consideration.

In so ruling, the Pennsylvania Supreme Court came down on the same side of this issue as the Kentucky Supreme Court in 2014.  In contrast, the Wisconsin Supreme Court in 2015 held that continued employment of a current at-will employee is sufficient consideration to support a covenant not-to-compete.

We expect this to remain a hot topic and we will continue to monitor developments in this area.

Illinois Appellate Court Strikes Down Overbroad Noncompete, Nonsolicit, and Confidentiality Provisions and Also Refuses to Judicially Modify Them

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In a decision issued in late October, AssuredPartners, Inc. et al. v. William Schmitt, 2015 IL  App. (1st) 141863 (Ill. App. 2015),  the Illinois Appellate Court struck down as overbroad and unreasonable, the noncompete, nonsolicit and confidentiality provisions in an employment agreement.  The Court then refused to judicially modify or “blue pencil” these provisions because the Court deemed their deficiencies “too great to permit modification.”  This decision is essentially a primer on current Illinois law regarding restrictive covenants and confidentiality agreements.

Starting with the noncompetition provision at issue, the Court held that it was overbroad because it restricted the former employee, a wholesale insurance broker of lawyers’ professional liability insurance, from a broader scope of activities than those he engaged in during his employment (i.e., it prohibited him from working with all types of professional liability insurance, not just the type that he actually brokered).

Additionally, the Court held that the geographic scope of the noncompetition agreement (i.e., all 50 states and the territories of the United States) clearly exceeded “that which is necessary to protect ProAccess and Jamison from threats against its business interest” and that such geographic overbreadth imposed “an undue burden” on the employee “by forcing him to work in another country if he wishes to continue earning a living as a wholesale broker specializing in LPLI or any other type of professional liability insurance.”

Finally, the Court noted that the length of the restriction – 28 months – was a “significant period to impose on an employee whose effective term of employment . . . lasted only 20 months.”

Accordingly, the Court held that the noncompetition provision failed to meet the requirements of reasonableness set out in the Illinois Supreme Court’s most recent pronouncement in this area, Reliable Fire Equip. Co. v. Arredondo, 2011 IL 111871 (2011).

Turning next to the post-employment, customer non-solicitation provision, the Court likewise found it to be unreasonably overbroad, as it applied to actual and potential customers of the plaintiff entities and of their subsidiaries, regardless of whether they were involved in the same activities as the former employee – and regardless of whether the former employee ever had contact with them while working for ProAccess.

Finally, the Court turned to the contractual confidentiality provision, which “prohibit[ed] the use or disclosure of any ‘information, observations and data (including trade secrets) obtained by [Schmitt] during the course of [his] employment with [Jamison/ProAccess] concerning the business or affairs of [plaintiffs] and their respective Subsidiaries and Affiliates.”  The Court held that this clause was broad enough to cover “ virtually every fact, plan, proposal, data, and opinion that he became aware of during the time he was employed by ProAccess – without regard as to whether such information was in any way proprietary or confidential in nature, or whether he in fact obtained the information through a source outside of his work.  It is patently overbroad.”

Additionally, the Court noted that it “cannot assume that the information Schmitt acquired during his employment with ProAccess resulted solely from plaintiffs’ businesses, as opposed to the customer relationships that he had established prior to his employment.”  The Court emphasized that this confidentiality provision “does not merely restrict the dissemination of confidential information; it drastically limits Schmitt’s ability to work in the insurance industry by preventing him from using any knowledge that he gained while in plaintiffs’ employ, regardless of whether he gained such knowledge, directly or indirectly, as a result of his employment” (emphasis in original).

For good measure, the Court further explained that the confidentiality clause is not saved because of its exception for confidential information that “becomes generally known to and available for use by the public.”  The Court explained that “[t]here is a great deal of information that is not ‘generally’ known to the public; not all of it merits protection under a confidentiality provision.”

Because the Court found these deficiencies to be so significant, it held that they were “too great to permit modification.”  Accordingly, rather than judicially modify or “blue pencil” any of these provisions, the Court struck them down.

Over all, the notion that permeates throughout AssuredPartners is that the restrictions at issue were fundamentally unfair to the individual former employee.

Coming on the heels of the Illinois Appellate Court’s blockbuster decision in Fifield v. Premier Dealer Services, Inc. (in which the same court held that, absent other consideration, two years of employment is required for a restrictive covenant to be deemed supported by adequate consideration – even where the employee signed the restrictive covenant as a condition to his employment offer – and even where the employee voluntarily resigned), AssuredPartners is a reiteration of the degree of judicial scrutiny currently being applied to restrictive covenants in Illinois.

In light of these decisions, Illinois employers are advised to draft as narrowly as possible, to pay particular heed to the consideration provided, to carefully consider choice of law and forum selection provisions, and to review existing restrictive covenants in light of the degree of judicial scrutiny currently being applied.

Fifth Circuit Sides with Oklahoma on Non-Competes in State Law Clash – Employment Law This Week

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One of the top stories on Employment Law This Week – Epstein Becker Green’s new video program – is the Fifth Circuit’s ruling that a Texas bank cannot enforce non-compete agreements signed by four former employees based in Oklahoma, where courts do not recognize the pacts, because the agreements would violate Oklahoma’s strong public policy favoring worker mobility. The fundamental law of the state trumped the choice of law.

See below to view the episode or read more about this important decision in an earlier post on this blog.

Open Secret—Trans Pacific Partnership Terms Revealed But Trade Secret Provisions Still Murky

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This morning the Obama administration publicly released the previously-undisclosed text of the Trans Pacific Partnership, or TPP, revealing, among other things, the provisions related to trade secrets that had previously been discussed here.  As noted in that earlier piece, the administration had said that the TPP would “provide strong enforcement systems, including, for example, civil procedures, provisional measures, border measures, and criminal procedures and penalties for commercial-scale trademark counterfeiting and copyright or related rights piracy. In particular, TPP Parties will provide the legal means to prevent the misappropriation of trade secrets, and establish criminal procedures and penalties for trade secret theft, including by means of cyber-theft…,” according to the statement from Office of the United States Trade Representative (“USTR”).  The just released terms do specify that member parties must provide criminal procedures to combat trade secret theft, but it is not clear that any enhanced civil remedies will be required.

Chapter 18, at Article 18.78, addresses trade secret protections, and requires each member country to assure that “persons have the legal means to prevent trade secrets lawfully in their control from being disclosed to, acquired by, or used by others (including state-owned enterprises) without their consent in a manner contrary to honest commercial practices.” Article 18.78.1. The TPP then defines “a manner contrary to honest commercial practices” to mean “at least practices such as breach of contract, breach of confidence and inducement to breach, and includes the acquisition of undisclosed information by third parties that knew, or were grossly negligent in failing to know, that those practices were involved in the acquisition.”  That article then goes on to state in Article 18.78.2 that “each Party shall provide for criminal procedures and penalties (emphasis added) for one or more of the following:

  1. the unauthorised and wilful access to a trade secret held in a computer system;
  2. the unauthorised and wilful misappropriation of a trade secret, including by means of a computer system; or
  3. the fraudulent disclosure, or alternatively, the unauthorised and wilful disclosure, of a trade secret, including by means of a computer system.

While some would have wanted member nations to provide for both criminal and civil remedies so that trade secret owners might have a more direct role in enforcing their rights, the lack of direct mention in this article of civil remedies is not likely the area of greatest concern for such trade owners.

Of greater concern should be the somewhat strange language of Article 18.78.3:

With respect to the relevant acts referred to in paragraph 2, a Party may, as appropriate, limit the availability of its criminal procedures, or limit the level of penalties available, to one or more of the following cases in which:

(a) the acts are for the purposes of commercial advantage or financial gain;

(b) the acts are related to a product or service in national or international commerce;

(c) the acts are intended to injure the owner of such trade secret;

(d) the acts are directed by or for the benefit of or in association with a foreign economic entity; or

(e) the acts are detrimental to a Party’s economic interests, international relations, or national defence or national security. (emphasis added)

Let’s hope something got lost in the translation or in the printing because, reading section 2 and 3 together, it looks like member countries have to provide procedures addressing unauthorised and wilful access, misappropriation and disclosure unless those acts were undertaken for financial gain in commerce to the intended detriment of the trade secret owner, perhaps in connection with a foreign entity.  If that article really means what it says, the TPP has promised nothing regarding trade secrets.

“Red River Rivalry” Reaches Right To Restrict Employment

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The United States Court of Appeals for the Fifth Circuit opened its October 29th opinion in Cardoni v. Prosperity Bank by noting that “[i]n addition to their well-known disagreements over boundaries and football” known as the Red River Rivalry, “Texas and Oklahoma do not see eye to eye on a less prominent issue: covenants not to compete.”   As the Court went on to note, “Texas generally allows them so long as they are limited both geographically and temporally… Oklahoma generally does not.”  “These different policy choices—Texas’s view which prioritizes parties’ freedom to contract and Oklahoma’s which emphasizes the right to earn a living and competition—came to a head” recently in dueling state court law suits removed to federal court, and consolidated.  Addressing the impact of choice of law provisions in such agreements and the impact of the public policy of states on the question of the enforceability of such covenants, the Fifth Circuit held that an Oklahoma court could, on public policy grounds, refuse to enforce a Texas choice of law provision that would have supported application of a non-compete provision to employees working in Oklahoma.  But the Court also remanded the matter for a determination of whether a non-solicitation clause would be enforceable under Texas law because Oklahoma public policy would not void a choice of law provision insofar as it required limitations on solicitation.

The decision highlights the need for employers to consider a multitude of factors when dealing with a multi-state employee population.  First, efforts to promote uniformity among employees are not always as simple as choosing the law of a single state to apply to the written agreements containing post-employment restrictions.  Second, all post-employment restrictions are not viewed monolithically under state law, and restrictions on solicitation may survive where broader bans on any competition would not, a particularly important consideration when dealing with an employee population in multiple states.  Third, while choice of law analysis will often cite the multi-factor “most significant relationship test” of Restatement (Second) of Conflict of Laws when deciding choice of law questions, the “place of performance” factors often holds great sway in employment contracts.  These and other factors will drive the enforceability of such covenants, and one must always consider the likelihood of success on the merits factor so critical at the initial injunctive relief stage on which these cases often turn.  An employer often may be better off seeking to enforce narrow non-solicitation or confidentiality obligations than making broader claims to ban all competition.  Counsel that can help an employer assess these state to state differences proves valuable for those with employees in multiple, sometimes disagreeing, jurisdictions.

California Supreme Court Will Review Malicious Prosecution Claim Against Latham & Watkins

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Latham & Watkins isn’t off the hook yet.

On April 17, 2012 and September 3, 2014, we blogged about a malicious prosecution claim brought against Latham & Watkins in the Los Angeles Superior Court.  The suit alleged the Plaintiffs, William Parrish and Timothy Fitzgibbons, were former officers and shareholders of Indigo Systems Corporation, which was purchased by FLIR Systems, Inc. in 2004.  From 2004 to 2006 the Plaintiffs worked for FLIR, leaving in 2006 to start their own business.  FLIR retained Latham & Watkins and sued Plaintiffs for, among other things, misappropriation of trade secrets.  The trial court denied the former employees’ motion for summary judgment.  At trial, however, it found FLIR brought the trade secrets action in bad faith, entered judgment in favor of the former employees, and awarded them attorney’s fees and costs of $1,641,216.78.  The trial court’s decision was affirmed on appeal.  FLIR Systems, Inc. v. William Parrish, et al., 174 Cal.App.4th 1270 (2009).

The former employees brought a malicious prosecution action against Latham & Watkins.  Latham  filed a motion pursuant to California’s anti-SLAPP law (a strategic lawsuit against public participation – California Code of Civil Procedure Section 425.16) contending, in part, (1) Plaintiffs’ claims were barred by the statute of limitations; and (2) the trial court’s denial of the former employees’ motion for summary judgment  established that the underlying action was brought with probable cause as a matter of law pursuant to the “interim adverse judgment rule.”  The trial court granted Latham’s SLAPP motion on the statute of limitations grounds and did not expressly address the other arguments.

The Court of Appeal in the first go around held the applicable statute of limitations for malicious prosecution claims was not the one-year period set forth in Cal. Code Civ. Proc. Section 340.6, but rather the two-year limitations period set forth in the Cal. Code Civ. Proc. Section 335.1 and held that, as such, the claim was not barred.  The court also addressed the issue on the merits and concluded the interim adverse judgment rule would not apply because, in part, Latham had “sought an obviously anti-competitive injunction based on the speculative possibility that the [Plaintiffs’] product might violate its client’s trade secrets….” and that when Plaintiffs presented evidence to Latham that there was no actual misappropriation of the business plan at issue, Latham changed the theory of the case to pursue a claim that the Plaintiffs could not effectuate the business plan without using FLIR’s intellectual property.   The Court of Appeal initially held that the Plaintiffs had established a reasonable probability of prevailing on the element of lack of probable cause and reversed the trial court’s order granting Latham’s SLAPP motion.

Latham filed a petition for re-hearing which was denied on September 19, 2014 and then, on the court’s own motion, was granted on September 25, 2014.  On June 26, 2015, the Court of Appeal issued its decision, affirming the trial court’s order granting Latham’s anti-SLAPP motion on the ground that the “interim adverse judgment rule” established Latham had probable cause to bring the action.  The court held that exceptions to the interim adverse judgment rule did not apply in this case because (1) the summary judgment motion was not denied on procedural or technical grounds and (2) the summary judgment motion was not obtained by fraud or perjury.  Parrish v. Latham & Watkins, 238 Cal.App.4th 81, 97 (2015).

The Plaintiffs argued that the trial court’s statement in the underlying action that the “former employees failed to sustain their burden of proof on the motion” established the motion was denied on “technical grounds” which would not trigger the interim adverse judgment rule.  The Court of Appeal disagreed because the party moving for summary judgment bears the ultimate burden of persuasion to establish there is no triable issue of material fact.

The Plaintiffs further argued the trial courts’ award of Uniform Trade Secret Act attorney’s fees based on a finding of bad faith negated the interim summary judgment rule.  Again, the court disagreed finding that simply because a trial court or jury later rejects a party’s claim, after weighing the competent evidence, does not negate other evidence which, standing alone establishes the existence of probable cause.

The California Supreme Court will now resolve this issue and hopefully clarify the law in this area.

The California Supreme Court’s opinion on this subject will be a must read for California trade secret litigators (and all litigators) and hopefully will articulate the standards that separate hardball litigation tactics from litigation that is deemed anti-competitive, which can create a substantial risk for both Plaintiff and Plaintiff’s attorneys.

Secret Trade Agreement Includes Agreement On Trade Secrets

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A great amount of attention has been focused in recent days on the just concluded Trans Pacific Partnership (“TPP”) negotiations, and it should not escape notice that the TPP promises to enhance trade secret protections in and across the Pacific Rim.  That is because the twelve TPP countries of Australia, Brunei Darussalam, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, United States, and Vietnam have apparently agreed that each of them will “provide strong enforcement systems, including, for example, civil procedures, provisional measures, border measures, and criminal procedures and penalties for commercial-scale trademark counterfeiting and copyright or related rights piracy. In particular, TPP Parties will provide the legal means to prevent the misappropriation of trade secrets, and establish criminal procedures and penalties for trade secret theft, including by means of cyber-theft…,” according to the statement from Office of the United States Trade Representative (“USTR”).  This could be good news for many businesses operating the Pacific Rim, or competing with those who do, because the future may see better and easier methods of protecting trade secrets and enforcing related agreements such as non-disclosure agreements (NDAs) and post-employment restrictions.

Unfortunately, the exact time table for TPP countries to have these systems in place, and the particular criteria against which compliance will be measured, remain unclear.  That is because the TPP countries, including the United States, signed confidentiality agreements under which each promised to maintain the secrecy of the negotiations and the agreement’s specific terms.  Indeed, as recently as September 25th, just weeks before the partnership terms were finalized, a federal district court issued an opinion, in Intellectual Property Watch v. U.S. Trade Representative, 13 Civ. 8955 (ER), 2015 U.S. Dist. LEXIS 130105 (S.D.N.Y. Sept. 25, 2015), holding that such agreements were enforceable to the extent that they provided a basis to withhold documentation otherwise called for under a Freedom of Information Act request.  The agreement in question stated that “All participants plan to hold these documents in confidence for four years after entry into force of the Trans Pacific Partnership Agreement, or if no agreement enters into force, for four years after the last round of negotiations.”  While the final terms of the TPP itself will undoubtedly be shared with Congress before any vote on approval, it will be interesting to see how claims for underlying drafts, documents and memos are dealt with, not just from the political perspective but from the legal one.  It would certainly be somewhat ironic if the necessity of full debate concerning a pact aimed at, among other things, strengthening confidentiality and trade secret enforcement leads to the parties testing the limits of disclosure of their own confidentiality agreement concerning the pact and its negotiations.

Another Federal Trade Secret Protection Bill Introduced

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In what has become an annual rite, legislators from both sides of the aisle in the U.S. Congress again have proposed a bill seeking to create a private right of action allowing companies to assert civil trade secret misappropriation claims under federal law (which would supplement the existing patchwork of state law remedies).  As we have blogged previously, similar bills were introduced in 2013 and 2014, but despite some progress they were not enacted into law.

Like past legislative efforts, the Defend Trade Secrets Act of 2015 would amend the Economic Espionage Act of 1996 (which allows prosecutors to bring criminal charges relating to trade secret theft) to empower private companies to bring civil suits to protect their trade secrets.

The previous bills were criticized for, among other things, allowing federal courts to issue relatively broad orders for seizure of purported trade secret materials and information.  Mindful of such criticism, this year’s Defend Trade Secrets Act narrows the circumstances in which an ex parte seizure order can be obtained, and in order to prevent hacking of seized devices, the bill bars a seized electronic storage medium from being connected to the internet without the consent of both plaintiff(s) and defendant(s).  It also allows for defendant(s) to make a motion to encrypt any material seized that is stored on an electronic storage medium.

The Defend Trade Secrets Act of 2015 was introduced on July 29, 2015 and supported by Senators Orrin Hatch (R-UT), Chris Coons (D-DE), Jeff Flake (R-AZ), Dick Durbin (D-IL), Thom Tillis (R-NC), Tammy Baldwin (D-WI), and U.S. Representatives Doug Collins (R-GA) and Jerrold Nadler (D-NY).  It is also backed by a varied assortment of trade associations and corporations.

Will this year’s break the pattern established by past bills of failing to advance out of Congressional committees?  As in the past, there seems to be enough concern in the business community, coupled with periodic news stories about trade secret theft, to support introduction of the bill.  Absent a defining trade secret theft event, however, that breaks through into broader public consciousness and crystallizes public opinion toward the necessity of creating a federal trade secret theft private right of action, the Defend Trade Secrets Act of 2015 may suffer a fate similar to the earlier bills.  Stay tuned.

Is Fifield’s holding holding?

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A couple years ago, the Illinois First District Appellate Court decided the case of Fifield v. Premier Dealer Services, 2013 IL App. 120327.  There, the Court held that, absent other consideration, two years of employment are required to constitute adequate consideration for a restrictive covenant, regardless of whether the covenant was signed at the outset of employment or after, and regardless of whether the employee quit or was fired.  Since then, some Judges in the United States District Court for the Northern District of Illinois have applied Fifield, and others have declined to do so.

Earlier this week, the United States Court of Appeals for the Seventh Circuit issued its first opinion reviewing a decision in which the District Court applied, or refused to apply, FifieldInstant Technology LLC v. DeFazio, (Case Nos. 14-2132 & 14-2243).  In the District Court, Judge Holderman applied Fifield.  In its opinion, however, the Seventh Circuit simply reviewed the District Court’s factual determinations, determined that they were not clearly erroneous, and did not discuss Fifield or its application by the District Court at all.  The Court did, though, spend some time discussing an anti-raiding clause that was also at issue.  The Seventh Circuit explained that, because Instant Technology had such high workforce turnover (77% of the people who worked there two years before the trial left in the interim), it could not argue that its interest in maintaining the stability of its workforce was a legitimate business interest sufficient to support an anti-raiding clause that prohibited former employees from soliciting Instant Technology employees to join competing companies.