Trade Secrets & Noncompete Blog

Trade Secrets & Noncompete Blog

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

Consideration in Restrictive Covenants: Courts Take a Closer Look

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Our colleagues Peter Steinmeyer and Scarlett Freeman of Epstein Becker Green authored an article in Workforce Magazine titled “Courts Take Closer Look at Noncompete Clauses.”

Following is an excerpt:

In the past few years, courts have been re-examining what constitutes adequate consideration for a restrictive covenant. In 2013, the Illinois Court of Appeals held, contrary to longstanding precedent, that in the absence of other considerations, mere employment constitutes adequate consideration for a restrictive covenant only if the employee remains employed for at least two years after signing the restrictive covenant.

This two-year rule applies regardless of whether the employee signed the restrictive covenant as a new or existing employee and regardless of whether the employee voluntarily resigned or was fired. Notably, multiple federal district courts in Illinois subsequently declined to apply the bright-line rule, instead considering other factors such as compensation, raises and bonuses, and the terms of the employee’s termination. …

As courts increasingly address challenges to the adequacy of consideration in restrictive covenants, employers can take measures to ensure that a restrictive covenant will be enforced. By simply remaining aware of fluctuating state laws, employers can structure employment agreements to incorporate adequate consideration under applicable state law.

Read the full article here.

Companies on Notice as White House Releases Report on Non-Competes

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Matthew Savage Aibel

Matthew Savage Aibel

On May 6, the White House released a report entitled: “Non-Compete Agreements: Analysis of the Usage, Potential Issues, and State Responses” (the “White House Report”).  This report comes on the heels of the United States Department of Treasury’s Office of Economic Policy releasing a similar report about non-competes in March 2016 (the “Treasury Report”).  While the U.S. economy has recovered since the last recession, the Obama Administration has identified a decline in competition for workers as a structural problem worth tackling in its final months.  The Administration believes that non-competes restrict workers’ ability to move between jobs.  Both reports rely heavily on a study performed by three economics professors and draw on popular news stories to show the potential downsides of non-competes.  While the reports take a largely dim view of non-competes, they do provide some ideas employers should consider when drafting and implementing non-compete agreements and also highlight some of the benefits of non-competes.

Both reports consider protection of trade secrets a “beneficial” use of non-competes, but believe there are very few alternative justifications for non-competes.  This view establishes non-competes as a “problem” in the economy because “[o]nly 24 percent of workers report that they possess trade Secrets.” (White House Report at 4).  The characterization of non-competes, however, may be one instance where a lack of understanding of real world conditions informs the Administration’s view on the subject.  The White House Report does not consider client lists or relationships in its discussion of noncompetes and instead relies only on trade secrets as a legitimate business interest worth protecting; the Treasury Report acknowledges them, but does not afford them any weight.  “For instance, a trade secret involving intellectual property may be the product of expensive investments. If the investment had not been made, none of the benefits of the property would have been realized. By contrast, the client, and their need for a good or service, presumably exist independently of any investment made by the employer.” (Treasury Report at 7n.5).

The problem with this view is that it fails to acknowledge that businesses invest time and money into client relationships.  Those investments deserve a degree of protection, especially from a potentially disloyal employee who might attempt to leave a company and take valuable client relationships with him.  Thus, most non-competes, often in the form of non-solicitation provisions, recognize that for some period of time after the employment ceases the former employee cannot  solicit or service clients of a company.  Courts in many states routinely enforce these types of agreements, while carving out any pre-existing client relationships as falling outside the scope of the employee’s non-compete.  There are incentives for employers to hire individuals if the companies know that workers who they hire and enable to establish client relationships will not be able to steal such clients when they leave.  Thus, non-competes help align incentives between the employer and employee.  Both reports recognize this fact as they acknowledge the strong correlation that non-competes have with increased worker training.  Where an employer is less worried about employees leaving, the employer is incentivized to provide on the job training for employees.

The White House Report identifies other problems with the way non-competes are implemented and employers should consider these factors in their hiring process:  1) workers often do not understand they have signed a non-compete, 2) workers are asked to sign a non-compete only after accepting the job offer, and 3) many firms ask workers to sign unenforceable non-competes. (White House Report 7).  All of these issues are problematic from a legal perspective.  Basic issues of contract law, consideration, modification or a meeting of the minds, could be grounds for an employee to use the legal system to disregard non-compete obligations.  Thus, employers should be cognizant of when and how the issue of non-competes is presented to new employees, and must also consider the jurisdiction in which the company operates when crafting the provision.  Courts in many jurisdictions will not enforce overbroad restrictive covenants.

The White House Report pointed to a turning tide against non-competes, especially for low-wage workers.  Many states have recently passed some sort of prohibition or limits on them, including Hawaii, New Mexico, Oregon and Utah. (White House Report at 7).  Recent news stories have also highlighted when use of a non-compete by an employer seems burdensome and unfair to workers.  As the Obama Administration moves into its final months, the Report mentions that it plans to “convene a group of experts in labor law, economics, government and business to facilitate discussion on non-compete agreements and their consequences.” (White House Report at 3).  In light of this push, companies should evaluate whether their use of non-competes complies with best practices, focusing on the necessity of the clauses in protecting a legitimate business interest.

Massachusetts Legislature Makes Another Attempt to Pass a Non-Compete Law

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Barry A. Guryan

Barry A. Guryan

Over the last several years, I have blogged about the Massachusetts Legislature’s many unsuccessful attempts to pass a statute establishing guidelines applicable to non-competes.  (See my latest blog posted last March “Proposed Legislation to Place Limits on Enforcement of Non-Competes in Massachusetts.”)  Former proposed bills have contained several types of provisions to accomplish this including ones that: a) prohibited the enforcement of all non-competes following California’s approach; b) created presumptions of reasonableness regarding the time and geographic scope; and c) banned the enforcement of non-competes signed by non-exempt and lower paid employees. (See my previous blog post “Massachusetts Legislature Fails to Pass any Proposed Bills on Non-Compete or Trade Secret Laws,” which discussed these bills.)

The common goal of all of these bills has been to balance the interests of some employers (primarily startups in the High-Tech sector) in facilitating employee mobility in order to foster more innovation with those of other employers whose goal is to protect their business interests, confidential information and trade secrets.  The debate has been lively in the Legislature as well as the business community.

On May 16, the Joint Committee on Labor Workforce Development in the Massachusetts legislature made another attempt at a “compromise” bill by favorably reporting H. 1701, which includes amendments to the “Massachusetts Non-Competition Agreement Act” proposed this past March.  If it becomes law, it would apply to agreements entered into or after July 1, 2016.

Unlike prior bills, this bill contains a “garden leave” provision that has a lot of stakeholders expressing strong opinions for and against it.  Although “garden leave” traditionally has been understood as an extension of the employment relationship through the end of the “leave,” under the proposed bill the employment relationship does not continue during this period.  The proposed bill requires that a garden leave clause be included within a non-compete agreement, and that a covered departing employee will receive payment, on a pro rata basis, of at least 50% of his or her pay during the restricted period.  The only exception to the applicability of garden leave is when an employee breaches his or her fiduciary duty.

According to legislative observers, this provision has generated criticism from large employers and trade associations which could jeopardize the passage of the bill.  Garden leave provisions have been used as a technique for limiting competition from employees who leave the company, but unlike this bill, they are not used in addition to the non-compete which is supported by its own financial incentives.  Some well-known employer trade organizations have criticized the provision, stating that since the employee is usually paid an additional sum of money when the non-compete is signed, they believe it is unfair to also pay someone additional pay for not working.  Those in favor of this provision believe that an employer would be willing to pay to insure that a particular employee stays out of the market. No doubt, there will be more debate as the bill continues through the legislative process.

The following is a summary of the other key elements of the proposed bill.

Non-compete agreements:

  1. must be signed, in writing, and state that the employee has the right to seek advice from an attorney;
  2. must be given to the employee the earlier of a “formal offer of employment or 10 days before” starting work;
  3. that are signed after employment must be supported by “fair and reasonable considerationin addition to continued employment.  The current prevailing view of the courts in Massachusetts is that continued employment is adequate consideration whether signed before being hired or signed after employment;
  4. must be tailored to protect certain legitimate business interests, such as confidential business information, goodwill and trade secrets.  Interestingly, the bill states that if another restrictive covenant cannot adequately protect these interests, such as a non-solicitation agreement or a nondisclosure agreement, the non-compete “may be presumed reasonable” if it meets this mandate;
  5. may not exceed a 12 month term (This extends a former bill’s maximum term of 6 months.);
  6. must be reasonable in scope of proscribed activities.  In other words, if there is a nexus between the restricted activities and services that the affected employee has performed over the last 2 years of employment, the non-compete agreement will be “presumptively reasonable”;
  7. must be reasonable in geographic reach, which is limited to the geographic areas where the employee provided services in the last 2 years of employment;
  8. will not be enforced against certain types of workers, including non-exempt employees, student interns or employees that are employed for a short term while in school, employees that have been terminated or laid off, and employees 18 years of age and under;
  9. may not be judicially “reformed” or revised to render it valid (otherwise known as the “blue pencil” rule).  In the past, judges have not been consistent in this regard.

What to Do Now:

There is nothing different that employers must do until a final bill becomes law.  Employers should continue to seek legal advice about properly drafting and enforcing non-competes or to seek legal assistance to enjoin their enforcement.  At present, we are guided by precedent generated by different judges.  The goal of this new legislation is to pass a law that will generate more consistency.  We will continue to keep you posted on its progress through the legislature.

Defend Trade Secrets Act of 2016 Signed Into Law – Employment Law This Week

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David Clark, contributor to this blog and Senior Counsel at Epstein Becker Green, is featured on Employment Law This Week, discussing the Defend Trade Secrets Act of 2016 (DTSA).

Under the DTSA, employers can now sue in federal court for trade secret misappropriation. Though there is some overlap with the Uniform Trade Secrets Act—adopted in some version by 48 states—the DTSA marks a notable change in how these cases are litigated, creating a federal civil cause of action. The new law contains broad whistleblower protections and new requirements for employers to give notice of these protections.

View the episode below and a Thomson Reuters Practical Law Q&A co-authored by Mr. Clark with Peter Steinmeyer.

What Issues Might the SEC and/or NLRB Have with Employee Confidentiality Agreements?

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It is a common practice for employers to obtain a written agreement from employees to refrain from disclosing company trade secrets and other confidential and proprietary information. Such agreements are structured to be effective after an employee departs, as well as while he or she is actively employed. Confidentiality and non-disclosure agreements can be an important tool in an employer’s efforts to protect trade secret, business-sensitive, and other confidential information, but if they are not thoughtfully and carefully drafted, they could engender unwelcome scrutiny, or even enforcement action, from executive agencies, such as the U.S. Securities and Exchange Commission (“SEC”) and the National Labor Relations Board (“NLRB”). The SEC and NLRB have shown interest in confidentiality provisions even in the absence of an existing action or a complaint from the employee.

The SEC, NLRB, and other executive agencies have expressed concerns that the prevalence and broad language of confidentiality agreements could prevent or discourage employees from engaging in lawful activities, such as whistleblowing, or otherwise reporting potential violations of law to outsiders, or engaging in concerted activity relating to the terms and conditions of their employment. Accordingly, the SEC and NLRB have each taken an aggressive stance that seeks to examine and limit the extent to which employers can require total confidentiality, even if such confidentiality agreements are not being enforced by the employer or otherwise involved in a dispute.

SEC Encourages Whistleblowing

The Dodd-Frank Wall Street Reform and Consumer Protection Act, enacted in 2010 (“Dodd-Frank”), among many other things, amended the Securities Exchange Act of 1934 (“Exchange Act”) to encourage, and enhance protection of, whistleblowers who might have knowledge of a potential violation of securities and other laws. The new provision is Section 21F of the Exchange Act, entitled “Securities Whistleblower Incentives and Protection.” The SEC adopted Regulation 21F, effective in August 2011, to implement the new provision, and established an Office of the Whistleblower to administer it. The SEC whistleblowing law provides for financial payments for whistleblowers who meet the appropriate standards, prohibits retaliation by employers against whistleblowers, and includes other protections. In 2014, as part of its administration of the Dodd-Frank whistleblowing provision, the SEC announced its intention to closely examine employee agreements that, in the agency’s view, could discourage whistleblowers, in violation of Rule 21F-17 of the SEC’s 2011 regulations.

Consistent with this expressed intent, on April 1, 2015, the SEC brought an enforcement action under Rule 21F-17 against KBR Inc. (“KBR”), a global-based technology and engineering firm. The enforcement action arose entirely out of the language of KBR’s confidentiality agreements, even though the agreements were not enforced against any employee (i.e., no employee suffered any adverse action) and even though no employee appears to have complained to the SEC. During select internal investigations, including allegations of possible securities law violations, KBR required witnesses to sign confidentiality agreements that contained language warning that they could face discipline and even termination if they talked about the inquiries with outside parties without first receiving prior approval of KBR’s legal department. Such terms are similar to those in confidentiality agreements of numerous employers, but the SEC deemed the terms improperly restrictive language that could potentially impede whistleblowing.

As a result, the SEC obtained a settlement in which KBR agreed to (i) revise the confidentiality language to explicitly clarify that employees were free to report possible securities violations without employer approval or fear of retaliation, (ii) send out notices to that effect to current and former employees who had signed the confidentiality agreement containing the old language, and (iii) comply with a cease and desist order and pay a $130,000 fine to the SEC.

The clear message from the SEC is that any confidentiality provisions that may have the effect of discouraging whistleblowing, even by implication, could be problematic. Employees are not expected to automatically know or understand that, despite a general confidentiality requirement, they may bring potential violation of securities laws to SEC investigators. Rather, in order to be safe from enforcement action, such agreements should clearly provide that the employee is not only entitled to notify authorities of suspected violations of law but also does not have to seek permission from the employer before doing so, and cannot be subject to reprisals.

NLRB Protects Concerted Action

The NLRB has also moved on its own initiative to scrutinize confidentiality agreements, as well as employment manuals, handbooks, and other employee directives. In March 2015, the agency issued a General Counsel report (“Report”) relating to employer rules. In its Report, the NLRB provided numerous examples of unlawful confidentiality provisions and rules.

For example, the NLRB indicated that an employer rule stating, “You must not disclose proprietary or confidential information about [the Employer, or] other associates (if the proprietary or confidential information relating to [the Employer’s] associates was obtained in violation of law or lawful Company policy)” would be unlawfully overbroad because a reasonable employee would not understand how the employer determines what amounts to a “lawful Company policy.”

In addition, a policy defining confidential information as “[A]ll information in which its [sic] loss, undue use or unauthorized disclosure could adversely affect the [Employer’s] interests, image and reputation or compromise personal and private information of its members” is unlawful because employees have a National Labor Relations Act (“NLRA”) Section 7 absolute right to complain about their wages and work conditions, and the right to discuss and share information in support of such complaints. As such, the NLRB found that a rule broadly prohibiting disclosure of employment information would reasonably, but unlawfully, lead employees to believe they could not even disclose information about the terms and conditions of employment, because it might negatively affect the employer’s interest, image, or reputation.

The NLRB has enforced those policies very recently in a detailed decision regarding a challenge to numerous provisions of an employment manual maintained by employer Quicken Loans, Inc. and several other companies, colloquially known as the “Big Book.”[1] In Quicken Loans, the administrative law judge (“ALJ”) painstakingly analyzed each of the challenged provisions separately and decided many of them violated Section 7 of the NLRA, while others did not.

For example, a rule in the employee handbook prohibiting disclosure of unspecified “confidential information” was deemed overly broad. Another rule was also found by the ALJ to unlawfully chill employees’ rights to engage in protected activities, such as discussing workplace conditions and wages, in violation of Section 7, since the rule stated, in part, “[K]eep it confidential. What shouldn’t you share? Non-public financial or operational information. This includes . . . anything with a dollar figure attached to it.” Because employees unquestionably have a right, under the NLRA, to disclose and discuss salary and operation information, for example, the ALJ deemed the phrases “anything with a dollar figure attached to it” and “non-public financial or operational information” to be overly broad restrictions that employees would reasonably understand to prohibit protected activity.

In contrast, a more specific provision directing employees to keep confidential “private Company information, for example, information about financial performance, strategy, forecasts, etc.,” was found to be permissible. The ALJ noted that employees would reasonably understand the more specific rule to be directed to the employer’s interest in its own proprietary information, as opposed to information that employees are entitled to discuss and share.

Indeed, the lengthy Quicken Loans decision provides valuable guidance about the limitations on employers’ efforts, through confidentiality agreements or otherwise, to protect confidential information from disclosure by employees.

What Employers Should Do Now

The more aggressive enforcement actions being taken by government agencies do not mean that employers must stop using confidentiality agreements. Employers, however, would be well advised to review existing agreements and revise them, if necessary, to ensure that they do not, intentionally or inadvertently, discourage or chill employees from taking lawful action, such as whistleblowing or engaging in concerted activity.

A version of this article originally appeared in the Take 5 newsletter “Restrictive Covenants: Do Yours Meet a Changing Landscape?”

[1] In re Quicken Loans, Inc. et al, Case 07-CA-145794 (2016).

Defend Trade Secrets Act Signed Into Law

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On May 11, 2016, President Obama signed into law the Defend Trade Secrets Act (“DTSA”), which became effective immediately. The DTSA provides the first private federal cause of action for trade secret misappropriation, and it allows parties to sue in federal court for trade secret misappropriation—regardless of the dollar value of the trade secrets at issue.

Although the DTSA’s remedies largely overlap with those in the 48 states that have adopted some version of the Uniform Trade Secrets Act, the DTSA will nevertheless significantly alter how trade secret misappropriation cases are litigated. Additionally, the DTSA has broad whistleblower protections, and it requires that employers provide certain notices of these whistleblower protections in employment-related agreements that govern trade secrets or other confidential information entered into or amended after May 11, 2016.

For more information concerning the impact of the DTSA on employers, please see our “Q&A” on this topic, published by the Practical Law Company.

In Today’s Environment, What Is “Adequate Consideration” for a Restrictive Covenant Signed by an Existing Employee?

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Employers seeking to require an existing employee to sign a restrictive covenant should consider current litigation trends surrounding what constitutes “adequate consideration.” Under the traditional rule followed by a majority of states, continued employment, standing alone, is adequate consideration for a restrictive covenant signed by an at-will employee. Several courts, however, have recently reexamined this issue, so employers must be aware of differences among the states as to whether some consideration beyond mere continued at-will employment is required.

Fifield v. Premier Dealer Services, Inc.

For example, the Illinois Appellate Court held in Fifield v. Premier Dealer Services, Inc.,[1] that, absent other consideration, at least two years of continued employment are required to constitute adequate consideration for a restrictive covenant. Under Fifield, the two-year rule applies regardless of whether the employee signed the restrictive covenant as a new or existing employee and regardless of whether the employee voluntarily resigned or was fired.

Although Fifield has been followed in subsequent Illinois state appellate decisions,[2] multiple federal district courts in Illinois have refused to apply Fifield’s bright line, two-year rule. For example, last month, the U.S. District Court for the Northern District of Illinois concluded that the Illinois Supreme Court, which has not yet ruled on the issue, “would reject a two year bright-line rule in favor of a fact specific test.”[3] Therefore, while “[t]wo years may be sufficient to find adequate consideration,” “it is not always necessary,” particularly when considering other factors, like compensation, raises and bonuses, and the terms of the employee’s termination.[4]

Differing State Rules

Since Fifield, other state courts have similarly grappled with the issue of what constitutes adequate consideration for a restrictive covenant. Kentucky, North Carolina, and Pennsylvania courts each have issued decisions requiring some consideration beyond mere continued employment to enforce a non-compete.[5]

In contrast, the Wisconsin Supreme Court recently held in Runzheimer Int’l, Ltd. v. Friedlen,[6] that employers may require existing at-will employees to sign non-compete agreements without offering additional consideration beyond continued employment, although the court did not provide clear guidance as to the period of time that the employment must continue after the non-compete is signed.

Courts in New York and New Jersey have been relatively consistent regarding the required consideration for a restrictive covenant. Both states consider continued employment to constitute adequate consideration for a restrictive covenant signed by a current employee, provided that the employer forbears from discharging the employee for a “substantial” period of time.[7]

What Employers Should Do Now

In light of this judicial focus on appropriate consideration and given the number of states that have recently addressed adequacy of consideration, employers nationwide should monitor this issue—even in states where the law is currently stable.

In terms of addressing this issue, employers should consider these options:

  1. Where there is a plausible nexus to a state with more favorable laws regarding the enforceability of restrictive covenants, include a choice-of-law provision designating the law of that state (e.g., the state where the employer’s headquarters is located or where the employee actually works). Courts generally enforce contractual choice-of-law provisions unless they violate the fundamental public policy of a state with a materially greater interest in the situation or where the parties and contract do not have a substantial relationship with the chosen state.
  2. Provide consideration in addition to an offer of employment or continued employment. Examples of such possible “additional consideration” include a cash payment, stock options, training, education, a raise, additional paid time off, guaranteed severance, or a promotion. In the absence of judicial guidance, it would be prudent to be as generous as possible and to provide consideration that is more than de minimis. Regardless of the “additional consideration” ultimately decided upon, the restrictive covenant itself should both explicitly recite the consideration provided to the employee for signing it and further provide that the employee acknowledges the consideration and its adequacy.
  3. Agree to continue the employee’s salary during any restricted period, thereby alleviating concern about consideration being illusory.
  4. Consider trying to evade consideration concerns entirely by having employees agree to a “garden leave” or “required notice” clause, rather than a traditional non-compete or non-solicit clause. Under such a provision, an employee is required to give advance notice of his or her resignation (e.g., 30 – 90 days) and, during the notice period, the employee remains on your payroll and owes you a fiduciary duty of loyalty (and therefore cannot work for a competitor during that period). Because the employee remains on the payroll and because garden leave provisions tend to be shorter in duration than traditional restrictive covenants, they are less onerous to the individual and thus more likely to be enforced.

A version of this article originally appeared in the Take 5 newsletter “Restrictive Covenants: Do Yours Meet a Changing Landscape?”

[1] Fifield v. Premier Dealer Services, Inc., 2013 IL App. (1st) 120327.

[2] See, e.g., Prairie Rheumatology Assocs., S.C. v. Francis, 2014 IL App. (3d) 140338; McInnis v. OAG Motorcycle Ventures, Inc., 2015 IL App. (1st) 142644).

[3] R.J. O’Brien & Assocs., LLC v. Williamson, No. 14 C 2715, 2016 U.S. Dist. LEXIS 32350, at *7 (N.D. Ill. Mar. 10, 2016).

[4] Id. at *7-9.

[5] See, e.g., Charles T. Creech, Inc. v. Brown, 433 S.W.3d 345 (Ky. 2014) (mere continued at-will employment does not constitute adequate consideration); Emp’t Staffing Grp., Inc. v. Little, 777 S.E.2d 309, 314 (N.C. App. 2015) (upholding as adequate a $100 payment made to defendant in conjunction with signing a mid-employment non-compete); and Socko v. Mid-Atl. Sys. of CPA, Inc., 126 A.3d 1266, 1275 (Pa. 2015) (an existing employee must receive some “new” and valuable consideration in exchange for signing a mid-employment non-compete agreement, even where the employee expressly “inten[ded] to be legally bound” by the agreement).

[6] Runzheimer Int’l, Ltd. v. Friedlen, 2015 WI 45 (Wis. 2015).

[7] See Int’l Paper Co. v. Suwyn, 951 F. Supp. 445, 448 (S.D.N.Y. 1997) (under New York law, continued employment for a “substantial period” following the execution of the agreement is sufficient consideration for a restrictive covenant); Hogan v. Bergen Brunswig Corp., 153 N.J. Super. 37, 43 (Super. Ct. App. Div. 1977) (continued employment is sufficient consideration to support a restrictive covenant found in an original or post-employment contract).

Former Workers Violated Ex-Employer’s Trade Secret Rights – Employment Law This Week

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Peter Steinmeyer, co-editor of this blog, is featured in the top story on Employment Law This Week.

As the story explains, the U.S. Court of Appeals for the Sixth Circuit has upheld a ruling that a group of workers at a fastener company used confidential drawings from the company to design, manufacture, and sell competing parts for their new business venture. On appeal, the former workers argued that they were “filling a gap” for customers, not competing with the original company. But the Sixth Circuit found that this argument ignored undisputed evidence in the case.

Mr. Steinmeyer discusses steps that employers should take to protect their trade secrets.

View the episode, below.

 

Should You Be Wary of the Overzealous Use of Trade Secret Claims?

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High-stakes trade secret cases are typically aggressively prosecuted. But plaintiffs (and their attorneys) who prosecute these claims face substantial risks if the evidence does not support the contention that a trade secret has been misappropriated. Even a plaintiff who may have initiated a misappropriation action in good faith risks attorneys’ fees and malicious prosecution liability by continuing to prosecute the matter after it learns that the case is not substantiated.

Section 4 of the Uniform Trade Secrets Act authorizes a court to award costs and attorneys’ fees if the court determines that a claim for misappropriation is made in bad faith, and most jurisdictions include this provision. For example, California Civil Code § 3426.4 provides that “[i]f a claim of misappropriation is made in bad faith, a motion to terminate an injunction is made or resisted in bad faith, or willful and malicious misappropriation exists, the court may award reasonable attorney’s fees and costs to the prevailing party.”

SASCO v. Rosendin Electric, Inc.

Several recent California cases highlight that the risk to employers (and the law firms representing them) is not simply in initiating actions for misappropriation but also for continuing to pursue them when the facts of the claim are not borne out in litigation.

In SASCO v. Rosendin Electric, Inc., 207 Cal.App.4th 837 (2012), the California Court of Appeal affirmed a trial court’s order awarding the defendants almost $485,000 in attorneys’ fees and costs pursuant to California Civil Code § 3426.4. SASCO sued Rosendin Electric, Inc.; another licensed electrical contractor; and three individual defendants for misappropriation of trade secrets, among other things. The trial court accepted for the sake of argument that SASCO’s computer program was a trade secret. The court concluded, however, that there was no evidence of misappropriation and that SASCO had sued the defendants based on the suspicion that they must have misappropriated trade secrets because the individual defendants went to work for a competitor, which subsequently secured a contract for which both companies were competing. The trial court concluded that the plaintiff engaged in bad faith pursuant to Section 3426.4, which consisted of both objective speciousness and subjective bad faith. The appellate court agreed with the trial court that continuing to prosecute the action without evidence of actual misappropriation constituted subjective bad faith.

FLIR Systems, Inc. v. Parrish

The risk to plaintiff employers (and their law firms) in pursuing claims in bad faith is not limited to attorneys’ fees and costs under the statute. On April 6, 2012, Latham & Watkins was sued for malicious prosecution in Los Angeles Superior Court. 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 and sued the plaintiffs for, among other things, misappropriation of trade secrets. After a summary judgment motion was denied, the case proceeded to trial on FLIR’s claim for injunctive relief. The trial court denied FLIR’s request for a permanent injunction, found that FLIR brought the trade secrets action in bad faith, and awarded attorneys’ fees and costs of $1,641,216.78. The trial court’s decision was affirmed on appeal.[1]

In the subsequent malicious prosecution suit, Latham & Watkins filed a motion contending that the plaintiffs’ claims were barred by the statute of limitations and on their merits, contending that (i) a one-year statute of limitations applied to the plaintiffs’ claims and the claims were untimely under that limitations period and (ii) the trial court’s denial of summary judgment for the plaintiffs on the claims brought against them by FLIR established that the underlying action was brought with probable cause as a matter of law. The trial court granted Latham’s motion on statute of limitations grounds and did not expressly address Latham’s argument that the claims against the law firm were without probable cause.

On August 27, 2014, the Court of Appeal issued an opinion reversing the trial court. The Court of Appeal held that the applicable statute of limitations for malicious prosecution claims was not the one-year, but rather the two-year, limitation period set forth in Cal. Code Civ. Proc. Section 335.1.

The Court of Appeal then considered Latham’s argument disputing the merits of the plaintiffs’ malicious prosecution complaint. Key to Latham’s argument was the fact that the plaintiffs had moved for summary judgment in the underlying case and that motion had been denied. Latham argued that the “interim adverse judgment rule” applied, under which claims that have succeeded at a hearing on the merits are deemed not so lacking in potential merit to serve as the basis for a malicious prosecution claim (unless such ruling is obtained by fraud or perjury). Prior courts had routinely applied the interim adverse judgment rule to bar claims for malicious prosecution where there had been a denial of a defendant’s motion for summary judgment in the underlying action.

The Court of Appeal noted that the plaintiffs had evidence that:

  1. Latham filed a complaint alleging actual misappropriation of a business plan, disregarding a claim that the plaintiffs had created the business plan prior to their employment with FLIR;
  2. when plaintiffs presented that evidence to Latham, Latham changed the theory of the case to pursue a claim that the plaintiffs could not effectuate the business plan without inevitably using FLIR’s intellectual property;
  3. Latham knew that inevitable disclosure is not a viable legal theory in California and, therefore, knew that this theory lacked legal basis;
  4. the factual basis for Latham’s theory was expert testimony that considered only publicly available technology when Latham knew that the plaintiffs’ business plan would be using non-public technology obtained lawfully from third parties; and
  5. FLIR’s president testified that he had no factual basis to assert that the plaintiffs would use FLIR’s intellectual property, strongly implying that the claim against them was a preemptive strike.

Critically, the Court of Appeal found that Latham had “sought an obviously anti-competitive injunction based on the speculative possibility that the [plaintiffs’] product might violate its client’s trade secrets . . . .” The Court of Appeal held that these circumstances supported the conclusion that “no reasonable attorney would have believed [the] case had merit,” and it reinstated plaintiffs’ claim.

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, this time, affirming the trial court’s order granting Latham’s 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 (i) the summary judgment motion was not denied on procedural or technical grounds and (ii) the summary judgment motion was not obtained by fraud or perjury.[2]

But this ruling did not conclude the matter. On October 14, 2015, the California Supreme Court granted the plaintiffs’ Petition for Review, and the case is pending.

Understand the Risk Before Prosecuting

There are substantial risks in pursuing trade secret actions if it appears that plaintiffs are using the Trade Secrets Act to mask an anti-competitive intent. If, during the course of the litigation, there is no evidence that a trade secret has been misappropriated or it does not look like a trade secret can be proven, plaintiffs and their attorneys must understand this risk in assessing whether, or to what extent, to continue to pursue the action.

A version of this article originally appeared in the Take 5 newsletter “Restrictive Covenants: Do Yours Meet a Changing Landscape?

[1] FLIR Systems, Inc. v. William Parrish, et al., 174 Cal.App.4th 1270 (2009).

[2] Parrish v. Latham & Watkins, 238 Cal.App.4th 81, 97 (2015).

Sixth Circuit Affirms $3.7 Million Award And Permanent Injunction In Trade Secret/Breach Of Duty Of Loyalty Case

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In Nedschroef Detroit Corp. et al. v. Bemas Enterprises et al., the U.S. Court of Appeals for the Sixth Circuit recently affirmed an award of nearly $3.7  million in damages against two individuals found to have engaged in misconduct related to the operation of a business which competed with their employer.

Nedschroef Detroit Corporation (“Nedschroef”) services and provides replacement parts for fastener machines made by an affiliate in Europe.  Without Nedschroef’s knowledge, two of its employees formed a business – under their wives’ names – to do exactly what Nedschroef did.

After Nedschroef learned about this, it fired the two individuals and then filed suit against them and their competitive business.  The District Court granted summary judgment to Nedschroef on nine counts: breach of the duty of loyalty, breach of fiduciary duty and misappropriation of corporate opportunities, violation of the Michigan Uniform Trade Secrets Act, conversion, statutory conversion, unfair competition, tortious interference, unjust enrichment, and civil conspiracy.  The District Court also awarded $3.7 million in damages and permanently enjoined the defendants from providing replacement parts or services for these machines in North America.

On appeal, the defendants argued that they did not actually compete with Nedschroef, because they only provided parts and/or services to customers who had “previously requested a quote for the same part or service from Nedschroef” — but who had rejected Nedschroef’s quote.  The Sixth Circuit did not find this convincing, holding that the argument “ignor[ed] both common sense and the undisputed evidence in the case.”

On appeal, the defendants also challenged the District Court’s finding that they had misappropriated Nedschroef’s proprietary secrets.  However, the Sixth Circuit found no error in the District Court’s finding that the defendants obtained Nedschroef’s proprietary secrets through breach of a duty to maintain their secrecy, and “then used those drawings to manufacture and sell parts in direct competition with Nedschroef.”

Although the size of the award in this case is eye-catching, the controlling legal principles are well-established: barring a contractual limitation, an employee is generally free to take limited steps to prepare to compete with his employer, but he cannot actually compete while still employed, and he can never do so using his employer’s trade secrets or confidential information.

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