Trade Secrets & Noncompete Blog

Trade Secrets & Noncompete Blog

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

New York Attorney General Targets Non-Competes for Rank-and-File Workers

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This summer, New York Attorney General Eric T. Schneiderman has reached agreements with a number of companies curtailing their use of non-competition agreements with respect to non-executive and low-wage employees in New York. The issue appears to have caught the attention of Mr. Schneiderman, who stated recently that “restricting rank-and-file workers from being able to find other jobs is unjust and inappropriate” and “workers should be able to change jobs without fear of being sued.”

For example, on August 4, 2016, Examination Management Services, Inc. (“EMSI”), a medical information services provider headquartered in Texas, agreed to stop using non-compete agreements for most of its employees in New York. Prior to the agreement, EMSI’s mandatory non-compete agreements prohibited employees for nine months after leaving the company from working for competitors within fifty miles of any locations they worked for EMSI.

As another example, on June 15, 2016, the legal news website Law360 reached a similar agreement with Mr. Schneiderman’s office. Prior to that, Law360 required a majority of employees, including all editorial employees, to sign an employment contract with a non-compete provision that prohibited them for one year after leaving the company from working for any media outlet that provides legal news.

The Attorney General’s actions on this issue may be part of a larger trend. A March 2016 report by the U.S. Treasury Department found that non-compete agreements cause various harms to “worker welfare, job mobility, business dynamics, and economic growth more generally.” A May 2016 report published by the White House reached similar conclusions. Employers thus should make sure that their non-compete agreements with employees protect legitimate business interests such as safeguarding trade secrets and/or customer relationships.

Connecticut and Rhode Island Enact Statutes Restricting Physician Non-Competes

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David J. Clark

David J. Clark

Last month, two New England states enacted laws restricting the use of non-competition provisions in agreements governing an employment, partnership or other professional relationship of a physician.

Broadly speaking, the aim of both of these laws is to protect patients’ choice regarding medical care by limiting the ability of employers or partners to contract with physicians such that the physicians’ ability to practice medicine would be restricted at the end of the professional relationship.

Effective on July 12, 2016, the new law in Rhode Island (R.I. Gen. Laws §5-37-33) prohibits non-compete language in most physician agreements.  It renders void and unenforceable “any restriction on the right to practice medicine” found in virtually any contract creating the terms of employment, partnership or other professional relationship involving a state-licensed physician.  The new law therefore invalidates non-competition or patient non-solicitation provisions for Rhode Island physicians.  The new law does not apply in connection with the purchase and sale of a physician practice, provided the restrictive covenant is less than five years in duration.

Effective on July 1, 2016, the new law in Connecticut (Public Act No. 16-95) is less sweeping than the Rhode Island law.  Rather than prohibiting physician non-competes, the Connecticut law limits the allowable duration (to one year) and geographical scope (up to 15 miles from the “primary site where such physician practices”) of any new, amended or renewed physician agreement.  The new law also renders physician non-competes unenforceable if the physician’s employment or contractual relationship is terminated without cause.

Rhode Island and Connecticut are the latest in a slowly growing number of states that have taken legislative action to limit the use of physician non-competes.  Their neighbor Massachusetts was an early adopter of such a statute.  Mass. Gen. Laws chapter 112, §12X (enacted in 1977) bars physician non-competes which include any restriction of the right of a physician to practice medicine in any geographic area for any period of time after termination.  Much of the language in the Massachusetts law appears in the recently enacted Rhode Island statute.

Similar language appears in Delaware and Colorado statutes dating from the early 1980s, which state that covenants are void if they restrict the rights of physicians to practice medicine upon termination of the agreements containing the covenants.

More recently, Texas (in 1999) and Tennessee (in 2012) both enacted statutes (as did Connecticut) applying stricter standards to physician non-competes than are applicable to employee non-competes in general, while stopping short of invalidating such physician non-competes.

It remains to be seen if the enactment this summer of these statutes in Connecticut and Rhode Island is merely a coincidence, or foreshadows more state legislatures pursuing such limitations of physician non-competes.

No New Non-Compete Law for Massachusetts in 2016

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David J. Clark

David J. Clark

The Massachusetts legislature ended its 2015-2106 session on July 31, 2016, and lawmakers did not pass new legislation regarding non-compete agreements before doing so.

For the last few years, numerous efforts have been made in the Commonwealth to limit the use of non-compete agreements, resulting in several bills introduced in the Statehouse.  The latest bills, introduced in the House in June and the Senate in mid-July, would have set clear boundaries on the use of non-compete agreements by employers, including by establishing requirements that such non-compete provisions be signed and in writing, not exceed 12 months in duration, and be limited to geographic areas where the employee actually provided services. Another notable feature of the proposed bills was the incorporation of the concept of “garden leave” into non-compete provisions, in which an employer would be required to pay its former employee at least 50% of his or her pay, on a pro rata basis, during the non-compete period. The bills also would have prohibited judicial modification of non-competes and enforcement of non-competes against certain types of workers like students, interns, or fired employees.

As the legislative session drew to a close, however, legislators were unable to reach compromises upon issues such as whether and in what form garden leave might be allowed, and whether an employer and employee could agree upon a payment to support a non-compete entered at the termination of employment.

In this presidential election year, the Massachusetts legislature is adjourned until the start of a new session in January 2017. Renewed efforts to pass a non-compete bill in Massachusetts can be expected then.

Criminal Enforcement Protects Trade Secrets Taken By Departed Employees

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James P. Flynn

James P. Flynn

In the recent case of United States v. Nosal, the United States Court of Appeals for the Ninth Circuit confirmed the applicability of both the Computer Fraud and Abuse Act and the Economic Espionage Act as safeguards against theft of trade secrets by departed former employees.  Importantly, Nosal applied such laws to convict a former employee in a case involving domestic businesses and personnel without any alleged overseas connections.  Because of civil enforcement provisions in the CFAA itself and the recently enacted Defend Trade Secrets Act, Nosal represents a possible guide to employers seeking to protect their trade secrets through civil or criminal mechanisms, or both.

In assessing the implication of Nosal, one may consider three framing questions:

  1. How does this case take the trend of criminalization and federalization of trade secret law a step further?

The Nosal case is a great example of three trends coming together to give corporate employer and trade secret owners access to new avenues for relief.

First, Nosal pushes forward the trend that began in 2013 when the Department of Justice announced that trade secret prosecutions would become an area of emphasis.  Since then, DOJ has been much more receptive to business crime claims.

Second, it is the next step in the law’s evolution—the majority decision construed both the Consumer Fraud & Abuse Act and Economic Espionage Act in a complementary manner consistent with their plain language and applied them to common sense circumstances that seemed like theft. The CFAA is written in language beyond that of  a technical anti-hacking statute, and it is important that a federal appeals court has recognized that scope.

Third, and most importantly, Nosal is a step in the right direction on protecting trade secrets whether or not there are later criminal prosecutions on similar theories.  That is because the CFAA and now, since April, the Defend Trade Secrets Act also allow for civil remedies. Nosal’s common sense result was that one is acting without authorization when one uses another’s password because the actor’s password  has been revoked—that holding is not only a tool for prosecutors, but is one that civil litigants could use as well.

2. Why have there been more criminal convictions in trade secrets cases in the past few years?

Changes in in policy, changes in politics, and changes in perceptions.

First, the Obama administration formally issued a written policy in February 2013 announcing ADMINISTRATION STRATEGY ON MITIGATING THE THEFT OF U.S. TRADE SECRETS.  So one is seeing more prosecutions, and convictions, in some sense because DOJ has pursued that policy.

Second, there is a growing sense that these crimes not only hurt individual companies economically, but hurt the United States and its citizens more generally. That is why so many of the higher profile trade secret prosecutions have involved defendants who were foreign nationals or were assisting foreign companies.  Public and political support for pursuing such cases cannot be underestimated.

Finally, in light of the announced policy and the evolving political reality, companies are simply more likely to report such crimes. In the past, victimized companies hesitated to draw attention to their own losses or injuries and thought doing so also required them to give up control of recovery efforts to prosecutors.  Those perceptions have changed, and Nosal and cases like it are examples of such changes.

3. What were the key takeaways from the dissent in Nosal that might gain traction as other circuits address these issues?

The dissent had three main criticisms of the majority opinion.

The first criticism was that, in the dissent’s view, the 9th Circuit improperly expanded the CFAA beyond its anti-hacking roots to apply it to what the dissent described as mere password sharing.

Second, the dissenting judge contended that the decision effectively turns employers’ computer use policies into non-public criminal codes of which defendants have inadequate notice.

Third, and what likely in some ways probably motivates the dissent’s first two points, the dissent observed that this decision potentially empowers corporate employers to have undue influence in criminal prosecutions.

These statutes and the criminal prosecution of trade secret theft continue to be areas of interest that trade secret owners and their counsel should follow, and should consider in enforcing their own rights in these matters.

Assignment Lessons: 8th Circuit Finds Assigned Non-Competes Enforceable — Under Certain Facts

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The 8th Circuit’s recent decision in Symphony Diagnostic Servs. No. 1 v. Greenbaum, No. 15-2294, __ F.3d __ (8th Cir. July 6, 2016), upheld the enforceability of non-compete and confidentiality agreements assigned by Ozark Mobile Imaging to Mobilex as part of Mobilex’s purchase of Ozark’s assets.  Although the 8th Circuit is careful to ground its analysis in that case’s specific factual and legal framework, this decision is helpful in providing some guidance to those dealing with the assignability of rights under non-compete and confidentiality agreements.

The non-compete and confidentiality agreements at issue were (1) “free standing” and (2) assignment did not “materially change the obligations of the employee” nor (3) were the agreements dependent upon “qualities specific to the employer.” Symphony Diagnostic Servs. It is also notable that the agreements contained no language regarding assignability, i.e. they did not expressly restrict or permit assignment. Symphony Diagnostic Servs. No. 1 v. Greenbaum, 97 F. Supp. 3d 1126 (W.D. Mo. March 16, 2015).  Under those factual circumstances, the 8th Circuit, applying Missouri law, concluded that a Missouri court would find the agreements assignable and enforceable.

There are lessons for both those seeking to enforce or to avoid enforcement of non-compete and confidentiality agreements following the acquisition of a business via an asset purchase.

The first lesson is “pay attention to state law.” While the 8th Circuit applying the Missouri framework is helpful, it may vary significantly by state.  For example, in Ohio, courts generally construe non-compete clauses against the employer, and do not view non-competes as per se assignable. Fitness Experience, Inc. v. TFC Fitness Equip., Inc., 355 F. Supp. 2d 877 (N.D. Ohio Dec. 17, 2004) (looking to factors such as contract language, protection of the employer’s goodwill, and additional employee burden to determine assignability).  In fact, the Ohio Court of Appeals stated that “the employment relationship is a personal matter between an employee and the company who hired him and for whom he chose to work. Unless an employee explicitly agreed to an assignability provision, an employer may not treat him as some chattel to be conveyed, like a filing cabinet, to a successor firm.” Cary Corp. v. Linder, No. 80589, 2002-Ohio-6483, 19 I.E.R. Cas. (BNA) 1170 (Ohio Ct. App. Nov. 27, 2002); see also Reynolds & Reynolds v. Hardee, 932 F. Supp. 149 (E.D. Va. July 11, 1996) (employment agreement is based on mutual trust and confidence; non-compete is not assignable).  Pennsylvania also takes a dim view of the assignability of such agreements in the asset purchase context. See Hess v. Gebhard & Co. Inc., 570 Pa. 148, 808 A.2d 912 (Pa. Oct. 16, 2002)(“We hold that a restrictive covenant not to compete, contained in an employment agreement, is not assignable to the purchasing entity, in the absence of a specific assignability provision, where the covenant is included in a sale of assets”). Non-compete restrictions are generally not enforceable and void in California, subject to certain exceptions including acquisition of a business that includes purchase of goodwill or sale of an of an ownership interest in a business, with such restrictions limited to similar businesses to the acquired business and a specific geographic area.  Cal. Bus. & Prof. Code §16601.  Non-compete restrictions are generally not enforceable and void in Colorado. Colo. Rev. Stat. §8-2-113(2).  New York has also emphasized the need to determine whether the contract containing such a covenant is a personal services contract, and therefore not assignable. Seligman & Latz, Inc. v. Noonan, 201 Misc. 96, 104 N.Y.S.2d 35 (N.Y. Sup. Ct. April 23, 1951). On the other hand, Kentucky law takes a more assignment friendly approach and generally views non-competes as assignable. Managed Health Care Assocs. v. Kethan, 209 F.3d 923 (6th Cir. (Ky.) March 10, 2000) (where “the only thing that changed was the entity now entitled to enforce” the agreement, and the contractual rights and duties of an employee remain, non-competes are assignable).   New Jersey takes a similar approach, noting that “[u]pon the sale of a business a restrictive covenant …is assignable without express words to that effect and passes as an incident of the business sold even though not specifically assigned” and should “be assignable as an incident of the business even if not made so by express words.” JH Renerde, Inc. v. Sims, 312 N.J. Super. 195, 711 A.2d 410 (N.J. App. Div. Feb. 19, 1998).

Based on the 8th Circuit’s decision, another lesson for employers is that they may want to consider stand-alone non-compete or confidentiality agreements, taking care, of course, to assure that there remains valid supporting consideration under applicable law.  Having the non-compete or confidentiality agreement stand alone and apart from any employment contract at issue was critical for the 8th Circuit in distinguishing assignable agreements from personal service contracts that may not be assigned. Likewise, such employers may want to negotiate agreements that include language specifically allowing assignment to an acquirer of the business without consent of the other party, typically found in a successors and assigns clause.  Use of language that precludes working in a particular field or a narrow subset within that field may make assigned rights easier to enforce than more generic references to prohibiting competition with any aspect of the employer’s business, which, post sale, may have expanded greatly.

For those seeking to avoid assignability of rights under non-compete or confidentiality agreements, the lessons are inverse, save the common direction to make sure that the law of the applicable state is considered first and foremost. Challengers should review agreements to see whether they include language that prohibits assignability, or whether assignability language is absent. They may wish to argue that where non-compete or confidentiality provisions are integrated into broader employment agreements, a personal services contract exists, which may impact on assignability under state law. Finally, they should look to whether the terms of the non-compete or confidentiality agreement are linked to the specific practice of the former employer or to the employee’s particular duties, customers and territories, or are of broader scope, preventing competition against the employer’s business generally.  In the latter case, it is more likely that assignment could result in a material change to the restrictions and obligations placed upon the employee where the acquiring employer’s overall business varies significantly from that of the original assigning employer.  Though such rights may be assignable, they are less likely to be enforceable. As noted above, any such assessments are also made in light of each state’s approach to assignability of non-competes – which varies across the country.

Would-be purchasers of another employer’s assets can also take such lessons into account. If any of the aids to enforceability are absent from the contracts to be assigned, a purchaser or its counsel may seek to leverage such facts in negotiating price or in adjusting escrow or indemnification obligations.  Conversely, a purchaser could suggest, or a seller could decide, that existing and possibly deficient agreements be amended pre-sale.  Of course, in such circumstances, the amending employer must again resort to state law analysis of such terms.

In those same circumstances, one must also consider whether the amended agreement is supported by adequate consideration. Such consideration requirement can vary, depending on the state.  For instance, mere continued at-will employment is sufficient consideration to support a new non-competition agreement in New Jersey under various cases. See Martindale v. Sandvik, Inc., 173 N.J. 76, 800 A.2d 872 (N.J. Supreme Court July 17, 2002); see also Quigley v. KPMG Peat Marwick, LLP, 330 N.J. Super. 252, 749 A.2d 405 (N.J. App. Div. 2000), certif. denied, 165 N.J. 527, 760 A.2d 781 (N.J. Sep. 7, 2000) (stating that employment can be deemed consideration for employee’s submission to employer’s demands, including arbitration); Hogan v. Bergen Brunswig Corp., 153 N.J. Super. 37, 378 A.2d 1164 (N.J. App. Div. Sep. 29, 1977) (holding that continuation of plaintiff’s employment after plaintiff signed letter acknowledging restrictive covenant against post-employment competition constituted sufficient consideration to enforce agreement). But, in a state like Illinois, the continued employment must meet a certain threshold minimum time period. See Fifield v. Premier Dealer Services, Inc., 2013 IL App (1st) 120327, 993 N.E.2d 938 (Ill. 1st Dist. June 24, 2013) (noting that Illinois courts have “repeatedly held that two years of continued employment is adequate consideration to support a restrictive covenant”).  Further, in other jurisdictions like Texas and Pennsylvania, there is a requirement that non-competition agreements be supported by independent consideration beyond continued employment. See, e.g., Alex Sheshunoff Management Serv. v. Johnson, 209 S.W.3d 644, 50 Tex. Sup. J. 44, 25 I.E.R. Cas. (BNA) 481 (Tex. Sup. Ct. Oct. 20, 2006) (training or disclosure of confidential information could provide additional necessary consideration); Socko v. Mid-Atlantic Systems of CPA, Inc., 126 A.3d 1266, 40 I.E.R. Cas. (BNA) 1568  (Pa. Sup. Ct. Nov. 18, 2015) (“In the context of requiring an employee to agree to a restrictive covenant mid-employment, however, such a restraint on trade will be enforceable only if new and valuable consideration, beyond mere continued employment, is provided and is sufficient to support the restrictive clause.”)  These factors thus also become issues that one must consider in valuing the agreements assigned or to be assigned.

Of course, it is also important for transactional attorneys to specify expressly in the transactional documents themselves that such employment agreements are among the assets being transferred. This was highlighted in a district court case in Washington DC decided only two days after Symphony Diagnostic Servs. See Hedgeye Risk Mgmt., LLC v. Heldman, __ F. Supp. 3d. __ (DDC July 8, 2016) (denying enforcement of covenant, holding that “[t]he text and structure of the APA answer that question [i.e. whether the agreement were conveyed], and they belie any claim that PRG’s employment contracts were among the ‘assets’ conveyed in the APA).  The court rejected plaintiff’s argument that the overall purpose of the asset purchase agreement precluded the need for an express reference to the agreements as assigned assets:

Hedgeye’s only remaining argument—and, in truth, its primary argument—is that “the entire point of the sale between PR[G] and Hedgeye was that Hedgeye was desirous of obtaining PRG’s talent.” Dkt. 3-1 at 8. That is, Hedgeye argues that its goal in acquiring PRG (and thus in executing the APA) was to acquire the services of PRG’s employees, and particularly Heldman. See id. (arguing that the APA provision requiring Hedgeye to pay Heldman’s bonus “evidenc[es] Heldman’s clear value to the transaction”). It is not hard for the Court to believe that Hedgeye desired to hire PRG’s employees, nor that it wanted to hire Heldman in particular. But it is hard to read the APA to achieve that result itself—not in light of the APA’s express statement that Hedgeye may “offer employment” to all PRG employees. See Dkt. 1-2 at 15 (APA at 14) (emphasis added).

Thus, the Hedgeye Court offered a lesson at the asset sale stage that care be taken to be clear, just as Symphony Diagnostic Servs. provided lessons on considerations for drafting the post-employment restrictions originally.

Whether seeking to support or challenge assigned agreements or just trying to determine the value of restrictive covenant agreements to be assigned, cases like Symphony Diagnostic Servs. merit continued attention, especially as they emerge in additional jurisdictions.  The ability to determine what rights may exist for an acquired business to protect from direct competition by its former employees may be vitally important in determining the value to be paid for the assets of the business, whether to proceed with the acquisition at all, and the options that are presented in its aftermath.

A version of this article appeared in Bloomberg BNA Daily Labor Report (PDF). 

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).