Trade Secrets & Noncompete Blog

Trade Secrets & Noncompete Blog

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

Law Professors Object to New Trade Secrets Acts Proposed in Congress

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As we have previously noted, Congress this year is actively considering two bills that would create a federal private right of action for trade secret theft: The Trade Secrets Protection Act (H.R. 5233) and the Defend Trade Secrets Act (S. 2267). These bills have been spurred in large part by increased foreign cyber-espionage affecting American companies.

Although the bills have enjoyed bipartisan support in Congress and in the business community, including from the National Association of Manufacturers, last month a group of dozens of law professors in the intellectual property and trade secret fields sounded a note of caution by publishing a Letter in opposition to the two bills. While acknowledging that the United States needs to increase protection against cyber-espionage, the professors argue that the bills should be rejected for several reasons, including:

1) existing state law is sufficiently uniform and effective;

2) if enacted, the bills will create parallel, redundant and damaging law; and

3) the bills as drafted could lead to unintended consequences such as anti-competitive results, increased risk of accidental disclosure of trade secrets, and damage to collaboration among businesses and mobility of labor.

The Professors’ Letter and continued engagement in the future on these issues may well affect the passage and/or shape of the two pending bills. We will continue to monitor and report upon these proposed federal trade secrets bills.

Court of Appeal Reinstates Malicious Prosecution Case Against Latham & Watkins

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Co-authored by Ted A. Gehring.

On April 17th, 2012, we blogged about a malicious prosecution claim brought against Latham & Watkins in Los Angeles Superior Court. The suit alleged that 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 them for, among other things, misappropriation of trade secrets. The trial court denied FLIR’s request for a permanent injunction, found FLIR brought the trade secrets action in bad faith, and awarded 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).

In our blog post, we noted that:

The malicious prosecution complaint against Latham alleges that there is a related malicious prosecution action against FLIR and that Plaintiffs did not discover the basis for the malicious prosecution action against Latham until May 2010, when FLIR indicated at a court conference in the related malicious prosecution action that they might by invoking the advice of counsel defense. So it appears there will be a statute of limitations defense to be litigated.

We will follow the progress of this case, and it will be interesting to see if Latham files a motion pursuant to California’s anti-SLAPP law (a strategic lawsuit against public participation – California Code of Civil Procedure 425.16).

Latham & Watkins did file an anti- SLAPP motion contending, in part, that the Plaintiffs’ claims were barred by the statute of limitations. The motion was granted by the trial court, which held that a one-year statute of limitations period applied to the Plaintiffs’ claims. On August 27, 2014, the Court of Appeal issued its opinion reversing the trial court.

Latham’s anti- SLAPP motion argued that the Plaintiffs would be unable to establish a reasonable probability of prevailing on their action, contending that (1) a one-year statute of limitations applied to Plaintiff’s claims, and that the claim was untimely under that limitations period and that (2) 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 them were without probable cause.

The Court of Appeal held first that the applicable state 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 Cal. Code Civ. Proc. Section 335.1. Under that limitations period, all parties agreed the action was timely. The Court of Appeal then considered Latham’s argument that the Plaintiffs did not have a probability of prevailing on their malicious prosecution complaint. Specifically, Latham contended that the Plaintiffs could not establish, as a necessary element of their malicious prosecution claim, that the underlying claim against the Plaintiffs had been brought without probable cause. 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 that rule, claims that have succeeded at a hearing on the merits, unless such ruling is obtained by fraud or perjury, are deemed not so lacking in potential merit to serve as the basis for a malicious prosecution claim, even if the judgment is later reversed on appeal. Courts had 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 interim adverse judgment rule would not apply in cases where there had been perjury or fraud, or where the motion for summary judgment had been denied on technical or procedural grounds. Further, the Court of Appeal noted that the rule does not apply where there is an ultimate ruling in the underlying action that the underlying action was, in fact, brought in bad faith. In the underlying case against the Plaintiffs, the trial court had found, after denying the Plaintiffs’ motion for summary judgment, but after a trial on the merits, that the case against them had been brought in bad faith.

The Court of Appeal held that the trial court’s finding that the underlying action had been pursued in bad faith was some evidence that probable cause did exist for the malicious prosecution claim. The Court of Appeal further held that, even without considering that finding, the Plaintiffs had established that the claims against them had been brought without probable cause. 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) that, 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 using FLIR’s intellectual property, (3) that Latham knew that inevitable disclosure is not a viable legal theory in California, and therefore knew that this theory lacked legal basis, (4) that 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) that 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 pre-emptive 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 the relief sought and the basis therefore supported the conclusion that “no reasonable attorney would have believed [the] case had merit.”

The Court of Appeal 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 anti-SLAPP motion.

This opinion is a must read for trade secret litigators and establishes—at least in California—that there is a thin line separating hard ball litigation tactics from litigation that is deemed anti-competitive and which creates substantial risk for both plaintiff and plaintiff’s attorneys.

 

Restrictive Covenants: Better To Ask And Disclose

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When recruiting an executive, or when being recruited, it is best practice for the future employer, the employee and any executive recruiting firm involved in the placement to address head-on the existence of any restrictive covenant limiting the future activities of the employee. The New York State Supreme Court – First Department Appellate Division – yesterday upheld a claim that by not clearly disclosing the existence of a non-solicitation restriction in an executive recruit’s employment agreement, the head hunter involved in the placement could potentially be held liable to the new employer for negligent and/or fraudulent misrepresentation. See Amsterdam Hospitality Group v. Marshall-Alan Associates, Index Number 113685/11 (1st Dep’t Aug. 28, 2014).

Knowing what restrictions are in a recruit’s agreement and obtaining sound legal advice about the enforceability thereof enables all the parties involved in the recruiting process to assess, mitigate and avoid the risks attendant to hiring individuals subject to non-compete or other restrictive covenant provisions. Failing to ask or disclose, on the other hand, can potentially expose everyone involved to claims of breach of contract, tortious interference or worse yet, fraud. “Don’t ask, don’t tell” can be a dangerous policy when recruiting executives with employment agreements containing restrictive covenants.

Guilty Plea Highlights Cost of Complicity in Trade Secrets Theft

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For some time, the media has covered the prosecution of a former Citadel, LLC employee, Yihao Pu, for allegedly stealing Citadel’s trade secrets. The recent guilty plea of another Citadel LLC employee, Sahil Uppal, highlights the potential consequences of complicity in trade secrets theft.

In his plea deal earlier this month, Uppal admitted that he transferred Citadel’s intellectual property (consisting of computer code) to Pu without Citadel’s authorization or approval. Additionally, Uppal admitted that, after he learned that Citadel representatives had confronted Pu about having obtained confidential business information from Citadel, he and a third person removed certain computer equipment from Pu’s apartment to impede the investigation into Pu’s conduct. In the plea deal, Uppal pled guilty to obstruction of justice and faces a maximum sentence of 20 years in prison and a $250,000 fine.

Massachusetts Legislature Fails to Pass Any Proposed Bills on Non-Compete or Trade Secret Law

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For years, I have been writing about the continuing efforts of legislators and others to reform the Massachusetts trade secret and non-compete law (see, e.g., my previous blog posts here and here). In this legislative session, Governor Patrick surprised many by submitting a bill that would, with some exceptions, make non-competes unenforceable in Massachusetts (much like the law in California), in an effort to encourage spin-offs, primarily in the high tech area, to compete more effectively with competitors in other states. There was also an effort for Massachusetts to adapt the Uniform Trade Secrets Act (“UTSA”), a federal law adopted by 48 other states. (Only New York and Massachusetts have not adopted the UTSA). There were also “compromise” bills that sought to codify the non-compete law in Massachusetts in many ways, including: a) banning the use of non-competes for non-exempt workers; b) requiring advance notice and consideration for those who are required to sign a non-compete after starting employment; and c) creating presumptions addressing the reasonableness of the duration of the non-compete obligation and the scope of the activities that would be prohibited.

Although there have been bills introduced in the Massachusetts legislature aimed at reforming the trade secret and non-compete laws in Massachusetts for years without success, I thought that this year, a compromise bill would pass. I was wrong. None of the bills introduced in this year’s Legislative session became law. The reason for my view that there would be some type of compromise bill passed was that many companies and attorneys were attracted to those provisions in the bills that would have given businesses guidance on the enforceability of restrictive covenants they required their employees to sign, as well as on the enforceability of any restrictive covenants that companies might have to comply with upon hiring someone subject to one. Many who blog on this subject, including me, believe that there will continue to be legislation on this subject proposed in the next legislative session.

We will keep you posted.

Bill Introduced in House Would Create Federal Private Right of Action for Trade Secret Theft

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On July 29, 2014, a bipartisan group of members of the U.S. House of Representatives introduced a bill that would create a federal private right of action for trade secret theft. The Trade Secrets Protection Act (H.R. 5233) is a House version of the Senate’s Defend Trade Secrets Act (S. 2267), a bill introduced earlier this year.

As we discussed in a previous blog post, in the last couple of years, numerous legislators in Washington have made efforts to amend the Economic Espionage Act, 18 U.S.C. §1831 et seq. (which currently allows only prosecutors to pursue trade secret thieves), to empower companies and individuals who have been victimized by trade secret misappropriation to pursue their own remedies in federal court. If successful, these efforts would give aggrieved persons a more standard and straightforward path to sue violators than is currently available in the patchwork of state laws dealing with trade secrets.

This most recent bill was introduced by Rep. George Holding (R. N.C.) and co-sponsored by Jerrold Nadler (D. N.Y.), Howard Coble (R. N.C.), Hakeem Jeffries (D. N.Y.), Steve Chabot (R. Ohio), and John Conyers (D. Mich.).

The bill follows the model of the Senate’s Defend Trade Secrets Act, which was introduced on April 29, 2014 and referred to the Judiciary Committee, where it currently remains. The structure of the two bills is similar and many provisions in the bills are identical.

Several industry groups, including the National Association of Manufacturers, BSA/The Software Alliance, and the Information Technology Information Council, immediately came out in support of H.R. 5233.

We will continue to monitor these efforts to expand trade secret protections at the federal level, which now seem to enjoy bipartisan and bicameral, as well as business, support. Whether that support is enough to get the bills through Congressional committees to become law remains very much an open question.

Customer Lists And Pricing Information Not Trade Secrets Under Missouri Law

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Judge Ross of the United States District for the Eastern District of Missouri recently declined to issue a preliminary injunction in a trade secret misappropriation case, holding that a transportation company did not offer sufficient evidence to show that its customer lists and pricing information were trade secrets under Missouri law. Towne Air Freight, LLC v. Double M. Carriers, Inc., Case no. 4:14-CV-750-JAR (E.D. MO June 9, 2014).

In so ruling, Judge Ross quoted from an earlier case which held that “[c]ustomer lists are protectable as trade secrets only when they represent a selective accumulation of information based on past selling experience, or when considerable time and effort have gone into compiling it.” “Information that can be compiled from other, generally available sources such as names, phone numbers and contact persons, is not protectable as trade secrets.”

With respect to the pricing information at issue, Judge Ross noted that it “could be obtained from other generally available sources” and therefore did not qualify as a trade secret.

This case illustrates that while the Uniform Trade Secrets Act can be a powerful tool for protecting confidential information, its sweep is not as broad as is sometimes assumed. Employers may want to consider using contractual restrictions such as confidentiality agreements and post-employment restrictive covenants to further protect confidential and proprietary information. In addition to providing stand-alone legal protections, such contractual restrictions can also help to bolster a claim under the Uniform Trade Secrets Act by showing that the employer undertook reasonable measures to protect the information at issue (one factor that a court will consider when determining trade secret status) in addition to showing that the information is so sensitive that the employer also chose to protect it contractually.

 

“Material Change” Defense To Enforcement Of A Non-Compete In Massachusetts Still Alive And Well, But There Remain Unanswered Questions

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For some time, I have been following the evolution of the “material change” defense to enforcement of a non-compete agreement in Massachusetts. Recently, it has been gaining traction, but there are still unanswered questions.

The doctrine was first introduced in F.A. Bartlett Tree Expert Co. v. Barrington by the Massachusetts Supreme Judicial Court in 1968. However, it was not applied with any consistency by Massachusetts courts until very recently when a number of trial level courts and a Massachusetts Federal District Court held that a restrictive covenant is not enforceable if the employee’s job duties, compensation or employment relationship substantially changed between the time the employee signed the initial non-compete agreement and the time the employee left the company. In short, these courts have refused to issue preliminary injunctions to employers of former employees who have been hired by competitors on the grounds that there was not a likelihood of success on the merits (one of the critical requirements that parties seeking preliminary injunctive relief must demonstrate to the court). Although the Eastern District of New York in Iron Mountain Information Management, Inc. v. Taddeo, applying Massachusetts law, adopted the doctrine in 2006, other states have not embraced the “material change” defense.

Recent Illustrative Massachusetts Cases

In Rent-A-PC, Inc., d/b/a SmartSource Computer & Audio Visuals v. March, decided in May 2013, the U.S. District Court for the District Court of Massachusetts refused to issue a preliminary injunction against three former employees of the plaintiff Smartsource and defendant CCR Solutions, the company that hired them. The Court based its decision on the fact that the defendant employees had experienced “material changes” in their employment relationship from the time they entered into the restrictive covenants that SmartSource sought to enforce. One former employee entered into the restrictive covenants with a company that Smartsource later purchased. His job changed a number of times, first in the inventory department and then in the sales department. A second defendant employee’s duties, authority, and compensation changed significantly even though his job title had not changed. The third employee had not signed a non-compete agreement.

In Intepros, Inc. v. Athy, 31 Mass. L. Rep. 144, 2013 Mass. Super. LEXIS 48, 2013 WL 2181650 (May 5, 2013), the Massachusetts Superior Court relied on the fact that since signing the non-compete agreement, the former employee was promoted, his duties and responsibilities had changed, and his salary had increased several times.

Some Takeaways

1. When there has been a “material change” in an employee’s job or a change in ownership of the business, the employee should sign a new non-compete agreement.
2. Even if the employee is not given a new non-compete to sign under these circumstances, it may be prudent, in any event, to include a clause in the original non-compete that it is enforceable in the event that there are material changes in employee’s job, duties, responsibilities, salary or otherwise in the employee’s relationship with the company.

Unanswered Questions Still Remain

These suggested takeaways are given with the caveat that at present, the highest court of Massachusetts has not answered the following questions:

1. Is the “material change” clause noted above which is included in a non-compete agreement enough to defeat a “material change” defense?”
2. What is the definition of “material?” How much of a change is necessary to be considered “material?”

In light of this relative uncertainty, consideration of various options in each of these cases should be undertaken with advice of counsel.

Conclusion

If the bill recently filed by the Governor of Massachusetts to make non-competes unenforceable passes, these issues may become moot. However, pending the outcome of that bill, we suggest that employers who believe that an employee’s relationship with the company has undergone a “material change” should have the employee sign a new agreement or, at least, should consider inserting a “material change” clause into such agreements.
 

A Mere Peppercorn Can Constitute Consideration? Not always.

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Most lawyers learn during their first year in law school that courts won’t inquire into the adequacy of consideration for a contract and that, as a result, a “mere peppercorn” can constitute consideration. It’s important to remember, though, that in many states, restrictive covenants are an exception to that rule.

The recent decision in the Pennsylvania Superior Court case of Socko v. Mid-Atlantic Systems of CPA, Inc. (2014 PA Super 103) illustrates this principle. The case involved a salesman in the basement waterproofing industry. He signed a noncompete agreement during his at-will employment. Continued at-will employment doesn’t constitute consideration for a noncompete signed under those circumstances under Pennsylvania law. However, the company argued that there was sufficient consideration for the salesman’s non-compete because: a) the Pennsylvania Uniform Written Obligations Act, 33 P.S. 6, provides that “[a] written…promise…shall not be invalid or unenforceable for lack of consideration, if the writing also contains an additional express statement…that the signer intends to be legally bound”; and b) the salesman’s noncompete stated that the parties “intend[ed] to be bound” by its terms.

The court determined that the Act was designed to apply where the adequacy of consideration is not a factor to be considered in determining a contract’s validity or enforceability. The court then observed that restrictive covenants are different than other contracts because the Pennsylvania Supreme Court has held that it is appropriate to inquire about the adequacy of consideration for restrictive covenants. As a result, the court determined that the Act is inapplicable to restrictive covenants, and that the Act could not rectify the lack of consideration for the salesman’s noncompete. The court reiterated that in Pennsylvania, “when the restrictive covenant is added to an existing employment relationship,…to restrict himself the employee must receive a corresponding benefit or a change in job status.”

Federal District Judges In Chicago Are Now Split Over Whether To Follow The Illinois Appellate Court’s Landmark Fifield Decision

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Federal district judges in Chicago are now split over whether to follow the Illinois appellate court’s landmark non-compete decision, Fifield v. Premier Dealer Services, Inc., 373 Ill. Dec. 379, 993 N.E. 2d 938 (Ill. App. 1st Dist. 2013).

In the summer of 2013, long held beliefs about the required consideration for a restrictive covenant under Illinois law were thrown a curve when the Illinois Appellate Court for the First District (i.e., Cook County) held in Fifield 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.

Earlier this year, in Montel Aetnastak, Inc. and Montel Inc. v. Kristine Miessen et al., No 13 C 3801, 2014 U.S. Dist. LEXIS 11889 (N.D. Ill. Jan. 28, 2014), Judge Ruben Castillo, the Chief Judge for the United States District Court for the Northern District of Illinois, declined to follow Fifield, holding that “[g]iven the contradictory holdings of the lower Illinois courts and the lack of a clear direction from the Illinois Supreme Court, this Court does not find it appropriate to apply a bright line rule” regarding what constitutes sufficient consideration for a non-compete. Instead, Judge Castillo chose to employ “the fact-specific approach employed by some Illinois courts.”

Judge Castillo’s immediate predecessor as Chief Judge for the United States District Court for the Northern District of Illinois, James F. Holderman, has now come down exactly the opposite way on this issue, and specifically applied Fifield and specifically rejected Judge Castillo’s holding in Montel. Instant Technology, LLC v. DeFazio et al., No. 12 C 491, 2014 U.S. Dist. LEXIS 61232 (N.D. Ill. May 2, 2014).
We are not aware of any other published federal court decisions or any published Illinois appellate court decisions to address this issue. However, at least two Cook County, Illinois judges have acknowledged and applied Fifield.

We will continue to monitor developments regarding Fifield. In the meantime, Illinois employers hoping to enforce restrictive covenants within two years after the signing date should be prepared to distinguish Fifield factually or legally.
 

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