Trade Secrets & Noncompete Blog

Trade Secrets & Noncompete Blog

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

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.

House Passes Federal Trade Secrets Bill

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After years of stops and starts in Congressional efforts to pass a law creating a federal claim for misappropriation of trade secrets that can be pursued by private citizens and companies (as opposed to federal prosecutors), the last few weeks have produced an astonishing acceleration of those efforts.  This month, the Defend Trade Secrets Act has been approved by both houses of Congress in resounding fashion.  It is on the brink of being enacted into law.

On April 27, 2016, the House of Representatives voted 410-2 to pass the Defend Trade Secrets Act.  That vote came quickly on the heels of the April 20, 2016 approval of the bill by the House Judiciary Committee, where the bill had languished since July 2015.  The Judiciary Committee finally took action on the bill after the Senate voted unanimously by a tally of 87-0 to approve the bill on April 4, 2016.

The bill will soon be sent to President Obama for signature, and his administration has previously stated that it strongly supports it. The law is designed to go into effect on the day it is enacted and apply to any misappropriation that occurs thereafter.

For further discussion of the efforts to make a federal private right of action for trade secret misappropriation a reality, as well as discussion of some of its significant provisions, see our recent blog posts, and also Epstein Becker Green’s Take 5 article Will There Finally Be a Federal Private Right of Action for Trade Secret Misappropriation?

Are Courts Still Willing to “Blue Pencil” Overbroad Restrictive Covenants to Make Them Enforceable?

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Restrictive covenant agreements are traditionally governed by state law and thus subject to various jurisdictions’ rules regarding enforceability. They stand on a different footing than most other contracts, in that their enforcement is typically susceptible to a court’s equitable powers, and may not always be enforced as written, if at all. States differ on whether their courts will deny enforcement of a restrictive covenant deemed overbroad as written by the parties or instead modify it to meet the particular state’s standards of enforceability. In those states where such modification is authorized, a court may strike out (or “blue pencil”) certain terms of the covenant and, in a few states, even insert or modify provisions as deemed necessary to validate the covenant (known as “equitable reformation”).

Recent Court Decisions Involving Blue-Penciling

New York courts had traditionally been receptive to blue-penciling an overbroad restrictive covenant. However, in a recent case, the Court of Appeals (New York State’s highest court) emphasized that under New York law, restrictive covenants will not be blue-penciled if there is “coercive use of dominant bargaining power” to achieve their formation.[1]

In Brown & Brown, the Court of Appeals remarked that because the employee was unemployed at the time that she signed the covenant, there were questions over whether that “caused her to feel pressure to sign the agreement rather than risk being unemployed.”[2] The Court of Appeals further noted that a “case-specific analysis” is necessary to determine these surrounding circumstances and found factual issues precluding summary judgment there.

In January 2016, Brown & Brown was applied when a New York Supreme Court, in Aqualife Inc. v. Leibzon, found such unequal bargaining power in the creation of an overbroad restrictive covenant and refused to blue-pencil it, granting instead defendants’ motion to dismiss.[3]

New York is not alone in its judicial philosophy regarding the blue-pencil doctrine. In late October 2015, an Illinois Appellate Court refused to judicially modify overbroad restrictive covenants because the court deemed their deficiencies “too great to permit modification.”[4] Even though that agreement contained a clause allowing for judicial modification, the court refused to do so, explaining that “[i]n determining whether modification is appropriate, the fairness of the restraints contained in the contract is a key consideration.”[5]

At least one other state has taken a dim view lately of a non-compete agreement in which the parties agreed to allow a court to modify any provision deemed overbroad. In Beverage Sys. of the Carolinas, LLC v. Associated Bev. Repair, LLC, the Supreme Court of North Carolina recently refused to modify an overbroad agreement, notwithstanding the agreement containing a clause empowering the court to rewrite the offending provisions.[6] The court determined that such a clause was in violation of the state’s “strict blue-pencil” doctrine, which only allowed for provisions to be stricken and did not allow for any equitable reformation.[7]

While there appears to be a growing hesitancy among courts to blue-pencil or equitably reform agreements that may be overbroad, some recent decisions show that there is still a place for the practice. In Turnell v. CentiMark Corp., the U.S. Court of Appeals for the Seventh Circuit recently applied Pennsylvania law to modify an overly broad agreement.[8] Similar to New York law, the Seventh Circuit initially noted that where “the restrictions are so ‘gratuitous[ly]’ overbroad that they ‘indicate[] an intent to oppress the employee and/or to foster a monopoly,’ a court of equity may refuse to enforce the covenant at all.”[9] But generally, “absent bad faith, Pennsylvania courts do attempt to blue-pencil covenants before refusing enforcement altogether.”[10]

What Employers Should Do Now

  1. As has always been the case, look at the provisions within your restrictive covenants to ensure that they are tied to protecting a legitimate business interest and that their scope is narrowly tailored such that they would not be viewed as oppressive or overreaching.
  2. Consider the interaction between the forum selection clause, the choice-of-law provision, and the covenant itself in terms of what state law might apply to any potential blue-penciling or equitable reformation.
  3. In states that allow for equitable reformation, make sure that the agreement itself indicates that it can be modified by a court.

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

[1] Brown & Brown Inc. v. Johnson, 25 N.Y.3d 364, 371 (2015).

[2] Id. at 372.

[3] Aqualife Inc. v. Leibzon, 2016 N.Y. Misc. LEXIS 6, 2016 NY Slip Op 50002(U), 1, 50 Misc. 3d 1206(A) (N.Y. Sup. Ct. Jan. 5, 2016).

[4] AssuredPartners Inc. v. Schmitt, 2015 IL App. (1st) 141863 (Ill. App. 2015).

[5] Id. at ¶ 51.

[6] Beverage Sys. of the Carolinas, LLC v. Associated Bev. Repair, LLC, 2016 N.C. LEXIS 177, *6 (N.C. Mar. 18, 2016).

[7] Id. at *17.

[8] Turnell v. CentiMark Corp., 796 F. 3d 656, 664 (7th Cir. 2015).

[9] Id. at 663 (citations omitted).

[10] Id.

Treasury Department Calls for Transparency in Non-Competes – Employment Law This Week

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Featured on Employment Law This Week: Non-competes are coming under the microscope of the U.S. Treasury.

A recent report from the Treasury calls for more transparency in non-compete agreements and better communication around their use. Approximately 18 percent of the workforce is subject to these restrictive covenants, and there is increasing scrutiny around them on both the state and federal levels. A recent Utah statute restricts non-competes to no more than one year, while Oregon and Alabama recently tightened their statutory restrictions.

View the episode below or read more about this story in a previous blog post.

Utah Restricts Post-Employment Restrictions

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James P. Flynn

James P. Flynn

The State of Utah recently enacted Utah Code Annotated 34-51-101 et seq., the so-called Post-Employment Restrictions Amendments, which limit restrictive covenants entered into on or after May 10, 2016 to a one-year time period from termination. Although this could curtail certain employers’ plans, the amendments enacted provide some important exceptions and are in fact much more favorable to employers than those first proposed, which would have precluded virtually all post-employment restrictions in Utah. The statute and the exceptions and limitations are discussed below.

The statute as written declares a non-conforming “post-employment restrictive covenant” is “void.” Because Utah courts have not specifically adopted the “blue-pencil approach,” and any approach to reformation is unclear from case law or unresolved, the implications of the statute are unclear. Will voiding the “post-employment restrictive covenant” void the entire agreement of which it is a part, or just the post employment restrictions? Such questions remain to be answered.

The new law does have several important exceptions. It does not apply to (1) a “reasonable severance agreement,” (2) any restrictive covenants stemming from the sale of a business, (3) non-solicitation agreements, (4) nondisclosure agreements, and (5) confidentiality agreements. Perhaps most importantly, it is not retroactive. Of course, whether or not the statute will apply to an amendment to a pre-existing non-compete with a restricted period greater than one year remains to be seen.

Additionally, the statute’s exceptions must themselves be examined and applied with care. For example with respect to severance agreements, the statute will only allow enforceable post-employment restrictions “mutually and freely agreed upon in good faith at or after the time of termination.” Thus, employees may argue that the very use of a form restriction weighs against enforceability. Utah employers will need to carefully consider how to approach these issues, and to make any updates or changes to existing agreements before May 10, 2016.

Finally, and perhaps of most practical importance, Section 34-51-301 of the statute allows employees to recover attorneys’ fees where a post-employment restriction is found unenforceable:

If an employer seeks to enforce a post-employment restrictive covenant through arbitration or by filing a civil action and it is determined that the post-employment restrictive covenant is unenforceable, the employer is liable for the employee’s:
(1) costs associated with arbitration;
(2) attorney fees and court costs; and
(3) actual damages.

This provision could have a practical impact on the risk calculus associated with pursuing enforcement of restrictive covenants. Just another consideration among the many that are occasioned by this new statute.

Jurisdiction to Pursue Non-Compete Claims in the Age of Remote Employees

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Matthew Savage Aibel

Matthew Aibel

Anthony J. Laura

Anthony Laura

With remote access technology becoming standard across industries, companies readily engage a multi-state workforce, with many employees residing outside of the employer’s home state.  While an expanded access to talent may be beneficial, one drawback is the ability to enforce restrictive covenants with out of state employees in a consistent manner and in the employer’s home state.  The case of Numeric Analytics, LLC v. McCabe, et al., offers insight into that issue. 2:16-cv-00051-GAM (E.D. Pa. 2/9/16).

Background

Numeric Analytics, a web analytics and marketing consulting company based in Pennsylvania, engaged employees working remotely in various states across the country.  Its President left the company to start a competing business and in the process, recruited four other employees to join her.  All the employees worked remotely in other states and had signed offer letters that included Non-Solicitation Agreements.  Those agreements provided that Pennsylvania law controlled, but lacked any forum-selection provision.  Numeric brought suit in Pennsylvania against its former employees seeking to enforce the Non-Solicitation Agreements and alleging various tort claims as well.

Jurisdiction Analysis

After noting that it did not have general jurisdiction over the non-resident defendants, the court proceeded with a specific jurisdiction analysis.  Numeric alleged that the employees directed their activities to Pennsylvania because they “signed employment contracts with a Pennsylvania company, continuously communicated with a Pennsylvania company about their employment, ran all invoices for the work they performed through Pennsylvania, and were paid by their Pennsylvania employer.” (Id. at 6-7).  Additionally, Numeric presented evidence that the employees needed to contact the Pennsylvania office to resolve payroll, benefits, or other problems throughout the course of their employment; that medical coverage, medical benefits, and retirement plans were administered from Pennsylvania; that each employee’s timekeeping, billing of customers, and email were managed by the Pennsylvania office; and that Numeric paid Defendants’ salaries using a Pennsylvania bank. (Id. at 7).

The court held that all of those factors “are characteristic of a traditional employer-employee relationship, except for location.” (Id.).  The court decided that the claim for breach of the restrictive covenant arose out of and related to the Defendants’ contract, and that exercising specific jurisdiction over them with respect to that claim was fair and reasonable given the circumstances.  The court remarked, however, that the lack of a forum selection clause in the contract made this a much more difficult issue, and that such a clause “would be the preferred method of resolving such ambiguity.” (Id. at 8).  The court declined to exercise specific jurisdiction with respect to all of the tort claims (except for the fiduciary duty and tortious interference claims against the former president), finding that the tortious conduct on those claims was not directed at the forum nor caused sufficient injury in the forum in a manner sufficient to support specific jurisdiction.

Takeaways

As the court sums up: “[I]n a business with its operations and personnel widely distributed across state or even national boundaries, questions of jurisdiction can become significantly more complicated.” (Id. at 2).  One obvious solution to this problem is to have a forum selection clause in all employment agreements, especially those with out-of-state employees.  Such a provision will usually control the analysis and enable a company to seek to enforce the agreements in its preferred locale.   This case should serve as a cautionary tale for employers with remote employees and should remind all legal and human resource departments to check on the contracts they currently have with remote employees to ensure they contain forum selection clauses.

Gillette Denied Injunction of Former In-House Counsel – Employment Law This Week

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A featured story on Employment Law This Week is a Massachusetts court’s ruling that former counsel is not barred from giving advice to a competitor.

An in-house lawyer for Gillette left the company 10 years ago. Four years later, he became General Counsel for Shavelogic, a Gillette competitor. Gillette recently tried to obtain a broad injunction against the lawyer, who they claimed would inevitably disclose trade secrets in his position. The Massachusetts Superior Court’s Business Litigation Session ruled that there was insufficient evidence that trade secrets would be revealed, and any knowledge the counsel had of patents was likely outdated or general knowledge.

View the episode below or read more on this topic in an earlier post on this blog.

Proposed Legislation to Place Limits on the Enforcement of Non-Competes in Massachusetts

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Barry A. Guryan

Barry A. Guryan

The Speaker of the Massachusetts House of Representatives, Robert DeLeo, announced last week that he will introduce a compromise bill this session to place limits on the enforcement of non-competes in Massachusetts.

The Speaker’s stated motive is to find a balance between the goal of protecting businesses in Massachusetts and fostering a business environment that encourages the incubation for talent. The proposed bill would place a 12-month limit on non-compete agreements, require prior notice to workers, and ban non-competes for low wage workers.

We have been following previous attempts over the years to limit or make non-competes unenforceable in Massachusetts.  For example, several bills proposed two years ago, including a compromise bill to limit the enforcement of non-competes to 6 months and another one filed by the former Governor to ban the enforcement of non-competes, failed to pass the Legislature.  See our previous blog post “Massachusetts Legislature Fails to Pass Any Proposed Bills on Non-Compete or Trade Secret Law,” which discussed these bills.

Some say the proposed bill does not go far enough. Like the prior ones, this one should generate lively debate.

We will continue to keep you posted.

Applying the Employee Choice Doctrine: Focusing on Forfeiture to Protect Company Assets

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Our colleagues Lauri F. Rasnick and Adriana S. Kosovych, attorneys in the Employment, Labor & Workforce Management practice at Epstein Becker Green, have a post on the Financial Services Employment Law blog that will be of interest to many of our readers: “Implementing and Applying the Employee Choice Doctrine: Employers Focus on Forfeiture to Protect Their Company’s Assets.”

Following is an excerpt:

Employers seeking to protect their competitive advantage and find an alternative method of influencing employees to not compete are increasingly relying on so-called “forfeiture for competition” agreements in place of traditional non-competes. This trend is driven, in large part, by the “employee choice” doctrine. In states that have adopted the employee choice doctrine, such as New York, a post-employment non-compete will not be subject to the usual reasonableness standard when it is contingent upon an employee’s choice between receiving and retaining a benefit (e.g., restricted stock, stock options, or some other deferred compensation) and competing.

Read the full post here.

 

Massachusetts Court Denies Gillette’s Motion to Enjoin Former in House Counsel Who Became General Counsel of Competitor

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Barry A. Guryan

Barry A. Guryan

In a recent case decided by the Massachusetts Superior Court’s Business Litigation Session (which typically handles restrictive covenant cases), Gillette lost its attempt to obtain a broad injunction against a former in-house counsel who became the General Counsel at a competitor, Shavelogic.  In THE GILLETTE COMPANY v. CRAIG PROVOST, ET AL., Civil Action No. 15-0149 BLS 2 (Dec. 22, 2015), the Court found Gillette unlikely to succeed on its claims that  the General Counsel, who left Gillette ten years earlier and joined Shavelogic six years ago, must have inevitably disclosed Gillette’s trade secrets to Shavelogic and that he otherwise breached his fiduciary duty to Gillette.

The former employee had a non-compete with Gillette which is unusual since non-competes are not enforceable against lawyers in Massachusetts.  The Court did not rely on this, but noted that the non-compete had long expired.

Gillette’s claims focused on the lawyer’s ethical duty not to represent his new “client,” Shavelogic, in matters “substantially related” to those on which he worked at Gillette, specifically on technology relating to the development of a wet shaver.  Gillette also argued that due to the nature of the General Counsel’s responsibilities, he would inevitably draw upon and disclose to his new employer confidential information that he obtained during his tenure at Gillette.

On the facts presented, the Court determined there was insufficient evidence presented that the General Counsel had given any advice on any work relating to the Gillette patents or even that he worked on any of those patents at Gillette.   The Court further noted that many of the patents and the 10-year old technology were outdated and already publicly available. The Court also refused to apply the legal theory of “inevitable disclosure of trade secrets” (i.e., that the General Counsel would inevitably disclose Gillette’s trade secrets in his new position), stating that “Massachusetts courts have not embraced the doctrine of inevitable disclosure, since it has the potential for severely curtailing one’s employment opportunities.”

This case is a noteworthy reminder that “time is of the essence” in restrictive covenant and trade secret litigation.  Gillette brought this action about 10 years after the former in-house counsel had left Gillette and over three years after he became Shavelogic’s General Counsel.  In addition to other flaws with Gillette’s request for injunctive relief, this delay in acting was fatal.

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