Inevitable Disclosure: A Theory, Not A Claim

In a recent decision from the Southern District of New York, Judge William H. Pauley III rejected the use of the “inevitable disclosure” doctrine as a basis for an independent claim and outright granted a Rule 12(6)(6) motion to dismiss the complaint brought by a California employer against its former New York based employee.

Janus et Cie v. Andrew Kahnke, 12 Civ. 7201 (WHP) (U.S. District Court, S.D.N.Y., August 29, 2013) is a case brought by Janus, a provider of high-end residential and commercial furnishings, against Andrew Kahnke, a sales manager in one of its showrooms who was subject to a confidentiality agreement without any restrictive covenants. When Kahnke resigned and went to work for a direct competitor, Janus commenced an action for inevitable disclosure of trade secrets, seeking a permanent injunction barring him from disclosing any of Janus’ trade secrets or confidential information and from working for Dedon, his new employer, in any area where they are direct competitors.

Janus does not allege that Kahnke breached the non-disclosure agreement. Nor does Janus assert any facts indicating that Kahnke actually misappropriated or disclosed any of Janus’ trade secrets. Rather, Janus seeks an injunction based on the theory that “Kahnke’ s position with Dedon is so similar . . . that he cannot possibly perform the functions of his position . . . without using and/or disclosing confidential information and trade secrets belonging to Janus.” (Compl. ¶ 28.)

The Court wrote:

Janus makes the extraordinary request that this court be the first to recognize the inevitable disclosure of trade secrets as a stand-alone claim in a complaint bereft of any allegations that Kahnke misappropriated trade secrets or breached a non-compete agreement. In essence, Janus asks this court to allow a lawsuit to proceed to discovery when the Complaint alleges no wrongdoing by Kahnke. But the end game is a permanent injunction that would greatly expand the reaches of a restricted doctrine heavily disfavored under New York law.

After analyzing New York precedent, the Court acknowledged the possible validity of the doctrine of inevitable disclosure, but rejected the notion that it constituted a stand-alone cause of action absent allegations of related unlawful conduct. In granting the motion to dismiss the case, the Court refused “to countenance the imposition of an unlimited, unbargained-for restrictive covenant on Mr. Kahnke based on thread bare allegations.”

When suing a former employee with sensitive confidential information, this case stands for the proposition that you need more than mere inference of potential use or disclosure of such information to withstand a motion to dismiss. Some evidence of wrong-doing rising to level of an actual breach of contract, misappropriation or other tortious conduct will be necessary to plead a sustainable cause of action.
 

Federal Court In Chicago Refuses To Issue Injunction Based Upon Either An "Inevitable Disclosure" Claim Or A 24-Month Non-Compete With An "Extremely Broad" Geographic Scope

Co-authored by Viktoria Lovei.

A federal judge in Chicago recently refused to issue an injunction based upon either the “inevitable disclosure” of trade secrets doctrine or a geographically broad, 24-month non-compete that did not have a narrowly drawn activity restriction. Triumph Packaging Group v. Ward, et al., No. 11-cv-7927 (N.D. Ill. Dec. 2, 2011).

The case was brought by Triumph, a manufacturer of packaging for consumer goods suppliers. It sought, among other things, to enjoin Ward, its former Chief Operating Officer, from assuming a position with AGI, a manufacturer of packaging primarily for the media and entertainment industries.

Triumph argued, among other things, that Ward’s employment with AGI would require him to inevitably use or disclose Triumph’s trade secrets. In evaluating Triumph's claim under the Illinois Trade Secrets Act (“ITSA”), the Court found that Triumph was reasonably likely to succeed in proving the existence of certain trade secrets. However, the Court concluded that Triumph was unlikely to succeed in establishing that the disclosure of such trade secrets by Ward was inevitable because the evidence demonstrated that Ward's role at AGI presented no reasonable danger of him using or disclosing Triumph's trade secrets. Specifically, the Court relied on its findings that: (1) Triumph and AGI were neither “fierce” nor “even direct” competitors because they focused on the manufacture of different types of packaging for mostly different industries and do not currently share any customers; (2) Ward's position at AGI was dissimilar from his position at Triumph in “a variety of ways”; (3) “there is no evidence in the record that Mr. Ward’s new position will require him to use or disclose Triumph’s trade secrets, and he testified credibly that he will not do so”; and (4) Triumph’s trade secrets were not applicable to AGI’s business.

With respect to Ward’s post-employment non-compete, the Court held that it was “extremely overbroad and likely unenforceable.” First, the Court held that it was “extremely broad in geographical scope” because it prohibited Ward “from working with any competitor ‘within any geographical area’ of where Triumph or its subsidiaries engage in business or have plans to engage in business.” Additionally, the Court noted that “the qualifying term ‘within any geographical area’ is unclear and does not provide any degree of certainty as to where Mr. Ward may work without violating the provision.” Second, the Court held that the “duration of the non-compete clause -- 24 months by default and 30 months if Mr. Ward breaches his obligations under the agreement during the prior 24 months – is very lengthy.” The Court agreed with Ward that where “temporal and geographic restrictions on an employee’s conduct are broad . . . the agreement’s activity restrictions should be correspondingly narrowly drawn to protect the employee’s ability to be employed in his chosen field.”

Because the Court found that the non-compete was “significantly overbroad in several ways,” it refused to modify or “blue-pencil” it.

Though not a path breaking decision, this case is nevertheless a reminder about the narrowness of the inevitable disclosure doctrine and the need to draft non-compete clauses as tightly as possible to address a company’s legitimate needs.

Eleventh Circuit Weighs in on Florida Non-Compete Law

Florida law, specifically section 542.335, Florida statutes, generally authorizes courts to enforce non-compete and other post-employment restrictive covenants, provided the agreements are in writing and signed by the employees against whom enforcement is sought, are reasonable in time, area, and line of business, and are supported by one or more legitimate business interests supporting the restrictive covenants.

Section 542.335 is fairly detailed. The statute defines what a reasonable time period is (it depends on the nature of the restrictive covenant), it lists several legitimate business interests, and it even addresses potential defenses. For example, it states that the court "[s]hall not consider any individualized economic or other hardship that might be caused to the person against whom enforcement is sought."

Still, section 542.335 leaves several issues unaddressed, leaving the courts to sort them out. Several of those issues are addressed in a 48 page opinion issued recently by the Eleventh Circuit Court of Appeals in Proudfoot Consulting Co. v. Gordon (11th Cir., July 30, 2009). The Eleventh Circuit affirmed the district court's injunction, but reversed the $1.66 million damages award to the former employer.

Here are some key points to take away from the court's decision:

• Where a non-compete covenant does not contain a geographic limitation, the court can supply a reasonable geographic scope. And where, as here, the employee had been assigned to a territory that included all of North American and Europe, this geographic area is reasonable.

• The court expressed doubt that a broad non-compete agreement that prohibits the former employee from working for a competitor, irrespective of which clients he is serving, would be reasonably necessary to protect an employer's interest in the relationships that the former employee developed with its clients.

• The court also expressed doubt that such a broad non-compete agreement would be reasonably necessary to protect client-specific confidential information, if restrictions that prevent the employee from contacting, or working for, those clients would be sufficient to protect that information.

• On the other hand, the court stated that where an employee has access to confidential business information crucial to the success of the employer's business, the employer has a strong interest in enforcing a covenant not to compete, irrespective of whether the employee improperly retains and uses that information in his new employment. But the court noted that it is unclear under Florida case law precisely when confidential information will justify a broad non-compete covenant. Is it sufficient that the employee be in a position at his new employer to use the former employer's confidential information? Or must the former employer meet the higher burden of proving that disclosure of the confidential information by the employee would be inevitable in the employee's new position? The court declined to answer this question, finding that under the facts of this case, where the employee had actually retained some of his former employer's confidential business information, the potential disclosure of that information to his new employer justified the enforcement of the non-compete covenant.

• It is not necessary that the former employer prove that the employee intentionally breached the restrictive covenants at issue in order to receive injunctive relief. The employee's good faith, reasonable belief that he is not in breach of a restrictive covenant is no defense.

• With respect to damages, the fact that the new employer profits from a breach of its employee's non-compete agreement with his former employer is irrelevant absent a finding that the employee directly caused his former employer to lose profits. "Damages for breach of a non-compete are intended to make the prior employer whole, not to punish employees." Furthermore, "disgorgement of profits earned is not a remedy for breach of contract," especially where the new employer is not even a party to the litigation.
 

Adult Nightclub Seeks Injunctive Relief Against Former Director for Poaching High Revenue Clients and Exotic Dancers

Employers across all sectors of industry rely on narrowly tailored employment agreements to prevent employees from unfairly competing and stealing clients and customers post-employment. Last week, the adult nightclub chain, Penthouse Club, filed a suit seeking a temporary restraining order and other injunctive relief against a former director for violating a noncompete and nondisclosure agreement.

Penthouse claims that after the former director was fired for cause, he became employed at a rival nightclub not far from the Penthouse Club. Such mere employment allegedly directly violated the terms of his noncompete agreement. Penthouse also alleges that he is now using his contacts and intimate knowledge of Penthouse’s customers and employees to bring business to his new employer. As a result of his high-level position, which included access to the club’s VIP room where members pay a $2,500 fee to join and then a $1,000 fee each year, the former director obtained extensive knowledge concerning the real names of members and exotic dancers who worked there. Penthouse is relying on the “inevitable disclosure” theory to assert that it would be inevitable that the former director would use his knowledge of clients and employees to his and his new employer’s competitive advantage.

The agreement that the former director signed in 2004 contained restrictive covenants including a noncompete, nondisclosure, and nonsolicitation provisions. Penthouse is relying on the unique nature of its business, and, in particular, the fact that its exotic dancers and entertainers specifically attract particular customers, in order to establish its legitimate business interests and the competitive disadvantage that the former director’s solicitations could cause to Penthouse.

Penthouse attempted to resolve the dispute informally through a cease and desist letter but ultimately filed suit in federal court in Illinois seeking an injunction and monetary damages in excess of $75,000.
 

New York Court Holds That Familiarity with Software Program, Without Evidence of Knowledge of Program's Source Codes or Imminent Commercial Piracy, Does Not Support Injunction Seeking Enforcement of Restrictive Covenants and Protection of Trade Secrets

In a decision, dated January 26, 2009, in the matter Epiq Systems, Inc. v. Hartie, Index No. 111950/08, the Supreme Court of the State of New York, New York County, by Judicial Hearing Officer (and retired Justice) Ira Gammerman, denied a preliminary injunction in aid of arbitration sought by plaintiffs Epiq Systems, Inc. and related companies (collectively, “Epiq”). Epiq claimed that it faced inevitable disclosure of its trade secrets by three individual defendants formerly employed at Epiq and their new employer Kurtzman Carson Consultants LLC (“KCC”) with respect to three computer programs, including one web-based system, developed and used by Epiq to solicit ballots and tabulate ballot results in Chapter 11 bankruptcy proceedings, and in analogous foreign proceedings, involving widely-held public securities.

Epiq sought to enforce restrictive covenants in its employment agreements, which barred the individual defendants from disclosing Epiq’s confidential, proprietary or trade secret information, competing against Epiq or soliciting Epiq’s customers for one year after termination, and soliciting Epiq’s employees during employment and for one year after termination. After a two-day hearing in September 2008, the Court entered a temporary restraining order specifically limiting, although not prohibiting, the individuals’ employment with KCC.

Although the Court held that any arbitration award to which Epiq might ultimately be entitled apparently would be rendered ineffectual absent preliminary relief, it declined to issue a preliminary injunction against defendants, finding that Epiq had not satisfied any of the elements of the traditional tripartite test for injunctive relief: likelihood of success on the merits, showing of irreparable harm, and balance of equities favoring the movant.

Key findings for the Court were that the individual defendants did not know any part of the source code or the underlying algorithms of Epiq’s programs, even though they had worked at length with Epiq’s programmers, and so they could not disclose such information to KCC. In addition, KCC already had its own software program that allowed KCC to perform bankruptcy-related solicitation and tabulating projects in-house. Moreover, the Court held that even if the defendants would seek to improve KCC’s software, their knowledge brought to bear on such a project would not constitute a trade secret under the definition of trade secret under section 757, comment b, of the Restatement of Torts, which applies under New York law. In finding a lack of irreparable harm, the Court also noted that it had been presented with no real evidence that defendants had committed or were about to commit commercial piracy.

Epiq filed a notice of appeal on February 11, 2009.
 

A New Byte of the "Inevitable Disclosure" Apple

A recent decision of the United States District Court, Southern District of New York, entitled International Business Machines Corporation v. Papermaster, No. 08-CV-9078 (KMK), 2008 WL 4974508, 2008 U.S. Dist. LEXIS 95516 (S.D.N.Y. Nov. 21, 2008), appears to have breathed new life into the “inevitable disclosure” doctrine, apparently easing the burden of proof that an employer must satisfy in order to show the irreparable harm necessary for a court to grant an injunction preventing the former employee from working for a competitor.

Under the inevitable disclosure doctrine, certain employees cannot “wipe clean” their knowledge of their former employers’ trade secrets. Despite such employee’s best efforts to avoid disclosing any trade secrets to the new employer, the employee will inevitably disclose trade secrets to the new employer simply by virtue of the employment, and therefore should be enjoined from working for the new employer for some period of time, even in the absence of any non-compete agreement. The inevitable disclosure doctrine may provide a source of relief against improper competition by former employees even where the employer cannot show actual misuse, or intent to misuse, confidential or trade secret information. PepsiCo, Inc. v. Redmond, 54 F.3d 1262 (7th Cir. 1995).

The recent IBM v. Papermaster decision not only grants injunctive relief to IBM preventing Papermaster’s employment with competitor Apple, Inc. without IBM presenting evidence of actual misappropriation, but bases its finding of irreparable harm largely upon the probability of “inadvertent” disclosure by Papermaster and Papermaster’s acknowledgement in his employment agreement with IBM that IBM would suffer irreparable harm were he to breach the agreement’s non-competition provision. This seems a surprisingly low threshold for applying the inevitable disclosure doctrine to find irreparable harm in the absence of any evidence of misuse or even misappropriation of confidential information and/or trade secrets.

Mark D. Papermaster worked at IBM for 26 years in various product design and development roles, and in 2006 joined an elite group of about 300 top executives that develops IBM’s corporate strategy. Papermaster’s last day of employment with IBM was October 24, 2008, and he began working at Apple on November 3, 2008. IBM sought a preliminary injunction and in its November 21, 2008 decision, the District Court enjoined Papermaster from working for or with Apple until further order of the Court.

The Court held that IBM faced irreparable harm, even though there was no reason to ascribe ill-will to Papermaster or to doubt that he would abide by Apple’s Intellectual Property Agreement, in which he agreed not to use or disclose to Apple any confidential, proprietary or secret information of his previous employers, or otherwise to think that he would misuse or disclose IBM’s trade secrets. The Court’s holding that such disclosure was nonetheless inevitable rested in large part on its conclusion that inadvertent disclosure would probably occur, on the boilerplate provision in Papermaster’s IBM Noncompetition Agreement stating that he agreed that IBM would suffer “irreparable harm” if he worked for a competitor, and on what the Court termed “common sense.”

Having relied on these factors, which may not previously have been sufficient, to find irreparable harm, the Papermaster decision could have the effect of further expanding the application of the inevitable disclosure doctrine. The Papermaster matter was set to go to trial in late February 2009, but the parties reached a settlement by consent order on January 27, 2009 which will allow Papermaster to begin working for Apple on April 24, 2009. Time will tell if other courts follow the lead of the Papermaster decision in applying the inevitable disclosure doctrine.
 
For a recent New York Law Journal column discussing further the inevitable disclosure doctrine and the IBM v. Papermaster decision, click here.