Trading Secrets : Trade Secrets Lawyers & Attorneys : Seyfarth Shaw Law Firm : Computer Fraud, Confidentiality Agreements, Corporate Espionage

By Rebecca Woods

The Oklahoma Supreme Court recenty held that noncompete agreements are reviewable by a court, even if the agreement contains an arbitration clause and there is no claim as to the validity or enforceability of the arbitration clause. The Howard ruling is consistent with prior rulings by the court that evidence a hostility to the U.S. Supreme Court’s broad interpretation of the Federal Arbitration Act (“FAA”). The court also found the non-compete agreement at issue was in such serious violation of Oklahoma’s statutory limitations on non-compete agreements, see Title 15 O.S. 2001 § 219A, that it refused to blue pencil the agreement and struck it in its entirety.

An employer, Nitro-Lift Technologies, LLC (“Nitro-Lift”) sought to enforce against two former employees non-compete agreements that prohibited the former employees from, in relevant part, (1) owning, managing, operating, joining, controlling, participating, being connected with (as an officer, director, employee, consultant, etc.), loaning money to, or selling or leasing equipment to any business or person engaged in the nitrogen generation business in the oil and gas industry in the U.S; (2) canvassing, soliciting, approaching, or enticing away any past or present Nitro-Lift customers or suppliers; and (3) engaging, employing, soliciting, inducing, or attempting to influence any Nitro-Lift officer or employee to terminate their employment. This non-compete was to apply for a period of two years post employment. After Nitro-Lift served the employees with a demand for arbitration for allegedly violating the non-compete, the employees filed a motion for declaratory judgment, seeking a determination that the non-competes were null and void. The trial court held that the arbitration agreement was valid and enforceable and dismissed the employees’ complaint. On appeal, the Oklahoma Supreme Court reversed the dismissal and held that the employees were entitled to permanent relief.

The Howard ruling rebukes the U.S. Supreme Court’s broad application of the FAA and concludes that state courts should determine, in the first instance, whether a contract is valid and enforceable, even if the validity of the arbitration clause is not at issue. Combined with the court’s prior rulings, and with the court’s unwillingness to blue pencil the contract, the Howard ruling also indicates an apparent hostility by the court to arbitration clauses in employment contracts. 

The Howard court quickly dispatched U.S. Supreme court precedent by invoking its own ruling in Bruner v. Timberlane Manor Ltd. Partnership, 2006 OK 90, 155 P.3d 16, which contained an “exhaustive review” of U.S. Supreme Court decisions that “were found not to inhibit our review of the underlying contract’s validity.” Without analysis, the Howard court then broadly declared that “the existence of an arbitration agreement in an employment contract does not prohibit judicial review of the underlying agreement.” At issue in the Bruner decision was whether a nursing home agreement, which required arbitration of all disputes, was enforceable when Oklahoma law had an anti-arbitration statute with respect to claims against nursing homes. The Bruner court concluded that the nursing home contract did not involve interstate commerce and thus, Oklahoma’s anti-arbitration statute for nursing home contracts was not preempted by the FAA. The Howard court engaged in no analysis of interstate commerce. If it had, it would have been difficult to conclude that interstate commerce was not involved, as the multi-state employer at issue also sought to enforce the non-compete across state lines. Nor was there any issue in the Howard case of a direct conflict between state law and the FAA. The issue in Howard was simply whether a non-compete was enforceable under Oklahoma law and whether that determination should be made by a court or an arbitrator. The Howard decision makes clear that, in Oklahoma, the enforceability of a contractual provision is for courts, not arbitrators.

This ruling is directly at odds with the U.S. Supreme Court’s rulings with respect to the broad application of the FAA. For example, in Buckeye Check Cashing, Inc. v. Cardenga, 546 U.S. 440 (2006), the Supreme Court held that a challenge to a check-cashing contract as illegal under various Florida lending and consumer protection laws was improper, and that such challenges, even as to void contracts, should be heard in the first instance by an arbitrator. Id. at 5 (“[U]nless the challenge is to the arbitration clause itself, the issue of the contract’s validity is considered by the arbitrator in the first instance.”) The Supreme Court rejected the Florida Supreme Court’s conclusion that “enforceability of the arbitration agreement should turn on ‘Florida public policy and contract law.’” Id. at 6 (citation omitted). It is difficult to see a ready, and material, distinction between the Cardenga ruling and the Howard facts: in Howard, there was no contest as to the arbitration clause itself, and the employer was merely seeking to enforce a statutorily impermissible (as opposed to illegal) contract.

With respect to the non-compete agreement, it was plainly at odds with Oklahoma law. Oklahoma law provides, in relevant part, that employees “shall be permitted to engage in the same business as that conducted by the former employer or in a similar business as that conducted by the former employer as long as that former employee does not directly solicit the sale of goods [or] services . . . from the established customers of the former employer.” 20 Title O.S. 2001 § 219A. Any provision at odds with this section “shall be void and unenforceable.” The court concluded that Oklahoma allows an employer to bar a former employee from soliciting goods or services from the employer’s established customers only. The court then readily found all three prongs of Nitro-Lift’s non-compete agreement to be in violation of the statute. The court then declined to modify the agreement, characterizing the agreement as “offensive” and concluding that revising the agreement to comply with Oklahoma law would require the court to “decimate its provisions.”

Lessons for employers with contracts to which Oklahoma law applies? (1) Do not rely upon an arbitration clause to avoid litigation of any non-compete agreement; and (2) limit the agreement to the statutory limitations or it may be voided in its entirety.

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In Eastman Chemical Company, v. Alphapet Inc., et al., Civ. Action No. 09-971-LPS-CJB 2011 U.S. Dist. LEXIS 127757 (Dist. DE) (November 4, 2011) (unpublished) Plaintiff Eastman Chemical Company ("Eastman" or "Plaintiff') filed an amended complaint alleging patent infringement, breach of contract and trade secret misappropriation.  Plaintiff alleged that former Eastman employees at the direction of one or more of the Defendants, improperly disclosed Eastman's confidential, proprietary, and trade secret information relating to the manufacture of certain products in violation of a technology license agreement.  Defendants moved to dismiss the trade secret misappropriation claim based on a failure to specifically plead this claim.  

Defendants argued that Plaintiff’s claim for trade secret misappropriation failed to satisfy the pleading standard of Fed. R. Civ. P. 8 in three principal respects.  First, Defendants asserted that the amended complaint failed to identify which of the Defendants allegedly obtained Eastman's trade secrets, and which individuals were involved in the allegedly illicit disclosure and use of that information. Second, Defendants argued that the description of the trade secrets that were allegedly used or disclosed is "so broad as to be meaningless."  Finally, Defendants contended that "Eastman failed to adequately plead that any [particular] defendant actually used or disclosed" any trade secrets.  

For purposes of its analysis, the Magistrate Judge considered case law from other states that have adopted the Uniform Trade Secrets Act to be persuasive authority.  Viewing Plaintiff's misappropriation claim and the associated facts in the light most favorable to Plaintiff, the Magistrate Judge found that Defendants had not shown that this misappropriation claim should be dismissed pursuant to Rule 8.   Having outlined and considered the contours of Plaintiff’s factual allegations, the Magistrate Judge found that Defendants have been given sufficient factual information to provide adequate notice of the plausible grounds for Plaintiff’s misappropriation claim under the Twombly/lqbal standard.
 

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By Paul Freehling

As a result of a recent ruling by the Montana Supreme Court in a case of first impression in that state, an employer there -- as in several other states -- ordinarily will not be permitted to enforce a non-compete provision in an employment agreement where the employer was solely responsible for ending the employment relationship. Significantly, the ruling might be different if the employee misappropriated trade secrets.

Wrigg, a CPA, started working for JCCS in Helena as a staff accountant in 1987 and was promoted to shareholder in 2003. She signed a series of two-year employment agreements each of which contained a provision which had the effect of imposing a monetary penalty if, during the 12 months after termination “for any reason,” she rendered certain professional services to a competitor of JCCS. In May 2009, JCCS informed Wrigg that the agreement which would be expiring June 30, 2009 would not be renewed. After she left JCCS, she was hired by another accounting firm but for significantly less compensation because, allegedly, of that firm’s concerns about the JCCS covenant. She filed a declaratory judgment suit against JCCS, seeking to invalidate the non-compete. JCCS counterclaimed based on the penalty clause and prevailed at trial, but the Montana Supreme Court reversed in all respects. Wrigg v. Junkermier, Clark, Campanella, Stevens, P.C., Case No. DA 11-0147, 2011 MT 290 (Nov. 22, 2011).

In its unsuccessful effort to persuade the Supreme Court to affirm, JCCS cited Dobbins, Deguire & Tucker, P.C. v. Rutherford, MacDonald & Olson, 218 Mont. 392, 394-97, 708 P.2d 577, 578-80 (1985), a decision also involving an accountant. In Dobbins, that court reversed and remanded a lower tribunal’s holding that a non-compete covenant virtually identical to the one in Wrigg was unenforceable. But JCCS’ reliance on Dobbins was misplaced, according to Montana’s highest court in Wrigg, because the trial court in Dobbins did not address the issue of whether the “covenant served a legitimate business interest.” In both cases, the high court stressed that “Montana law strongly disfavors covenants not to compete” but added that it may be enforceable if it does not impose an unreasonable burden on the parties and the public. So, according to Wrigg, all that the Dobbins Court meant was that the trial court needed “to make factual findings as to the covenant’s reasonableness.”     

In Wrigg, by contrast, the Supreme Court said that because JCCS was responsible for Wrigg’s termination, it could not show that its “legitimate business interest” would be furthered by enforcement of the non-compete (according to Wrigg’s appellate brief, the accountants in Dobbins left their employment voluntarily). Therefore, under the circumstances in Wrigg  (involuntary termination) but not necessarily in Dobbins (voluntary), penalizing an accountant for pursuing her livelihood during the 12 months after her employment ended apparently was considered to be an unwarranted punishment. JCCS’ contention that Wrigg repeatedly had consented to the non-compete provision as written -- “termination for any reason” -- did not carry the day.

The Montana Supreme Court asserted in Wrigg that the applicable legal principle where an employee is terminated without cause is that “courts should scrutinize highly a covenant’s enforcement given the involuntary nature of the departure.” Intense scrutiny is required because the employer could have prevented harmful competition “simply by maintaining the employment relationship.” Further, “An employer’s decision to end the employment relationship reveals the employer’s belief that the employee is incapable of generating profits for the employer. It would be disingenuous for an employer to claim that an employee was worthless to the business and simultaneously claim that the employee constituted an existential competitive threat.” The court said that its ruling is supported by decisions from Iowa, New York, Pennsylvania, Tennessee, and the Seventh Circuit Court of Appeals (interpreting Illinois law).

Employers be aware: A non-compete provision in an agreement with an employee who is discharged without cause and who does not misappropriate trade secrets may be unenforceable.

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Throughout 2011, Seyfarth Shaw LLP’s dedicated Trade Secrets, Computer Fraud & Non-Competes practice group hosted a series of CLE webinars that addressed significant issues facing clients today in this important and ever changing area of law. The series consisted of six webinars: Trade Secrets in the Financial Services Industry, The Anatomy of a Trade Secret Audit, Georgia’s New Non-Compete Statute, Managing and Protecting Trade Secrets in the Brave New World of Cloud Computing and Social Media, Choosing the Right IP Protection: Patent, Trade Secret or Both?, and Key Considerations Concerning Trade Secrets and Non-Competes in Business Transactions. As a conclusion to this well-received 2011 webinar series, we have compiled a list of key takeaway points for each of the webinars, which are listed below. For those clients who missed any of the programs in this year’s webinar series, the webinars are available on compact disc upon request and CLE credit is available as discussed below. We are also pleased to announce that Seyfarth Shaw LLP will continue its trade secrets webinar programming in 2012 and has several exciting topics lined up.

Trade Secrets in the Financial Services Industry

The first webinar of the year, Trade Secrets in the Financial Services Industry, was led by Seyfarth attorneys Scott Humphrey and Scott Schaefers.   The financial services industry has unique concerns with respect to trade secret protection. This webinar had a particular focus on a financial institution’s relationship with its FINRA members and also covered practical steps that can be implemented to protect trade secrets and what to do if trade secrets are disclosed.

• Enforcement of restrictive covenants and confidentiality obligations for FINRA and non-FINRA members are different. Although FINRA allows a former employer to initially file an injunction action before both the Court and FINRA, FINRA, not the Court, will ultimately decide whether to enter a permanent injunction and/or whether the former employer is entitled to damages as a result of the former employee’s illegal conduct.
   
• Address restrictive covenant enforcement and trade secret protection before a crisis situation arises. An early understanding of the viability of your restrictive covenants and the steps that you have taken to ensure that your confidential information remains confidential will allow you to successfully and swiftly evaluate your legal options when an emergency arises.
   
• Understand the Protocol for Broker Recruiting’s impact on your restrictive covenant and confidentially requirements. The Protocol significantly limits the use of restrictive covenants and allows departing brokers to take client and account information with them to their new firm.

The Anatomy of a Trade Secret Audit

The second webinar was led by Robert Milligan, Bob Niemann and David Monachino. This webinar dissected what is involved in an audit of your company’s trade secret protections, including, identifying trade secrets and secrecy protections and implementing effective secrecy protections and hiring and termination protocols. The webinar also discussed employing a comprehensive trade secret protection plan, as well as managing and working to protect computer-stored data, including responding to emergency issues related to computer fraud and security breaches.

• The issues relating to all the aspects of trade secrets can be overwhelming to those that deal with it on rare occasions or in emergencies. Having effective checklists are helpful to marshal evidence, evaluate your claims, and be pro-active to pursue litigation and defend against claims.  Ask your Seyfarth Shaw attorney for sample checklists.
   
• Use a forensic computer investigator to assess former employees’ computer activities, including use of email and USB devices to unlawfully transmit company data.  Ensure that you have strong computer usage restrictions that prohibit unauthorized and unpermitted computer activities on your computer network.
   
• Mark your confidential documents confidential and treat them as such, including having company policies requiring that they not be removed from the workplace and that they be returned at time of termination. Also establish clear employee entrance and exit policies to ensure that trade secret information is adequately protected throughout the hiring and termination process.

Georgia’s New Non-Compete Statute

The third webinar of the year, led by Bob Stevens and Erika Birg with guest panelist Kevin Levitas, former member of the Georgia House of Representatives, focused on Georgia’s Revised Restrictive Covenant Act. The webinar addressed the fundamental paradigm shift toward enforcing restrictive covenant agreements in Georgia and addressed the underlying legislation, legislative history that led to the 180 degree change for enforcement of such agreements in Georgia and detailed the significant changes to the law.  

• There has been a fundamental change in Georgia public policy toward enforcement of restrictive covenant agreements, including non-competes and non-solicits.
   
• The Georgia Revised Restrictive Covenant Act addressing restrictive covenants permits courts for the first time to blue pencil or modify agreements entered into after May 10, 2011 to make overbroad agreements enforceable. The old Georgia law still applies to agreements entered into prior to January 1, 2011. Due to arguments over the constitutionality over Georgia’s Restrictive Covenant Act passed in late 2010, the law regarding agreements entered into between January 1, 2011 and May 10, 2011 is still uncertain.
   
• Employers operating in Georgia should have their non-compete agreements evaluated by competent counsel to ensure that they comply with the new Act and provide employers with the greatest protections under Georgia law.  

Managing and Protecting Trade Secrets in the Brave New World of Cloud Computing and Social Media

2011’s fourth trade secrets webinar focused on cloud computing and social media and their impact on trade secret  status and protection efforts. Robert Milligan, Jason Stiehl and Jason Priebe led this highly attended webinar. This webinar discussed a technological overview of cloud computing and social media, “both sides of the coin” look at cloud computing adoption as a business decision, trade secrets and reasonable secrecy measures, key considerations in selecting a cloud provider from a security and trade secrets perspective, effective vendor and employment agreements and policies to protect trade secrets in the cloud, and effective social media policies to protect trade secrets.

• When utilizing cloud computing, generally follow a three-step process: (1) ensure you understand and define your trade secrets internally through a trade secret audit before consider placing such information in the cloud; (2) create necessary barrier/security protocol to protect those secrets; and (3) develop comprehensive and cohesive social media and restrictive covenants/confidentiality policies to avoid disclosure.
   
• Identifying and collecting information to fulfill an organization’s duty to preserve and/or discovery obligations can be tricky in cloud environments. While the information may belong to your company or organization, the underlying software structure belongs to a service provider, and the data may be scattered over multiple locations. It is a good idea to consider potential issues of data control, ownership, and jurisdiction when evaluating a software as a service (SAAS) cloud-based platform solution.
   
• Carefully review the proposed service agreement with the cloud provider and ensure that provider agrees to keep data confidential and has reasonable security measures in place to protect your information; also consider avoiding contractual limitations on provider liability depending upon bargaining power.  If the secrets involved are “bet the company” type information, the cloud may not be the place to store it.

Choosing the Right IP Protection: Patent, Trade Secret or Both?

The fifth webinar, led by Brian Michaelis, Dan Schwartz and Jim McNairy, focused on choosing the best legal tool to protect particular types of intellectual property. The topics discussed in this webinar included a definition of a patent and what information is patentable, defining a trade secret and what information qualifies for trade secret protection, the pros and cons of patent vs. trade secret protection, which types of information/technology may be best protected through both trade secret and patent protection, the impact the new America Invent Act (Patent Reform Legislation) has on the decision to seek patent or trade secret protection.

• There may be “tension” between patent protection and trade secrets; for instance, patents require public disclosure in return for a government granted monopoly whereas trade secret require that the information remain secret throughout its life. Once information is no longer secret or otherwise becomes available, trade secret protection will be lost.
   
• The remedies available under patent laws and trade secret law differ significantly. A patent owner is always entitled to at least a “reasonable royalty” for any infringement. There is no statutory floor of damages such as a “reasonable royalty” for trade secret owners.
   
• Recent changes to the patent laws provide trade secret owners with additional defenses to allegations of patent infringement where the trade secret owner has maintained as a trade secret a later patented method or system.

Key Considerations Concerning Trade Secrets and Non-Competes in Business Transactions

The final webinar of 2011 was led by Todd Hunt, Erik Weibust and Jim McNairy. This webinar included a discussion of which relationships other than employer/employee relationships require trade secret protections, the most significant risks to the trade secret status of your valuable confidential information under the Uniform Trade Secrets Act and best practices for protecting trade secrets in business transactions.

• Broader non-competes are better tolerated in the sale of a business context, but care should be taken to carefully assess your specific facts and applicable law to help ensure that time, place, and subject matter restrictions, if any, are consistent with law in the jurisdiction(s) at issue. Pay special consideration to choice of law and choice of forum issues as they impact enforceability.
   
• Adequately protecting trade secrets and goodwill in business presentations and transactions requires careful planning and forethought. The often large and frequent exchange of information in these contexts requires use of Non-Disclosure/Confidentiality Agreements.
   
• All business relationships are potential threats to trade secret status and opportunities for misappropriation. Given this, it is imperative to identify any trade secrets at issue and proactively assess any aspects of the business relationship or transaction that may present risks of unintended or unauthorized disclosure or use of trade secrets, as well opportunities for bad actors to improperly acquire your trade secret information.

2012 Trade Secrets Webinar Series

Beginning in January 2012, we will begin another series of Trade Secret webinars. The first webinar of 2012, Latest Developments in the Computer Fraud and Abuse Act, Social Media and Privacy, will be held on January 26. To receive an invitation to this webinar or any of our future webinars, please sign up for our Trade Secrets, Computer Fraud & Non-Competes mailing list by clicking here.

For client attorneys licensed in Illinois, New York or California, who are interested in receiving CLE credit for viewing recorded versions of the 2011 webinars, please e-mail CLE@seyfarth.com to request a username and password.

If you have any questions, please contact the Seyfarth Shaw attorney with whom you work or any Trade Secrets, Computer Fraud & Non-Compete attorney on our website (www.seyfarth.com/tradesecrets). 

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By Paul Freehling

A recent Eighth Circuit Court of Appeals decision, extremely favorable to a plaintiff alleging trade secret misappropriation, holds that protection may be accorded to a compilation of information if reasonable efforts were made to keep the compilation secret, where the compilation adds value to the information, regardless of the amount of the information that already was in the public domain. The defendant, who used the compilation after obtaining it from a third party who was not authorized to provide it, was hammered by the court. 

Rolls-Royce developed procedures, approved by the FAA, for repairing and overhauling helicopter engines. The procedures were compiled and disclosed in documents provided to its Authorized Maintenance Centers (AMCs) with, in at least some instances, a proprietary rights legend on the front page. AvidAir, which was not an AMC, acquired the information partly from public sources and partly by a purchase from an AMC that did not have permission to sell it. When AvidAir began using the procedures, Rolls-Royce demanded that AvidAir deliver the compilation documents to Rolls-Royce and cease using them. AvidAir proceeded to file suit in a Missouri federal court seeking a declaratory judgment that the information was not a trade secret and accusing Rolls-Royce of antitrust violations and tortious interference. Rolls-Royce countered with a misappropriation lawsuit in an Indiana federal court. Both Indiana and Missouri have adopted the Uniform Trade Secrets Law. The two cases were consolidated in the Missouri court. 

On cross-motions for summary judgment, the trial court ruled in favor of Rolls-Royce and dismissed AvidAir’s claims. A jury then awarded Rolls-Royce $350,000 in damages. The trial court entered judgment on the jury verdict and awarded permanent injunctive relief to Rolls-Royce. The Eighth Circuit affirmed in all respects. AvidAir Helicopter Supply, Inc. v. Rolls-Royce Corp., No. 10-3444 (8th Cir., Dec. 13, 2011).

AvidAir asserted that the non-public information in the compilations was too trivial to be accorded protection. The appellate court rejected that assertion, stating that a compilation has value if it gives the compiler “a competitive advantage,” even if the compiled information itself is generally available. Contrasting a trade secret with a patented invention, the court said that engineering advances are not a prerequisite to trade secret protection: “Unlike patent law, which predicates protection on novelty and nonobviousness, trade secret laws are meant to govern commercial ethics.” Rolls-Royce’s compilation was a trade secret because (a) it consisted of information with value “independent of older publicly available versions,” and (b) Rolls-Royce made “reasonable efforts to keep it secret.” The court stressed that Rolls-Royce showed that the compilation required “a substantial investment of time, effort, and energy,” and so the fact that others could have duplicated it by legitimate means is not a defense to a misappropriation claim. Indeed, “AvidAir’s repeated [unsuccessful] attempts to secure the [compilation] without Rolls-Royce’s approval belies its claim that the information in the documents was readily ascertainable or not independently valuable.” 

AvidAir maintained that Rolls-Royce did not try very hard to protect the confidentiality of the compilation. The court responded: “Reasonable efforts to maintain secrecy need not be overly extravagant, and absolute secrecy is not required.” Rolls-Royce’s use of a proprietary legend is evidence of Rolls-Royce’s attempt, and its “[m]isplaced trust in a third party who breaches a duty of confidentiality does not necessarily negate efforts to maintain secrecy.”

The lesson of this ground-breaking decision is that one who makes commercial use of even a minimal amount of confidential information, after obtaining it from a source without authority to provide it, runs a risk of incurring the wrath of a court adjudicating a trade secret misappropriation lawsuit (at least in the Eighth Circuit).

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By Robert Milligan

The Ninth Circuit held oral argument on the key United States v. Nosal case yesterday before an en banc panel.

The Court has made the oral argument available on-line.

At stake is whether the government can maintain criminal charges and an employer can maintain a civil cause of action under the Computer Fraud and Abuse Act against an employee who steals company data by "exceeding authorized access" in violation of an employer's computer usage policies.

Ninth Circuit Chief Judge Alex Kozinski repeatedly challenged the Justice Department's position on the scope of the CFAA during the oral argument and questioned why the government should be able to prosecute individuals for providing false information on Facebook, Google, or Match.com in violation of terms of use agreements or using work computers in violation of employer policies.

Ninth Circuit Judge Richard Tallman challenged Nosal's position by questioning why employees should not be held responsible under the CFAA for violating clear and express computer usage policies by stealing company data.

Oral argument revealed that the en banc panel is likely divided on whether to reverse to the Ninth Circuit's April decision which permitted the government to maintain its indictment against the employee for violating the employer's computer usage policies.

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By Molly Joyce

The Idaho Supreme Court, in the case of T.J.T., Inc. v. Mori, 2011 WL 5966870, No. 37805 (Id. Nov. 30, 2011), recently found that a two-year non-compete agreement executed in connection with the sale of a business was enforceable under California law, despite the fact that the seller also became an employee of the purchasing company as a result of the sale. The Idaho high court also remanded the case for consideration of whether the non-compete agreement’s overbroad geographic restriction could be “blue-penciled” to comply with California law.

The case arose out of a 1997 non-compete agreement between plaintiff, T.J.T., and defendant, Mori, executed in connection with the sale of Mori’s tire and axel recycling business, Leg-It Tire Company, Inc., based in California. The agreement prohibited Mori from operating anywhere within 1,000 miles of any facility owned or operated by T.J.T. or Leg-It for two years following the termination of his employment with T.J.T. Although Mori became an employee of T.J.T. as part of the deal, his employment was governed by a separate employment agreement. 

Mori worked for T.J.T. until February 7, 2007. Within weeks of his resignation, Mori began work with a competitor of T.J.T. In June 2007, T.J.T. filed a complaint seeking injunctive relief and a constructive trust based on several claims, including breach of fiduciary duty and breach of contract. The district court denied T.J.T.’s request for injunctive relief and ultimately granted Mori’s motion for summary judgment, finding that the agreement was void under California law. The district court concluded that the agreement was tied to Mori’s employment instead of the sale of his business, and that the durational and geographical scopes of the agreement were too broad. 

The Idaho Supreme Court reversed and remanded the district court’s opinion. First, the court held that the non-compete provision was indeed enforceable. The court recognized that, as a general proposition, California has a strong public policy against non-compete agreements. An exception, however, to this prohibition is in the case of the sale of the goodwill of a business, citing California Business and Professions Code § 16601, the purpose of which “is to permit the purchaser of a business to protect himself or itself against competition from the seller which competition would have the effect of reducing the value of the property right that was acquired.” Citing Monogram Industries, Inc. v. SAR Industries, Inc., 64 Cal. App. 3d 692, 701, 134 Cal. Rptr 714, 720 (Ct. App. 1976). 

Mori argued that the non-compete provision was clearly tied to his employment with T.J.T., and therefore unenforceable. The Idaho Supreme Court disagreed, noting that “California courts have held that a non-competition agreement can be incidentally linked to the seller’s employment agreement with the buying business without offending section 16600 [which prohibits non-compete agreements generally].” Even though Mori’s non-compete agreement referred to Mori’s employment with T.J.T. to determine its duration and enforceability, the court found that such an “incidental” link does not necessarily mean the provision is unenforceable. Instead, the court reasoned that Mori’s employment only came about as part of the larger transaction -- the sale of the business to a competitor -- and was therefore enforceable.

The Idaho Supreme Court also found that non-compete provision’s duration, which was to last for a period “ending two (2) years following Seller’s termination of employment with the Company for any reason,” was not unreasonable. Mori argued that the non-compete was not enforceable beyond six years (his term of employment, which was four years, plus two years). Yet, the court found that because the language of the non-compete agreement was not tied to the employment agreement, it existed independently of the employment agreement and operated pursuant to its own plain terms. Again relying on the language of California Business and Professions Code §16601, which provides that a seller may agree to refrain from competing so long as the buyer carries on a like business, the court found that the agreement was not unreasonable because T.J.T. continued to operate in the same line of business that Mori’s former business (Leg-It) did at the time of the alleged breach.

Finally, the Supreme Court remanded the case to the district court for consideration of whether geographical component of the non-compete, which prohibited Mori from working anywhere within 1,000 miles of any facility owned or operated by T.J.T. could be judicially narrowed, or “blue-penciled,” to comply with California law. The court recognized that the geographical restriction was indeed overbroad under California law as written, but queried whether the provision could be narrowed. The court reasoned that courts construing California agreements have the authority to narrow otherwise enforceable provisions pursuant to the portion of Section 16600 of the California Business and Professions Code that provides that “[e]xcept as provided in this chapter, every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.” The agreement at issue also contained a “Reformation” clause, giving courts the power to reform the agreement to the extent necessary to be enforceable.  The court was careful to note that while California courts refuse to modify the agreements before them, they do have a continuing ability to narrow the scope of an otherwise valid agreement. 

The T.J.T. court concluded that the key factor in determining a covenant’s proper geographic scope is the determination of what area is necessary to protect the goodwill of the sold business from competition by the seller. The Idaho Supreme Court refused to narrow the agreement, finding that the parties demonstrated a genuine issue of material fact as to the scope of Leg-It’s business. It nonetheless remanded the case to the district court to determine the question of fact and whether the agreement could be narrowed within a scope that was reasonably necessary to protect the goodwill of the sold business.

Although this case involves an Idaho court construing California law, T.J.T. serves as a reminder that one should not automatically assume that a California non-compete agreement with certain employees (particularly those selling their interest in a business) is always unenforceable – even if the party seeking to enforce the agreement is the employer or former employer of the defendant. Likewise, just because a California non-compete agreement contains an overbroad restriction, that might not render the entire non-compete agreement unenforceable if it can be narrowed in scope by the court. 

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A recent opinion issued by a U.S. Magistrate Judge for the District of Colorado with respect to a discovery dispute in a trade secret misappropriation case may please defense counsel, but create headaches for plaintiffs’ lawyers, because the Court set harsh pleadings standards that plaintiffs must meet. The Court seems to have been more sympathetic (a) to the defendants’ and the court’s desire to have identification “with reasonable particularity” of the supposedly misappropriated trade secrets, than to (b) the justifiable reluctance of plaintiffs to disclose detailed confidential information.   If the Court's reasoning becomes generally accepted, plaintiffs may decide that some trade secret misappropriation claims are better left unfiled rather than making disclosures with the requisite specificity.

The Court recognized that “the case law does not provide clear guidance” as to the pleading requirements. However, basing her ruling primarily on unreported (plus a few reported) decisions, she held that before the plaintiffs may compel discovery, they must file a complaint that “describe(s) the actual equipment, methods, software or other information” they claim as trade secrets. Plaintiffs’ “general allegations and generic references to products or information are insufficient to satisfy the reasonable particularity standard.” L-3 Communications Corp. v. Jaxon Eng’r’g Maintenance, Inc., Civ. Ac. No. 10-cv-02868-MSK-KMT (D.Colo., Oct. 12, 2011) (emphasis added).

According to the Court, allegations that defendants misappropriated broad categories, such as “customer lists, pricing templates and labor rates, vendor lists, drawings, designs and processes,” are inadequate. Plaintiffs must identify the actual “parts and vendors, the actual methods by which they use their equipment, or the actual software they use to process the generated raw data.” The Court faulted the plaintiffs in the case before her both for inadequate pleading and for not filing, or at least seeking to file, the requisite disclosures of their trade secrets under seal. Accordingly, the Court determined that the plaintiffs were not entitled to compel discovery responses. 

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By Scott Humphrey

Illinois courts have traditionally followed the three pronged rule of reasonableness test when determining whether to enforce a restrictive covenant:

           a.         is the restriction no greater than what is required to protect the
                       legitimate business interest of the employer;

            b.         does the restriction impose undue hardship on the employee;

            c.         is the restriction injurious to the public.

However, on September 23, 2009, the Illinois Fourth District Appellate Court, in Sunbelt Rentals, Inc. v. Ehlers, 394 Ill.App.3d 421, held that a court need not consider the first prong of the rule of reasonableness test, an employer’s legitimate business interest, when determining whether to enforce a restrictive covenant. We previously blogged on this decision. The Sunbelt decision has been widely criticized since its publication and Illinois’ four other Appellate districts have declined to follow it. 

Today, the Illinois Supreme Court effectively reversed, and ended all further discussion on Sunbelt in Reliable Fire Equipment Co., v. Arredondo, 2011 IL 111871 (December 1, 2011).  While writing that it “emphatically disagreed” with the Sunbelt decision, the Illinois Supreme Court scolded the Fourth District Appellate Court for “overlooking or misapprehending” Illinois Supreme Court precedent that calls for a court to consider all three prongs of the rule of reasonableness test, including an employer’s legitimate business interest, when determining whether to enforce a restrictive covenant.   

The Reliable Fire decision also resolves another dispute that has been raging in the Illinois Appellate Courts for sometime; what is the proper test for assessing whether an employer has a business interest worthy of restrictive covenant enforcement/protection. Some Illinois Appellate courts have ruled that only “trade secrets” and “near permanent customer relationships” establish a legitimate business interest. Other Illinois Appellate courts have taken a more flexible approach, and look at the following seven factors when assessing whether an employer has a legitimate business interest:

1)         the number of years required to develop the customer;

2)         the amount of money invested to acquire customers;

3)         the degree of difficulty in acquiring customers;

4)         the extent of personal customer contact by the employer;

5)         the extent of the employer’s knowledge of its customers;

6)         the duration of customer association with the employer; and

 7)         the intent to retain employer-customer relations.

In Reliable Fire, the Illinois Supreme Court sides with the more flexible approach. Specifically, the Illinois Supreme Court informs its lower courts that only considering whether an employer has trade secrets and/or near permanent customer relationships is insufficient when assessing a legitimate business interest. Rather, Illinois Courts are to consider “the totality of the facts and circumstances of the individual case” when assessing whether a “legitimate business interest exists.” The “totality of the facts and circumstances” can include, but is not limited to, an evaluation of near permanent customer relationships, the former employee’s access to confidential information, the seven factors identified above, and/or anything else found in the common law. Moreover, the Reliable Fire decision declines to place any weight on the possible “facts and circumstances” that could create a legitimate business interest because “the same identical contract and restraints may be reasonable and valid under one set of circumstances, and unreasonable and invalid under another set of circumstances.” 

Thus, Reliable Fire appears to expand what an employer can state/argue is a legitimate business interest, and gives the trial court significant discretion when deciding what factors establish a legitimate business interest and whether to enforce a restrictive covenant. We will continue to monitor Illinois courts to see if the Reliable Fire holding leads to any changes in how trial courts assess and enforce restrictive coventants.

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