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

By Kate Perrelli and Erik Weibust

On October 7, 2009, the Massachusetts Legislature’s Joint Committee on Labor and Workforce Development held a hearing on a non-compete bill, House No. 1799, sponsored by Representatives Will Brownsberger and Lori Ehrlich. Representatives Brownsberger and Ehrlich had each previously sponsored their own independent bills – Brownsberger’s based on California’s statute that bans non-compete agreements altogether, and Ehrlich’s based on Oregon’s statute that permits non-compete agreements with certain restrictions. The two Representatives have spent a considerable amount of time and energy over the past few months crafting a compromise bill, relying on input from proponents and opponents of non-compete agreements, including industry leaders, employees, trade associations, and attorneys. Several of these people testified before the committee about the need for predictability in the area of restrictive covenants -- for both employers and employees -- and the need to balance the interest of employer’s in protecting their confidential information, trade secrets, and goodwill, with those of employees in being able to switch jobs freely. Although this compromise bill in some respects codifies Massachusetts common law, there are four provisions in particular that warrant further review and refinement:

• The bill prohibits enforcement of non-compete agreements against employees who make less than $75,000 per year. One concern with this provision is that start-up companies often pay their employees lower salaries until they are able to obtain greater financing, yet provide them with as much, if not more, confidential information and trade secrets than higher paid employees at other companies. The bill ignores this scenario. In addition, there is no method in the bill for determining whether companies that pay hourly wages to their employees, such as staffing agencies, are subject to the law, as it is difficult to determine whether an employee will make more than $75,000 in a given year when they begin their employment, which is when they would be required to execute a non-compete agreement. The bill makes no exception or accommodation for these types of companies or others that would be adversely impacted by the $75,000 minimum.
   
• The bill limits non-compete agreements to one year, with the exception of a garden leave clause provision, pursuant to which the employer would pay the employee to sit on the sidelines for the term of the restriction. Courts in the Commonwealth often enforce as reasonable two-year non-compete agreements, and in some limited instances, for longer. A one year limitation may be insufficient in many situations. 
   
• Attorneys’ fees are mandatory for successful defendant-employees, yet they are merely permissive for successful plaintiff-employers, and are to be awarded only in the latter situation if the employer can show that the employee acted with bad faith, a very subjective standard. Moreover, an employee also receives attorneys’ fees if he or she files a declaratory judgment action challenging his or her non-compete agreement, provided that two days before doing so, the employee provides the former employer with specific measures that the employee would take to protect the employer’s confidential business interests, which measures are substantially adopted by a court as part of a hearing on preliminary injunctive relief. Again, this provision may place undue pressure on a start-up to accept an employee’s proposal to avoid incurring legal fees.   
   
• The bill rejects the inevitable disclosure doctrine, under which it is presumed that an employee who had access to a significant amount of confidential information and trade secrets will disclose that information, even if unintentionally, to his or her new employer. This doctrine plays the important role of acting as a backstop to non-compete agreements, or as the only protection where no non-compete agreement is executed, and is necessary to further protect employers against disclosure by such employees. Complete obliteration of this doctrine will affect certain industries more dramatically than others.

Kudos to the legislators, and the group that they enlisted to fashion this compromise bill.  Massachusetts has stepped back, at least for the time being, from the precipice of following California’s legislature’s path in banning non-competes altogether, and instead, has taken a big step forward to provide more clarity to a very complex, fact-specific area of Massachusetts law. There are steps left to be taken, but the current debate is healthy and productive.

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Katherine (Kate) Perrelli (a Seyfarth Shaw partner in Boston) recently published an op-ed, “Is Banning Non-Competes the Answer for Massachusetts?" in the September 21, 2009 issue of Massachusetts Lawyers Weekly. In her article, Kate discusses two bills addressing non-competition agreements that are currently pending in the Massachusetts legislature; one bill would enforce reasonably tailored non-competes, while the other would ban them altogether.  A full copy of the article is available here. Kate outlines the supporting arguments of both critics and proponents of non-competition agreements. She explains that those criticizing non-competes claim that restrictive covenants limit employee mobility and industry innovation and should be banned altogether. Proponents of non-competes argue that banning them will hurt employers by negatively impacting employer research productivity and the employer’s ability to protect intellectual property. Kate contends that “reasonable and narrowly tailored non-competes, combined with non-solicitation and non-disclosure agreements, best balance the freedom and interests of the employee against the employer’s interest in protecting intellectual capital.” Kate notes that “while encouraging the free flow of employees and ideas in our economy is appealing, the Legislature should listen carefully to Massachusetts’ business leaders and examine relevant research closely before embracing an all outright ban. Such action may in the end have harmful effects on startups, current employers and the Massachusetts’ economy generally.” She further notes that “banning non-competes in Massachusetts would be a dramatic sea change for companies currently and considering, doing business here.”  A copy of joint proposed legislation is available here.  A hearing is scheduled for tomorrow, October 7, 2009, where debate will be heard on the competing bills.

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The Massachusetts House of Representatives has before it two competing bills relating to non-competition clauses to consider this Spring.  Representative Lori Erlich has sponsored House Bill No. 1799, which sets forth the standards by which a non-compete provision could be measured for enforceability.  The proposed statute includes (i) a ban on non-competes all together for any employee earning less than $100,000 in compensation, (ii) a mandate that any non-competition agreement entered into after employment must be based on consideration other than continued employment (presumably cash, although it is unclear), and (iii) the requirement that the employer must give the employee at least two weeks' notice of the agreement before it can become effective. 

In addition, and this is perhaps the most rigorous demand -- a non-compete agreement may be enforceable only if the the employer pays to the employee "for the full restricted period and without offset for any income the employee may receive from other noncompetitive activities, a minimum of the greater of:  (1) compensation equal to fifty percent of the employee's annual gross base salary and commissions at the time of the employee's termination or (2) $100,000." The proposed statute does not affect employee or customer non-solicitation agreements and expressly excludes the rights of companies to act to protect trade secrets and confidential information from misappropriation by way of an injunction. 

The other statute, House Bill No. 1794 submitted by Representative Will Brownsberger, proposes to ban non-compete and non-solicitation agreements in their entirety.  This bill reportedly is gaining support by those who believe that Massachusetts high-tech corridor has not been competitive with California's Silicon Valley because Massachusetts allows non-compete provisions and California does not.  

Although both statutes apply only prospectively by their terms, if either is passed, they clearly would affect all future contracts with employees governed by Massachusetts' law. 

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Massachusetts Rule of Professional Conduct 5.6 prohibits non-competition agreements for attorneys, and provides in part: “A lawyer shall not participate in offering or making . . . a partnership or employment agreement that restricts the right of a lawyer to practice after termination of the relationship, except an agreement concerning benefits upon retirement. . . .” The Massachusetts Supreme Judicial Court recently held that a law partnership agreement imposing financial consequences on all partners voluntarily withdrawing from the partnership, whether they compete with their prior firm or not, does not violate this rule.

In the case of Pierce & others v. Morrison Mahoney, LLP, the Supreme Judicial Court evaluated claims of former Morrison Mahoney partners that their partnership agreement’s amended separation clause violated Rule 5.6 because it provided that partners voluntarily leaving the partnership forfeited certain financial benefits if they departed before having served for 20 years as a partner or after having attained the age of sixty. Originally, the clause had restricted the financial benefits to partners who did not compete with the firm, but the Supreme Judicial Court held in a prior case concerning the same law firm that such a non-competitive restriction was against the public policy in favor of allowing clients to retain an attorney of their choosing and thus violated Rule 5.6. The firm revised the clause in response to the prior case.

Despite this revision, several partners who had left the firm challenged it as violating Rule 5.6, in that it worked a de facto constraint on competition. The Supreme Judicial Court, however, rejected that argument, noting that the revised policy did not provide any disincentive in taking a particular client. That the law firm had created an appropriate incentive for its partners to stay with the firm until they turned 60 or had been partners for 20 years did not violate public policy, according to the Supreme Judicial Court, and it rejected the claims of the former partners.

This case demonstrates that although attorney non-competition agreements remain against public policy, the purpose of that policy is to promote unfettered client access to attorneys, not, as the Supreme Judicial Court put it, to “protect lawyer mobility.” Law firms employing similar restrictions should take care that they are applied across the board to all partners leaving the firm, not just ones that compete with it. In that manner, incentive programs like the one employed by Morrison Mahoney will survive judicial scrutiny, at least in Massachusetts.

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