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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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 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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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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By Marcus Mintz

Earlier this month, the Virginia Supreme Court issued an opinion in which it clarified the burdens an employer must meet to enforce a non-compete against a former employee. Specifically, that the employer must demonstrate that the non-compete is no broader than necessary to protect the employer’s “legitimate business interests” and does not “unduly burden” the ex-employee’s right to earn a living. Home Paramount Pest Control Cos., Inc. v. Shaffer, No. 101837, 2011 WL 5248212 (Va. Nov. 4, 2011). In doing so, the Virginia Supreme Court overruled a 1989 opinion in which it upheld the exact same non-compete brought by the plaintiff’s predecessor-in-interest. See Paramount Termite Control Co. v. Rector, 238 Va. 171, 380 S.E.2d 922 (1989). While a dissenting justice took issue with the court’s departure from its prior decision and the effect it may have on parties looking to rely on established precedent, the majority held that its 1989 opinion was effectively eroded over time and its current holding reflected the current state of the law.

The case itself focused on the “function,” or activity, restrictions within the non-compete which the plaintiff, Home Paramount Pest Control Companies, Inc. (“Pest Control”), sought to enforce against its former employee, Justin Shaffer (“Shaffer”). Pest Control claimed that Shaffer’s new employment with a direct competitor violated his non-compete. The specific language at issue prohibited Shaffer from “engage[ing] directly or indirectly or concern himself/herself in any manner whatsoever in the carrying on or conducting the business of exterminating, pest control, termite control and/or fumigation services as an owner, agent … stockholder” for two years in any area in which the employee worked on behalf of Pest Control. However, the case never went to the merits because the circuit court held that the activity restriction of the non-compete was overbroad on its face and consequently, was unenforceable.

Upon appeal, the Virginia Supreme Court affirmed the circuit court and held that the function restriction was facially over-broad because it could prevent Shaffer from performing any duties at a competitor, irrespective of whether such duties were similar to the duties Shaffer held at Pest Control or would have any effect on Pest Control’s legitimate business interests. For example, the court noted that on its face, the non-compete prohibits Shaffer from owning stock in a publicly-traded company which owned a pest control business and Pest Control was not found to have a legitimate business purpose “in such a sweeping prohibition.” After comparing the instant restrictions to non-competes which were upheld in several recent cases, the court affirmed the circuit court’s ruling that Pest Control failed to prove that its chosen language furthered its legitimate business interests and did not unduly burden Shaffer’s right to earn a living.

Ultimately, employers seeking to enforce a non-compete under Virginia law (as well as many other jurisdictions) must take care to utilize language which narrowly tailors the activity restrictions of a non-compete to actual services and/or activities which actually or potentially compete with the former employer and threaten its legitimate business interests.

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Courts around the country are split as to the circumstances under which the parties’ choice of law set forth in a non-compete agreement will be honored. In a recent diversity jurisdiction case ruling, Arizona U.S. District Court Judge David Campbell recently refused to enjoin violations of a non-compete clause which said that the law of Washington State applied. He held that Arizona had a greater interest than Washington in the case before him, and that Arizona’s “fundamental policy” (a) requires courts in that state to be less tolerant than courts in Washington with regard to enforcing broad non-compete clauses, and (b) prohibits Arizona jurists (unlike their Washington counterparts) from using a “blue pencil” to make such clauses reasonable. He concluded that an Arizona court would be unwilling to enforce the parties’ agreement in the circumstances here. Pathway Med. Technologies, Inc. v. Nelson, Case No. CV11-0857 PHX DGC (D.Ariz., Sept. 30, 2011).

For two years, Nelson was a sales representative in Arizona for Pathway, a developer, manufacturer and seller of medical devices for the treatment of arterial disease. While employed, he signed a confidentiality agreement in which he promised that for one year after his employment ceased, he would not “divert or take away,” or “attempt or assist” anyone else in diverting or taking away, any Pathway customer. The agreement recited that it is governed by Washington law. 

Following his resignation from Pathway, he was hired by a direct competitor and allegedly engaged in the prohibited conduct for the benefit of the competitor and the detriment of Pathway. Pathway sued Nelson and the competitor, and moved for temporary and preliminary injunctive relief. Judge Campbell denied both motions.

Arizona courts determine the enforceability of a choice of law provision in a non-compete clause by applying Sections 177 and 188 of the Restatement (Second) of Conflicts of Laws. According to the court’s reading of those sections, the parties’ choice will be honored only if they “could have agreed in their contract to the same provisions that the chosen law would impose, and could have done so under the law of the state with the most significant contacts with the transaction.” Washington law differs from that of Arizona in the two respects described above. First, Arizona “requires that non-compete provisions be narrowly drafted and no greater than necessary to protect the employer’s legitimate interests,” whereas Washington enforces agreements “even if they are quite broad and last for long periods of time.” Second, in contrast to the law of Washington, Arizona “courts may not rewrite non-compete agreements to make them reasonable.” 

The contract was negotiated and signed in Arizona, the state where Nelson lived and where he performed his duties both for Pathway and for its competitor. The court held that application of Washington law in this case would be contrary to the “fundamental policy” of Arizona law. The non-compete clause here had no express geographical limitations. Further, it applied to all Pathway customers including those with whom Nelson never had had contact. Finally, the phrases “divert or take away any customer,” and “attempt or assist” such diversion or taking away, were deemed to be unduly vague.

Employers who want to enforce non-compete agreements containing a choice of law provision must take care to select operative language that meets legal requirements not only of the chosen state but also those of the likely forum state if its law is different.

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Lane, a 16-year employee of food distributor Nash Finch Co. in Nebraska, was terminated in June 2011. He promptly filed a declaratory judgment suit in a Nebraska state court against his former employer, challenging the enforceability of non-competition clauses in a series of incentive compensation plans in which he was a participant. His challenge included, but was not limited to, the Minnesota forum selection and choice of law provisions -- Nash Finch was headquartered in Minnesota -- which were included in the 2010 Long-Term Incentive Program (LTIP) but in none of its predecessors. After removing the case to federal court based on diversity of citizenship, Nash Finch moved to dismiss for improper venue or, alternatively, to transfer the entire case pursuant to 28 U.S.C. §1404(a), including the dispute over the plans without forum selection and choice of law requirements, to the federal court in Minnesota as a more convenient forum. The Nebraska court denied the motion to dismiss but, over Lane’s objection, granted the motion to transfer.   

Lane maintained that the non-competition clauses, as written, were not reasonably necessary to protect Nash Finch’s legitimate business interests and were unduly harsh and oppressive. He contended, among other things, that the clauses identified by name so many competitors for whom he was prohibited from working that he effectively was precluded from employment in the food distribution industry. He also insisted that (a) there was no consideration for the forum selection and choice of law provisions in the LTIP, and (b) the outcome of the case, if it was tried in a Minnesota court, would be contrary to Nebraska public policy because Minnesota permits blue penciling of restrictive covenants if necessary to protect a legitimate business interest whereas Nebraska courts do not. The Nebraska federal court declined to rule on the merits of those contentions.  However, it reasoned that the Minnesota court would be obligated to follow the same Restatement (Second) of Conflicts of Laws rules as would a Nebraska court in deciding whether to enforce the choice of law provision. Lane v. Nash Finch Co., Case No. 8:11 CV 241 (D.Neb., Sept. 26, 2011). 

Another interesting part of the opinion deals with denial of Nash Finch’s Federal Rule of Civil Procedure 12(b)(3) motion to dismiss for improper venue because of the forum selection clause. After examining the split of authority regarding such motions in similar circumstances, the court decided that venue was proper under 28 U.S.C. §1391. However, even though the other incentive programs did not contain a mandate that litigation must be filed in Minnesota, the court decided that judicial economy would be better served by resolution of all of Lane’s claims in a single forum.

This case involves an interesting application of Section 1404(a) to forum selection and choice of law provisions included in only the last of a series of employment agreements each of which contains a non-competition clause. The court decided that the plaintiff’s choice of a forum, in a lawsuit alleging that all of those clauses were unenforceable, was insufficient to prevent transfer to the federal court in the selected forum state even though only one of the agreement contained forum selection and choice of law provisions. As many seasoned non-compete litigators can attest, the forum selected for a non-compete action often plays a prominent role in whether the forum court will enforce the non-compete.

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By Bob Stevens and Daniel Hart

As we have discussed on this blog before, on May 11, 2011, Georgia reissued its new Restrictive Covenant Act (the “New Act”). The New Act reflected a fundamental change in Georgia’s law regarding restrictive covenants because it permitted Georgia courts to “blue pencil” (i.e., partially enforce) restrictive covenants that otherwise would be overbroad and, therefore, completely unenforceable under then-existing Georgia case law. While the New Act permits Georgia courts to partially enforce overbroad restrictive covenants, it does not require that they do so.

For the first time since Georgia passed the New Act, a Court in Georgia has elected to exercise its discretion to blue pencil restrictive covenants that it found to be overbroad. In Pointenorth Insur. Group v. Zander, No. 1:11-cv-3262-RWS, 2011 U.S. Dist. LEXIS 113413 (N. D. Ga. Sept. 30, 2011), the Court found that, among other things, the non-solicitation covenant contained in the employment agreement at issue was overbroad because it extended to any of the former employer’s clients, not just the ones with whom the former employee had contact during her employment. 

Rather than attempting to excise or mark out the overbroad provision and enforce the remaining restrictive covenants, the Court modified or altered the restrictive covenant and enjoined the former employee only from soliciting the clients with whom she had contact while employed by the plaintiff. The Court also enjoined the new employer from soliciting the same clients. 

This suggests that at least the Court interprets the New Act as providing it with the discretion to re-write restrictive covenants to make them enforceable, rather than merely providing a court with the power to remove overbroad covenants. It remains to be seen if other courts in Georgia follow the Pointenorth Court’s lead and use the New Act as a basis for re-writing restrictive covenants that are found to be overbroad. For the time being, this decision represents the lone voice on the stage and indicates that there may be a willingness to modify restrictive covenants instead of simply excising them and enforcing the remaining provisions.

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           In a recent decision, a California Second District Appellate Court upheld a trial court “issue sanction,” which effectively enforced, albeit temporarily, a five-year, unlimited geographic scope employee noncompete agreement against the defendant former employee. NewLife Sciences v. Weinstock, -- Cal.Rptr.3rd --, No. B223212, 2011 WL 2739653 (July 15, 2011). While such noncompete agreements are normally void and unenforceable under California’s well-known statutory bar against employee noncompetes (see Cal. Bus. & Prof. Code § 16600), the court stated that the temporary enforcement of the employee noncompete was a permissible issue sanction against the former employee, who time and time again refused to appear for depositions or answer hundreds of deposition questions. The court did not appear to rule on plaintiff’s argument that the noncompete fell within the sale-of-business exception under Section 16601, even though the court acknowledged that argument in its opinion. Section 16601 makes enforceable a reasonable non-competition clause executed by any “person who sells the goodwill of a business, or any owner of a business entity selling or otherwise disposing of all of his or her ownership interest in the business entity . . . .”  Section 16601 protects the purchaser of a business against competition from the seller.

            Some may argue, and the dissent so stated, that the decision may conflict with California’s settled public policy against employee noncompetes. Nevertheless, the decision is an example that courts sometimes find ways to enforce noncompetes if there is strong evidence of the former employees’ untoward conduct, particularly discovery abuses.

The Parties and the TMR Device

           Plaintiff NewLife Sciences (“NLS”) purchased from defendant Weinstock and his company the patent rights to a Therapeutic Magnetic Resonance Device (“TMR”), which was developed for pain management therapy, and all the other assets of the company. As part of the transaction, NLS hired Weinstock (who was not a doctor) as its chief science and technology officer and board chairman for five years. Weinstock’s employment contract provided, in relevant part, that he (i) could be terminated at any time for “fraudulent or unlawful conduct,” (ii) could not compete with NLS while working there, and, (iii) for five years after his employment, could not compete “directly or indirectly with any activity now or in the future engaged in by NLS.” The post-employment noncompete contained no geographic limitation.

            NLS terminated Weinstock in December 2007 for administering TMR services outside of a physician’s presence, in violation of California law, FDA rules, and NLS policy. NLS demanded that Weinstock return to NLS all of its property, including the patented TMR devices. Weinstock did not do so. He continued marketing the devices, and administering treatments.

NLS’s Lawsuit and the Trial Court’s Ruling

            NLS sued Weinstock, claiming breach of the noncompete, and other tortious conduct directed at NLS. NLS produced evidence that Weinstock was smearing NLS in the marketplace, appeared on a television show pawning himself off as the owner of the TMR patent, and soliciting customers and investors for the TMR operations. The trial court denied Weinstock’s early motion to strike, which was based on the Section 16600 noncompete bar. Weinstock subsequently refused to appear for his deposition, answer relevant deposition questions, and produce documents as ordered by the court. Weinstock cited the statutory bar as justification for his refusal to respond to discovery. As punishment for what the trial court called his “arrogant and contemptuous disregard for the orders of this court,” the trial court entered a severe issue sanction against Weinstock, such that the following issues were established for all purposes in the litigation:

1.                  Weinstock breached his employment contract by competing with NLS while still employed;

2.                  The noncompete was enforceable;

3.                  Weinstock breached the noncompete post-employment by using the TMR device without proper physician supervision; and

4.                  Weinstock’s breach caused NLS damages.

            Based on the issue sanctions and NLS’s evidence, the trial court entered a preliminary injunction against Weinstock and his affiliated companies from competing with NLS throughout the litigation, including an injunction against making or marketing the TMR device or something similar, and soliciting new, potential or existing customers for TMR devices. The trial court later entered terminating sanctions against Weinstock, and awarded NLS default judgment against Weinstock. He appealed.

Appellate Court Decision and Dissent

            The Appellate Court upheld the trial court’s preliminary injunction and default judgment. The court did not examine the merits of the Weinstock’s Section 16600 or NLS’s 16601 argument. Rather, the court held that the trial court did not abuse its discretion by entering the issue sanction, and later awarding default judgment in favor of NLS and against Weinstock. Defendants’ repeated and willful non-compliance with the trial court’s discovery orders, the Appellate Court held, were sufficient to warrant the court’s sanctions.

            The dissent stated that the trial court should not have enforced an illegal noncompete by way of a discovery sanction. The trial court and the Appellate Court majority should not have set aside, in the name of discovery sanctions, California’s strong public policy against employee noncompetes. At a minimum, the dissent stated, the trial court should have held an evidentiary hearing on whether the noncompete fell under the Section 16601 sale-of-business exception.

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By Scott Schaefers

            In a recent decision involving whether a former employer could obtain a temporary restraining order under its broad non-competition agreement with its former employees and former software development company, the federal court in Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158 (N.D.Cal. July 1, 2011) granted plaintiff’s request and enjoined defendants from competing with plaintiff while using its proprietary information. The court attempted to balance plaintiff’s property interests in its confidential data and business reputation against California’s long held public policy against noncompetition agreements. Ultimately, the court held there was sufficient evidence of defendant’s alleged wrongdoing to justify a TRO. 

            The Richmond court effectively “blue penciled,” or reformed, plaintiff’s broad non-compete agreement, rolling back its provisions to conform with California’s “trade secret exception” to California’s statutory bar on employee non-competes. Such blue penciling is arguably inconsistent with several recent California state court decisions prohibiting such reformation of overbroad noncompetes. In the end, the case highlights the difficulty in applying a trade secret exception to Business and Professions Code section 16600 and determining whether sued-upon noncompete covenants are necessary to protect an employer’s trade secrets.

Plaintiff’s Allegations in Richmond Technologies

            The plaintiff in Richmond was a distributor of enterprise planning software. Plaintiff sued defendants, which were plaintiff’s source-code company and plaintiff’s former employees, for misusing plaintiff’s source code and proprietary customer data to unfairly compete with plaintiff, before and after defendants terminated their relationships with plaintiff. In doing so, defendants (plaintiff alleged) breached their noncompete, non-solicitation, and non-disclosure agreements with plaintiff, violated California’s unfair competition statute, and were liable under other related common law theories. Notably, plaintiff did not make a claim for trade secret misappropriation under California’s Uniform Trade Secret Act (Cal. Civ. Code § 3426.1 et seq.).

.           The noncompete agreement prohibited defendants from competing with plaintiff for one year after their relationships terminated, and the non-solicitation agreements prohibited defendants from soliciting plaintiff’s customers during defendants’ employment and for one year thereafter. There appeared to be no significant difference in the broad application of the non-solicitation and noncompete agreements; in fact, the non-solicitation agreements, which contained certain exceptions regarding time lapse and the employees pre-existing relationship with the customer, were narrower than the noncompete. The non-disclosure agreement prohibited defendants from using plaintiff’s proprietary data.

The Court’s Decision

            Even though the court denied an injunction based on plaintiff’s non-solicitation agreements because they were overbroad and likely unenforceable under California’s statutory bar against restrictive covenants (Cal. Bus. & Prof. Code § 16600), the court issued a limited injunction based on the non-competition agreement. The court noted and discussed at some length the “trade secret exception” under Section 16600, which, despite California’s strong public policy against non-competition agreements, permitted claims for breach of noncompete agreements if necessary to protect a trade secret. Retirement Group v. Galante, 176 Cal.App.4th 1226, 1237, 98 Cal.Rptr.3d 585 (Cal.Ct.App.2009) and Edwards v. Arthur Andersen LLP, 44 Cal.4th 937, 81 Cal.Rptr.3d 282, 189 P.3d 285 (2008).  Plaintiff presented sufficient evidence, the court found, that:

• defendants had access to Richmond’s customers’ specialized requirements;
• defendants set up their competing business almost a year prior to terminating relationship with plaintiff;
• prior to terminating, defendants stopped using their Richmond e-mail accounts to communicate with plaintiff’s customer, and instead began using their Aumtech e-mail accounts;
• defendants listed plaintiff’s customers on Aumtech’s website as Aumtech customers;
• defendants contacted specific plaintiff customers and induced them to switch to defendants; and
• one of the individual defendants, prior to resigning from plaintiff, wiped her Richmond computer using three wiping programs, thus forever deleting many customer files and e-mails that Richmond needed to carry on its business with those customers.

            In light of this evidence, the court found that there were, at a minimum, “serious questions going to the merits” of plaintiff’s claims which justified its TRO.

            Nevertheless, to balance plaintiff’s interests against California’s policy against noncompetes, the court “narrowly” drew its injunction, such that defendants were prohibited from:

• holding out plaintiff’s customers on Aumtech’s website as defendants’ customers;
• initiating contact with plaintiff’s customers that defendants knew of or had contact with during their employment with plaintiff (except for broad-based marketing of its products), but defendants were not prohibited from responding to requests initiated by such customers;
• using plaintiff’s proprietary data to negotiate or do business with plaintiff’s customers, but defendants were allowed to do business with those customers so long as defendant’s did not use such plaintiff’s proprietary information; and
• using plaintiff’s source code in their business, but defendants were allowed to market and sell similar products so long as they did not use plaintiff’s trade secrets.

The Court’s Decision and State Court Authority

            The court’s findings are arguably inconsistent with recent California state court decisions; however, this is just a decision on the temporary restraining order and not a preliminary injunction. On the one hand, the Richmond court held that plaintiff’s broad non-solicitation agreements were unenforceable under Section 16600 because they were not “narrowly tailored” to protect plaintiff’s trade secrets, even though the agreements contained certain exceptions. Plaintiff’s noncompete agreement, however, was just as broad, if not more so - it provided that, upon defendants’ termination of their relationships with plaintiff and without exception, they “will not compete with [plaintiff] with similar product and or Service using its technology for a period of one year thereafter.” Nevertheless, the court issued the injunction under the noncompete.

             In effect, the court blue-penciled or reformed the noncompete to conform to the trade-secret exception under Section 16600. Such blue-penciling has been held impermissible by several California cases, including those which held that employers violate California’s unfair competition statute (Cal. Bus. & Prof. Code § 17200) by even requiring employees to sign overly broad noncompete agreements at the beginning of their employment. See Kolani v. Gluska, 64 Cal.App.4th 402, 407-08 (1998) (holding that trial court properly declined to rewrite illegal covenant not to compete into a narrow bar on theft of confidential information); D’Sa v. Playhut, Inc., 85 Cal.App.4th, 927, 934-35 (2000) (refusing to narrowly construe invalid covenant not to compete so as to make it enforceable); Dowell v. Biosense Webster, Inc., 179 Cal.App.4th 564, 579  (2009).                                                                     

Lessons Learned           

               The takeaways from the Richmond decision are that (1) California courts still struggle with whether there is a trade secret exception to Section 16600 that would permit certain narrow noncompete restrictions; (2) when drafting restrictive covenants, employers should make sure they are tailored to protect against the misuse of trade secrets; (3) employers should monitor employee’s conduct and keep an eye out for unlawful activity (defendants in Richmond allegedly engaged in unlawful activity for almost a year without plaintiff knowing), and (4) when suing a former employee for breach of contract and trade secret theft, recognize that courts will likely impose heavy pleading and proof burdens, and diligently investigate and document alleged misconduct.

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Starting this year, restrictive covenants in employment agreements and other business-related agreements in Georgia are subject to new rules governing who can enter into these agreements, how these agreements should be written, and how disputes will be handled by the courts.

What's changed - for businesses, the bench and the bar? What's remained the same? What can we do? What should we do?

Please join us for this webinar, the third in our 2011 Trade Secrets Webinar Series-as we break-down the new law, highlight important features, and provide tips on how to protect businesses' investment in their people and their confidential information in Georgia. Our experienced panel of Seyfarth attorneys will be joined by Kevin Levitas, a former member of Georgia House of Representatives, who played a key role in the passage of the new law.

When:

Thursday, July 21, 2011

2:00 p.m. to 3:15 p.m. Eastern

1:00 p.m. to 2:15 p.m. Central

12:00 p.m. to 1:15 p.m. Mountain

11:00 a.m. to 12:15 p.m. Pacific

 Who Should Attend:

General Counsel, In-House Labor and Employment Counsel, In-House Intellectual Property Counsel, HR Directors and HR Supervisors, Chief Technology Officers, Chief Security and Information Officers, and Competitive Intelligence Professionals

Speakers:

Kevin Levitas, Former Member Georgia House of Representatives

Erika Birg, Seyfarth Shaw LLP

Bob Stevens, Seyfarth Shaw LLP

Register Here

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A Robert Samuelson piece in the Washington Post on the mismatch between the skills of job seekers and the requirements for open positions may seem like an unlikely place to find an angle on non-compete restrictions. However, in his column on the unemployment rate, Samuelson makes an argument that touches on the role that non-competes can play for employers and employees. In explaining why many individuals who are currently unemployed have struggled to find jobs despite the fact that a number of employers have listed openings, Samuelson theorizes as to why many companies have not responded to the situation by increasing training for new employees:

Companies traditionally provided much training, but that may also have changed. Loyalties have weakened. Companies are more willing to fire; workers are more willing to jump ship. Training may seem a poor investment because workers won’t stay long enough to earn a return. In the McKinsey [Global Institute] survey, companies denied cutting training budgets. But [Georgetown’s Anthony] Carnevale and others think the training has altered. Before, firms provided more basic training in business or technology skills; now, firms expect workers to come with these skills and focus training on firm-specific practices and systems.

In a nutshell, Samuelson’s argument is that a fluid job market acts as a disincentive for employers to train new employees on the general skills required for a position. Rather, they are looking for employees who have the general skills already. 

If this analysis is correct, then one potential response by employers to the situation would be greater use of restrictive covenants because such covenants are an important tool for employers to protect their investment in training. An employer is more likely to spend time and money to train an employee if it knows that the employee is likely to stay for a significant period of time. A non-compete restriction acts as an incentive for an employee to stay. Moreover, the law in many states recognizes the linkage between training and non-compete provisions in that a significant expenditure in training can be a legitimate interest to support the enforcement of such a covenant. In short, if an issue in the job market is a concern that money spent on training will be wasted, then use of non-compete provisions can be a solution.

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A recent decision by the Texas Supreme Court makes it easier for employers to enforce restrictive covenants in Texas. Employers often seek to obtain these types of contracts with key employees to prevent them from going to work for competitors or to leave to start competing businesses. The enforceability of such contracts is typically governed by state law, resulting in a patchwork of differing standards across the United States, with some states favoring enforcement, and others precluding such agreements altogether. Please read Seyfarth Shaw's One Minute Memo on the new case.

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Trade Secrets 2011 Webinar Series - The Anatomy of a Trade Secret Audit: Is the Data That Drives Your Company Adequately Protected?

May 25, 2011

10:00 am - 11:00 am Pacific
11:00 am - 12:00 pm Mountain 
12:00 pm - 1:00 pm Central
1:00 pm - 2:00 pm Eastern

CLICK HERE TO REGISTER

With the economy recovering in some sectors, the risk of trade secret theft to businesses has increased with greater employee mobility and the incumbent pressures on production and sales, together with the alarming frequency of targeted data theft attacks and the explosion of social media and cloud computing. Companies cannot simply react to these real business risks to their data once the data is compromised but should employ a thoughtful and comprehensive approach to the protection of their trade secrets and confidential information.
 
It is not uncommon for companies to find themselves in situations where important assets are overlooked or taken for granted. Yet, those same assets can be lost or compromised in a moment through what is often benign neglect. Authoritative sources estimate that companies lose hundreds of billions of dollars as a result of trade secret theft. At the same time, companies sometimes find themselves, through poor controls, exposed when they inadvertently obtain others’ trade secrets. Recent jury verdicts across the nation demonstrate the risk is real. Moreover, once the trade secret is lost, it is lost forever along with the value the company derives from the information.
 
To address these recurrent issues, Seyfarth Shaw helps clients protect their important assets and effectively manage risk by conducting Trade Secret Audits. Our experience has shown that companies gain tremendous value by taking a proactive, systematic approach to assessing and protecting their trade secret portfolios through a Trade Secret Audit. Please join us for the second webinar of the 2011 series which focuses on Trade Secret Audits.

Topics will include:

• Identifying trade secrets and secrecy protections
• Effective secrecy protections, including employment and non-compete agreements.
• Effective hiring and termination protocols, including effective exit interviews and termination protocols.
• Employing a comprehensive approach and trade secret protection plan
• Managing and working to protect computer-stored data,including responding to emergency issues related to computer fraud and security breaches
• This informative presentation will include a question and answer portion and checklists.

Our panel consists of attorneys with experience advising clients on issues related to trade secret audits. CLE credit will be available for participants.*

For questions, please contact events@seyfarth.com and reference this event.

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A recent Indiana Court of Appeals opinion, designated as non-precedential, discussed that state’s law concerning non-competition agreements. Most significant, the court upheld a commitment not to solicit the employer’s current or recent customers for two years even though the covenant contains no geographical limitation. However, provisions precluding any “contact with” such customers, and forbidding acceptance of “referrals of” them, were “blue penciled.” The court reversed the entry of summary judgment for the ex-employees and remanded for trial. Think Tank Software Dev. Corp. v. Chester, Inc., No. 64A03-1003-PL-172 (Ind. Ct. Appeals, Apr. 11, 2011).

Think Tank Software Development Corporation, and a number of companies affiliated with it (collectively, “Think Tank”), sued 10 former employees almost all of whom went to work for defendant Chester, Inc. Think Tank and Chester are competitors, engaging in what the court called “computer-related business activities.” Think Tank alleged violation of covenants not to compete and misappropriation of trade secrets. 

After more than five years of motion practice and discovery, the trial court granted summary judgment to the defendants on the grounds that the covenant not to compete “is overbroad and is therefore unenforceable . . . and cannot be reformed,” and that the property rights in which Think Tank claimed confidentiality did not constitute trade secrets. What the trial court apparently viewed as the covenant’s fatal flaw was that it was unlimited as to an applicable territory. Further, the affidavit of a former Think Tank director of technology seemingly demonstrated that the company had no protectable business information.

The Court of Appeals disagreed. Although upholding a two-year restriction on solicitation of recent former customers, the appellate court struck as unreasonable the prohibition against contacting them. Similarly, the court approved a ban on selling to, servicing, consulting, or negotiating with those customers, but a prohibition on acceptance of referrals of new customers -- for example, by the ex-employer’s customers -- was invalidated. Indiana recognizes “blue penciling” as an option for a court. The absence of a territorial restriction was not fatal, according to the court, because “the class of prohibited contacts [customers who had been such within two years of the former employees’ termination] is well defined and specific, thereby eliminating the need for any geographical limitation.” 

As for trade secrets, the appellate tribunal held that Think Tank sufficiently raised genuine issues of material fact with respect to whether the company’s “customer identities” and “tailored solutions to the customers’ information technology needs combine to form confidential information.” Similarly, Think Tank provided enough evidence of “its extensive security provisions in protecting” that information to withstand a motion for summary judgment.

The enforceability of a non-compete and non-solicitation agreement in a particular case frequently turns on the applicable facts and circumstances, the precise wording of the restriction, and the jurisdiction. The question of whether particular information qualifies as a trade secret also is fact-intensive. When in doubt, contact a Seyfarth Shaw Trade Secrets Group attorney.

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           Delaware Court of Chancery Vice Chancellor J. Travis Laster, faced with an unreasonable non-compete/non-solicitation agreement, indicated that he would have preferred to hold it invalid but said that he had no choice other than to modify its terms because its Maryland choice-of-law provision requires judicial “blue penciling.” He did enjoin the ex-employee from using his ex-employer’s customer list, a trade secret, but held that the ex-employee may call on any customer whose name is within his own knowledge.

            Delaware Elevator, Inc. (“DEI”), a national elevator installer and servicer, sued ex-employee John Williams who had 20 years of experience in the industry (six of them with DEI) at the time he left that corporation and started his own -- one man -- competing elevator maintenance company. He had signed an agreement with DEI (a) barring him for three years after leaving its employ from working in a competing business within 100 miles of any DEI office, and (b) prohibiting him from soliciting business from anyone who during the last six months of his employ had been either an actual DEI customer or a potential customer DEI was actively soliciting. While he claimed his signature on the agreement was a forgery, the court said that no rational fact finder could accept his claim. 

            The agreement contained a Maryland choice-of-law provision and a stipulation that a violation would inflict irreparable harm on DEI. Maryland law upholds non-competes if the restraints are reasonably necessary for the protection of the employer, do not impose an undue hardship on the employee, and are in the public interest. Even DEI recognized the unreasonableness of the territorial restriction as written (within 100 miles of any DEI office) and sought to enforce the agreement within 100 miles of just the Newark, Delaware office where Williams worked.   

            The Vice Chancellor observed that Williams has 34 years in the workforce, has personal and family ties to the area where he has been working, and could not readily re-locate or find an equivalent job in a new field. Rhetorically, the court asked DEI’s attorneys “how they would fare if forced to re-start in a far-off jurisdiction, to re-invent themselves as practitioners in a completely different subject-matter area, or to leave the law entirely and find employment in another industry.” 

            While he might have preferred to invalidate the agreement altogether, the Vice Chancellor stated that Maryland “does not authorize a policy-based refusal to enforce an unreasonable non-compete agreement. Maryland law instead calls on the court to carve back overly broad restrictive covenants by wielding the judicial ‘blue pencil.’” Accordingly, he modified the restrictive provisions to a two-year-30-miles-from-Newark-radius (since the two year period began January 17, 2010, Williams’ date of termination, it will expire less than one year after the decision was announced in March 2011). The court observed that, as modified, Williams would be able to earn a living by using his contacts and knowledge of the industry outside the non-compete zone immediately, and within the zone shortly, while at the same time DEI’s relationships with existing and prospective customers were adequately protected. 

            Williams admitted that he took a DEI customer list with him and used it. Because the list was held to constitute a trade secret, he was ordered to destroy all electronic and paper copies. However, the court said he is free to call on customers he knows, even if their names are on the list. A hearing on damages for wrongful use of the list will be scheduled.

            Employers should be cognizant of the applicable legal principles when they include a choice-of-law provision in a non-compete or non-solicitation agreement. If DEI’s agreement with Williams had provided for application of Delaware law, the agreement might have been voided altogether. By applying Maryland law, the employer salvaged at least some protection. Designation of another state’s law might have been even more favorable to the employer. Ask your Seyfarth Shaw trade secrets attorney for advice about choice-of-law provisions.

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By Paul Freehling

The national CPA firm of Mayer Hoffman McCann P.C. (“MHM”), based in Missouri, scored a major victory when the Eighth Circuit Court of Appeals affirmed a trial court’s injunctions and liquidated damages award of $1,369,921 against four former stockholder-employees in Minnesota. The injunctions prohibited them from soliciting MJM’s clients, directed them and their employees to make their office and home computers available to a computer forensic expert, and enjoined them from using (and ordered them to return) MJM’s trade secrets and confidential information. The appellate court’s decision is notable because of its analysis of when non-compete covenants and contractual liquidated damages provisions are enforceable, but also because of the court’s view that non-solicitation agreements are unenforceable.   

In 2005, the individuals executed a Stockholders Agreement pursuant to which they covenanted not to solicit MHM’s clients and customers for two years after leaving MHM’s employ. However, in 2008, immediately after their resignation from MHM, the individuals started a competing firm which proceeded to serve at least 124 MHM clients. 

The covenants were challenged as lacking in consideration, being contrary to Missouri law, and having unenforceable remedy terms. The court discussed and rejected almost every challenge. Mayer Hoffman McCann, P.C. v. Barton, 614 F.2d 893 (8th Cir. 2010).

With regard to consideration, the defendants relied on a 1996 Missouri appellate court decision that invalidated, for lack of sufficient consideration, a non-compete clause contained in a buy-sell agreement. That court, however, was influenced by the absence of a contemporaneous employment contract and the failure of the buy-sell agreement to state that the clause was intended to protect special interests of the buyer.   In the Mayer Hoffman case, the individuals who signed the covenants were employees. Further, the Agreements contained mutual promises, recited that the purpose of the covenants was protection of MHM’s legitimate special interests -- its proprietary trade secrets to which the individuals had access -- and did not include restrictions greater than fairly required. So, consideration was adequate.

Several Missouri appellate court opinions identify the types of agreements in which restrictive covenants are permissible. No reported case involved a covenant ancillary to a shareholder’s agreement relating to a professional corporation. But the Eighth Circuit Appeals Court held that since a few decisions upheld covenants in agreements with various kinds of close corporations, and a professional corporation is a type of close corporation, the covenants at issue are enforceable. The two-year covenant was without geographical restrictions, but it was limited to MHM clients who the defendants solicited, and that was held to conform with Missouri law.

The defendants claimed that the non-compete clause failed because MHM had no protectable interest in clients who the individuals had begun servicing before signing the Stockholder Agreements. The court disagreed. MHM had invested money, time and effort in strengthening the pre-existing relationships. The court did concur with the defendants that, under Missouri law, MHM had no protectable interests in the defendants’ co-workers’ continued employment, and so the non-solicitation clause was unenforceable.

The Agreements provided that a violator of the covenant not to compete would owe liquidated damages equal to the sum of MHM’s total billings, for the two years prior to violation of the covenant, to the clients the violators successfully solicited. Overruling the defendants’ contention that the damages clause created an unenforceable penalty, the court held that the clause was valid because an accurate estimate of damages was difficult to make, and two years’ billings was a reasonable forecast of the harm caused by the individuals’ breach of contract. 

The injunctive and monetary award in Mayer Hoffman might be harsher than some courts would have rendered. However, the contract violation here was particularly egregious. In any event, the opinion suggests how to draft enforceable trade secret protection agreements, non-compete covenants, and liquidated damages clauses. The decision shows the horrendous consequences that may be faced by anyone who misappropriates trade secrets and breaches a covenant not to compete. For questions about the Mayer Hoffman case or other trade secret issues, please contact the Trade Secrets team at Seyfarth Shaw.

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On January 20, 2011, Massachusetts State Representatives Lori Ehrlich, William Brownsberger, and Alice Hanlong Peisch re-filed the Massachusetts non-compete bill, aptly entitled “An Act Relative to Noncompetition Agreements.”  The bill was originally submitted in late 2009 as House No. 1799, and since that time has undergone significant review, comment, and revision.  While much of the bill remains the same, its sponsors made changes to address several concerns the business community had expressed about particular provisions.  There is no current timeline for a vote on the bill, but we do expect there to be ample opportunity to provide additional input.

What Remains the Same As the Prior Bill?

The bill applies to non-compete agreements in the context of employment, including forfeiture for competition agreements (agreements that impose adverse financial consequences if an employee engages in competitive activities).  However, the bill specifically excludes non-solicitation agreements (both of customers and employees); non-compete agreements outside the employment context, such as those that are executed in the sale of a business; forfeiture agreements (agreements that impose adverse financial consequences as a result of termination regardless of whether the employee engages in competitive activities); and agreements not to reapply for employment.  The bill does not apply to non-disclosure or confidentiality agreements. 
In essence, the bill codifies the existing common law rules, which provide that non-compete agreements are enforceable only if they are reasonable in duration, geographic reach, and scope of proscribed activities necessary to protect the employer’s trade secrets, confidential information, or goodwill, and are consonant with public policy.  In addition, the bill does not change current Massachusetts law permitting courts to reform or modify unreasonable non-compete agreement provisions.

The bill requires non-competes to be in writing, signed by both parties, and “to the extent reasonably feasible,” they must be provided to the employee at least seven business days in advance of employment.  If the agreement is executed after the commencement of the employment relationship, the employee must be provided with notice and “fair and reasonable” consideration (beyond continued employment).

The bill restricts non-compete agreements to one year, except for “garden leave” clauses (agreements by which the employer agrees to pay the employee during the restricted period), which may last up to two years. 

The bill mandates the payment of attorneys’ fees to employees if a court refuses to enforce “a material restriction or reforms a restriction in a substantial respect,” or if it finds that the employer acted in bad faith.  Attorneys’ fees are not mandated, however, if a particular provision is “presumptively reasonable,” as defined by the statute, or if the employer made “objectively reasonable efforts to draft the rejected or reformed restriction so that it would be presumptively reasonable,” even if a court refuses to enforce or reforms the provision.  An employer may be entitled to its legal fees if it prevails only if they are otherwise permitted by statute or contract, the agreement is presumptively reasonable, the non-compete was enforced, and the employee acted in bad faith.

What Has Changed From the Prior Bill?

Perhaps the most significant change in the current version of the bill is that it no longer restricts the use of non-compete agreements to employees making more than $75,000 per year.  Instead, the bill calls for courts to consider the economic circumstances of, and economic impact on, the employee.  This is important because there are many companies doing business in the Commonwealth, oftentimes start-ups, that employ individuals who are paid less than $75,000 per year, but who are otherwise provided with potentially lucrative equity interests, stock options, or the like.  The departure of these employees to a competitor can cripple a start-up company and can even cause hardship to well-established companies that may utilize these other types of non-monetary compensation and pay key employees less than $75,000.  This salary benchmark was also a concern for companies that employ part-time or seasonal employees, and staffing agencies, to name a few, which may not meet the $75,000 salary benchmark in a calendar year.    

Another change in the bill relates to the award of mandatory attorneys’ fees to employees.  While this provision remains in the bill, as discussed above, an employer can avoid paying fees if the court determines that it undertook “objectively reasonable efforts to draft the rejected or reformed restriction so that it would be presumptively reasonable,” even if unsuccessful.  This provision, however, does not provide clear guidance to employers as to the parameters of such “objectively reasonable efforts,” and remains a significant departure from existing law that litigants pay their own attorneys’ fees, win or lose.

Like some other states, including California, the bill, in its prior and current versions, explicitly rejects the inevitable disclosure doctrine (which holds that even in the absence of an enforceable non-compete agreement, a former employee may be prevented from working for a competitor based on the expectation that the employment would inevitably lead to the disclosure of trade secrets or confidential information of the former employer).  The newest version of the bill, however, recognizes that employers may nevertheless protect themselves using other laws and agreements, including applicable trade secrets laws and non-disclosure agreements.   

Other changes from the last version of the bill include: (a) non-competes executed after the commencement of employment no longer must be accompanied by a 10% increase in salary to be presumptively reasonable; now, they must simply be supported by “fair and reasonable consideration”; (b) non-compete agreements no longer need to be separate documents; (c) garden leave clauses are permitted; and (d) the scope of restrictions placed on forfeiture agreements has been limited.

Finally, it is important to note that the bill is not retroactive, and will not apply to agreements entered into before January 1, 2012.

Seyfarth Shaw plans to monitor and participate in the legislative process and will report on the status and evolution of this bill on our blog, Trading Secrets, at www.tradesecretslaw.com.  If you have any questions or would like to provide input on the bill, 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). Click here for Seyfarth Shaw's Management Alert on the bill.

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By Robert Milligan and Joshua Salinas

Wrongfully accessing someone’s personal email account may cost you $1,000 per unauthorized access, even if that person suffers no injury or loss. In Pure Power Boot Camp v. Warrior Fitness Boot Camp, 2010 WL 5222128 (S.D.N.Y. 2010), a New York district court permitted the recovery of statutory damages under the Stored Communications Act (SCA) (18 U.S.C. § 2707(a)) without proof of actual damages sustained.

Lauren Brenner allegedly hired former U.S. Marines Ruben Belliard and Alex Fell to work as “drill instructors” at her Pure Power Boot Camp physical fitness center. While still employed at Pure Power, Belliard and Fell allegedly made plans to open a competing boot camp style physical fitness center. Belliard and Fell left Pure Power, and shortly thereafter opened Warrior Fitness Boot Camp.

Fell alleged that after he left, Benner, or someone from Pure Power, accessed his personal e-mail account and printed e-mails from his personal Gmail, Hotmail, and Warrior Fitness accounts. Fell had left his username and password information saved on Pure Power computers, which allowed access to his email accounts. The emails revealed that Belliard and Fell allegedly copied Pure Power documents, stole Pure Power customers, and shredded their non-compete agreement.

Benner allegedly read these emails and Pure Power Boot Camp brought claims against Belliard and Fell, which included claims for breach of their non-compete agreements and theft of Pure Power’s business model, customers, and documents.

Fell counterclaimed against several parties, including Brenner and Pure Power, alleging that the unauthorized access of Fell’s account violated the SCA and entitled him to statutory and punitive damages, as well as attorneys’ fees.

A significant issue in this case was whether Fell could recover statutory damages under the SCA, even though he failed to allege or prove actual damages. In fact, Fell confirmed in his deposition that he sought only statutory and punitive damages.

On summary judgment, the court held that proof of actual damages is not required to recover under the SCA. The interesting aspect of this case was the court’s departure from the holding in Van Alstyne v. Elec. Scriptorium, Ltd.,560 F.3d 199 (4th Cir. 2009), the only federal appellate decision to analyze this issue. Van Alstyne required proof of actual damages in order to recover the $1,000 statutory damages under SCA. Van Alstyne based its decision on Doe v. Chao, 540 U.S. 614 (2004), where the Supreme Court required proof of actual damages for recovery under the Privacy Act. However, the Pure Power court criticized Van Alstyne’s analysis because the SCA and Privacy Act have different purposes, language construction, and legislative histories.

Indeed, according to the court, an overwhelming majority of jurisdictions decided after Doe permit recovery of statutory damages under the SCA absent actual damages. This has been applied to unauthorized access of employee’s email accounts (Cedar Hill Assocs., Inc. v. Paget, No. 04cv0557, 2005 WL 3430562 (N.D. Ill. 2005)), restricted websites (In re Hawaiian Airlines, Inc., 355 B.R. 225 (D.Haw. 2006)), and social media accounts (Pietrylo v. Hillstone Restaurant Group, No. 06-5754, 2009 WL 3128420 (D.N.J. 2009)).

The court, however, rejected Fell’s argument that each e-mail that was accessed constituted a separate $1000 violation under the SCA. The court found that, because the period over which the emails were accessed was relatively short (a nine day period), and because there was no evidence indicating the specific number of times each account was accessed, it was appropriate to aggregate the intrusions with respect to each individual e-mail account and find that there had been four independent violations of the SCA  --one violation for each unauthorized access of an electronic communications facility, which allowed access to electronic communications while still in electronic storage.  The court also rejected Fell’s request for punitive damages at this stage in the proceedings because the court was unable to determine as a matter of law which party accessed the email accounts, and the surrounding circumstances, and therefore, there was no basis upon which to decide whether punitive damages were appropriate. The court also rejected Fell’s request for attorneys’ fees as premature because the court was presently unable to determine which of the parties named in the counterclaim was liable for the four violations of the SCA.

The Pure Power court’s affirmation of some employee privacy rights and the removal of the actual damages hurdle to a SCA claim have several implications for employers and management. First, increased attention must be given when dealing with employee personal e-mail and social network accounts. The decision does not impair the ability to monitor employee web activity or work provided email accounts, provided that the employer has clear policies articulating that employees have no expectation of privacy. However, extra care must be given to employee personal accounts, particularly when the employee saves login information on the computer and the login information is used to access the employee’s personal accounts. Employers should not engage in such conduct. 

In Pure Power, the access of Fell’s email accounts created a cause of action to recover statutory damages for Fell, where the employer may have a solid non-compete/unfair competition suit against the employee. Perhaps more detrimental to employer Pure Power Boot Camp, the court also excluded the highly relevant emails demonstrating alleged employee disloyalty from evidence. Finally, the ability to recover statutory damages without proof of actual damages, as well as punitive damages and attorney fees, may provide an incentive for employees and their counsel to pursue SCA claims against current and former employers.

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Throughout 2010, Seyfarth Shaw LLP’s dedicated Trade Secrets, Computer Fraud & Non-Competes practice group hosted a series of webinars that addressed key issues facing clients today in this important and ever changing area of law. The series consisted of five webinars: The Computer Fraud and Abuse Act: What You Need to Know, Protecting the Secrets in Your Employees’ Heads, Trade Secret Litigation and Protection in California, Franchise and Dealer Relations: Protecting Your Trade Secrets and Brand, and Protecting Your Trade Secrets in the Global Economy: Non-Compete and Trade Secret Considerations In Europe and Asia. As a conclusion to this well-received 2010 webinar series, we have compiled a list of key takeaway points for each of the webinars. If you were not able to attend the webinars, we invite you to request the archived recordings of the webinars by contacting your Seyfarth Shaw LLP attorney. We are also pleased to announce that Seyfarth Shaw LLP will continue its webinar programming in 2011 and has several exciting topics lined up.

The Computer Fraud and Abuse Act

Our first webinar this year, led by Seyfarth attorneys James Yu, Michael Elkon, and Carolyn Sieve, was entitled The Computer Fraud and Abuse Act: What You Need to Know. The Computer Fraud and Abuse Act (CFAA) is a federal statute that has been used for almost a decade to obtain injunctive relief against, and impose liability on, employees and hackers who steal or interfere with a company’s electronic information. This webinar covered the essential points that employers need to know about the CFAA and its potential uses in protecting electronic assets.

·         CFAA claims often turn on what an employee was authorized to do on an employer’s computer system. Therefore, handbooks, IT policies, sign-in screens, and other materials that cover IT authorization should address what an employee is (and is not) allowed to do on the system. 

·         The CFAA is not limited to employees. An employer should consider what authorization instructions it provides to clients, vendors, potential business partners, and contractors. It should also carefully monitor the security protections for its website and internal servers as hackers remain a continuous threat. 

·         There is a split among federal courts regarding whether the CFAA applies to employees who are initially provided access to company data but then either exceed that authorization or otherwise act in a manner that revokes the initial authorization. Some courts have limited the use of the CFAA to unauthorized users such as hackers. Therefore, the location of a possible violation of the CFAA is important.

Inevitable Disclosure

The second webinar of the 2010 series, led by Erik von Zeipel, Jason Stiehl, and David Countiss, focused on Inevitable Disclosure, an evolving doctrine recognized in a large number of jurisdictions that may prevent an employee from accepting employment when the employee’s duties cannot be performed without the disclosure of a former employer’s trade secrets. This discussion covered what employers need to know about the Inevitable Disclosure Doctrine, including jurisdictions which have adopted the doctrine and its application to both exiting and incoming employees. The panel also discussed best practices for handling the hiring and termination of employees in such jurisdictions.

·         Understand the state of the law regarding inevitable disclosure in your jurisdiction. Injunctive relief may be easier to obtain if your jurisdiction has adopted the doctrine.

·         Require new employees to sign agreements acknowledging their obligation to protect company’s trade secrets, as well as acknowledging that they understand that they need to respect their prior employer’s trade secrets and any related agreements. Be prepared to marshall any breaches of these agreements if litigation ensues.

·         When an employee departs, sequester technology assets, conduct exit interviews and have the employee acknowledge agreements and covenants protecting trade secrets.

California Trade Secrets Law

This third webinar, conducted by Robert Milligan, Robert Niemann, and Jim McNairy, focused on how California trade secret law is similar and diverse from other jurisdictions, including a discussion of the California Uniform Trade Secrets Act, trade secret identification requirements, remedies, and the interplay between trade secret law and Business and Professions Code Section 16600, which codifies California’s general prohibition of employee non-compete agreements. The webinar also covered effective California trade secret protection policies and practices.

·         Aside from a few narrow exceptions, non-competition agreements are presumed void under California law in the typical employment context and recent cases hold that most non-solicitation of customer clauses are synonymous with non-compete agreements and are therefore also unlawful. It remains to be seen whether the so-called “trade secret exception” will be a viable exception to California’s general prohibition against non-competition agreements. Employers should keep these developments in mind when assessing such agreements and make sure that their agreements comport with the recent developments in the law. Failure to do so places employers at risk for unlawful business practice suits. 

·         Because non-compete agreements are typically unenforceable in California, employers typically pursue trade secret misappropriation claims against former employees who steal proprietary company information. In such suits, the employer has the burden of showing that the information is a trade secret, including showing that reasonable secrecy measures were in place to protect the information. Accordingly, prudent companies should consider investing the time and money to conduct a trade secret audit. A trade secret audit generally assesses what company information may be protectable as a trade secret and the security measures the company has in place to protect such information. The results of a successful audit are clearly identified trade secrets with adequate protection measures (including updated trade secret protection agreements) in place: the existence of which are essential to success in trade secret litigation, as well as to ensure that key company assets are adequately protected.

·         Conduct a thorough investigation prior to filing a trade secret misappropriation suit to ensure that the claim can be supported from all lines of attack to enable the court to issue appropriate injunctive relief and award damages. This includes obtaining evidence of the trade secret’s existence and the efforts used to protect it. Employers will need to dedicate the time and resources to arm their counsel with this essential information before and during the litigation. Trade secret plaintiffs are also required to identify their trade secrets with particularity before discovery commences in the case, so be prepared to have a trade secret identification statement prepared in advance of serving your discovery.

Trade Secrets and Franchise Law

The fourth webinar of the 2010 series, led by Andrea Okun, Jim McNairy, and Marcus Mintz, discussed how to protect trade secrets, trademarks, trade dress, and goodwill while maintaining and enhancing successful franchises and dealerships. These are often the core assets of a franchise or dealership, and this webinar presented an overview of what assets are protectable, how those assets can be protected, what state and federal laws can be used to protect these assets, and what can be done if these assets are threatened.

·         One of the best ways to protect trade secrets, trademarks, trade dress and goodwill is by entering into clear, enforceable agreements at the outset of the business relationship. These agreements should clearly identify the assets (such as confidential information and intellectual property) that are being shared/licensed and expressly state the receiving party’s agreement to (a) not make unauthorized use or disclosure of those assets, (b) return all assets at the termination of the relationship, and (c) the need for injunctive relief should the receiving party breach the agreement.

·         In addition to the federal Lanham Act, know the law of your jurisdiction(s). 46 out of 50 states plus the District of Columbia have adopted some variation of the Uniform Trade Secrets Act protecting highly confidential information. Of the remaining 4 states, Massachusetts, New Jersey, and New York have introduced their own versions of the Uniform Trade Secrets Act (only Texas has no trade secret act in place or pending). The franchise acts in Illinois, Indiana, Iowa, Louisiana, Michigan and Minnesota make mention of the enforceability of non-competes. Further, Alabama, California, Colorado, Florida, Georgia, Hawaii, Michigan, Montana, New York, South Dakota, and Texas all have statutes specifically dealing with non-competes.

·         When drafting restrictive covenants and seeking injunctive relief, do not overreach. Drafting overly broad agreements or seeking injunctive relief beyond the scope of legitimate business needs may result in invalidation of the agreements at issue and denial of any form of injunctive relief. Be careful not to assume that every jurisdiction will blue pencil or re-write your restrictive covenants to make them enforceable. Many will not.

International Trade Secrets and Non-Compete Law

The final webinar of the 2010 series, led by Marjorie Culver, Dominic Hodson, and Robert Milligan, focused on non-compete and trade secret considerations from an international perspective. The webinar involved a discussion of non-compete and trade secret issues in Europe and Asia, including the threats to trade secrets and confidential information in these regions. The similarities and differences in approach among the various jurisdictions were discussed and compared to the United States. The panel discussed drafting considerations for confidential/trade secret protection and non-compete agreements as well as appropriate policies in these regions, along with a discussion of sources of protection other than written agreements and policies. This webinar provided valuable insight for companies who compete in the global economy and must navigate the legal landscape in these regions and ensure protection of their trade secrets.

·         One size does not fit all when it comes to drafting employment restrictive covenants for employers operating in international countries. Local jurisdictions take an active interest in agreements that restrict employees from competition as a matter of public policy. Companies must be mindful of the legal requirements for valid non-competes and non-solicits where the employees predominantly provide services or where the employees are likely to later compete. Even where the parties agree on a governing law or forum, the courts in the local jurisdiction often apply local law requirements and void restrictive covenants that do not comply.   

·         Trade secrets: default statutory protections only go so far. Though many countries make trade secret misappropriation unlawful (similar in some respects to the U.S.), this protection may not be helpful unless a company takes active measures to define and protect its proprietary information. Companies should execute confidentiality agreements adequately defining what a company considers confidential and proprietary and also put in place technological and security protocols to restrict access to the company’s most valuable proprietary information. Failure to take such measures can undermine a company’s claim that the information constitutes a trade secret. Companies must also be mindful that their security precautions do not interfere with employees’ privacy rights, particularly in Europe.

·         Non-competes: are they worth the effort in every instance? In some jurisdictions, non-competition restrictions require payment to the former employee during the restrictive period. And, in some cases, even an employer who no longer wishes to oblige the employee cannot waive the non-compete and the obligation to pay. Additionally, injunctive relief may not be available in some countries, making a non-compete the least expedient means for protecting the company from unfair competition. Across the board use of non-competes may not be the most cost-effective or efficient way to protect a company’s competitive position or trade secrets. Rather, companies should formulate a thoughtful strategy that only utilizes non-competes with employees for which there is a legitimate business and legal justification.

2011 Trade Secrets Webinar Series

Beginning in January 2011, we will begin another series of Trade Secret webinars. Planned topics for the 2011 series include Trade Secrets in the Financial Services Industry, Georgia’s New Non-Compete Statute, Choosing the Right IP Protection: Patent or Trade Secret, The Anatomy of a Trade Secret Audit, and Maintaining Trade Secrets in the New World of Cloud Computing. For notifications concerning our upcoming webinars, please sign up for our Trade Secrets, Computer Fraud & Non-Competes mailing list by clicking here.

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The question has been raised:  What is the effective date of Georgia’s new non-compete statute, O.C.G.A. § 13-8-50 et seq.?

This Act shall become effective on the day following the ratification at the time of the 2010 general election of an amendment to the Constitution of Georgia providing for the enforcement of covenants in commercial contracts that limit competition and shall apply to contracts entered into on and after such date and shall not apply in actions determining the enforceability of restrictive covenants entered into before such date. If such amendment is not so ratified, then this Act shall stand automatically repealed.

Georgia’s electorate ratified Amendment 1 - the Constitutional amendment that enables the changes to Georgia’s restrictive covenant law - with 67.6% of the cast ballots. 

Article X, Section I, Paragraph VI of the Georgia Constitution, however, provides that amendments become effective on January 1 following an election “[u]nless the amendment or the new Constitution itself or the resolution proposing the amendment or the new Constitution shall provide otherwise.”  The enabling amendment and the resolution proposing the amendment are silent as to the effective date. 

Hence, already there is debate as to when the amendment will take effect. 

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What does the new law do?  Although the changes are extensive, and the effect of those changes will differ depending on the circumstances, we reviewed the statute when it was passed in 2009 and published an overview in the Georgia Bar Journal.   We also published a technology article, focusing on its effects on technology companies.  

As we noted yesterday, not all agreements need to be rewritten as the statute is not retroactive, but given that many agreements are unenforceable as written under the common law, the new law provides a new opportunity to conform agreements.  

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PLEASE CLICK HERE TO REGISTER

Date: Wednesday, October 6, 2010

Time:
9:00 am - 10:00 am Pacific
10:00 am - 11:00 am Mountain 
11:00 am - 12:00 pm Central
12:00 pm - 1:00 pm Eastern

The fifth webinar of the 2010 series will focus on non-compete and trade secret considerations from an international perspective. The webinar will involve a discussion of non-compete and trade secret issues in Europe and Asia, including the threats to trade secrets and confidential information in these regions. The similarities and differences in approach among the various jurisdictions will be touched upon and compared to the United States. This webinar will provide valuable insight for companies who compete in the global economy and must navigate the legal landscape in these regions and ensure protection of their trade secrets.

Our team will discuss:

• Overview of non-compete and trade secret law in selected European and Asian countries, including a discussion of the impact of a forum's legal system.
• Drafting considerations for confidential/trade secret protection and non-compete agreements as well as appropriate policies in these regions, along with a discussion of sources of protection other than written agreements and policies.
• Comparison of similarities and differences of non-compete and trade secret law in these regions and the United States.
• Enforcement mechanisms, including arbitration, remedies, as well as forum issues.
• Jurisdictions discussed will include China (including Hong Kong), India, France, Germany, Australia, the UK, Spain, Japan and Taiwan. 

For questions, please contact events@seyfarth.com and reference this event.

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Can a California corporation with virtually no ties to Rhode Island nonetheless be sued in Rhode Island federal court for misappropriation of a Rhode Island company’s trade secrets because the California corporation lured away a Florida employee who had a confidentiality agreement with the Rhode Island company?   Yes, according to the United States Court of Appeals for the First Circuit.  Astro-Med, Inc. v. Nihon Kohden America, Inc., Nos. 08-2334 and 08-2335, 2009 WL 3384786, 158 Lab. Cas. ¶60,887, and 29 IER Cas. 1543 (1^st Cir., Oct. 22, 2009). 

Although the three judges did not agree on the reason for upholding the district court’s jurisdiction over the California corporation and although the non-compete clause in the ex-employee’s employment agreement with his former employer contained an undeniably excessive territorial restriction, the court affirmed judgment against the ex-employee for breach of contract – and against the California corporation for tortious interference with the Rhode Island competitor’s prospective economic advantage. 

Astro-Med is a Rhode Island company that manufactures and sells “instruments for sleep and neurological research and clinical applications of sleep science and brain wave recording and analysis.” It employed Kevin Plant as a trainer and product demonstrator in Rhode Island. His employment agreement contained a comprehensive trade secrets-confidentiality provision as well as a one-year non-compete clause covering a vast territory: the whole of Europe and North America. The agreement recited that it would be governed by Rhode Island law and that all disputes would be heard in a Rhode Island court. 

When Plant asked Astro-Med for a transfer to Florida, Astro-Med agreed and soon promoted Plant to District Sales Manager. In his positions with Astro-Med in Rhode Island and Florida, Plant had access to his employer’s most sensitive proprietary and secret business information. 

Two years following Plant’s transfer, Astro-Med competitor Nihon Kohden America, a California company that had virtually no ties to Rhode Island but was fully aware of Plant’s contract, lured Plant away from Astro-Med to be Kohden’s Florida sales representative. Astro-Med promptly sued both Plant and Nihon in a Rhode Island state court. Both defendants were charged with misappropriation of trade secrets, which is a violation of the Rhode Island Uniform Trade Secrets Act. Astro-Med also accused Plant of breach of contract and Nihon of tortious interference with prospective economic advantage. 

The defendants removed the lawsuit to federal court on the basis of diversity of citizenship. Then, Nihon moved to dismiss the complaint as against it for lack of in personam jurisdiction or, in the alternative, to transfer the case to Florida or California as a more convenient forum, and Plant joined in the venue motion. The district court denied both motions.

Following “especially hard-fought” litigation, a jury returned a verdict in favor of Astro-Med against both defendants and awarded $375,000 in damages. The court added exemplary damages, attorneys’ fees, costs, and sanctions that brought the judgment to $1.16 million. The defendants, of course, appealed from the denial of their motions as well as the judgment. The appellate court affirmed the district court’s rulings.

Precedent in the First Circuit holds that minimum contacts with the forum state means satisfaction of three requirements: relatedness, purposeful availment, and reasonableness. Attacking relatedness, the defendants argued that all activity between Nihon and Plant occurred in Florida or California, and that Nihon never came in contact with Rhode Island in the course of wooing or employing Plant. Further, Nihon had no place of business, assets or employees in Rhode Island. Yet, District Judge Woodcock, sitting in the appellate court by designation, agreed with the trial judge that the relatedness requirement was satisfied by applying the “effects test” since Nihon’s “conduct in Florida and California was a cause of the breach of contract – the actual injury – that occurred in Rhode Island.” 

The “effects test” is commonly applied in determining whether a tort action bears a significant relationship to the forum state even though the tortfeasor, while not physically present there, purposefully engages in acts that cause injury there. The Astro-Med decision is unusual because the court held that the relatedness prong of the jurisdictional analysis was satisfied in Rhode Island on the basis that Nihon’s conduct outside that state caused breach of a Rhode Island contract. 

Judge Woodcock said that there was purposeful availment because Nihon was aware of Plant’s contract at all relevant times and knowingly accepted the risk of a possible lawsuit in Rhode Island by Astro-Med. The reasonableness test was met by litigation against Nihon in Rhode Island because, even though all of the events relevant to Nihon’s relationship with Plant took place in Florida and California, because “the Florida and California witnesses and evidence were heading for trial in Rhode Island” in any event since, indisputably, Astro-Med had a right to litigate with Plant in that state. 

The defendants insisted that the non-compete clause in Astro-Med’s contract with Plant was invalid because its territorial coverage obviously was over-broad. Over-broad? Yes, said the district and appellate courts, but not invalid. The clause could be “partially enforced” by “restricting its territorial application to the state of Florida and to a limited subset of Astro-Med customers.” Moreover, as the “breaching party,” Plant had no cause to complain since he “is being held to a more narrowly circumscribed agreement than the one he signed.”  

In separate opinions, the other two jurists on the appellate panel, Circuit Judges Howard and Lipez, concurred in the result. Judge Howard took exception to Judge Woodcock’s jurisdictional analysis on the ground that it was irreconcilable with First Circuit precedent, while Judge Lipez challenged the legitimacy of that precedent. 

Judge Howard noted that, to justify jurisdiction over an out-of-state defendant, the plaintiff must demonstrate that the claim relates to or arises out of the defendant’s contacts with the forum state. He stressed that Judge Woodcock’s application of the “effects test,” that is, where the injury occurred, to the relatedness prong of minimum contacts is irreconcilable with unequivocal First Circuit holdings that relatedness cannot be based solely on the in-forum consequences of distant conduct. He concluded that Judge Woodcock’s jurisdictional decision nevertheless was correct because a special rule can be applied in a business tort case where the defendant’s conduct was purposeful and where exercising jurisdiction is reasonable. In those circumstances, a court may construe the relatedness requirement “slightly more generously than we might in [other cases, thereby permitting] the best-suited forum to entertain the dispute.” The Rhode Island district court was that “best-suited forum.” 

Circuit Judge Lipez, also concurring, bemoaned what he called “an analytical flaw in our precedent” which seemingly confines the “effects test to the purposeful availment prong of the specific jurisdiction inquiry. It is the illogic of that precedent that has required my concurring colleague to justify our outcome here by raising the possibility of a special relatedness test for business torts.” Rather, according to Judge Lipez, the “in-forum impacts of conduct undertaken outside the forum” – the “effects test” – is properly considered both “in evaluating personal availment [and in] the relatedness inquiry. In my view, therefore, there should be no need for a special category of economic or business tort.”

The Astro-Med case shows that an employer of someone who has a confidentiality and non-compete agreement with a former employer can be forced to defend misappropriation of trade secrets and tortious interference litigation in an inconvenient forum, especially when the prospective employer was aware of the agreement at all relevant times and the former employer is located within the First Circuit. Further, the prospective employer and ex-employee will not necessarily prevail in their challenge to an invalid non-compete clause where a court exercises “blue pencil” authority to modify the clause.

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In Coleman v. Retina Consultants, P.C., the Georgia Supreme Court reversed a trial court’s decision to enjoin a former employee based on his non-compete provision, but it upheld the injunction to the extent that it prevented the employee from using his former employer’s trade secrets. The case is especially interesting from a factual perspective, as it covers the increasingly common situation of an employee and employer disputing ownership of software developed over the course of employment. The relevant facts as follows:

Retina Consultants is a medical practice specializing in retina surgery. Retina Consultants hired Brendan Coleman as a software engineer in 2000. When Coleman joined Retina Consultants, he already had written and marketed a medical billing program called Clinex.  While employed by Retina Consultants, Coleman, with the assistance of the doctors who worked for Retina Consultants, modified his Clinex program to suit Retina Consultants’s specific business needs. Coleman integrated Retina Consultants’s trade secrets and confidential information into the new program, which was named Clinex-RE. Clinex-RE integrated electronic medical records, image storage, and a billing software component. Clinex and Clinex-RE are different programs, but Clinex-RE only works in conjunction with Clinex.

In 2003, Coleman and Retina Consultants entered into a Software Agreement that set forth that Retina Consultants owned Clinex-RE, Coleman owned Clinex, and that Retina Consultants had a non-exclusive license to use and sell Clinex. The Software Agreement also contained a non-compete provision stating that “Coleman will not distribute, vend or license to any ophthalmologist or optometrist the Clinex software or any computer application competitive with the Clinex-RE software without the written consent of Retina Consultants.”

Shortly before resigning on November 24, 2008, Coleman removed all applicable encryption keys and source and access codes for Clinex, along with any manual/installation instructions. After his resignation, Coleman attempted to license Clinex and Clinex-RE to other ophthalmologists; refused to disclose to Retina Consultants the passwords required to use Clinex and Clinex-RE software; refused to provide copies to Retina Consultants of all documentation in his possession and control relating to the programming and use of the software; refused to return to Retina Consultants copies of the Clinex-RE software; used Retina Consultants’s trade secrets; and took funds from a bank account belonging to a business set up jointly by Retina Consultants and Coleman. It is not unreasonable to speculate that the trial court was influenced by Coleman’s pre- and post-resignation behavior when it elected to enjoin Coleman in a broad fashion based on the non-compete provision.

Coleman appealed directly to the Georgia Supreme Court, which held unsurprisingly that the non-compete provision was unenforceable because it lacked geographic or temporal terms. However, the Supreme Court decided that the Clinex-RE package was a trade secret belonging to Retina Consultants, so Coleman could be enjoined from using it. Coleman could not be enjoined from using Clinex, because that was his property. Thus, the Supreme Court found that the trial court erred when it enjoined Coleman from retaining Clinex encryption keys, access codes, source codes, manual/installation instructions, passwords, and documentation. In the end, Retina Consultants was able to prevent Coleman from using the software that it owned, but the trial court went too far in stopping Coleman from using his software and in enforcing a limitless non-compete provision. 

The case illustrates the fact that the statutory protections of an applicable trade secret statute can act as a useful backstop in the event that a non-compete provision is unenforceable.

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Earlier this week, Starbucks Corp. sued a former executive in the U.S. District Court for the Western District of Washington, seeking enforcement of a noncompetition agreement. (Starbucks Corp. v. Paul Twohig, Civil Action No. 09-01404 (W.D. Wash.))

Former Division Senior Vice President Paul Twohig left Starbucks in March 2009, and, according to news reports, purportedly accepted a position with Dunkin' Donuts as its Brand Operations Officer.  According to the complaint, Twohig executed a noncompetition agreement in 2004, promising that he would not participate in the management, operation, or control of any direct competitors for 18 months after leaving Starbucks.

Starbucks alleges that, as Division Senior Vice President, Twohig controlled all aspects of Starbucks' retail operations in the Southeast, including developing the brand and creating business plans. And, Starbucks contends that after leaving the company in March, Twohig contacted Starbucks in August to ask whether it would release him from his noncompetition agreement, so that he could accept a position with Dunkin' Donuts. Starbucks declined to release Twohig from the contract.

Starbucks is seeking preliminary and permanent injunctive relief, damages and fees.

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When we last wrote about IBM’s efforts to enjoin David Johnson, its former Vice President of Corporate Development, from joining Dell, Judge Stephen Robinson of the Southern District of New York had denied IBM’s Motion for Preliminary Injunction following a June 22, 2009 preliminary injunction hearing, and IBM had filed an interlocutory appeal. On June 24, 2009, IBM filed an amended complaint, alleging that Johnson violated the terms of IBM’s equity based compensation programs, as well as his fiduciary duties. Two days later (and on the same date that the court issued its decision denying IBM’s first motion for preliminary injunction), IBM filed a request to move a second time for a preliminary injunction based on information developed during the expedited discovery process. The court denied this request.

Two weeks later, IBM filed a second motion for preliminary injunction. In that July 10, 2009 motion, IBM set forth that Johnson should be enjoined pursuant to his "legal duties to protect IBM trade secrets and confidential information" and his "duties to IBM pursuant to a confidentiality agreement that he signed when he joined IBM, the provisions of his various IBM equity grants and IBM’s internal Business Conduct Guidelines." On July 23, 2009, the Court held a pre-motion conference at which IBM conceded that its second motion for preliminary injunction was not based on information obtained during the expedited discovery process.

On July 30, 2009, Judge Robinson denied IBM’s second motion for preliminary injunction in rather strong terms. The court stated that it would not allow IBM to "litigate this matter through piecemeal, seriatim motions requesting the same relief." In fact, the court used the term "piecemeal, seriatim motions" three separate times in its decision as it held that IBM should have asserted all its bases for injunctive relief at the first opportunity. The court went on to refer to IBM’s method of proceeding as "vexatious" and representing a "great disservice to the interests of Mr. Johnson and of the Court in the orderly conduct of this litigation." The court also held that IBM’s second motion would require the court to reconsider certain aspects of its ruling on the first motion for preliminary injunction, a ruling that is before the Second Circuit Court of Appeals.

IBM immediately appealed the decision denying its second motion for preliminary injunction and filed a petition for writ of mandamus on August 7, 2009. The Second Circuit Court of Appeals has consolidated IBM’s appeals and has scheduled oral argument for September 9, 2009. Also, Johnson moved to dismiss IBM’s claims set forth in its amended complaint and to stay discovery. That motion is fully briefed and is before Judge Robinson.

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In Azzouz v. Prime Pediatrics, P.C., Case No. A08A2340, 2009 WL 619189 (Ga. App. Mar. 12, 2009), the Georgia Court of Appeals upheld a trial court’s grant of an interlocutory injunction on behalf of Prime Pediatrics, P.C. against Dr. Rami Azzouz. Dr. Azzouz entered into a detailed non-competition provision upon the commencement of his employment with Prime. The provision is as follows:

Employee hereby covenants and agrees with Employer that during his employment pursuant to the terms of this Agreement and for a period of two (2) years following the termination of his employment for any reason, the Employee shall not practice pediatric medicine or any pediatric sub-speciality within the following counties located in the State of Georgia: Whitfield, Murray, Gordon, Catoosa, and Walker except as an Employee of the Employer pursuant to the terms of this Employment Agreement.

Nothing contained herein however shall be construed so as to prohibit the Employee from practicing medicine as a pediatrician outside the territory set forth above before the expiration of said two (2) years, or within the territory as described above after the expiration of two (2) years, nor from prohibiting the Employee from practicing specifically any specialty of medicine other than pediatrics....

The parties agree that prohibited competition shall include maintaining pediatric privileges at any hospital located in the prohibited area, advertising in any form, including but not limited to, telephone, white and yellow pages, radio, newspaper advertisements, signage advertising, keeping or maintaining an office within the prohibited geographical area, posting web-sites showing business locations in the prohibited geographical area, or mailings to patients of Employer within the prohibited geographical area.

Non-compete provisions in Georgia typically are limited to the language of the first paragraph of Dr. Azzouz’s non-compete section: a prohibition on competing in a specific field and a specific geographic area for a specific period of time. Prime Pediatrics added the subsequent paragraphs that have the effect of providing greater detail as to what is and is not prohibited by the provision. These subsequent paragraphs proved important when Dr. Azzouz left Prime Pediatrics to open a competing practice and litigation ensued.

Dr. Azzouz argued that the third paragraph barred him from working in any hospital that advertises within the five-county area covered by the non-compete provision. If this interpretation were correct, then the non-compete provision would have been overly broad and unenforceable. The Court of Appeals found that this paragraph was “not constructed perfectly” and then proceeded to add in semicolons to make the provision clearer:

The parties agree that prohibited competition shall include ..., advertising in any form, including but not limited to [ (1) ] telephone, white and yellow pages, radio, newspaper advertisements, signage advertising, keeping or maintaining an office within the prohibited geographical area[; (2) ] posting to web sites showing business locations within the prohibited geographical area [;] or [3] mailings to patients of Employer within the prohibited geographical area.

In so doing, the Court of Appeals relied on O.C.G.A. § 13-2-2(6), which provides that the rules of grammatical construction may be disregarded when interpreting a contract in order to give effect to the parties’ intent. Although the Court of Appeals’ action could be construed as blue-penciling (which is prohibited in Georgia for restrictive covenants in the employment context), the Court of Appeals was able to rely on statutory and common law authority that permits minor changes for grammatical purposes.

The Court of Appeals also cited the second paragraph of the non-compete section, noting that Dr. Azzouz’s construction of the third paragraph was inconsistent with the provision of the second paragraph stating that Dr. Azzouz was free to practice any specialty of medicine other than pediatrics. In the end, the additional paragraphs following the basic non-compete provision first gave Dr. Azzouz an angle of attack and then negated that angle.

Azzouz is interesting because Court of Appeals assumed that the trial court’s factual conclusions were correct. Yet, in other instances, the Court of Appeals has refused to enforce non-compete provisions based on fact-specific arguments made by defendants before a trial court. For instance, in Beacon Sec. Technology, Inc. v. Beasley, 286 Ga. App. 11, 648 S.E.2d 440 (2007), the Court of Appeals refused to enforce a non-compete provision because the record reflected that the employer did not prove that the employee performed each of the prohibited activities in each of the counties listed in the non-compete provision. It is possible that Azzouz could have made a similar argument regarding his provision of pediatric services in the five-county area covered by the non-compete provision, but he failed to get a transcript of the proceedings below.

Azzouz further illustrates that non-compete provisions, although disfavored under Georgia law, are useful in certain professions. Georgia has a strict rule that a non-compete provision has to be limited to the geographic area worked by an employee. This can create problems for employees who have very large assigned areas (such as sales personnel with nationwide books of business) or employees who have no assigned areas (such as research scientists). Physicians, on the other hand, typically see patients from defined geographic areas. As such, it often can be easier to draft and enforce a non-compete provision against a doctor.

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In Global Link Logistics, Inc. v. Briles, No. A08A1871, (Ga. App. Feb. 18, 2009), the Georgia Court of Appeals recently reiterated Georgia court’s requirements for non-compete and non-disclosure covenants. The case involved the departure of Jim Briles from Global Link Logistics to a competitor. Briles moved for a declaratory judgment stating that the restrictive covenants in his employment agreement – a non-compete provision and a non-disclosure of confidential information provision – were unenforceable. Global Link answered and moved to compel arbitration. The trial court found that the restrictive covenants were unenforceable.

The Court of Appeals upheld the trial court’s finding. It held that the non-disclosure provision was unenforceable because it purported to cover Briles’s “observations” and was therefore overly broad. The provision also lacked a time limit, as required by Georgia law. As far as we know, Georgia is unique among all 50 states in the latter requirement. 

The Court of Appeals held that the non-compete provision was unenforceable for two reasons. First, it purported to prevent Briles from working as an “owner, operator, manager, employee, officer, director, consultant, advisor, representative or otherwise.” As such, the prohibition was an impermissible “in any capacity” restriction. Second, it purported to bar solicitation of all of Global Link’s customers, regardless of whether Briles had material contact with them. 

Faced with hostile law, Global Link made two additional arguments. It asserted that Briles’s agreement should be viewed under Georgia’s more lenient degree of scrutiny afforded to restrictive covenants executed in connection with the sale of a business. The Court of Appeals rejected this argument, concluding that Briles did not own an interest in Global Link’s predecessor when he executed the agreement in question. Thus, the fact that he acquired an equity stake in Global Link when it purchased the predecessor was immaterial. 

Global Link also argued that the trial court’s order ignored Georgia’s policy of deferring to actions previously filed in other jurisdictions, as well as the parties’ own forum selection clause, and that it undermined state and federal policy favoring arbitration. The Court of Appeals dismissed each of these arguments. It found that Briles had obtained relief from the trial court after Global Link had dismissed an action filed against Briles in Delaware and before either party commenced arbitration. Moreover, the Court of Appeals cited to the language of the arbitration provision in Briles’s employment agreement, which specifically stated that the parties could obtain injunctive relief in court prior to arbitration.

Global Link illustrates the difficulties in enforcing a restrictive covenant in Georgia. The Court of Appeals was able to pick from any one of a number of rules to knock out the restrictive covenants. The decision also highlights the fact that the relaxed scrutiny for restrictive covenants in the sale of a business context applies only if the covenant was signed as part of the actual sale.

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HB 173, which we have written about before, heads to a vote before the Georgia House of Representatives today.  The legislation  dramatically changes the way Georgia court's will review restrictive covenants (non-competes, non-solicitation agreements) and fixes the time limit imposed on confidentiality restrictions (eliminating the two-year restriction).  To find out how to reach your State Representative to express your views, click here.  

If the bill does not pass today, it is my understanding that it will not be given any further consideration this session.

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The First Circuit recently rejected a taxpayer’s claim for a refund based on recharacterization of a payment for a noncompetition agreement. Muskat v. United States, 2009 WL 211067 (1st Cir. 2009).

Irwin Muskat was the CEO and largest shareholder of his company, Jac Pac Foods. He entered into an agreement with Corporate Brand Foods America to sell the company with him to remain as CEO. Muskat’s overall compensation package (a part of the asset purchase agreement between Jac Pac and Corporate Brand) included a covenant not to compete, in return for which he was provided separate compensation from his salary at the now-sold company, including an initial $1 million payout under the non-competition agreement.

Although Muskat initially recorded that payout as ordinary income for his 1998 taxes, in 2002 he filed an amended return for 1998, recharacterizing the $1 million payment as a capital gain (which would have entitled him to a refund of over $200,000). The IRS denied Muskat’s request so he brought an enforcement action against the IRS. The district court, too, denied his request, finding that Muskat lacked “strong proof” that the non-competition payment was intended as payment for personal “good will” rather than as a covenant not to compete.

The First Circuit noted two principles in reviewing Muskat’s appeal of this decision; first, that generally speaking, payments in return for covenants not to compete are taxable as ordinary income and payments for goodwill are taxable as capital gains; and, second, that ordinary income is usually taxed at a higher rate than capital gains. It also explained the “strong proof” rule to which Muskat’s claim was subject. This rule of heightened burden for one appealing a decision of the IRS applies “when the parties to a transaction have executed a written instrument allocating sums of money for particular items, and one party thereafter seeks to alter the written allocation for tax purposes on the basis that the sums were, in reality, intended as compensation for some other item.”

Here, Muskat argued, among other things, that his non competition agreement was in reality a payment for his personal goodwill as president of the company, which was what Corporate Brand purchased in connection with the non competition agreement. The First Circuit rejected that argument, noting that his non competition agreement was a “garden-variety agreement not to compete” and it affirmed the district court’s decision. It reiterated that compensation for non-competition agreements remain ordinary income. It is only if an agreement is actually a purchase of goodwill that the compensation may be classified as capital gains.

This case, however, raises a point of consideration for drafters and parties to non competition agreements and asset purchase agreements where one of the primary assets is goodwill. Although Muskat had to overcome a significant burden (of strong proof) to reverse the IRS qualification, the First Circuit did note that the compensation under the agreement expressly was for Muskat’s promise not to compete against the purchaser (Corporate Brand) and “to protect Jac Pac’s goodwill.” Thus, the questions then raised are whether Muskat could or should have executed separate agreements to take the tax benefits of the goodwill presumably purchased as a part of the sale of the business and whether, ab initio, it was the heightened legal burden placed on Muskat that kept him from successfully qualifying his compensation as a capital gain. The company or individual dealing in non-competition agreements in the sale of a business or goodwill should consult a tax professional for advice about these issues.
 

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In Zupnik v. All Florida Paper, Inc., No. 3DO8-1371, 2008 WL 5412090 (Fla. 3rd D.C.A. Dec. 31, 2008), the Florida Court of Appeals for the Third Circuit reversed a trial court’s entry of a temporary injunction against Stewart Zupnik and Dade Paper & Bag Company. The Court’s reasoning was that the restrictive covenants in question had expired and All Florida Paper did not provide evidence of misappropriation. The facts of the case are as follows:

Zupnik is a sales representative with experience selling paper and janitorial products to customers in the food industry. On March 14, 2004, Zupnik signed an Agreement with All Florida that stated that the "employment shall be for a term of two years." The Agreement gave Zupnik the option to remain with All Florida as an at-will employee if he so elected within 72 hours of the expiration of the two-year term. The Agreement also contained a one-year non-compete and five-year non-disclosure of confidential information provisions, both of which were triggered post-employment by the termination of the term of employment.

After the expiration of the two-year term, Zupnik formed his own company – South Florida Paper Products – and conducted negotiations with Dade Paper & Bag Company as a potential supplier. All Florida subsequently alleged that Zupnik shared confidential information with Dade Paper in a meeting at a local restaurant. At an evidentiary hearing, the only evidence that All Florida offered of such a disclosure was testimony from a private investigator that: (1) Zupnik appeared to give Dade Paper operations manager William Baltzell a folder; and (2) Zupnik and Baltzell had All Florida invoices at the table..

The trial court enforced the non-compete provision and also found that Zupnik had shared trade secrets and confidential information with Dade Paper. The Third Circuit Court of Appeals reversed, holding that the non-compete and non-disclosure restrictions expired at the end of the two-year term. The expiration of the two-year term did not constitute a "termination" to trigger the post-employment restrictions. The Court of Appeals also overturned the trial court’s finding that Zupnik and Dade Paper misappropriated trade secrets and confidential information. The Court of Appeals held that All Florida did not show that its invoices and pricing information were confidential or that defendants misappropriated pricing information.

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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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There have been several developments in the litigation between IBM and its former executive Mark Papermaster since the Court enjoined Papermaster from working for Apple on November 6, 2008. First, the Court has ordered IBM to post a bond in the amount of $3,000,000 to cover any potential finding that IBM wrongfully obtained its injunction against Papermaster. 

Papermaster filed his Answer, Affirmative Defenses, and Counterclaims on November 13, 2008. In his Counterclaims, Papermaster sets forth his arguments that the non-compete provision of his Noncompetition Agreement with IBM is unenforceable. Papermaster argues that the provision purports to prevent him from working for any company that competes with IBM, even if: (1) he is not working for the part of the company that competes with IBM; or (2) he is not doing work similar to the work he performed for IBM. Papermaster also argues that the worldwide scope of the non-compete is overly broad, as is the one-year time limitation because of the speed with which information becomes outdated in the world of technology. Finally, Papermaster argues that the New York choice of law provision in the agreement is unenforceable because he lives in Texas, he will be working for a California company, and he has no contacts with New York. Papermaster does not seek any relief in the Counterclaims beyond a declaratory judgment that the Noncompetition Agreement is overly broad and that it should be governed by Texas or California law.

One particular footnote in IBM’s Reply in Support of its Motion for Preliminary Injunction has led to a good deal of speculation regarding IBM’s motivation and interest in bringing its claims against Papermaster. In footnote 1 of its Reply, IBM states that it has developed a memory device that would enable an iPod to store 500,000 songs, all while being cheaper to produce. This device also would permit an iPod to run on a single battery charge for weeks at a time. IBM does not contend that Papermaster worked on this particular technology. 

Various observers of the technology industry have speculated that the unnamed technology referenced in the footnote is “racetrack memory,” a technology that allegedly uses the spin of an electron to keep track of data. If the observers are correct, then they may have put meat on the bones of one of IBM’s arguments to counter Papermaster’s claim that IBM and Apple do not compete. The argument, as set forth in IBM’s Reply, is that Apple used to buy personal computer chips from IBM and now buys iPod and iPhone chips from Intel, an IBM competitor. If Apple used its P.A. Semi to produce chips for the iPod and iPhone, the argument goes, then it will deprive IBM of the chance to sell such chips to Apple.

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New York Supreme Court Justice Debra James has issued a preliminary injunction restraining a former employee of a dog care business, which provides services such as dog walking, feeding and grooming, from competing with his former employer within a ten (10) mile radius of his former employer’s business. The action is entitled The Paw Shop, LLC v. Brian Mestre, New York County Supreme Court, Index No.: 601950/08, and Justice James’s order has likely left the Defendant growling. 

Defendant commenced employment with Plaintiff in January 2007 as a receptionist, kennel manager, driver and assistant dog trainer. On July 27, 2007, Defendant signed an “Employee Non-Compete Agreement,” which included a two year, ten (10) mile radius restrictive covenant against direct competition with Plaintiff. The covenant was to be effective from the date of termination, and the restrictive radius was to be measured from the location of Plaintiff’s business at the time of termination; the covenant was to be effective regardless of the reason of Defendant’s termination. At the time of entering into the non-compete agreement, Defendant received a pay-raise as consideration.

Defendant’s employment was terminated in May 2008, and Plaintiff shortly thereafter commenced the action and moved for the preliminary injunction enforcing the restrictive covenant, alleging that the Defendant had been observed performing dog walking services for the Plaintiff’s clients within the restricted radius.

In granting Plaintiff’s motion, Justice James found that the duration and scope of the restrictive covenant were not “unduly burdensome to the defendant.” Although silent as to its reasoning with regards to the duration, the Court found that the ten (10) mile radius was reasonable because: “defendant lives more than ten miles away from plaintiff’s business, and during the period of the covenant may certainly provide services to dog owners in the neighborhood where he resides.”

The Court found that the Defendant’s services were likely to be “unique” and/or “extraordinary,” by reason of affidavits of former customers of Plaintiff averring such. Ironically, these affidavits were submitted by Defendant in opposition to the motion. Surprisingly, given the result, the Court found that Plaintiff had failed to make a showing that Defendant had either used Plaintiff’s customer lists or used confidential client information. Regardless of this lack of showing, however, the Court nevertheless granted the preliminary injunction, citing holding finding that Plaintiff was being irreparably harmed by Defendant’s providing dog walking services to Plaintiff’s clients within the restricted area.

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On November 6, 2008, Judge Kenneth Karas of the United States District Court for the Southern District of New York granted preliminary injunctive relief to IBM and ordered that a former executive, Mark Papermaster, refrain from working for Apple. 

According to IBM’s Complaint, Papermaster worked for IBM as a member of the Company’s elite Integration and Values Team, which has a hand in developing corporate strategy. On June 21, 2006, Papermaster executed a Noncompetition Agreement with IBM that forbids Papermaster from engaging in or associating with any competitors within the area for which Papermaster had job responsibilities at IBM. At the time of his resignation, Papermaster served as IBM’s Vice President for a unit that designs and delivers servers using “blade” technology.   

Papermaster announced his intent to resign on October 13, 2008. IBM made efforts to retain Papermaster, offering him a salary increase, as well as the possibility of a year’s salary in return for not competing against the company. Papermaster declined these offers and resigned from employment with IBM on October 21, 2008. Papermaster set his last day of employment as October 24, 2008. Upon joining Apple, Papermaster was slated to become the Senior Vice President for Devices Hardware Engineering. According to Apple, Papermaster would supervise the development of iPods and iPhones in this position.

On October 22, 2008, IBM sued Papermaster in the Southern District of New York, and filed a Motion for Preliminary Injunction two days later. In the Complaint, IBM asserts that Papermaster breached the terms of the Noncompetition Agreement and misappropriated trade secrets. IBM specifically alleges that it competes with Apple in three areas: servers, personal computers, and microprocessors. The Noncompetition Agreement contains an exclusive jurisdiction clause mandating that all actions under the Agreement take place in the state and federal courts for Westchester County, New York. 

Papermaster responded to IBM’s Motion for Preliminary Injunction with several arguments. Papermaster argued that Apple does not compete with IBM because Apple is in the consumer electronic products market, whereas IBM focuses on business systems such as servers and IT infrastructure. More specifically, Papermaster claimed that the needs of microprocessors for servers and consumer electronics are different, with the former emphasizing speed and the latter emphasizing efficient use of power. Papermaster also contended that IBM could not show that it faced irreparable injury because it permitted Papermaster to continue to work for IBM and access its confidential information for two weeks after Papermaster stated his intention to resign. If Papermaster was privy to so much IBM confidential information and represented such a competitive threat, the argument goes, then why was he permitted to remain employed by IBM with unfettered access to its various systems and facilities after announcing his intention to join Apple?

Papermaster also argued that injunctive relief was inappropriate because the Noncompetition Agreement was unenforceable as written for two reasons. First, Papermaster offered that the Agreement was overbroad in that it purported to prevent him for working for a competitor, regardless of whether his acts were actually competitive. Second, Papermaster contended that the one-year time period covered by the non-compete provision was an “eternity” in the electronics industry and thus should not be considered reasonable under the circumstances. Third, Papermaster asserted that the agreement was overbroad because IBM claimed that the Agreement purported to cover the entire world. Papermaster further asserted in a footnote that because Papermaster lives in Texas and works in California, New York law should not govern the dispute, but it acknowledged that it did not have the space to fully develop this argument.  You can find IBM's reply brief here.

Although Judge Karas granted IBM’s Motion for Preliminary Injunction at the conclusion of the November 6, 2008 hearing, in the entry for the case on the Court’s docket, Judge Karas sets forth that an Opinion will follow. Until such time, it is unclear which arguments the Court found persuasive.  The case nonetheless continues.  At present, the parties are litigating the issue of the amount of a bond to be paid by IBM to the Court.  It also is likely that the parties will now want to engage in expedited discovery, a topic that will be discussed in a November 18, 2008 court conference.

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Eric Rush (a/k/a Eric Romero), a 37-year old dance instructor in Texas, was jailed last week when he violated the Court's order enforcing his non-compete agreement with his former employer, Arthur Murray Dance Studios in Plano, Texas.  The Associated Press reported that Rush a/k/a Romero was unrepentent. 

Rush acknowledged in a jailhouse interview that he advertised his services and provided forbidden dance lessons to students in the area.

But in his defense, Rush said, he couldn't help himself.

"I love to dance," Rush told The Dallas Morning News. "It's my soul."

(Assoc. Press Oct. 18, 2008.)

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Earlier this year, the Georgia Court of Appeals made news in Atlanta Bread Company Int'l v. Lupton-Smith, Court of Appeals Case No. A08A0348, when it struck down in-term restrictive covenants of a franchisee on the grounds that the in-term restrictive covenants did not pass the test of reasonableness applied to post-term restrictive covenants.  In this case, the franchisee had opened several allegedly competing stores at the same time that he was operating Atlanta Bread Company franchises.  Atlanta Bread Company then terminated his franchise.   The Court of Appeals ruled that the post-term restrictive covenants and the in-term covenants were inextricably tied and because the post-term restrictive covenants did not pass muster, the in-term covenants also failed. 

The case has sparked great interest within the franchise community, as the International Franchise Association has indicated that the lower court decision would wreak havoc on franchise systems in Georgia by  rendering  "unenforceable the in-term restrictive covenants in the vast majority of franchise contracts for businesses operated in Georgia, including many of the most well-known and respected franchises in the world."   The Court of Appeals ruling was cast as opening the door for franchisees potentially to compete with their own franchisors during the term of the franchise agreement.  Georgia applies strict scrutiny review to post-termination restrictive covenants between franchisees and franchisors, which is the same standard applied to such agreements between employees and employers.  As a result, Georgia will not blue pencil such an agreement, even though it will blue pencil a non-competition covenant contained in the sale of a business.  

On October 6, 2008, The Georgia Supreme Court granted Atlanta Bread Company's petition for certiorari.  The Court agreed to hear, in particular, the following questions:

1. Did the [Court of Appeals] err in holding that under Jackson & Coker v. Hart, 261 Ga. 371 (1991), the reasonableness standard applicable to post-termination restrictive covenants also applies to in-term restrictive covenants?

2. Did the [Court of Appeals] err in applying to in-term restrictive covenants in franchise agreements the rule against allowing the blue-pencil doctrine of severability.

The Supreme Court's decision to grant certiorari means that oral argument is mandatory.  The case will proceed on the January 2009 oral argument calendar. 

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Nixon Peabody v. Taylor Wessing France, 2008 NY Slip Op. 51885(U) (Sup. Ct. Monroe Cty. Sept. 16, 2008).

A trial court in upstate Monroe County, New York earlier this month granted summary judgment for law firm Nixon Peabody LLP (“Nixon”), which sought a declaratory judgment and injunctive relief as a result of alleged tortious interference with prospective business relations by French law firm Taylor Wessing France (“Taylor Wessing”). 

On July 31, 2007, in anticipation of entering into merger discussions, the two firms had executed a Mutual Non-Disclosure Agreement (the “Agreement”) containing a non-solicitation provision stating that neither firm would “employ or offer partnership directly or indirectly” to any partners or attorneys of the other firm for a period of two years from the date of the agreement. The merger negotiations eventually broke down in October 2007. However, Taylor Wessing’s founding partner subsequently joined Nixon and brought with him a dozen of Taylor Wessing’s non-equity partners. 

When Taylor Wessing sought to enforce the Agreement’s non-solicitation provision, Nixon filed this action, seeking a declaration that the Agreement was unenforceable and requesting injunctive relief preventing Taylor Wessing from interfering with its former partners’ right to join Nixon. Taylor Wessing brought suit against Nixon in New York County Supreme Court (subsequently consolidated with the Monroe County action and transferred to Monroe County) asserting claims for breach of the Agreement, aiding and abetting a breach of fiduciary duty, and tortious interference with contractual relations.

In a detailed decision that could have significant consequences for law firms engaged in merger or acquisition talks, the Monroe County trial court held that the Agreement was unenforceable as violative of New York State public policy. Citing to a 1989 New York case that “codified” ethics opinions by the ABA and the New York County Lawyers Association, the court noted that it is unethical for an attorney to include a restrictive covenant in an employment contract with another attorney. However, the court went on to observe that the policy “embraced” by this rule is not limited solely to employment agreements, and that this authority has been “woven into the fabric of New York case law.” The court concluded that the rationale behind the rule — protecting lawyers’ autonomy and the ability of clients to freely chose their counsel — applies to the Agreement in this case which, as the court characterized it, contained “an out-right prohibition[n] on the practice of law,” to which the affected non-equity partners had not agreed and of which they had no knowledge.  The court also granted summary judgment in favor of Nixon on Taylor Wessing’s fiduciary duty and tortious interference claims. The slip opinion can be viewed here . 

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A maritime attachment arising out of a contract action is appropriate where the underlying contract’s nature and character is one of maritime and not simply a non-competition agreement, the Second Circuit ruled recently in Williamson v. Recovery Ltd. Partnership, __ F.3d __, 2008 WL 3876570 (Aug. 22, 2008).

The plaintiffs in Williamson had assisted a recovery operation for the S.S. Central America, a steamship that sank off the coast of South Carolina in 1857. In return for a fraction of a percentage of any recovery, the plaintiffs had executed non-disclosure and non-competition agreements. After a successful recovery operation, defendants were able to sell the gold, silver, and valuable artifacts recovered from the S.S. Central America. But defendants never paid the plaintiffs their share, forcing the plaintiffs to bring a breach of contract action in Ohio State Court. 

Defendants removed the State Court action to federal court, and plaintiffs then filed a maritime action in the United States District Court for the Southern District of New York, in which plaintiffs sought an attachment on the salvage from the S.S. Central America. After the district court resolved, among other things, an order to show cause on the attachment in favor of plaintiffs, defendants appealed.

On appeal before the Second Circuit, the defendants argued that plaintiffs’ non-compete agreements were not maritime contracts (and thus there was no federal jurisdiction and prejudgment interest), but instead only non-competition agreements. The Second Circuit disagreed, noting that the test for whether a contract sounds in maritime law is its nature and character, and whether the contracts “principle objective . . . is maritime commerce . . . .” Thus, because the principle objective of the non-competition agreements concerned maritime operations (a salvage recovery operation), the Second Circuit concluded that “[w]hile the Defendants may be correct in stating that these are just standard non-compete, nondisclosure, and lease contract agreements, they are incorrect in arguing that the contracts are therefore not maritime contracts.”

Accordingly, companies entering into non-competition and non-disclosure agreements regarding maritime commerce should expect those contracts to provide federal maritime jurisdiction as non-competition agreements and maritime contracts are not mutually exclusive.

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On August 7, 2008, in Edwards v. Arthur Andersen LLP, No. S147190, the California Supreme Court seemingly ruled that Section 16600 of the Business and Professions Code prohibits every attempt by an employer to enforce a non-competition agreement. The court indicated that the only exceptions are those expressly set forth in the statute (agreements in connection with the sale or dissolution of a business).

The same day, a class-action complaint was filed in Contra Costa County Superior Court, Vokes, et al. v. Central Garden & Pet Co., No. C 08-01994, that could test the reach of the Edwards decision.  Plaintiffs are asking the court to invalidate a non-compete agreement signed by Vokes when he became Central Garden’s Senior VP Sales and Trade Relations and, on behalf of all all Central Gardens employees, seeking to invalidate all of Central Gardens’ non-compete agreements as violating Section 16600 and related California statutes.

For more than 20 years prior to going to work for Central Gardens, Vokes had been employed by Doskocil, a competitor of Central Gardens. When he left in January 2007, he was VP of Sales. Upon becoming employed by Central Gardens as its Senior VP Sales and Trade Relations, he signed a non-compete agreement. It provided for 24 months of paid post-termination “independent contractor” status (according to the complaint, however, the compensation amount was “a small fraction of his wages as [a Central Gardens] employee”). The agreement mandated non-competitor employment and non-customer solicitation, in virtually any geographic market served by Central Gardens' market, during and for the 12 months following the “independent contractor” period.

In July 2008, Vokes resigned from Central Gardens and returned to Doskocil, in Texas. Central Gardens immediately sued in Texas to enforce the agreement and obtained a TRO (according to the Contra Costa County complaint, ex parte and without notice) against Vokes and Doskocil. They then filed the Contra Costa County complaint.

Whether the Contra Costa County court will adjudicate the complaint or will stay the action in light of the earlier-filed Texas complaint is uncertain. Also unclear is whether the Contra Costa County Court will certify the class and whether the agreement might be enforceable at least during the 24-months “independent contractor” period. The outcome of this case, if it proceeds, will be interesting.

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 By Robert Milligan, Kurt Kappes and James McNairy

The California Supreme Court released its highly anticipated decision in Edwards v. Arthur Andersen LLP  today and held that employee non-competition agreements are invalid, even if narrowly drawn, unless the agreement falls within a statutory exception. 

In doing so, the Court rejected the Ninth Circuit’s narrow restraint exception, which excepted the prohibition contained in Business and Professions section 16600 on non-competition agreements where one was barred from pursuing only a small part or limited part of the business, trade or profession.

In its decision, the Court limited its review to two issues:

1)      To what extent does Business and Professions Code section 16600 prohibit employee non-competition agreements;

2)      Is a contract provision requiring an employee to release “any and all” claims unlawful because it encompasses nonwaivable statutory protections, such as the employee indemnity protection of Labor Code section 2802.

The Court concluded that Business and Professions Section 16600 prohibits employee non-competition agreements unless the agreement falls within the applicable statutory exceptions of sections 16601, 16602, or 16602.5. The Court also held that a contract provision whereby an employee releases “any and all” claims does not encompass nonwaivable statutory protections, such as the employee indemnity protection of Labor Code section 2802.

On the first issue, the Court found that California state courts have consistently affirmed that section 16600 evinces a settled legislative policy in favor of open competition and employee mobility. Section 16660 states: “Except 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.” (emphasis added) The chapter excepts non-competition agreements in the sale or dissolution of corporations (§ 16601), partnerships (§ 16602), and limited liability corporations (§ 16602.5). 

The Court noted that it had previously invalidated an otherwise narrowly tailored agreement as an improper restraint under section 16600 because it required a former employee to forfeit his pension rights on commencing work for a competitor (citing Muggill v. Reuben H. Donnelley Corp. (1965) 62 Cal.2d 239, 242-243). The Court, quoting Muggill, stated section 16600 invalidates provisions in employment contracts and retirement pension plans that prohibit “an employee from working for a competitor after completion of his employment or imposing a penalty if he does so unless they are necessary to protect the employer’s trade secrets.”

The two clauses at issue in Edwards’ agreement with Andersen provided:

1)      If you leave the Firm, for eighteen months after release or resignation, you agree not to perform professional services of the type you provided for any client on which you worked during the eighteen months prior to release or resignation. This does not prohibit you from accepting employment with a client. 

2)      For twelve months after you leave the Firm, you agree not to solicit (to perform professional services of the type you provided) any client of the office(s) [Los Angeles] to which you were assigned during the eighteen months preceding release or resignation. 

Andersen argued that the Court should interpret the term “restrain” under section 16600 to mean simply to “prohibit,” so that only contracts that totally prohibit an employee from engaging in his or her profession, trade, or business are illegal. 

The Court rejected that argument and found that Andersen’s non-competition agreement was invalid because the two specific clauses at issue in the agreement restricted Edwards from performing work for Andersen’s Los Angeles clients and therefore restricted his ability to practice his accounting profession. 

Earlier in the decision, the Court expressly stated it did not address the applicability of the “so-called trade secret exception to section 16660.” Before the Supreme Court granted the petition for review in Edwards, the lower appellate court’s decision remanded the case to the trial court to determine if the trade secret exception applied, i.e. the non-competition agreement was necessary to protect trade secrets. The Court’s disposition indicates that the issue is closed though and that there will be no such remand to the trial court:

We hold that the noncompetition agreement here is invalid under section 16600, and we reject the narrow-restraint exception urged by Andersen. Noncompetition agreements are invalid under section 16600 in California even if narrowly drawn, unless they within the applicable statutory exceptions of sections 16601, 16602, or 16602.5

Andersen asked the Court to adopt the limited or “narrow-restraint” exception to section 16600. The Court noted that confusion over the Ninth Circuit’s application of section 16600 arose in a paragraph in the Ninth Circuit’s decision in Campbell v. Trustees of Leland Stanford Jr. Univ. (9^th Cir. 1987) 817 F.2d 499, in which the Ninth Circuit stated that some California state courts have excepted application of section 16600 “where one is barred from pursuing only a small or limited part of the business, trade or profession” (citing Boughton v. Socony Mobil Oil Co. (1964) 231 Cal.App.2d 188 and King v. Gerold (1952) 109 Cal.App.2d 316). The Court found that the reasoning in these state court cases does not provide persuasive support for adopting the narrow restraint exception because Boughton involved the use of land, not a restriction upon a plaintiff’s practice of a profession, and King relied upon a trade secret exception to the statutory rule. 

The Court acknowledged that recent Ninth Circuit cases have followed Campbell to create a narrow-restraint exception to section 16600 in federal court. The Court stated that California state courts have not embraced the Ninth Circuit’s narrow restraint exception and stated “no reported California state court decision has endorsed the Ninth Circuit’s reasoning, and we are of the view that California courts have been clear in their expression that section 16660 represents a strong public policy of the state which should not be diluted by judicial fiat” (citing Scott v. Snelling and Snelling, Inc. (N.D. Cal. 1990) 732 F. Supp. 1034, 1042).

In sum, while the Court’s decision clearly states California does not recognize a “narrow restraint” exception to the general rule that employee non-competition agreements are invalid, the Court did not specifically address when non-solicitation of customer and employee clauses are permissible to protect trade secrets. 

The San Francisco Chronicle also has posted an article about this case.

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           According to the California Supreme Court's website, the Court’s highly anticipated decision in Edwards v. Arthur Andersen, LLP will be available tomorrow, August 7, 2008 at 10:00 a.m. on the Court’s website.

            Trade secret and employment attorneys have been closely following the Edwards case after the Supreme Court granted review of the case on November 29, 2006. 

            In the lower court, the Court of Appeal for the Second Appellate District expressly rejected somewhat settled Ninth Circuit case law that provides an exception to the general rule in California that covenants not to compete are unlawful in the employment context pursuant to Business and Professions Code section 16600. The narrow restraint exception essentially provides that a noncompetition agreement is not unlawful where it leaves a substantial portion of the market open to the employee. The lower court expressly found that the narrow restraint exception was a “misapplication of California law when applied to an employee’s noncompetition agreement.” The court further stated “[i]n our view, section 16600 prohibits noncompetition agreements between employers and employees even where the restriction is narrowly drawn and leaves a substantial portion of the market available for the employee.”

            The lower court also found that the broadly worded release that Edwards allegedly was required to sign was unlawful because it purportedly waived Edwards’ Labor Code section 2802 rights. Labor Code section 2802, subdivision (a), provides: "An employer shall indemnify his or her employee for all necessary expenditures or losses incurred by the employee in direct consequence of the discharge of his or her duties . . ." The lower court held that “[b]ecause Labor Code section 2802's indemnity provisions implement public policy, requiring Edwards to waive indemnity rights as a condition of continued employment violated public policy and constituted an independently wrongful act for purposes of . . .[Edwards’] intentional interference with prospective economic advantage claim.”

            The issues that the Supreme Court are expected to address in tomorrow’s decision are:

 (1) Is a non-competition agreement between an employer and an employee that prohibits the employee from performing services for former clients invalid under Business and Professions Code section 16600, unless it falls within the statutory or judicially-created trade secrets exceptions to the statute?

(2) Does a contract provision releasing "any and all" claims the employee might have against the employer encompass non-waivable statutory protections, such as the employee indemnity protection of Labor Code section 2802?

            We will provide a follow-up blog entry once the decision comes out.  

By Robert Milligan, James McNairy and Summer Associate Julia Brodsky

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In an order dated July 25, 2008, the Georgia Court of Appeals reiterated that non-compete provisions in Georgia cannot prohibit an ex-employee beyond performing services related to the employer’s business. Avion Systems, Inc. v. Thompson, No. A07A1488, 2008 WL 2854300 (Ga. App. Jul. 25, 2008). In Avion Systems, the Court of Appeals was asked to determine whether the following non-compete provision was enforceable:

For a period of twelve (12) months following the completion of project, the Employee unconditionally agrees to not deal directly, indirectly, or by any other means, either individually or in association with another individual or organization for any pecuniary gain with Corporation's customer or their client to whom he is assigned at the particular job site for that particular division or subdivision with whom Employee had contact....

Despite the fact that the non-compete provision was limited to 12 months in duration and to the customer to whom the employee was assigned, the Court of Appeals held that the provision was unenforceable. The restriction ran afoul of the prohibition in Georgia against “in any capacity” restrictions:

Here, the covenant did not specify the activities in which Thompson was prohibited from engaging, but instead prohibited her from dealing with a client “for any pecuniary gain,” regardless of whether her activities were related to Avion’s business. The provision was thus overbroad and unenforceable, as it is not reasonably necessary to protect the interests of Avion.

Avion Systems stands as a reminder that Georgia has very particular requirements for the enforcement of non-compete provisions and that an employer must pay attention to those requirements to have any chance of enforcing post-employment restrictions.

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TalentBurst, Inc. v. Collabera, Inc., Civ. No. 08-10940-WGY (D. Mass. July 25, 2008).

A federal court in Boston has dismissed a complaint brought by information technology temp agency TalentBurst against competitor Collabera for aiding and abetting a breach of fiduciary duty by TalentBurst’s former employee, who subsequently joined Collabera, on the ground that the employee owed no fiduciary duty of loyalty to TalentBurst.

Raj Mohan Pallerla was hired by TalentBurst as a systems administrator and, as a condition of his employment, was required to sign an employment agreement that included non-compete and non-solicitation provisions. While employed by TalentBurst, Pallerala performed work for one of Collabera’s clients pursuant to a consulting services agreement between the two firms. Immediately after resigning from TalentBurst, Pallerla became employed by Collabera where he continued without interruption servicing the same Collabera client he had serviced while employed by TalentBurst. In response to TalentBurst’s letter demanding that it enforce Pallerla’s restrictive covenant, Collabera asserted that TalentBurst had waived enforcement of the covenant by entering into the consulting services agreement with Collabera.

TalentBurst brought suit against Collabera alleging that Collabera aided and abetted Pallerla’s breach of his fiduciary duty to TalentBurst. The court, however, rejected this claim because Pallerla’s job title, duties, and the fact that he was hired out to clients while at TalentBurst demonstrated that he was a “worker bee” rather than a manager, executive, or officer. Thus, under Massachusetts law he owed no fiduciary duty of loyalty to his employer. The court concluded that because there was no predicate breach of fiduciary duty by Pallerla, and no direct fiduciary relationship between TalentBurst and Collabera, the claim must fail. 

Of particular interest, the court noted that TalentBurst failed to allege that Pallerla “was entrusted with confidential information or that other special circumstances existed such that he could be said to have occupied a position of ‘trust and confidence.’” In a footnote, the court further observed that “although it is clear that the employment agreement, including the Covenant, created contractual duties on Pallerla’s part, TalentBurst cites no authority for the proposition that the signing of a restrictive covenant also creates a fiduciary obligation.”

Based on this conclusion, the court also dismissed TalentBurst’s claim for tortious interference because the “aiding and abetting” was the sole basis upon which TalentBurst alleged that it had satisfied the element requiring improper means or motive. The court went on to consider whether Collabera’s interference with the restrictive covenant itself created a presumption that Collabera had an improper motive. Although other Massachusetts state court cases suggested this might be sufficient, the court found those cases distinguishable because in those cases the defendants obtained and used confidential information through the employee, whereas here there was no allegation that Collabera did anything more than simply hire TalentBurst’s employee. In addition, the court concluded that Collabera might have had a legitimate motive for hiring Pallerla, namely to save money by employing him directly.

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By Robert Milligan and Summer Associate Justin de Herrera

In City of Oakland v. Hassey, 163 Cal.App.4th 1477, (June 17, 2008), a California appellate court recently rejected a police officer’s claim that a provision in his employment contract requiring him to reimburse the City of Oakland for his training expenses constituted an illegal covenant not to compete in violation of Business & Professions Code Section 16600. The former Oakland police officer agreed in his employment contract to pay back the cost of his police academy training if, once hired, he left the department in less than five years time. The officer’s training expenses were approximately $8,000.

On appeal, after the trial court granted summary judgment in favor of the City on its reimbursement claim, the officer contended that the provision violated Business and Professions Code Section 16600. Section 16600 provides “[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 court disagreed and found that “[n]othing prevented [Hassey] from working for another police department, or anywhere else, for that matter.” 

The appellate court relied heavily on a Seventh Circuit federal case, Heder v. City of Two Rivers, Wisconsin, 295 F.3d 777 (2002), in reaching its decision. The Heder case involved a firefighter claiming that a provision in his employment contract – similar to the one at issue in Hassey – constituted an illegal covenant not to compete. The Heder court equated the provision to other valid employment incentives that employers offer to their employees. The Heder court reasoned that the residents of the city where the firefighters worked received the benefit of a more skilled fire department, and that the city might be less likely to provide that benefit if it feared that employees would leave the fire department, taking their new skills elsewhere. 

The court’s ruling in Hassey, however, leaves many questions unanswered. For instance, does the decision only apply to repayment provisions in government employment contracts or only those of public safety officials for that matter? After all, the court’s reference to Heder seems to suggest that when the agreement benefits city residents, additional latitude is granted to the government. On the other hand, if the ruling does apply to private employment contracts, how much money may an employer seek in reimbursement from an outgoing employee for training expenses, if at all, before a court finds that a Section 16600 restraint exists? To some, a $8,000 bill could represent a serious impediment to changing jobs.

More importantly, however, how does the court’s ruling in Hassey square with California Labor Code section 2802? That section requires an employer to “indemnify his or her employee for all necessary expenditures or losses incurred by the employee in direct consequence of the discharge of his or her duties . . . ” Oakland required that all of its officers obtain licensed academy training before becoming police officers. 

Interestingly, the court, in an addendum to its original decision, refused to address this issue because Hassey did not rely on Labor Code Section 2802 in his answer and because Hassey did not allege a Labor Code Section 2802 cause of action in his cross-complaint . The court also refused to address Hassey’s argument that the agreement violated Labor Code 2804 [contracts waiving benefits of this article or any part thereof are invalid] for similar reasons. Currently, Edwards v. Arthur Andersen, LLP, a case that will decide whether an employee can waive the protections of Labor Code Section 2802, is currently on appeal with the California Supreme Court. Oral argument was held on June 4, 2008 and an opinion in the case is due at any time.

Due to the many unanswered questions that the Hassey decision prompts, its application to private employment contracts remains dubious. The Supreme Court’s pending decision in Edwards v. Arthur Andersen, LLP may provide some additional guidance.

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