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

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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