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

By Kate Perrelli and Erik Weibust

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

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

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

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In a landmark decision just issued, the Illinois Appellate Court, Fourth District, ruled that an ex-employer seeking to enforce a covenant-not-to-compete against former sales personnel need only show that the time-and-territory restrictions are reasonable and need not prove, in addition, that there is a sufficient legitimate-business-interest in enforcement. 

In Sunbelt Rentals, Inc. v. Ehlers, No. 4-09-0290 (9/23/09), the appellate tribunal agreed with the trial judge that the defendants’ conduct amounted to breach of a reasonable contract and affirmed the entry of a preliminary injunction prohibiting the defendants from violating the covenant. The appellate court held for the first time that the plaintiff’s business interest – that is, a showing not only that the time-and-territory restrictions were reasonable but also that the ex-employer had a “near permanent relationship” with customers and/or that information it provided to ex-employees was confidential – is irrelevant. In the process, the court overruled a number of its own prior decisions and criticized the reasoning of virtually every previous Illinois intermediate appellate decision in point. 

Interestingly, the primary basis for this dramatic shift is the absence of any mention of the legitimate-business-interest test in a 2006 Illinois Supreme Court opinion (Mohanty v. St. John Heart Clinic, S.C., 225 Ill. 2d 52, 866 N.E.2d 85) enforcing a restrictive covenant. (For entertainment, read the Sunbelt court’s explanation for affirming the circuit court judge notwithstanding that judge’s indisputable violation of the principle “that a trial court is not free to ignore binding precedent from the appellate court in its own district.”) 

Note that the time to seek rehearing of the Sunbeltdecision, or a petition for leave to appeal to the Illinois Supreme Court, has not yet expired.

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I recently ran across this newsletter article regarding taxation of non-compete clauses in the sale of closely held businesses and thought it worth passing along for those who find themselves negotiating non-compete agreements in the context of the sale of a closely held business.

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In the back and forth battle between companies and former employees regarding the confidential nature of customer information, the United States District Court for the District of Nebraska has just issued a decision of note in Softchoice Corp. v. MacKenzie, 08-cv-00249. By the decision, the Court dismissed the action as against the defendant, finding that despite plaintiff’s treatment of the information as secret, had plaintiff truly wished to protect the information it should have had defendant enter into a properly tailored covenant not to compete instead of only having him sign a nondisclosure agreement.

The action was brought by Softchoice against MacKenzie, a former employee, alleging the usual panoply of claims: breach of confidentiality, misappropriation of trade secrets and confidential business information, unfair competition and tortious interference with business relations. The confidential information was alleged to be customer contact information and pricing. MacKenzie had not signed a non-compete covenant, but had signed a nondisclosure agreement.

In dismissing the action, Judge Joseph F. Batailon found that:

“The plaintiff cannot succeed on its claims for breach of contract, misappropriation of trade secrets or unfair competition without a showing that the information he allegedly misappropriated was a trade secret … MacKenzie has [] shown that he obtained the only information that could arguably be categorized as ‘secret,’ that is, pricing information, from the potential customers themselves, who freely shared the information with him in hopes of obtaining a lower price. MacKenzie has also shown that his suppliers shared this sort of information …”

This segued into the Court’s interpretation of the extent nondisclosure agreements will protect customer information:

“Softchoice, or its predecessor, could have limited MacKenzie’s contact with his former customers, and consequently protected its pricing information, through a narrowly drawn, valid and enforceable covenant not to compete, but id did not do so. Softchoice cannot achieve by way of a nondisclosure agreement what it could not have obtained via a non-solicitation agreement …”

It will be interesting to watch if any other courts pick up on Judge Batailon’s interpretation of nondisclosure agreements.

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Emigra Group, LLC v. Fragomen, Del Rey, Bernsen & Loewy LLP, et al., No. 07 Civ. 10688 (LAK) (S.D.N.Y. Mar. 31, 2009).

In a decision that should be considerable reassurance to employers in general and law firms in particular, a district judge in New York has rejected an antitrust claim brought by a consulting firm against its former employer, an attorney who returned to his former law firm. 

Emigra, an immigration consulting firm, sued its former vice president of operations, Ryan Freel, and the law firm that was his prior and subsequent employer after Freel resigned from Emigra and returned to practicing law at Fragomen, Del Rey, Bernsen & Loewy, an international immigration law firm headquartered in New York. Emigra alleged that Freel took confidential and trade secret information that he had obtained while employed by Emigra, including strategies, customer lists, pricing information, and profit and loss data; disclosed this information to Fragomen; and used it to contact Emigra’s customers on Fragomen’s behalf.

However, the court noted that while Emigra filed “the usual state law claims for misappropriation of trade secrets, unfair competition, and the like,…it did not seek a preliminary injunction.” Instead, Emigra asserted a number of antitrust claims and, the court noted, there is reason to believe that it did so in order to “gain access through pretrial discovery to precisely the sort of competitively sensitive information about Fragomen’s business that Emigra claims Freel improperly disclosed to Fragomen about Emigra’s business.”  

In a lengthy 63-page opinion, the district judge granted the defendants’ summary judgment motion. Among other findings, the court concluded that Emigra had offered no evidence of price control, exclusion of competition, or monopoly power in violation of the antitrust laws, and that “a contrary conclusion would turn many disputes over the hiring by one competitor of an employee of another, the stuff of everyday commercial tort claims, into monopolization or attempted monopolization cases.” The court further noted that Emigra cannot avoid summary judgment through “gamesmanship” by withholding its own evidence while insisting that its competitor reveal its competitively sensitive information. For these and other reasons, the court dismissed the federal antitrust claims on the merits with prejudice, and declined to exercise supplemental jurisdiction over the remaining state-law trade secret and unfair competition claims. The decision serves as a warning to litigants who might consider pursuing questionable antitrust claims in federal court as a means for obtaining discovery that would not otherwise be available to them in a state court proceeding.

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April 02, 2009
Daily Journal   Reprinted and/or posted with the permission of Daily Journal Corp. (2009).

The California Supreme Court's decision in Edwards v. Arthur Andersen LLP, 44 Cal.4th 937 (2008), reaffirmed that employee non-competition agreements are void in California unless they fall within narrow exceptions to Business and Professions Code Section 16600.

Notwithstanding the Edwards decision, it may be possible for employers to enforce non-competition forfeiture provisions in California by including them in retirement plans subject to the Employee Retirement Income Security Act of 1974. ERISA is a federal statute that governs most employee benefit plans (except those provided by government entities and churches), including retirement plans. ERISA plans are protected by a well-formed pre-emption doctrine that applies to most state laws except those regulating insurance, banking or securities matters.

In a series of cases dating back as early as 1980, the 9th Circuit has examined the inclusion of non-competition forfeiture provisions in ERISA plans and has determined that such clauses are permissible under ERISA, with some limitation, and state law is pre-empted on this issue.

It is important to point out that a non-competition forfeiture provision in an ERISA plan cannot apply to any amount an employee voluntarily contributes to a plan because such amounts are always automatically 100 percent vested and not otherwise subject to forfeiture. Similarly, a forfeiture provision added to an ERISA plan could not apply to benefits earned prior to the adoption of the amendment.

Also, ERISA's vesting rules generally establish a maximum time period over which employer contributions to a plan must vest. At the time most of the relevant 9th Circuit cases were decided, ERISA permitted employers to choose between one of two vesting schedules for employer contributions. One schedule was a 10-year "cliff vesting" schedule whereby an employee was zero percent vested until he or she worked for the employer for 10 years, at which time the employee became 100 percent vested. The other schedule provided for a graduated vesting schedule that allowed an employee to vest in incremental percentages (usually 10-20 percent) over time, but not to exceed 15 years.

These vesting rules have been amended a number of times over the years, and currently, employer contributions to profit-sharing and 401(k) plans must vest under either a three-year cliff vesting schedule or a six-year graduated schedule at the rate of 20 percent, beginning with the second year of service.

Accordingly, including a forfeiture provision in a profit-sharing or 401(k) plan may not be as effective as it was when the relevant cases were decided. Now, however, it may be more effective to include non-competition forfeiture provisions in top-hat or other executive compensation plans (which are generally ERISA plans that are exempt from the vesting rules). And there are others commentators who have suggested adding forfeiture provisions to ERISA-covered severance plans as another way of achieving this goal. No 9th Circuit cases have examined whether a forfeiture provision could be included in a top-hat or ERISA-covered severance plan but the arguments in favor of ERISA pre-emption should be the same as in the relevant cases. Instructively, the 2nd Circuit has held that state law was pre-empted by ERISA in the context of a top-hat plan containing a non-competition forfeiture clause and found that the forfeiture provision was valid. One of the earliest cases to examine the inclusion of a non-competition forfeiture provision was the pre-ERISA case of Muggill v. The Reuben H. Donnelley Corporation, 62 Cal. 2d 239 (1965). In Muggill, the California Supreme Court analyzed the validity of a provision in a pension plan that provided that an employee's right to receive payments from the plan would be terminated if he went to work for a competitor. The court held that the pension plan became part of the employment contract and, therefore, the forfeiture provision was invalid under Section 16600 - "[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."

ERISA was enacted in 1974 and, thereafter, the 9th Circuit's first occasion to analyze a non-competition forfeiture provision in an ERISA plan was in Hummell v. S.E. Rykoff & Co., 634 F.2d 446 (9th Cir. 1980). In Hummell, the court examined a plan provision that provided for the forfeiture of a percentage of the competing former employee's retirement benefits derived from employer contributions. The plan stated that the forfeiture provision only applied to former employees with less than 15 years of experience with the company who competed with the company (those with more than 15 years were fully vested, regardless of competitive activity).

In examining an issue of first impression, the court held that ERISA does not prohibit limited non-competition provisions that apply to amounts in excess of the minimum vesting requirements in ERISA. Ultimately, the court held that the forfeiture provision in the plan was invalid as to the plaintiff because he had more than the minimum years of service required to be 100 percent vested under that plan. Thus, the forfeiture provision was valid but it could not be applied by the company.

In Lojek v. Thomas, 716 F.2d 675 (9th Cir. 1983), the court examined a non-competition forfeiture provision contained in an ERISA-governed profit sharing plan sponsored by a law firm. The provision called for the forfeiture of all employer contributions made on behalf of an attorney who left the firm before completing 10 years of employment and engaged in competitive employment within two years of leaving within a five-county area.

The trial court granted partial summary judgment on a number of issues including that ERISA pre-empts Idaho state law on vesting and forfeiture of pension plan rights and non-competition forfeiture clauses are valid under ERISA. Lojek appealed arguing, inter alia, that Idaho common law on non-competition clauses should control and invalidated the provision. The court disagreed and held that the district court properly decided that ERISA pre-empted Idaho law and federal law governed the validity of the plan.

The plan at issue contained a vesting schedule more liberal than required by ERISA. It allowed attorneys to fully vest after completing five years of employment (the cliff vesting provision under ERISA at the time was 10 years). If an attorney worked for at least 10 years, the non-competition provision did not apply. As a result, the court held that the vesting schedule was valid.

Similarly, in Clark v. Lauren Young Tire Center Profit Sharing Trust, 816 F. 2nd 480 (9th Cir. 1987), the plaintiff argued that a forfeiture clause in an ERISA plan violated Oregon law and the plaintiff urged to the court to incorporate that law and invalidate the provision. In rejecting the plaintiff's argument, the court held that the reasoning in Lojek applied and that state law played "no part in assessing the validity of [a non-competition forfeiture provision] in an ERISA plan."

The court in Clark further held that non-competition forfeiture clauses in ERISA plans are valid so long as the plan provides that benefits earned after 10 years of service cannot be forfeited. Because ERISA's vesting requirements have been reduced, it is likely that a court reviewing facts similar to Clark today would require that the plan provide that benefits earned after three years of service cannot be forfeited (assuming the court followed the ERISA preemption authority).

Finally, in Weinfurther v. Source Services Corporation Employees Profit Sharing Plan and Trust, 759 F.Supp. 599 (N.D. Cal. 1991), the court reiterated that non-competition forfeiture clauses in the Ninth Circuit are valid (citing Lojek and Clark with approval).

Accordingly, based on the 9th Circuit authorities discussed above, employers have a plausible argument that non-competition forfeiture provisions included in ERISA plans should be analyzed under ERISA and are not subject to Business and Professions Code Section 16600. Employers should considering including ERISA plan provisions providing that an employee forfeits employer contributions exceeding ERISA's minimum vesting rules if the employee violates a non-competition provision included in the plan. The non-competition forfeiture provisions should be limited in scope and duration to the extent necessary to protect legitimate business interests.

Additionally, employers may consider trying to extend the ERISA approach to top-hat plans and ERISA severance plans (with structured payouts over time).

These approaches are not without risk and counsel should be consulted before including any non-competition forfeiture provisions as there is always a possibility that notwithstanding ERISA preemption that a court may find that it does not apply based on the strong public policy of Section 16600.

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As discussed in our March 9^th and 17^th postings, Illinois Senate Bill SB 2149 seeks to dramatically alter the landscape of trade secret enforcement and litigation in Illinois by, among other things, (a) requiring disclosure of trade secrets before a party issues written or oral discovery; (b) awarding attorneys’ fees to the prevailing party in a trade secrets case; and (c) mandating that a court enter an attorneys’ fees award against any party that subsequently amends its initial trade secret disclosure. Apparently not to be outdone, the Illinois House of Representatives is considering whether to enact a statute that would dramatically limit an employer’s ability to enforce non-competition agreements, and change the way restrictive covenant cases are handled in Illinois.

Currently, non-competition/restrictive covenant enforcement is governed by Illinois case, as opposed to statutory, law. Illinois case law does not limit the type or category of employee who can be subject to a restrictive covenant. Instead, the court examines the covenant to determine if the covenant is reasonably written (i.e. reasonable in both temporal and geographic scope) to protect a “legitimate business interest.”  A “legitimate business interest” exists if the employer demonstrates (1) near-permanent customer relationships that the employee would not know about but for his employment or (2) that the employee acquired trade secrets or other confidential information during his employment and subsequently tried to use the trade secrets for his own benefit. Lawrence & Allen, Inc. v. Cambridge Human Resource Group, Inc., 226 Ill. Dec. 331, 340, 685 N.E. 2d 434, 443 (2^nd Dist. 1997). 

In contrast, House Bill HB 4040 limits non-compete enforcement to employees or independent contractors who:

•                     have substantial involvement in the executive management of the employer’s business;

•                     have direct and substantial contact with the employer’s customers;

•                     possess knowledge of the employer’s trade secrets and/or proprietary information;

•                     possess such unique skills that they have achieved “a high degree of public or industry notoriety, fame, or reputation as a representative of the employer,” or

•                     are among the highest paid 5% of the employer’s work force for the year immediately preceding the separation.

HB 4040 also changes Illinois law so that an employer loses the right to enforce a non-competition covenant if the employer fails to notify the new employee two weeks prior to the first day of his employment that a covenant not to compete is required, or if the covenant is not accompanied by a “material” advancement, promotion, bonus or compensation increase. In addition, HB 4040 alters the court’s ability to determine whether a non-competition covenant is reasonable in temporal and geographic scope (an analysis that is done on a case-by-case basis) by creating a rebuttable presumption that a non-competition covenant is invalid if:

•                     the covenant exceeds one year;

•                     the geographic restrictions in the covenant cover areas beyond which the former employee provided services “during the one year preceding his termination;”

•                     the covenant concerns personal services activities that the employee did not perform during the “one year preceding termination of the employment.”

One of the few similarities between HB 4040 and Illinois case law is that HB 4040 does allow the court to modify a non-competition covenant to “make the covenant reasonable under the circumstances.”   However, HB 4040 goes on to state that, if a court chooses to modify the covenant, then the court cannot impose a damages award for the employee’s original breach of the covenant. Instead, the court can award damages only for conduct that occurs after the modification. Finally, HB 4040 instructs a court to interpret any attorneys’ fees provision found in a non-competition covenant as allowing either the employer or the employee to recover their attorneys’ fees; and further empowers the court to award attorneys’ fees to the employee if, through a declaratory judgment action brought by the employee, the court declares the non-competition covenant unenforceable.

We will continue to monitor HB 4040’s progress through the Illinois House of Representatives.

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EqualLogic, Inc. v. Shea, (N.H. Superior Court, Hillsborough County).

In an unusual reversal, a Nashua, New Hampshire judge admitted recently that she had erred in granting a preliminary injunction barring a former executive for computer data storage company EqualLogic from working for a competitor. 

EqualLogic was acquired by computer giant Dell for approximately $1.4 billion shortly before area vice president of sales Richard Shea left EqualLogic to take an identical position with LeftHand Networks, a direct competitor in the data storage industry. Dell subsequently sought to enforce the non-compete provision of Shea’s employment contract, which prohibited him from rendering any services to a competitor within twelve months of his departure from EqualLogic. According to Shea, Dell took the overly broad position that the non-compete prevented him from talking to any EqualLogic customers or former customers, although the law allows a company to protect only its actual business interests and goodwill.

In July 2008, Judge Diane Nicolosi granted Dell’s motion for a temporary restraining order, and in September 2008, she converted the TRO to a preliminary injunction barring Shea from working for LeftHand entirely. But Shea challenged the injunction, arguing that it was improperly granted because Judge Nicolosi had failed to apply the three-part test for injunctive relief, considering the likelihood of success on the merits, the risk of irreparable harm, and the absence of an adequate remedy at law. Specifically, Shea’s attorney asserted, Dell’s position on the non-compete went above and beyond protecting its legitimate business interests and goodwill since Shea had agreed not to contact any EqualLogic customers or former customers, and Dell was now seeking to prevent Shea from contacting even potential customers who had no association with EqualLogic. The court admitted its error and lifted the injunction, concluding that EqualLogic was neither likely to succeed on the merits nor in danger of suffering irreparable harm.

While the injunction was in effect, however, Shea was forced to resign from LeftHand, forsaking both his wages and stock options that later increased in value due to LeftHand’s subsequent sale to Hewlett Packard. Arbitration between Shea and Dell over the employment agreement has not yet been resolved, and the agreement leaves open the option for Shea to seek damages. Although the ultimate outcome is uncertain, the case serves as a reminder of the potential risks to employers who seek to broadly enforce non-compete provisions.

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Our own Robert Milligan and Damon Anastasia published an oustanding article in the California Lawyer on the status of the law in California on non-competition agreements in light of Edwards v. Arthur Anderson.  The article is publicly available here.

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In Southern Fire Analysis v. Rambo, No. M2008-00056-COA-R3-CV, 2009 WL 161088 (Tenn. Ct. App. Jan. 22, 2009), the Tennessee Court of Appeals reversed a trial court’s dismissal of a complaint alleging violations of three non-compete agreements. The facts are as follows:

Plaintiff Southern Fire Analysis is in the business of investigating fires on behalf of insurance company clients. Southern Fire Analysis employed James Jennings and Glenn Johnson as fire investigators. Jennings and Johnson signed “Corporate Resolution” documents in 1996 and 1997, respectively, that stated the following:

WHEREAS, in the opinion of this Board, it is for the best interests of this Corporation to adopt a No-Compete Agreement, be it

RESOLVED, That a No-Compete Agreement shall remain in effect for a period of Six (6) Months from the date of Termination with the Corporation by James D. Jennings, and shall cover an area of up to and including a One Hundred & Fifty (150) Mile radius from Nashville, Tennessee.

In 2004, Jennings and Johnson changed from being employees to being independent contractors. The Independent Contractor Agreements that Jennings and Johnson executed with Southern Fire Analysis stated that “[t]he Independent Contractor must have and maintain and must provide [Southern Fire] with documents of”... a “Valid Non-Compete Agreement effective for six (6) month time period.” Southern Fire Analysis also hired David Edge in 2005. Edge signed an independent contractor agreement, but Southern Fire Analysis was unable to locate a non-compete agreement attached to or part of the independent contractor agreement.

On July 2, 2007, Jennings, Johnson, and Edge resigned from Southern Fire Analysis, along with Southern Fire Analysis’s Nashville office manager, Michael Rambo. The four individuals started working for Southern Fire, Unified Investigations and Science, a competitor of Southern Fire Analysis. One month later, on August 3, 2007, Southern Fire Analysis initiated an action against Rambo, Jennings, Johnson and Edge. Southern Fire Analysis alleged that Edge, Jennings and Johnson were working in violation of their respective non-compete agreements. Southern Fire Analysis attached copies of the Corporate Resolutions and Independent Contractor Agreements for Jennings and Johnson. It further alleged, upon information and belief, that Rambo removed Edge’s Independent Contractor Agreement and Non-Compete Agreement from Southern Fire Analysis’s files. The Complaint also included a breach of the duty of loyalty claim against Rambo and civil conspiracy claims against all four defendants.

On September 18, 2007, all four defendants moved to dismiss, arguing that the non-compete agreements were invalid. Specifically, defendants argued that Southern Fire Analysis had not pled a protectable business interest, the non-compete agreements were overbroad in their scope, and if valid, the non-compete provisions had expired six months after the Independent Contractor Agreements were signed. Additionally, Edge moved to dismiss the breach of contract claim on the ground there was no evidence that he had entered into a non-compete agreement. The trial court granted the Motion to Dismiss, finding that “the documents relied upon by Plaintiff and attached to the Petition as non-compete agreements between it and Defendants Edge, Jennings, and Johnson are unenforceable and fail to support the claims alleged in the Complaint.” It is unclear from the Court of Appeals’s decision whether the trial court provided any further reasoning in reaching its decision.

The Tennessee Court of Appeals reversed the trial court’s finding, reciting the Tennessee standard that: “Covenants not to compete are enforceable if an employee or independent contractor would otherwise be able ‘to exercise an unfair advantage in future competition with his employer, and if they are no broader in duration or as to the territory they embrace than is reasonably necessary to secure the protection of the business or good will of the employer.’” The Court of Appeals pointed out that:

• Southern Fire Analysis attached to its Complaint copies of the alleged non-compete agreements with Jennings and Johnson.
• Southern Fire Analysis alleged upon information and belief that Edge had signed a non-compete agreement and an independent contractor agreement identical to those of Jennings and Johnson, but they could not be produced because Rambo, had removed the signed documents from the company’s files.
• Southern Fire Analysis alleged that the non-compete agreements were signed by the defendants in exchange for specialized training.
• Finally, Southern Fire Analysis alleged that defendants were competing within 150 miles of its Nashville office, the same geographic area in which they worked as fire investigators for Southern Fire Analysis.

Thus, the Court of Appeals found that Southern Fire Analysis had made a sufficient showing under Tennessee law to survive a motion to dismiss. The Court of Appeals did not explain why the trial court was wrong. Instead, it described the allegations made by Southern Fire Analysis in its Complaint and then concluded that the allegations were sufficient to set forth a claim for breach of contract. It is not clear if the Court of Appeals held that the trial court applied the wrong standard or erred in applying the right standard, possibly because the trial court likely did not set forth its reasoning. 

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Just before the end of 2008, Georgia's House Study Committee on Restrictive Covenants in the Commercia Arena, chaired by Representative Kevin Levitas, issued its final report, asking for support to "[m]oderniz[e] Georgia law" and to "attract new business to our great state and retain those companies that are already located here." 

Following two hearings involving testimony and letters from a number of witnesses (in full disclosure, I participated in providing testimony), the Committee concluded that "[t]he time has come for a change in Georgia law, both to bring our state in line with the overwhelming majority of other states as well as to establish a rule of reasonableness in the analysis of restrictive covenants." 

Additionally, the Committee recommended that Georgia courts be allowed to "blue pencil" restrictive covenants in connection with employment agreements (blue-pencling in connection with agreements relating to sale of a business already is allowed).  A couple of practitioners who testified before the Committee expressed concern that blue-penciling would make it more difficult to predict outcomes; that is that there is no certainty until the litigation concludes.  Proponents of blue-penciling countered that argument by noting that blue-penciling may lead to more negotiated settlements of disputes. 

It appears that the legislation may be headed for a hearing this session.   The question that remains is whether a constitutional amendment will be required.  Previous attempts by the General Assembly to bring clarity to Georgia's law were struck down by Georgia's Supreme Court as violating Art. III, Sec. VI, Par.  V(c) of the Constitution of Georgia of 1983, which reads: "The General Assembly shall not have the power to authorize any contract or agreement which may have the effect of or which is intended to have the effect of defeating or lessening competition, or encouraging a monopoly, which are hereby declared to be unlawful and void."  So, in addition to making it through the General Assembly, we may also see support for a constitutional amendment to avoid uncertainty in the Georgia's courts.

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In D.L. Anderson’s Lakeside Leisure Co. v. Anderson, the Wisconsin Supreme Court recently upheld an award of damages for violation of a non-compete provision in a sale of business agreement. The facts of situation are as follows:

D.L. Anderson built D.L. Anderson Co., a business offering a range of marine services and products, such as shore landscaping and manufacturing and selling and servicing piers and lifts. He sold the business for $891,000 to Scott and Steven Statz in 2000. Of the purchase price, $400,000 was allocated as consideration for Anderson executing a non-compete provision that forbade him from engaging in the business of providing marine products and services within a 120-mile radius of the business. The non-compete provision also prevented Anderson from allowing his name to be used in the industry; $200,000 of the purchase price was allocated to the business’s goodwill and for use of the trade name.

Starting in 2002, Anderson performed a number of acts that the Statzes alleged violated the non-compete agreement. Specifically, Anderson: (1) worked on the development of a boat for installing and removing boatlifts; (2) acted as a factory representative of a company that manufactured and distributed boat lifts; (3) established a new business (one mile from his prior location) named “The Sailboat House at Anderson Marine” that sold, stored, and repaired boats and sold marine accessories; and (4) publicized his ability to perform shoreline restoration work.

The Statzes sued Anderson in September 2004. In April 2006, a jury awarded compensatory and punitive damages to the Statzes for breach of the non-compete provision and trademark infringement. After the entry of the verdict, the Statzes moved for injunctive relief and asked that the non-compete provision be extended by 591 days, pursuant to a tolling provision in the sale agreement. The Statzes also requested recovery of their attorney’s fees pursuant to the agreement. The trial court granted these requests. 

The Wisconsin Court of Appeals upheld the findings of breach of the agreement and trademark infringement, as well as the damages awarded for breach of the agreement. The Court of Appeals reversed the damages award for trademark infringement and remanded the attorney’s fees issue to the trial court for further consideration.

The Wisconsin Supreme Court upheld the award of compensatory damages for the violation of the non-compete provision. In so doing, the Supreme Court found that the Statzes presented evidence showing a decrease in gross receipts for pier installation, as well as testimony attributing the decline to Anderson’s competitive activities in areas where the Statzes had previously made sales. This evidence was sufficient to uphold the award of compensatory damages. 

The Supreme Court also upheld the extension of the non-compete period. In so doing, the Supreme Court recited the Court of Appeals’s finding that the extension of the period was proper because of the jury’s findings that Anderson violated the non-compete provision and the Statzes suffered damages as a result.

The Supreme Court upheld the jury’s verdict that Anderson infringed upon the trademark that he sold to the Statzes. The Supreme Court reversed the Court of Appeals’s finding that the Statzes provided insufficient evidence to support the damages awarded by the jury for infringement. In so doing, the Supreme Court found that the Statzes were not required to offer evidence of actual confusion and negative impressions on the part of customers; the $200,000 allocated to the goodwill was sufficient to support the award, as was the testimony of the Statzes as to the value of the goodwill. The Supreme Court also cited to testimony presented by the Statzes that established customer confusion and frustration resulting from billing issues caused by Anderson operating his similarly named business. The Supreme Court concluded that the jury did not have to apportion damages with mathematical precision because of the nature of the tort. 

Because the Court of Appeals’s decision to remand the attorney’s fees question was based on its reversal of the award of compensatory damages for trademark infringement, the Supreme Court reinstated the award of attorney’s fees. The Supreme Court remanded the matter to the trial court for consideration of an award of attorney’s fees to the Statzes for fees incurred during the appellate process.

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As a result of the instability in the financial markets generally and at financial institutions in particular, the financial services industry has experienced significant turnover in 2008. The below chart recently found in the New York Times reflects that the financial services industry has experienced more layoffs than any other industry.

Because of the importance of relationships between brokers and other customer-facing personnel in the financial services industry on the one hand and customers on the other, restrictive covenants are commonplace in the industry. These covenants typically take the form of: (1) customer non-solicitation covenants, in which employees agree not to solicit the clients of their former employees for a set period of time; and (2) non-disclosure covenants, in which employees agree not to use confidential information such as client lists and account or trading information.

It is likely that the significant turnover in the financial services industry will lead to an increase in the number of disputes between financial firms and their former employers, especially as those employees who were laid off find new positions in the industry and seek to mine relationships with former customers. (The obvious exception here is that employees laid off by liquidating financial institutions do not face the prospect of being sued by their former employers.)

an additional factor that can lead to an increase in restrictive covenant litigation in the financial services industry is the prevalence of larger firms buying smaller or distressed firms. Acquisitions of new companies often lead to restrictive covenant litigation because the employees of the purchased company find themselves working in a new work culture. A common scenario in such a situation is for the employee to bristle at the new culture, leave the company shortly after the acquisition, and then solicit their former clients. 

One factor that will reduce the tide of restrictive covenant litigation is the Protocol for Broker Recruiting. The Protocol, which has been signed by a number of (but by no means all) financial services institutions, identifies with particularity the information that departing brokers may take to their new employers. The Protocol also sets forth the clients that departing brokers may solicit after leaving. The Protocol was created for the purpose of reducing litigation between financial institutions and normalizing the process of broker movement. As such, it becomes especially important in the current environment for financial services institutions.

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 By James McNairy & Robert Milligan

A new Ninth Circuit case, Asset Marketing Systems, Inc. v. Gagnon, 2008 WL 4138181 (Sept. 9, 2008), acknowledges (at least in dicta) that there is a trade secrets exception to Business and Professions Code Section 16600.

In the case, Gagnon, an independent contractor who developed computer programs for AMS, a field marketing organization, alleged, among other things that AMS had misappropriated his trade secrets that were contained in the programs’ source code.

The Ninth Circuit rejected Gagnon’s claims that AMS misappropriated his trade secrets.  The Ninth Circuit affirmed the district court’s determination that Gagnon had granted AMS an implied, unlimited license to retain, use, and modify the software, thus destroying any trade secret status the code might have had.

In rejecting Gagnon’s trade secret claim, the Court affirmed the district court’s holding that the noncompetition agreements signed by Gagnon’s employees were invalid. Gagnon contended that even if AMS obtained an implied license, it still misappropriated his trade secrets that were contained in the programs’ source code by hiring away his employees in violation of their employment agreements. One of the provisions in the employees’ agreements was an agreement not to engage in any employment or personal contractual agreement for AMS for twenty-four months without written consent from Gagnon.

Citing the California Supreme Court’s recent decision in Edwards v. Arthur Andersen LLP, 189 P.3d. 285, 288 (2008), the Ninth Circuit stated (arguably in dicta) that noncompetition agreements in California are invalid unless necessary to protect an employer’s trade secrets. The California Supreme Court in Edwards, however, specifically did not address what it called the so-called trade secret exception to Bus. & Prof. Code § 16600 and rejected the Ninth Circuit’s narrow restraint exception to section 16600 (the “narrow restraint” exception interpreted section 16600 to allow noncompetition agreements where departing employees were barred from pursuing only a small or limited part of a business, trade or profession). According to the Ninth Circuit, the non-competition agreements that Gagnon had his employees execute “were no longer enforceable” because they were no longer necessary to protect Gagnon’s trade secrets against AMS.

In this first post-Edwards published Ninth Circuit decision regarding section 16600, the Court did not provide any specific analysis concerning the nature of the trade secrets exception and what one must show to make defensible use of it. The Court’s dicta appears to suggest that non-competition agreements executed “to protect” an employer’s trade secrets will be enforceable. But as with most things legal, with trade secrets, the devil is in the details. What exactly the Court meant by a non-competition agreement to protect trade secrets is unclear. Further, mere assertions in employee/employer noncompetition agreements that the agreement has been executed “to protect” trade secrets without more is unlikely to withstand challenge.

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This morning (September 24, 2008), Rep. Kevin Levitas and Sen. Judson Hill from the Georgia Legislature convened the first meeting of a legislative study committee reviewing the law of Georgia with respect to restrictive covenants in employment and business relationships. The House Committee is chaired by Representative Kevin Levitas, and includes the following members: Representative Tim Bearden; Representative Butch Parrish; Representative Richard Smith; Representative Brian Thomas; and Representative Al Williams. As Representative Levitas previously remarked,

“It is time that the legislature studied this issue in depth and provided clear guidance to the courts regarding the sustainability of these private agreements between private contracting parties and how to make them fair to all parties. . . .

 “It is imperative that we carefully examine all aspects of this important issue so that both employer and employee can know their rights and duties after employment has ended.

“Both parties need to know with certainty what they can and cannot do, and that is why legislation in this area is so important. In addition to providing certainty to the parties, clarifying the law will have a significant impact on Georgia’s economy and the ability of the state to attract businesses to this state and to keep them here.”

Levitas noted th[at] he expects that the committee will hear from a diversity of witnesses with differing viewpoints on the subject. Levitas said that he intends for the committee “to bring together all necessary points of view and to gather all of the facts so that we can, once and for all, clearly define and bring certainty to this important area of the law.”

Erika Birg, a partner with Seyfarth Shaw’s Trade Secrets, Non-Competes, and Computer Fraud team, led off the morning’s testimony, highlighting the background of restrictive covenant law in Georgia. A lively question-and-answer session followed between the committee members and Ms. Birg. The committee’s questions, although varied in substance, primarily involved how a court or a legislature would determine whether a covenant is “reasonable,” as well as how the legislature might craft legislation (and a constitutional amendment if needed) that would address the concerns of both Georgia employers and their valued employees. 

J. Henry Walker IV, a partner with the litigation group of Kilpatrick Stockton and former in-house litigation counsel for BellSouth, spoke, representing the Georgia Chamber of Commerce. Mr. Walker noted the Chamber’s support for the committee’s work directed towards re-vamping Georgia’s law to provide certainty for both employers and employees. Mr. Walker also discussed BellSouth v. Forsee, 265 Ga. App. 589 (2004), a case in which BellSouth lost the ability to enforce a non-compete for a high-level executive because of Georgia court’s prohibition on enforcing a non-compete that is not certain at the time of execution of the agreement. He highlighted that certainty in the law benefited all concerned – employers and employees alike. 

The committee then heard from R. Samuel Snider, Vice President and Lead Acquisition Counsel for LexisNexis, a subsidiary of Reed Elsevier, regarding the effect of Georgia’s admittedly confusing law on the company’s decision to relocate to Georgia following its acquisition of ChoicePoint. Mr. Snider focused on the needs of technology companies to protect both intangible intellectual property but also protect the companies’ investments in highly compensated and sought-after personnel. He noted that in such instances, restrictive covenants may be part of a negotiated employment arrangement.

The study committee is set to meet again this fall, before the Legislature reconvenes in January. As the date and time are set, we will post the information here.

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 Following is a Press Release from the Georgia House of Representatives.

Speaker Richardson Appoints Representative Kevin Levitas to Chair House Study Committee on Restrictive Covenants in the Commercial Arena

ATLANTA –Speaker of the House Glenn Richardson (R-Hiram) has appointed Representative Kevin Levitas (D-Atlanta) to chair the House Study Committee on Restrictive Covenants in the Commercial Arena.

“I am confident that Representative Levitas will be an asset to this study committee. He is an extremely diligent worker, and I know he will work well with the other Representatives appointed to this committee,” Richardson said.

House Resolution 1879 established the House Study Committee on Restrictive Covenants in the Commercial Arena to examine the proper functioning of restrictive covenants in today’s marketplace and to fulfill the legislature’s role in defining public policy in this area.  

A restrictive covenant is an agreement between an employer and an employee (or an independent contractor) that limits the ability of a former employee to unfairly compete against the employer after termination of employment. 

In the absence of clear direction from the General Assembly, Georgia courts have issued conflicting decisions and voided many of these agreements in their entirety, often on the basis of a strict reading of a technical defect in one part of an agreement. 

Levitas said, “It is time that the legislature studied this issue in depth and provided clear guidance to the courts regarding the sustainability of these private agreements between private contracting parties and how to make them fair to all parties.” Levitas said that the study committee will examine court precedent and hear testimony from witnesses regarding the effect of the current state of the law.

“I am honored that Speaker Richardson has appointed me to chair this study committee,” noted Levitas. “The history and treatment of restrictive covenants in Georgia have never been fully studied before by the General Assembly. It is imperative that we carefully examine all aspects of this important issue so that both employer and employee can know their rights and duties after employment has ended.”

Levitas remarked, “Both parties need to know with certainty what they can and cannot do, and that is why legislation in this area is so important. In addition to providing certainty to the parties, clarifying the law will have a significant impact on Georgia’s economy and the ability of the state to attract businesses to this state and to keep them here.”

Levitas noted the he expects that the committee will hear from a diversity of witnesses with differing viewpoints on the subject. Levitas said that he intends for the committee “to bring together all necessary points of view and to gather all of the facts so that we can, once and for all, clearly define and bring certainty to this important area of the law.”

The committee will hold its first meeting at 9:00 a.m. on Wednesday, September 24, in Room 132 of the State Capitol. The other members of the committee are: Representative Tim Bearden (R-Villa Rica), Representative Butch Parrish (R-Swainsboro), Representative Richard Smith (R-Columbus), Representative Brian Thomas (D-Lilburn) and Representative Al Williams (D-Midway).

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On August 6, 2008, New York Governor David A. Paterson signed Bill S02393, dubbed the “Broadcast Employees Freedom to Work Act” into law. The act, amends the New York Labor Law so as to prohibit non-compete agreements in the broadcasting industry.  The enactment is effective immediately, and is codified as section 202-k of the Labor Law

Specifically, the newly minted Section 202-k provides that a “broadcasting industry employer shall not require as a condition of employment, whether in an employment contract or otherwise,” that a broadcast employee or prospective broadcast employee, after the conclusion of employment, refrain from obtaining subsequent employment “(a) in any specified geographic area, (b) for a specific period of time, or (c) with any particular employer or in any particular industry.” The act further declares as unenforceable any contractual provisions that would waive these prohibitions.

Within Section 202-k definition of “broadcasting industry employer” are companies operating television, radio, cable stations, networks, and/or internet or satellite-based services “similar to a broadcast station or network,” any broadcast entities “affiliated” with such entities, and “any other entity that provides broadcasting services such as news, weather, traffic, sports, or entertainment reports or programming.”  Likewise, a “broadcast employee” is defined as any on- or off-air employee of a broadcasting industry employer, “excluding management employees.”

The act provides that broadcast employees, as defined, can seek civil damages, including attorney’s fees and costs, as against a broadcasting industry employer violating Section 202-k.

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In Baird and Warner Residential Sales, Inc. v. Mazzone, No. 1-07-2179, the Illinois Appellate Court, First District reversed the circuit court’s determination that a restrictive covenant between Patricia Mazzone and her former employer, real estate broker Baird & Warner, was unenforceable as a matter of law. The ruling was issued in June as an unpublished order but was later published on August 15, 2008, upon the motion of Baird & Warner, which requested publication to provide guidance to the real estate industry where restrictive covenants are commonplace.

Baird & Warner sued Mazzone and her current employer, competing broker Midwest Realty Ventures, seeking to enjoin Mazzone for violating the restrictive covenant that prohibited her from soliciting Baird and Warner employees and independent contractors for one year following the end of her employment there. Although the circuit court initially granted a temporary restraining order and ordered expedited discovery, Mazzone and Midwest Realty quickly moved to dismiss on the ground that the non-solicitation agreement was unreasonable, overly broad, and thus enforceable because it sought to impose a “poison pill” whereby any competitor that hired any Baird & Warner manager was then precluded from hiring any of Baird & Warner’s thousands of employees and independent contractors. 

Baird & Warner opposed the motion, contending that, based on other language in the agreement, the covenant should be interpreted to apply only to the Baird & Warner office where Mazzone had worked.   But the circuit court dismissed the complaint and dissolved the TRO, concluding that the plain language of the agreement was not limited to the one office and declining to “blue pencil” the agreement because doing so would discourage precise drafting of agreements.

In an interlocutory appeal, the Appellate Court determined that even though the agreement was ambiguous as to whether it applied to one office or all of the company’s employees, “there is insufficient evidence to support a finding that the agreement was overly broad.” The court noted that under Illinois law, a court determining the reasonableness of a restrictive covenant should consider, among other factors, the hardship caused to the employee and the effect upon the general public. Here, the court concluded, there was no evidence on the face of the complaint to weigh those factors, and therefore it cannot be determined that the covenant is unreasonable as a matter of law. 

Based on this ruling, the court concluded that it need not address Baird & Warner’s alternative argument that the circuit court erred in refusing to exercise its “blue pencil” powers to modify the non-solicitation agreement to render it enforceable.

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Zimmer, Inc. v. Albring, 2008 WL 2604969 (E.D. Mich.June 27, 2008)

Judge Steeh in the Eastern District of Michigan carefully crafted a narrowly tailored injunction order to prevent a former employee (Albring) from violating her non-compete and non-solicit agreements, but allowed her to remain employed by her new employer, and to be paid by that employer, pending the expiration of the restrictive covenants.   Albring had entered into an arrangement to become employed full-time by a competitor of her former employer, Zimmer (both in the surgical implant business) pending expiration of her restrictive covenants. Her deal paid her “$3,000 per week to do nothing as the company is waiting for her non-compete agreement with Zimmer to run out and then she will begin selling . . . products for them.” Judge Steeh found that Albring’s profitable arrangement did not violate the non-compete, because she was not actively selling competing products. 

Zimmer also argued that Albring should be enjoined on the grounds that it put the company’s confidential information at risk. The court rejected that argument based on its conclusion that none of the information that the company sought to protect were properly raised. The court said that “Zimmer has not shown or even alleged any trade secrets involving surgical implants or the identity of [defendant’s] customers. . . .” 2008 WL 2604969 at *6. The court went on to reject any claim that customer information was confidential, noting that the defendant claimed that the targeted surgeons were friends of hers before she became employed by Zimmer and “[i]n any event, their identity is easily accessible and can be located merely by checking the telephone book.” 

Nonetheless, the Court did enjoin the defendant from a second job that put her in direct contact with the same surgeons and had the effect of promoting or selling surgical implants that competed with Zimmer's.

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Cynergies Consulting, Inc. v. Wheeler, 2008 WL 2623960 (Ohio App. 8 Dist. July 3, 2008)

An Ohio Court of Appeals recently ruled that although “‘an injunction must account for period of noncompliance in order to make judicial enforcement effective’,” 2008 WL 2623960 at *4 (citation omitted), failure to file the complaint before the expiration of the non-compete clause will prevent the complaining party from seeking to take advantage of the tolling provision when looking for injunctive relief. The court emphasized that if the non-compete period had not expired as of the time that the plaintiff filed the complaint, then injunctive relief and tolling for purposes of extending the period of the injunction would be potentially available remedies. 

The court also denied the plaintiff’s request for an accounting for the revenues received by the defendant (former employee) in connection with the alleged breach of the non-compete agreement. The court ruled that the “discovery process provides adequate means to obtain the same information sought through an accounting. . . .” Id. at *5.

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Where hearsay and speculation form the sole basis for a complaint, summary judgment and sanctions against counsel will be the result, according to a recent decision of the Third Circuit. In Brubaker Kitchens, Inc. v. Brown, 2008 WL 2123327 (3d Cir. 2008), the Court granted defendants summary judgment and sanctioned plaintiff’s counsel because non-competition allegations against a defendant lacked reasonable foundation.

Brubaker Kitchens manufactures custom cabinetry. In 2005, both the general manager and plant manager of Brubaker resigned from their positions to form a competing cabinet company. During their time at Brubaker, the two managers had become friendly with defendant Mark Schibanoff, one of the principals of Kitchen Consultants, a sales and marketing company that had done work with Brubaker. On highly tenuous hearsay and speculation, Brubaker’s president suspected that Schibanoff had been inappropriately involved with the formation of the managers’ competing company. Regardless, however, Brubaker brought a series of claims again Schibanoff, including tortious interference claims, in response to which defendant filed a motion for summary judgment and a request for sanctions under Rule 11. The District Court granted summary judgment in favor of Schibanoff on all claims and also imposed direct sanctions against Brubaker’s counsel for submitting the frivolous claims.

The Third Circuit upheld the judgment of the District Court, agreeing that Brubaker had failed to substantiate its allegations with sufficient factual support to satisfy the essential elements of the claims against Schibanoff. Since the only significant evidence of Schibanoff’s involvement with the competing company was an informal dinner discussion and a single innocuous reference letter, the claims were deemed frivolous.

Although the Third Circuit unanimously affirmed the grant of summary judgment in favor of Schibanoff, Judges Jordan and Sloviter were split regarding the standard of review on the issue of sanctions. Judge Jordan, writing for the majority, found that the District Court did not abuse its discretion in imposing sanctions against Brubaker’s counsel where its lawsuit consisted solely of a “vague belief based on bad feelings and a stray comment that the accused was ‘involved,’” while Judge Sloviter believed the District Court incorrectly had relied on an earlier version of Rule 11 that stated the imposition of sanctions was mandatory rather than discretionary and had abused its discretion in this instance.

This case serves as a reminder to employers that they must have concrete evidence of improper competition and cannot rely simply on guesswork in bringing claims of tortious interference. In addition, counsel should also exercise careful judgment when deciding whether or not to proceed with a case, as the courts will not hesitate to impose sanctions if they believe claims lack a factual basis.

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The California Courts of Appeal recently concluded that a former employee could not have breached a duty of loyalty to his employer where he entered into competition with the employer only after leaving the company. Primetech Corp. v. Cohen, 2008 WL 1899976 (Cal. App. 4 Dist. April 30, 2008).

The plaintiff, Primetech Corporation, a supplier of aircraft parts to the military and civilian industry, hired defendant Jonathan Cohen to help produce a database of aircraft parts. A year after Cohen started, the United States Air Force suspended Primetech and “debarred” many of its principals from any government contracting because of allegations that the company had knowingly delivered counterfeit parts to the Department of Defense. Around this time, Cohen, and another employee of Primetech, formed Air Sonic, an aircraft parts business, where they continued to use Primetech’s database. Cohen ultimately separated from Primetech in July 2005, taking several computers with him, as well as a database program containing Primetech’s financial information.

Primetech sued Cohen and his new aircraft parts company, Air Spectrum, which had replaced the earlier Air Sonic. After a bench trial, the trial court entered judgment for Cohen on most of the causes of action, rejecting Primetech’s claims for breach of loyalty, misappropriation of trade secrets, and unfair competition, among others. Primetech argued on appeal that the trial court had erred in denying its motion for a directed verdict (nonsuit) on its cause of action for breach of loyalty. Primetech alleged that Cohen had breached his duty of loyalty when he began operating his own aircraft parts company while still employed at Primetech. The trial court, however, concluded that Cohen was never an officer of the company and furthermore, he had started Air Sonic with the consent of Primetech’s vice president and had not actually decided to compete with Primetech until after he had separated from the company, which he was entitled to do since there was no non-compete clause in his employment contract. Reviewing the facts, the Courts of Appeal observed that while substantial evidence supported a determination that Cohen was an officer of Primetech when he set up a competing business using Primetech’s database, Primetech had failed to demonstrate that Cohen had directly harmed the company with his competing venture, so any error was not prejudicial and thus reversal was not warranted. As a result, the Courts of Appeal held that the trial court’s factual findings precluded Primetech from succeeding under a breach of loyalty theory.

This case should prompt companies to consider carefully the circumstances under which they separate from former executives. Although non-competition agreements can protect an employer, a company should not rely on breach of loyalty claims to protect against contemporaneous competition where there is any inference of an amicable split. Employers should also realize that to pursue a breach of loyalty claim successfully , they must demonstrate that the employee “formed the design to compete” while still employed with the company. Similarly, without adequate trade secrets counseling and preparation, even a company’s most valuable asset (in this case the airplane parts database) can be used by former employees in competing businesses if the proper protections are not in place.

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By Scott Krol, New York

A six-panelist jury awarded $6.9 million in punitive damages and $126,511 in compensatory damages to CBS Radio f/k/a Infinity Radio in a dispute stemming from an action to enforce a non-compete clause against radio host Jennifer Ross, whose real name is Elena Whitby. According to published reports, CBS has spent approximately $4 million in attorney fees pursuing Ross since 2000. Ross’s attorney plans to appeal the verdict. http://www.sun-sentinel.com/news/local/palmbeach/sfl-flpross0509pnmay09,0,3372540.story

The dispute started in 2000, when after failed negotiations, Ross left “Sunny 104.3” WEAT, for rival WRMF 97.9 FM. Ross had worked for WEAT since 1995 under an agreement, as amended in 1999, which contained a non-compete clause prohibiting Ross from appearing on radio or television and for working for any competitor within 125 miles of WEAT, for 12 months after leaving WEAT. (See Elena Whitby v. Infinity Radio Inc., 951 So. 2d 890) In January 2000, Infinity send a letter to Ross stating its intent to exercise its option to renew the agreement for 5 years. The two sides were unable to negotiate a new agreement, and Ross started broadcasting for rival WRMF in September 25, 2000 at the expiration of the 1995 Agreement. Infinity sued Ross and Licensees, seeking injunctive relief, contract damages, tortious interference and punitive damages. In 2005, Infinity was awarded $17.2 million. That judgment was set aside on appeal. http://www.4dca.org/Jan2007/01-24-07/4D05-3888.op.pdf.

In 2008, the jury again found for Infinity and awarded $6.9 million in punitive damages and $126,511 in compensatory damages. According to the Sun-Sentinel, David Gorman, Ross’s attorney, plans to appeal the verdict saying that it would be a financial hardship for Ross who is being paid $200,000 a year at WRMF, to pay the $126,511 verdict plus interest plus attorney fees. Gorman contends that Ross was underpaid at WEAT, “she was paid $135,000 a year… If she’s that great, that’s all you’re going to pay her?” (See Missy Diaz, South Florida Sun-Sentinel , May 8, 2008, http://www.sun-sentinel.com/news/local/palmbeach/sfl-flpross0509pnmay09,0,3372540.story) In light of nearly 8 years of litigation, $4 million in attorney fees and only $60,000 difference in salary, perhaps the sides should have been more diligent in their contract talks in 2000.

Currently Jennifer Ross is the morning co-host of “The Jennifer and Danny Show” on WRMF. CBS’s WEAT FM has “The Sunny Morning Show” with a similar format. For the record WEAT FM is ranked number 1 in the West Palm Beach Radio market, while WRMF is third.

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The Eleventh Circuit recently affirmed the enforcement of a non-competition agreement against a former employee where the plaintiff-company appealed from judgment entered in its favor because it was dissatisfied with the result. See MQ Associates, Inc. v. North Bay Imaging, LLC, 2008 WL 713688 (11th Cir. March 18, 2008).

Plaintiff MQ Associates (“MedQuest”) operates outpatient medical imaging clinics, providing services such as Magnetic Resonance Imaging (MRI), X-rays, and CT Scans. MedQuest employed defendant Bruce Woolum, first as a technician moving up eventually to area manager. In return for his employment and stock options, Woolum agreed to a non-competition agreement, which prevented his solicitation of MedQuest employees and competition with MedQuest within a 25-mile radius of the relevant imaging clinic for 24 months. The non-competition agreement also included an “extension” provision, which provided that “If [Woolum] violates the provisions [stated above], [Woolum] shall continue to be bound by the restrictions set forth [above] and the Non-Compete Period shall continue until the expiration of a cumulative period of twenty four months after the cessation of the violation.” In other words, if Woolum violated the agreement just before it expired, it could result in a total prohibition on competition of nearly four years.

Despite this agreement, Woolum left MedQuest and prepared to open a competing imaging center two miles away. In so doing, he solicited a MedQuest employee to join him at his new venture: North Bay Imaging. In response, MedQuest filed an action requesting, among other things, an injunction against North Bay and Woolum preventing competition and solicitation. The district court granted the injunction as to the non-solicitation provision, including extending its length because, it concluded, the extension clause operated independently based on the particular prohibition challenged. But as North Bay had not opened for business yet, the court reasoned, it was not actually in competition, thus, the non-competition provision could not be enforced against North Bay.

MedQuest appealed, claiming that these conclusions were incorrect because (i) the extension clause applied to both prohibitions and (ii) even if it did not apply to both prohibitions, entering into a venture for the purposes of competing was sufficient to find “indirect competition.”

The appeals court disagreed on both counts and refused to find that the district court had abused its discretion in tailoring the injunctive relief. Most notable from this decision is the difficult place into which MedQuest was placed when its former employee began preparing to compete. It could prohibit him from soliciting its employees, to be sure, but the Court held that “formation and start-up” are insufficient to support finding competition.

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In Navair v. IFR Americas, the Tenth Circuit reversed the district court’s grant of summary judgment to defendants, holding that an extension of time to a distribution agreement should be for a reasonable time even if no specific term is agreed upon by the parties.

Plaintiff Navair, Inc. was the exclusive Canadian distributor for IFR, a military communications equipment manufacturer. Under a long-running series of distribution agreements, when Navair would find a buyer for IFR equipment, IFR would agree to sell the equipment to Navair at a discount, and Navair could then resell the equipment for a profit. In other words, Navair would enter into a purchase and sale agreement with a customer on reliance of a below-fair market value price from IFR and sell the equipment at fair market value to its own customer. But after almost 30 years of this relationship, IFR told Navair that it would not renew their relationship, based in part on allegations that Navair was in violation of its noncompetition clause. Rather than immediately terminating their distribution agreement, however, the parties entered into two open-ended extensions.

Navair and the Canadian Government entered into a purchase and sale contract for IFR equipment a few months after termination of the Navair—IFR agreement. It was unclear if this contract occurred within the extension period, but the district court concluded that it did not. The Tenth Circuit disagreed. Because the parties had agreed to an extension, it reasoned, even though they had not set a specific time for the extension to end, the extension would be in effect for “a reasonable time.”

This case bears noting for two reasons. First, violations of a non-compete, particularly in a business-to-business context, can have other ramifications than simply an injunction or potential damages. Second, companies should be sure that the terms of their agreements are clear and that all essential terms of the contract (including expiration) is clearly conveyed to the opposing party. From the tenor of the Court’s language in remanding the case, it sounds like IFR will learn an expensive lesson.

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Alliant Insurance Services, Inc. v. Gaddy, No. C055192, 2008 WL 331065 (Cal. App. 3 Dist., Feb. 07, 2008)

On February 7, 2008, the California Court of Appeals affirmed a preliminary injunction, enjoining defendant G. Scott Gaddy from competing against his former employer, Alliant Insurance Services, Inc., within the entire state of California. The appellate court also upheld a non-solicitation provision prohibiting Gaddy from contacting Alliant customers. Alliant acquired Gaddy’s insurance brokerage business in 2004. Prior to the acquisition, the brokerage competed directly with Alliant to provide insurance for construction companies. In the Stock Purchase Agreement, Gaddy agreed, for a period of 5 years from the date of acquisition, “to refrain from carrying on a business, directly or indirectly, which provides any [of Alliant’s] business” within the 58 counties of the State of California. Alliant employed Gaddy after the acquisition until it terminated his employment in October 2006. In both the Stock Purchase Agreement and in his employment agreement with Alliant, Gaddy agreed that, for a period of 3 years after termination of his employment with Alliant, he would not solicit clients of his former business or Alliant clients known to him by virtue of his employment with Alliant. After his termination, Gaddy started a business that provided insurance and surety consulting in the construction industry. In connection with that business, he contacted, and admitted to contacting, “[h]alf a dozen to a dozen” former clients. Alliant sued Gaddy and moved for preliminary injunctive relief.

The trial court’s tentative ruling was to deny injunctive relief, but after a hearing during which Gaddy testified, the court ultimately issued an order preliminarily enjoining Gaddy from:

(a) directly or indirectly using or willfully disclosing to any person (without [Alliant]’s permission or court approval) information about [Alliant]’s clients, as defined by the court; (b) directly or indirectly soliciting [Alliant]’s clients within the 58 counties of California; (c) carrying on business directly or indirectly which “provides any Company business” within the 58 counties of California; (d) directly or indirectly soliciting, hiring, retaining the services of plaintiffs’ employees or independent producers who were employees or independent producers of [Gaddy’s former business] or [Alliant]; (e) destroying or altering any information regarding the facts at issue in this case; and (f) directly or indirectly soliciting, hiring, assisting, or accepting assistance of any other person or entity in attempting to accomplish any of the acts prohibited by the preliminary injunction.

On appeal, Gaddy focused only on whether the non-competition and non-solicitation of customers covenants were enforceable. The court of appeal held that substantial evidence supported the enforceability of these provisions.

Although California has a strong public policy of prohibiting non-competition provisions in the employment context (Bus. & Prof. Code § 16600), an exception exists for a non-competition covenants in connection with the sale of a business (Bus. & Prof. Code § 16601). Section 16601 provides, in part: “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 . . . may agree with the buyer to refrain from carrying on a similar business within a specified geographic area in which the business so sold . . . has been carried on, so long as the buyer, or any person deriving title to the goodwill or ownership interest from the buyer, carries on a like business therein.” Id. (emphasis added). In this case, the geographic area encompassed by the non-competition agreement was the entire state of California. Defendant Gaddy argued that the acquired business’s clients were in Northern California. Plaintiff’s supplemental declaration in support of its request for an injunction stated that, although its construction company clients were in Northern California, it procured insurance products from insurance companies located throughout the 58 counties of California. Thus, the court of appeal found that substantial evidence showed that the acquired business “carried on” its business in every county in California. As for the non-solicitation agreement, the trial court found that Alliant’s client information constituted trade secrets and that Gaddy had used trade secret information. The court of appeal rejected Gaddy’s effort to challenge the trade secret ruling on appeal because it was raised for the first time in his reply brief. The court, deciding that the non-solicitation provision was a valid restraint to protect trade secrets, found the non-solicitation provision enforceable.

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Al Minor & Associates, Inc. v. Martin, Slip Opinion No. 2008-Ohio-292.

The Supreme Court of Ohio ruled yesterday in a case in which it was asked to decide whether a former employee, having taken no confidential documents from the plaintiff employer but instead memorizing client lists, could be held liable for a statutory trade secret violation.

The plaintiff, Al Minor & Associates, Inc. (“AMA”), is an actuarial firm that serves approximately 500 clients. In 1998, AMA hired the defendant, Robert Martin, but did not require him to sign a non-compete agreement or an employment contract. While still employed with AMA, Martin took steps to form his own company which would provide essentially the same services as AMA. He resigned in 2003, and did not take any confidential documents with him. He later successfully solicited 15 AMA clients, using client information that he had memorized.

AMA filed suit, alleging that Martin had violated Ohio’s Uniform Trade Secrets Act (UTSA), and a magistrate found for AMA. The magistrate recommended that the trial court award AMA over $25,000 in fees that AMA would have earned from the clients which Martin solicited. The court of appeals affirmed, and Martin appealed to the Supreme Court of Ohio, contending that a client list memorized by a former employee cannot be the basis of a trade secret violation, and that the trial court’s decision unduly restricted his right to compete with AMA. AMA maintained that public policy favored the protection of trade secrets regardless of whether they were written or memorized.

The Court analyzed a 1902 case which defined trade secrets, as well as the UTSA, which was adopted in 1994. The Court noted that a 1997 Ohio case had established a six-factor test to determine the existence of a trade secret: 1) the extent to which the information is known outside the business; 2) the extent to which it is known to those in the business; 3) precautions taken to guard the secrecy of the trade secret; 4) the value of the secret to the holder; 5) the amount of money or effort expended in developing the information; and 6) the amount of time and expense needed for others to acquire and duplicate the information.

After looking at these sources, the Court determined that nothing in any of them indicated that the determination of whether or not a client list is a trade secret hinges on its form (e.g., written or memorized). The Court also noted that the legislature could have excluded memorized information from the definition of a trade secret in enacting the UTSA, but it failed to do so. The Court further mentioned that the majority position in the other states is that memorized information can be the basis of a trade secret violation. The Court also recognized the numerous treatises on the issue which supported this view (quoting one for the proposition that “the form of the information and the manner in which it is obtained are unimportant; the nature of the relationship and the defendant’s conduct should be the determinative factors”).

The Court noted that the protection of trade secrets requires a balancing of employers’ rights in their trade secrets and the former employee’s right to use his talents. However, the Court declared, by adopting the UTSA, the Ohio legislature clearly determined that Ohio public policy favors the protection of the employer’s trade secrets. The Court thus affirmed the judgment of the court of appeals.

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Trujillo v. Great Southern Equipment Sales, LLC, No. A08A0245, 2008 WL 269606 (Ga. Ct. App. Feb. 1, 2008).

Reviewing the “Confidentiality and Restrictive Covenant Agreement” signed by Sarah Alexandra Trujillo while employed by Great Southern Equipment Sales, LLC, the Georgia Court of Appeals reversed the part of the trial court’s judgment that enjoined Ms. Trujillo from competing with Great Southern and soliciting its customers.

Ms. Trujillo had worked as a salesperson for Great Southern, a company primarily engaged in the business of selling transportation equipment, for over two years at the time of her resignation and departure for a competitor. In the early months of Ms. Trujillo’s employment, Great Southern’s president gave her on-the-job training; provided her with lists of Great Southern’s customers; and introduced her to many of the company’s customers and suppliers. After nine months of service, she was asked to sign the “Confidentiality and Restrictive Covenant Agreement.” At issue on appeal were the agreement’s non-solicitation and non-competition clauses.

Under Georgia law, restrictive covenants found in an employment contract must be strictly limited as to time, territorial effect, capacity in which the employee is prohibited from competing, and as to overall reasonableness. Moreover, unless a non-solicitation covenant pertains only to those clients with whom the employee had a business relationship during the term of the agreement, the covenant must contain a territorial restriction. Here, the court looked to the language of the non-solicitation provision in finding that it applied to a broad class of customers:

“The non-solicitation restriction set forth in this Section 2 is specifically limited to Customers of Employer with whom Employee had contact (whether personally, telephonically, or through written or electronic correspondence) during the three (3) year period immediately preceding the Separation Date or about whom Employee had confidential or proprietary information because of his/her position with Employer.”

The latter category of customers was not, as Great Southern argued, merely a reiteration of the separate confidentiality clause found in the agreement. Instead, the court said it was “an effort to impermissibly broaden the class of customers whom Trujillo could not solicit.” Because the non-solicitation clause at issue purported to apply to an expansive class of customers, but failed to include a geographical restriction, the court held that the provision was overbroad and unenforceable. Further, Georgia does not employ the “blue pencil” doctrine of severability, so the non-competition clause of the agreement was also unenforceable.

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National Elevator Cab & Door Corp. v. H & B, Inc., 2008 WL 207843 (E.D.N.Y.) No. 07 CV 1562

United States Magistrate Judge Levy recently denied a motion for reconsideration after he granted the plaintiff National Elevator Cab & Door Corp.’s motion for a preliminary injunction against defendant H & B, Inc. The litigation stems from the failed acquisition talks between National (a supplier of elevator entrances and cabs in the New York metropolitan area) and H & B (also an elevator cab and entrance supplier, working nationally and internationally), and the resulting alleged breaches of non-compete and confidentiality provisions in an agreement between the two parties.

In 2005, H & B, having little presence in the New York metropolitan market, expressed interest in acquiring National. During discussions between the two corporations, National asked H & B to sign an agreement stating that if the acquisition did not occur, H & B would not solicit business with three of National’s customers (Fujitec New York, ThyssenKrupp Elevator, and the New York City Housing Authority) for five years, would not use National’s confidential information or intellectual property to compete with National, would not test or reverse engineer National’s products, and would not solicit National employees for three years. H & B signed the agreement, and National eventually disclosed such information to H & B as its business model, marketing strategies, internal projections for sales and expenses, and information on its pricing, outsourcing, gross margins, and annual sales.

The acquisition discussions failed, and H & B eventually began to do business with Fujitec and solicited National employees. H & B admitted these facts, but argued that the terms of the agreement were unenforceable. National was granted a preliminary injunction against H & B, and H & B moved for reconsideration.

In evaluating the motion, Judge Levy discussed whether National had demonstrated that it would suffer irreparable harm in the absence of an injunction. He noted that not only would it be difficult to calculate monetary damages to redress National’s losses, but also that in the agreement, H & B expressed admitted that money damages would be an insufficient remedy for breach. Judge Levy found that National made a sufficient showing that H & B’s continued solicitation of the three specified National customers would result in irreparable harm in the absence of an injunction. Although H & B argued that it had been unsuccessful in attracting business from two of the three specified customers, Judge Levy declared that National “need not wait until its relationships…are damaged before seeking an injunction.”

Next, Judge Levy reviewed whether National was likely to succeed on the merits of its claims, first analyzing the non-compete and non-solicitation provisions of the agreement. He noted that a non-compete covenant must pass a reasonableness test, and New York courts will only enforce such a provision between businesses where it protects a legitimate business interest, and its terms are reasonable, both temporally and geographically. Judge Levy expressly held that the agreement was reasonable and did not impose undue restraint on competition, because it applied only to three identified customers in one market (the New York metropolitan area). He noted that the customers were not obliged to work with National, but instead could employ other suppliers, and as such, the anti-competitive effects were not so great as to outweigh the harm to National.

Finally, Judge Levy addressed the confidentiality provisions of the agreement. He outlined the factors that New York courts consider in determining whether information constitutes a trade secret: the extent to which the information is known to the public, the extent to which it is known by employees and others in the business, what measures are taken to protect the information, the value of the information to the business and its competitor, the amount of effort or money used by the business to develop the information, and the ease or difficulty with which the information could be acquired by others.

Judge Levy found that the information given to H & B was confidential, and that National had taken adequate steps to guard this information. Despite the fact that National presented no evidence that H & B misused some of its information, Judge Levy found that H & B attempted to procure some of the materials from a mutual client of the two businesses after the acquisition talks failed and it was forced to return what it had been given. Thus, Judge Levy reasoned, the materials contained information that was valuable and not publicly available at the time. Additionally, Judge Levy noted that almost immediately after receiving National’s materials, H & B began offering installation (which it had never done before), changed its design, and was able to successfully attract one of National’s clients. Finding the timing more than merely coincidental, Judge Levy held that H & B violated the terms of the agreement, and further held that the confidentiality provisions were enforceable. Thus, H & B’s motion for reconsideration was denied.

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On December 7, 2007, the Illinois First District Appellate Court in Cambridge Engineering, Inc. (“Cambridge”) v. Mercury Partners 90 BI, Inc., No. 1-06-0758 (1st District Appellate Court of Illinois, Sixth Division) determined that Cambridge’s non-solicitation and non-competition provisions were overly broad and unenforceable because the provisions prevented former Cambridge employees from (a) taking any job, “even that of a janitor,” with a competitor (b) working in markets that Cambridge did not do business in, and (c) speaking with Cambridge customers that the employer never serviced or knew were Cambridge customers (thereby requiring the former employee to speculate about who he can and cannot contact/solicit). Although the Appellate Court’s decision was not surprising given Illinois case law, the Appellate Court’s unsolicited opinion/warning to employers who write overly broad restrictive covenants is noteworthy.

Specifically, the Appellate Court wrote/warned after its analysis that:

Allowing extensive judicial reformation of blatantly unreasonable post-termination restrictive covenants may be against public policy, because of the potentially severe effect it could have on the employees who are subject to such covenants. Such reformation, if permitted by courts, would give employers an incentive to draft restrictive covenants as broadly as possible, since the courts would automatically amend and enforce them to the extent that they were reasonable … This could have a severe chilling effect on employee post-termination activities.

The Appellate Court went on to state that judicial reformation (i.e. blue penciling) is unfair to the employee who is “unschooled in the law” and “cannot be expected to know to what extent such a covenant is in enforceable.” Accordingly, “blatantly unreasonable” restrictive covenants, such as the ones authored by Cambridge, should not be revised to comply with Illinois law.

The Appellate Court’s unsolicited opinion will likely find its way into the response of every employee who is faced with an employer’s request to modify or blue pencil an existing restrictive covenant. Accordingly, Illinois employers who rely on the enforcement of restrictive covenants should confer with legal counsel familiar with Illinois restrictive covenant law to ensure that the restrictions contained in their Agreements do not fall into the “blatantly unreasonable” category enunciated in Cambridge.

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A half-dozen H&R Block employees in LaCrosse, Wisconsin, who had worked for the company for periods ranging from 10-25 years, left and within a few months began competing with their ex-employer. Each of the former employees had signed non-compete and non-solicitation covenants reciting that they lasted for a two-year period, but “such period to be extended by any period(s) of violation.” Seeking to enforce the covenants, H&R Block filed an injunction action immediately in a Wisconsin circuit court. The ex-employees moved for summary judgment on the ground that the restrictive clauses were unenforceable. H&R Block’s motion for an injunction was denied, the former employees’ motion for summary judgment was granted, and those decisions were affirmed on appeal. H&R Block Eastern Enterprises, Inc. v. Swenson, No. 2006AP1210 (Wis. Ct. of App., Distr. 4, Dec. 20, 2007).

The lower court reasoned that two-year limitations were more than H&R Block needed, and with the potential extension, the covenants were plainly invalid. The appellate court assumed “without deciding that the two-year period is reasonable.” Although a Wisconsin employer has a legitimate “interest in protecting its stock of customers” who have been dealing with a particular employee who departs, the State has a “strong public policy against the enforcement of unreasonable trade restraints on employees.” The appellate court concluded that the H&R Block covenants imposed unreasonable restraints because (a) “a former employee cannot tell from the terms of his or her contract how long the extension will be for particular conduct in violation of the clauses,” and (b) the duration of the restraint is “not a fixed and definite time period but a time period that is contingent upon outcomes the employee cannot predict,” namely a court decision as to whether the conduct is a violation. Under Wisconsin law, if any covenant contains both reasonable and unreasonable restraints, the entire covenant is unenforceable. Therefore, H&R Block’s case was doomed.

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A recently filed action in state court in Duluth, Minnesota illustrates the problems that can arise when a business divorce goes wrong. The case involves EmpowerMX, a Duluth-based maker of software for airlines. EmpowerMX filed a lawsuit against its founder, Barry Sinex, alleging that Sinex intended to violate the non-compete provision in his separation agreement with the company.

Sinex argues that the provision is unenforceable, not for the typical reasons relating to the geographic scope covered by the agreement or the activities proscribed, but instead because of a provision in the agreement that states that the non-compete provision becomes null and void if “holders of common stock are paid less than $1 per share for their stock.” Sinex’s claim is that the company has not been managed properly since his departure and that the value of the shares is now less than $1.

The company counters by arguing that the non-compete provision is rendered null only in the event that shares are actually sold for less than $1 in connection with a “sale, merger, consolidation or other significant change in ownership of the company.” EmpowerMX obtained a temporary restraining order against Sinex on or shortly after filing the complaint on December 17, 2007.

http://www.duluthnewstribune.com/articles/index.cfm?id=57689§ion=homepage&freebie_check&CFID=80821590&CFTOKEN=94821650&jsessionid=88303c98b0845370581d

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In Kinesis Advertising, Inc. v. Hill, 652 S.E.2d 284 (N.C. Ct. App. 2007), the North Carolina Court of Appeals reversed the trial court’s grant of summary judgment and touched on two important issues under North Carolina law. Kinesis filed the action, attempting to enforce non-compete and non-solicitation provisions against its former employees, Larry Hill and Dan Robinette, as well as the former employees’ new business, Altyris Incorporated, among other claims. The trial court found that the agreement containing the restrictive covenants was unenforceable, and therefore, granted summary judgment in favor of the defendants on the breach of contract claim. The trial court had two bases for finding that the covenants were unenforceable: (1) Kinesis did not provide consideration to Hill and Robinette when they signed the agreements, and (2) the restrictions were overly broad. The Court of Appeals reversed on both grounds.

Kinesis contended on appeal that it had transferred shares to Hill and Robinette. The Court of Appeals found conflicting evidence as to whether Kinesis had actually done so. The parties agreed that Hill and Robinette never received stock certificates representing their shares, so the Court of Appeals sought to determine whether Kinesis had performed the tasks necessary to issue uncertificated shares under North Carolina’s Business Corporations Act. The Court of Appeals found conflicting evidence on the point and concluded that final determination of the question was a province of the jury. The Court of Appeals concluded that ”a genuine issue of material fact remains as to whether the Kinesis shares promised to Mr. Hill and Mr. Robinette were actually issued, such that they constituted valuable consideration to make the covenant-not-to-compete and confidentiality and non-solicitation agreement valid and enforceable.”

On the question of the scope of activity proscribed by the agreements, the Court of Appeals distinguished between non-competes that prevent employees from performing any type of activity for competitors and non-competes that prevent employees from performing acts in competition with their former employer. Kinesis’s agreement was the latter rather than the former and was therefore enforceable because “the restrictions imposed by Kinesis in the covenant-not-to-compete are ‘no wider in scope than is necessary to protect the business of the employer.’” The Court of Appeals concluded by stating that the question of whether Hill and Robinette actually were engaging in activities similar to those they performed for Kinesis was a matter for a jury.

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The District Court for the Southern District of New York recently demonstrated the importance of including nonsolicitation language in employment agreements, in addition to noncompetition language, where employers seek to protect their customer base from departing employees. In Silipos, the court, despite finding that the noncompetition covenant in the subject agreement was not enforceable, nevertheless found that the nonsolicitation covenant was enforceable and that the defendant would be bound by the restriction - effectively preventing defendant from competing with plaintiff for its customers.

In the action, the court found that the defendant, a former executive vice president of plaintiff, had entered into a valid employment agreement containing: (1) a post-employment, worldwide, one-year noncompetition covenant prohibiting defendant from having employment with anyone direct or indirect competitor in plaintiff's industry; and (2) a post-employment, worldwide, one-year nonsolicitation covenant prohibiting defendant from soliciting any of plaintiff's current or prospective customers, distributors, suppliers and/or vendors.

The court, applying New York law, repeated the well-established precept that noncompetition and nonsolicitation covenants are enforceable only to the extent necessary to protect Silipos's "legitimate interests." In the action, plaintiff asserted that both covenants were necessary to protect three legitimate interests: (1) protection of its trade secrets; (2) protection of its confidential customer information; and (3) protection of its client base. Plaintiff further alleged that defendant, due to his position within the company and his responsibilities, had access to various types of information during his employment, including business strategy information and pricing information, which constituted trade secrets and/or confidential customer information.

The court, however, found that plaintiff only had one demonstrable "legitimate interest," to wit, protecting its client base. In particular, the court concluded that none of the business information to which defendant had access rose to the level of trade secrets or confidential customer information, and as such, plaintiff lacked a "legitimate interest" to warrant enforcement of the noncompetition covenant.

In contrast to the noncompetition covenant, however, the court found that the worldwide nonsolicitation covenant was enforceable because the protection of a client base was a "legitimate interest" of plaintiff. Consistent with this "legitimate interest," the court enforced the nonsolicitation covenant with respect to: (1) customers that defendant brought to Silipos; (2) customers for whom defendant was the primary contact; and (3) customers with whom defendant had a substantial degree of long-term involvement. The court moreover found that the restriction was not unreasonably broad, holding that "in light of [Silipos's industry's] intimate yet geographically diffuse nature, Silipos's legitimate interests in protecting its customer base extend worldwide."

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An Illinois Appellate Court recently affirmed a preliminary injunction granted to a medical products manufacturer against its former employee, enforcing 24-months’ non-competition and non-solicitation agreements. The non-competition agreement barred the defendant-employee from competing with the plaintiff with respect to all products and territory assigned to the defendant during his final 18 months of employment. The non-solicitation agreement prohibited the defendant from soliciting or assisting in the solicitation of sales or leases of such products competitive with the plaintiff’s products in that same territory.

The court concluded that the defendant possessed confidential information concerning his ex-employer’s method of calculating so-called “open quotes,” offers to sell products in bulk to specific customers, even though the open quotes themselves were not confidential and they resulted in orders less than 50% of the time. Moreover, the competitor for whom the defendant went to work already was selling similar products to the same customers before the defendant changed employers. Furthermore, many of the plaintiff manufacturer’s employees did not have confidentiality agreements, and the defendant was not charged with taking any information with him when he left the plaintiff’s employ, other than what he had in his head. Lifetec, Inc. v. Edwards, No. 4-07-0300 (Ill.App., 4th Dist., Nov. 6, 2007).

The three appellate court justices were somewhat divided in their reasoning. Two ruled that the plaintiff had “legitimate business interests” in protecting its trade secrets, and found that the time and territorial restrictions applicable to the defendant were reasonable. The third justice concurred in the result. He expressed his opinion that enforcement is appropriate if an employer demonstrates that reasonable time and territorial restrictions were violated, but that courts should not impose on a plaintiff the additional burden of proving that it had a protectible or “legitimate” business interest.

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Clients often ask whether they need to provide any consideration to their existing employees when they ask their employees to sign non-compete or non-solicitation agreements. The answer in Georgia typically is that continued employment is sufficient consideration for such an agreement. (The answer is different in Texas and North Carolina, for example.) Glisson v. Global Security Services, LLC, Georgia Court of Appeals, No. A07A1456, 2007 Ga. App. LEXIS 1047 ( Sept. 25, 2007), however, reminds us that this is not a universal rule. In that case, William Glisson entered into a two-year employment contract with his employer, Global Security Services. The agreement contained a non-compete provision, as well as a two-year term for employment. Approximately eighteen months after entering the agreement, GSS requested that Glisson sign a more extensive, non-competition agreement. Glisson did so, but shortly thereafter left GSS and formed a competing business. GSS brought an action against Glisson under the second non-compete provision that Glisson had signed.

The trial court ruled that the non-compete provision was enforceable and that GSS was entitled to an injunction preventing Glisson from competing in a certain area. The Georgia Court of Appeals reversed that judgment, holding that GSS was already obligated to employ Glisson through the end of his two-year term when it compelled him to sign the second non-compete agreement. Thus, the second non-compete agreement lacked consideration and was unenforceable.Glisson illustrates that continued employment may not be sufficient consideration for an existing employee to sign a non-compete agreement where the employee is not an at-will employee (instead, the employee is under contract). This could be an important exception to the general rule that an employer does not have to provide its employees any consideration for execution of a restrictive covenant.

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The Texas Supreme Court recently held that no Texas precedent allows a Texas court to ignore a forum selection clause in an employment agreement.

Autonation owns automobile dealerships across the country, including Houston , Texas , and its corporate headquarters and principal place of business is in Florida . In re Autonation, Inc., 2007 WL 1861341, *1 (TX 2007) (orig. proceeding). Garrick Hatfield worked as a general manager for one of Autonation's dealerships in Houston . In 2003, Mr. Hatfield signed a non-competition agreement that contained a Florida choice-of-law provision and forum-selection clause. Two years later, Hatfield went to work for a competitor. Autonation sought to enforce the non-competition agreement in Florida . But before learning of the first-filed Florida action, Hatfield filed a declaratory judgment action in Harris County, Texas, asking the court there to rule that Texas law governed the non-competition agreement and that the agreement was unenforceable. After learning of the Florida action, Hatfield also sought an anti-suit temporary restraining order and temporary injunction to enjoin further proceedings in the Florida action. Hatfield argued that Autonation was attempting to circumvent Texas law by pursuing the Florida action and that Florida would likely refuse to apply Texas law. (Note: The agreement also had a Florida choice of law provision in it.)

The trial court issued the anti-suit injunction, and the Houston Court of Appeals denied the petition for writ of mandamus by holding that the trial judge did not abuse his discretion by issuing the anti-suit injunction because "fundamental Texas public policy requires the application of Texas law to the question of enforceability of a non-compete agreement." Id. (citing DeSantis v. Wackenhut Corp., 793 S.W.2d 670, 679-81 ( Tex. 1990)).

The Supreme Court of Texas acknowledged this prior precedent in DeSantis , but rejected the application of DeSantis on the grounds that a forum-selection clause is not the same as a choice-of-law clause.

The Court held that "even if DeSantis requires Texas courts to apply Texas law to certain employment disputes, it does not require suit to be brought in Texas when a forum-selection clause mandates venue elsewhere." Autonation, 2007 WL at *4. The Court also stated that "[n]o Texas precedent compels us to enjoin a party from asking a Florida court to honor the parties' express agreement to litigate a non-compete agreement in Florida , the employer's headquarters and principal place of business." Id . According to the Court, this holding (1) gives deference to the first-filed Florida action; (2) honors the parties' contractual commitment; and (3) also honors principles of interstate comity. Id.

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In a recent decision, Bender v. Xcel Energy, Inc., the Eighth Circuit Court of Appeals suggested that attempts by executives to replace employer release agreements must comply precisely with contractual requirements. A unanimous panel affirmed the District Court’s grant of summary judgment to defendant Xcel Energy, Inc., on the claims of former executives of a subsidiary company of Xcel, NRG Energy, Inc. Most interesting to those in the non-compete/restrictive covenant arena was Xcel’s (successful) argument regarding the company release form. Xcel argued that because two of the executives did not use the provided form, and instead attempted to use their own, they had not satisfied their obligations under the contract. Thus, the executives could not participate in the severance plan.

For executives to receive their NRG stock options after its merger with Xcel, the severance plan then in effect for NRG executives required that they provide the company with a release “in a form to be provided by the Company.” Plaintiffs James Bender and Craig Mataczynski thought that the release language was too broad, and provided an alternative release, which they said satisfied the same obligations under the severance plan. Specifically, Bender and Mataczynski argued that the release they were asked to execute was much broader than a “standard release of claims.” The Eighth Circuit noted, however, that not only was it generally appropriate for employers to condition severance payments on releases, but, more importantly, the plain language of the severance plan clearly called for a release form “to be provided by the Company.” Accordingly, the Eighth Circuit affirmed the district court’s summary judgment against Bender and Mataczynski’s claims, because, simply put, they did not use the form provided by the company and there was nothing inherently wrong in requiring such a form.

By holding to a “plain language” understanding of the severance agreement, the Eighth Circuit did not undertake any significant analysis of the non-competition issues. It is fair to question whether the Court even cared whether the release form was too broad since it never posed that question. Moreover, the Court undertook no unconscionability test, nor did it evaluate the non-compete or confidentiality provisions, all issues raised by Bender and Mataczynski. In other words, while the Court was at least nominally concerned with the release and strict compliance with the form to be provided, it did not express any trepidation about confidentiality or non-competition issues.

The moral of the story for executives (and the companies for which they work): do not plan to rely on competition-related arguments in the Eighth Circuit where a strict textualist approach to severance plan contracts seems to carry the day.

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