Please join us for our sixth trade secrets webinar of the year entitled Trade Secrets and Non-Compete Legislative Update.

The webinar will be September 20, 2012 from noon to 1:00 p.m. central.

The past year has seen significant statutory changes to several jurisdictions’ laws regarding trade secrets and restrictive covenants and pending legislation proposed in additional jurisdictions. As trade secrets and non-compete laws continue to evolve from state to state in piecemeal fashion, companies should continually revisit their trade secrets and non-compete strategies in light of the evolving legal landscape and legislative trends.

Topics will include:

1) Judicial opinions on Georgia’s Restrictive Covenant Act one-year after its adoption in 2011;

2) Recent and proposed statutory changes to restrictive covenant laws (including recent statutory changes in New Hampshire and proposed legislation in Massachusetts);

3) Recent and proposed statutory changes to trade secrets laws (including passage of the New Jersey Trade Secrets Act, amendments to Idaho’s trade secrets statute, and proposed federal legislation); and

4) Practical tips for anticipating trends in trade secrets and non-compete law.

The webinar will be led by Bob Stevens, Erik Weibust, and Daniel Hart.

You can register here for the webinar.

CLE credit will be available for participants.

As a special feature of our blog –special guest postings by experts, clients, and other professionals –please enjoy this blog entry by University of Florida Law Professor Elizabeth Rowe regarding protecting trade secrets from disclosure by the government. Professor Rowe’s expertise is in intellectual property law. Her scholarship focuses on trade secrets, as well as the interaction of intellectual property policies with business and technology. She is a prolific scholar who has published numerous law review articles and contributed to several books. Professor Rowe’s recent casebook is the first in the United States devoted exclusively to Trade Secret Law. Enjoy Professor Rowe’s article

-Robert Milligan, Editor of Trading Secrets

By Elizabeth Rowe

I. INTRODUCTION

The government collects an enormous amount of information from companies that it stores, analyzes, and disseminates to government agencies, other companies, and the public. This practice increases the chances that information disclosed to the government that should remain secret does not. Accidental disclosures of confidential and trade-secret information do occur. Over the last few years, several government agencies have inappropriately handled or inadvertently disclosed company trade secrets. In one case, for example, the EPA disclosed one organization’s trade secrets to an environmental organization. In another case, the FDA has been accused of inappropriately disclosing to a prisoner the secret formula to a drug, and posting on its website another company’s trade secrets contained in a New Drug Application.

Disclosure of company trade secrets by the government to the public is already addressed in the elaborate regulatory scheme of agency rules and regulations, as well as in the FOIA case law. However, there is a paucity of case law and other guidance specifically relevant to cases where a company refuses to submit trade-secret information to the government (“refusal-to-submit” cases) and when the government is entitled to a company’s trade-secret information. I propose a “shield or disclose” model that, among other things, makes clear the roles and burdens the various players must assume. It requires a threshold determination that the information in question qualifies for trade-secret protection under the common law. It also requires evidence of need, relevance, and potential harm before a court could order disclosure.

II. STRIKING THE BALANCE IN DISCLOSING TO THE GOVERNMENT

The unique nature of trade secrets—that they exist only so long as they are not disclosed or disclosed in confidence—requires an arrangement that ensures against accidental, unauthorized, or other improper disclosure. The owner of trade-secret information should never make a disclosure, either voluntary or involuntary, without enforceable restrictions against general disclosure. However, when it is determined that it is in the public’s interest that the information be disclosed to the government, a delicate balance must be observed.

Accordingly, a clear model is needed to determine when trade-secret information should be submitted to the government in the first place. The model suggested here addresses disclosure to the government, not the subsequent and separate step of disclosure by the government to the public. The latter is already addressed, albeit not perfectly, in the elaborate regulatory scheme of agency rules and regulations, as well as in the reverse-FOIA case law. Thus, once the government has the information in its possession, whether received voluntarily or through compliance mandates, the current regulations are applicable to protecting them.

A. THE SHIELD-OR-DISCLOSE MODEL

The body of law that would allow corporations to refuse to submit proprietary information to the government, when they are not required to do so under a regulatory scheme, is trade-secret law. Because of the dearth of case law and other guidance specifically relevant to refusal-to-submit cases, I have considered a wider body of cases that implicate disclosures of trade secret by the government as well as disclosures made in the context of pending litigation. The end result is what I will refer to as the “shield or disclose” model.

Ultimately, the proposal creates a procedural and substantive path to identify the circumstances under which a court should compel a trade-secret holder to produce its trade-secret to the government. As a general policy matter, when the public interest in the disclosure outweighs the harm to the company from disclosure, the court may justifiably compel disclosure. What does that mean, however? How is it determined? These are the questions for which this framework aims to provide guidance. It is, admittedly, not the sole answer, but rather a modest step in the direction of achieving a more principled approach to refusal-to-submit cases, a step that is grounded in trade-secret law and consistent with the policy considerations that underlie governmental access and disclosure.

1. Company Establishes Trade-Secret Status and Harm

The first step of the process, having both procedural and substantive significance, requires that the trade-secret owner establish that the requested information qualifies for trade-secret protection and that harm will result from disclosure of the trade secret to the government. Whether the information in question meets the status of a “trade secret” should always be the threshold question, and it is the trade-secret owner’s burden to make that showing. While companies often try to claim protection for confidential and proprietary business information, trade-secret protection applies only to the smaller subset of information that qualifies as an actual trade secret. Therefore, in most cases, this first question could be determinative of the entire issue of disclosure because if the information is not a trade secret, then that significantly weakens the argument against disclosure. If the trade-secret owner is unable to establish trade-secret status, then the inquiry likely ends in favor of the government.

The trade-secret owner must then articulate the competitive harm that would be caused from disclosure of the information to the government. This is in keeping with trade-secret law’s focus on protecting against unfair competition and the existing articulation of harm in some of the regulations as competitive harm. For example, SEC regulations require that a business provide information regarding the adverse consequences that could result from disclosure of confidential information, including any adverse effect on its competitive position. Similarly, on the likelihood that the disclosure would result in harm, EPA regulations require a showing of “substantial harmful effects to the business’ competitive position” and “an explanation of the causal relationship between disclosure” and the harm. Moreover, in the FOIA context, competitive harm has been interpreted to mean that the harm flows directly from a competitor rather than from a customer or employee or other source. Thus, a trade-secret owner would need to establish the likelihood that such harm would occur if the information it produced to the government were to be obtained by its competitors.

2. Government Establishes Relevance and Need

Once the trade-secret owner has established the trade-secret status of the information and the harm that is likely to result from its disclosure, the burden then shifts to the party requesting the information (i.e., the government) to prove relevance and need for the information. This is similar to the good-cause burden under the discovery rules. Given the unique nature of a protectable trade secret and the devastating harm that could result from its disclosure, the better policy is that a trade secret should not be ordered produced unless the actual trade secret (as opposed to some other information related to the trade secret) is directly relevant to the inquiry for which it is sought.

Relevance, for the purposes of this proposal, is similar to the standard that has been used under Rule 26 of the Federal Rules of Civil Procedure. However, relevance should probably not be interpreted as broadly for trade-secret purposes as it is under the discovery rules. Whereas the underlying rules and policies in the discovery context favor greater disclosure between the parties, trade-secret law, on the other hand, is grounded in secrecy and the requirement that trade secrets should not be disclosed without appropriate assurances of confidentiality by the receiver. Accordingly, this might suggest that the relevance standard should be interpreted narrower than under the discovery rules. The current FOIA rules and cases do not require that the party requesting information from the governmental agency establish relevance. However, given the higher scrutiny that should be given to the disclosure of trade secrets, it makes sense to require a showing of relevance.

While the FOIA rules do not require a showing of need either, evidence of need is required under my proposal. The government requestor should demonstrate need for the information separate and apart from relevance. This inquiry would focus on such considerations as: (1) whether the information sought is available elsewhere; (2) whether acceptable substitutes for the information can be found from other sources; (3) whether the public interest in receiving the information can only be protected via receipt of the trade-secret information; and (4) whether the public could suffer injury to their health or safety if the information is not released to the government.

3. Court Balances Need Versus Potential Injury

Satisfied that the requested information qualifies for trade-secret protection, the court must ultimately balance the government’s showing of relevance and need against the trade-secret owner’s claim of injury that could result if disclosure is compelled. In considering the government’s need for the information, the court could factor in who the requestor is and the purpose for which the information is sought. None of the existing approaches pay particular attention to these questions, but they could add value when dealing with trade-secret cases. A further consideration may be whether the trade-secret information is critical to the government or the public. If not, perhaps the company can comply without disclosing the specific trade secret. If yes, then disclosure with greater assurance of protection might be advisable, possibly ordering, for instance, that the information is outside the agency’s discretion to disclose or that it be “sealed.”

Moreover, the court could also consider the nature of the trade secret in evaluating need and risk of injury. Because trade secrets can be virtually any kind of business information, it may matter whether the information sought is the secret formula to the company’s core product, or a list of the company’s customers; the encryption code to a black box or the record of drivers’ braking patterns during an unintended-acceleration incident.

The shelf life of the information could also be considered to determine whether the nature of the information is such that it will no longer be secret after a short period of time. It could, for instance, be a marketing-related secret that will be divulged or reverse-engineered after a product is released. In that situation, the court may lean toward not ordering disclosure, since the requestor will likely have access to the information by legitimate means in a relatively short period of time. This assumes, however, that there is no immediate critical need for the information.

Whether the trade-secret owner can persuade the court of the harm that could result if the trade secret is ordered disclosed is a very important part of the balance that the court must aim to achieve. The scope of harm, whether limited to that by a competitor, for instance, compared to a more widespread public harm, may matter. However, defining harm can be difficult. The risk of harm is an important component of this evaluation and could be influenced by the government’s assurances of safeguarding the trade secret.

Besides harm to the company, the court may also consider harm to the public if the information is not produced to the government. This would therefore allow for those circumstances where the health and safety of the public are so threatened that disclosure should be compelled. In other words, the harm to the public would outweigh any competitive harm that the proprietor of the trade secret may suffer. As recognized under well-settled takings principles, the government’s use of information for the public good (with adequate compensation) would not likely violate constitutional norms. Accordingly, a court in its discretion could order disclosure in those circumstances.

4. Court Determines Scope of Order

After weighing the various considerations, a court could find that production of the trade-secret should not be ordered. This will end the inquiry and the trade-secret owner prevails. On the other hand, if the court determines that production should be compelled, then the delicate task of crafting an appropriate protective order will remain. A court should not compel production of a trade secret without a protective order and appropriate safeguards for protection of the secret.

The court could choose from a range of options, depending on the particular case, to determine the appropriate scope of the order. For instance, limited disclosure could be ordered, such that the government may not receive the entire trade secret, but part of it. This does not appear to be the current scheme under FOIA, which is an all-or-nothing approach. Thus, there could be a middle-ground approach, one that would meet the requestor’s need for the information while still protecting the trade-secret owner’s interests. A mosaic approach might also work, where the trade-secret information is disaggregated such that the disaggregated form does not reveal the trade secret, yet it remains valuable information to the requestor. The FTC rules, for instance, provide for the disclosure of disaggregated information to other agencies, and to the extent the secret information can be segregated from the nonsecret information, a portion of the record may be disclosed to a FOIA requestor. In some circumstances, a court could order disclosure contingent upon some payment to the trade-secret owner. This would be akin to a compulsory license where, for instance, the court has deemed that withholding the information from the public will have an injurious effect on the public welfare.

III. CONCLUSION

Refusal-to-submit cases raise some delicate issues on both sides, since the interests of all involved parties must be given very serious consideration. While these cases will necessarily be decided on a case-by-case basis, an approach that takes into account trade-secrecy principles, in addition to a more structured approach to government-disclosure policies, will better achieve the balance between secrecy and access. It will also allow for the crafting of more creative solutions that are better able to serve the needs of the respective parties. The shield-or-disclose model presented here helps meet those ideals by making clear the parties’ burdens of proof on showing harm, relevance, and need before trade secrets are to be handed over to the government. Ultimately, it provides a more balanced, more specifically tailored approach that offers more of a middle-ground solution than currently exists.

Professor Rowe’s piece is derived from a law review article which first appeared in the Iowa Law Review. The article more thoroughly presents and explores the background research leading to the development of the shield-or-disclose model, including a discussion of existing agency regulations governing trade secrets. See Elizabeth A. Rowe, Striking a Balance: When Should Trade-Secret Law Shield Disclosures to the Government? 96 Iowa Law Review 791 (2011). Professor Rowe thanks Lamar Miller for providing research assistance on this piece.

In a shocking scandal, a federal court clerk has been accused of leaking confidential files, including information disclosing details of contemplated law enforcement raids on Armenian street gangs.

As reported by the ABA, Nune Gevorkyan (“Gevorkyan”), a district court criminal intake clerk, and her husband, Oganes Koshkaryan (“Koshkaryan”) were arrested and charged with conspiring to obstruct justice, a violation of Title 18, United States Code Sections 371 and 1512. The charges were filed in the US District Court for the Central District of California, and if convicted, both face up to twenty years in prison.

The Eurasian Organized Crime Task Force (EOCTF), a law enforcement group comprised of nine different local law enforcement agencies in Los Angeles County, as well as the FBI, U.S. Secret Service, and the U.S. Immigration & Customs Enforcement, first initiated an investigation of several high profile members of the Armenian Power gang in 2006. The Armenian Power gang, an organized crime syndicate which primarily includes members of Armenian descent, is believed to be involved in a variety of criminal activities, including kidnapping, extortion, bank fraud, identity theft, credit card fraud, distribution of narcotics and various other criminal acts.

The FBI alleges that Gevorkyan accessed sealed indictments prior to February 2011 raids across Southern California which led to the arrests of over 70 associates of the Armenian Power gang. After looking at the indictments Gevorkyan allegedly passed the information on to her husband, Oganes Koshkaryan (“Koshkaryan”). Koshkaryan allegedly acted as an intermediary, promising clients he could get confidential information from the courts in exchange for cash.

The FBI first learned of the leaks after a defendant who was seeking a reduced sentence informed them that the raids were known to some of the gang members who were arrested. The cooperating defendant told the FBI that he had fled his home prior to the arrests because of the information Koshkaryan allegedly had provided to him. The defendant later surrendered. A second defendant also fled for his or her safety based on Koshkaryan’s alleged information.

On at least two occasions, Koshkaryn alleged delivered information from the sealed court records to an FBI informant. This past month, the informant allegedly asked Koshkaryan about a person currently under investigation, and was told the person would be arrested soon. Koshkaryan provided additional information regarding another defendant, and was paid $2000. Record searches completed by FBI allegedly confirmed that Gevorkyan had accessed sealed court documents pertaining to the ongoing investigations. Specifically, checks of electronic court records allegedly confirmed that Gevorkyan had accessed the sealed court records pertaining to the named individuals shortly after the undercover had delivered the names to Koshkaryan.

According to a story in the Glendale News-Press, law enforcement officials view the arrest of Gevorkyan and Koshkaryan as exposing a major “betrayal within the system.” According to the story, law enforcement officials are  concerned that “organized crime is infiltrating areas we wouldn’t have expected,” putting officer’s safety in danger, and allowing defendants under investigation to possibly destroy evidence and threaten criminal investigations. The EOTCF has already had to move up operations for fear that the suspects might flee or destroy incriminating evidence.

The arrest of Gevorkyan and Koshkaryan may be emblematic of a more widespread FBI crack down on insider threats. In recent years, the FBI has put an increasing premium on detecting such threats and preventing the significant harm such threats cause. These threats are often difficult to detect because an insider, as an employee with legitimate access, may not initially appear to be doing anything wrong. However, such insiders can cause significant damage by stealing company information or products to benefit another organization. The FBI has provided detailed tips on its website to detect insiders who may compromise company assets.

We will continue to keep you apprised of future developments in this case, as well as other FBI efforts to reduce the growing threat posed by rogue insiders. The case also highlights why some legal commentators and courts believe that the Computer Fraud and Abuse Act should be broadly construed to prevent insider data theft.

By Robert Milligan and Joshua Salinas

Non-competition agreements executed in connection with the sale of a business are typically enforceable as a limited exception under Business and Professions Code section 16601 and applicable case authority to California’s general prohibition against non-competition agreements. A recent California Court of Appeal decision, however, further narrows this limited exception. 

In Fillpoint v. Maas, 2012 WL 3631266 (Aug. 24, 2012), the California Court of Appeal, Fourth District, found that two separate agreements–a stock purchase agreement and employment agreement–executed pursuant to the sale of a business, must be read together when analyzing the restrictive covenants contained in each agreement. The Court then held that the non-competition covenant in the employment agreement, whose terms differed from the non-competition covenant in the purchase agreement, did not fall under the “sale of business” exception, and thus was unenforceable. The Court reasoned that the covenant was not focused on protecting the acquired company’s goodwill. Rather, it impermissibly “targeted an employee’s fundamental right to pursue his or her profession” in violation of Business and Professions Code section 16600, California’s statute prohibiting non-competition agreements.

Background Facts

Defendant Michael Maas was an employee of specialty video game publisher Crave Entertainment Group. When Handleman Company acquired Crave, Maas sold his company stock and signed a stock purchase agreement. The purchase agreement contained a three-year covenant not to compete, which restricted Maas from engaging in the business he sold, with the exception of working on behalf of Crave. Business was defined as “distribut[ion] and publish[ing] of interactive entertainment (videogames), software, hardware and accessories and provid[ing] videogame software, hardware and accessories category management services for certain game retailers.”

In the purchase agreement, Crave also agreed to ensure that Maas would execute an employment agreement at closing. In fact, the purchase agreement contained an integration clause that made a blank form employment agreement part of the purchase agreement.

A month after the purchase agreement was signed, Maas entered into an employment agreement with Crave by which he agreed to work for Crave for three years. The employment agreement contained a covenant not to compete or solicit paragraph. The non-compete provision contained therein was different than the covenant not to compete in the purchase agreement. It prevented Maas from participating, engaging or having an interest in any competitive business in any county in which Crave does business. In addition to the covenant not to compete provision, the paragraph contained a covenant not to sell competitive products to customers and prospective customers of Crave, and a covenant not to employ or solicit employees or consultants of Crave –hereinafter this is referred to as the non-solicitation provision. Both the non-competition and the non-solicitation provisions lasted for one year after the expiration of the employment agreement or after the earlier termination of his employment. The employment agreement contained an integration clause specifying that the employment agreement and purchase agreement constituted the sole and entire agreements between the parties, that any prior agreements were of no force and effect, and that to the extent that there was any conflict between the two agreements, the purchase agreement shall prevail.

Maas resigned exactly three years after executing the purchase agreement, purportedly satisfying the three-year non-competition covenant contained within the purchase agreement. Shortly thereafter, Maas became the President and CEO of competitor Solutions 2 Go.

Plaintiff Fillpoint LLC is a videogame distributor that acquired Crave’s assets from Handleman, including the rights to Maas’ employment agreement. Because of Maas’ employment with competitor Solutions 2 Go, Fillpoint filed suit against Maas for breach of the employment agreement and against Solutions 2 Go for tortious interference with the employment agreement. The defendants asserted, among other defenses, that the covenant not to compete or solicit paragraph in the employment agreement was unenforceable under California Business and Professions Code section 16600.

Trial Court’s Decision

After Fillpoint’s opening statement at trial, the defendants moved for nonsuit (i.e. as a matter of law, the evidence presented by plaintiff was insufficient to permit a jury to find in its favor). The trial court granted the defendants’ nonsuit motion and found the following: (1) Maas’ non-competition covenants were assignable to Fillpoint, (2) the covenants were contained in separate agreements and should not be read together, and (3) the covenant not to compete or solicit in the employment agreement was unenforceable under section 16600. The court later decided to dismiss the tortious interference claim because it was based upon the covenant not to compete or solicit in the employment agreement, which the court found to be unenforceable.

Court of Appeal’s Holding

The Court of Appeal reversed the trial court’s decision and held that the purchase agreement and employment agreement must be read together, adopting Fillpoint’s argument. (See Cal. Civ. Code § 1642: “Several contracts relating to the same matters, between the same parties, and made as parts of substantially one transaction, are to be taken together.”). The Court, however, affirmed the trial court’s judgment and found that the covenant not to compete or solicit in the employment agreement was void and unenforceable under California law. The Court reasoned that the covenant not to compete or solicit did not fall under the “sale of business” exception (Business and Professions Code section 16601) because it was overly broad and not designed to protect the acquired company’s goodwill.

(1) The Non-Competition Covenants in the Purchase Agreement and Employment Agreement Must Be Read Together

The Court stated that neither party cited any case with the same facts presented by the instant case–a purchase agreement and employment agreement entered at roughly the same time and as part of a single transaction, but containing different non-competition covenants. The Court proceeded to discuss several California cases that addressed non-competition covenants located in different and/or multiple documents.

The Court referenced the Court of Appeal decision in Hilb, Rogal & Hamilton Ins. Services v. Robb (1995) 33 Cal.App.4th 1812, which held that the placement of a three-year post-termination non-compete in an employment contract, rather than a merger agreement, did not affect the covenant’s enforceability under section 16601 when both agreements were executed pursuant to the same business acquisition.

The Court also referenced the Court of Appeal decision in Alliant Ins. Services, Inc. v. Gaddy (2008) 159 Cal.App.4th 1292, which held that a non-compete contained in a purchase agreement executed pursuant to the sale of a business was enforceable under section 16601 in the context of a motion for preliminary injunction. The Fillpoint Court noted that the language in the purchase agreement was identical to the covenant contained in the related employment agreement. The identical covenants applied to the entire state of California, for a period of five years after the stock purchase closing date or two years after the termination of Gaddy’s employment with the new company, whichever was later.

The Fillpoint Court distinguished the two cases from the instant case because they essentially involved a single non-competition covenant, where the instant non-competition covenants were different–three years after the purchase of Maas stock (purchase agreement) vs. one year after the termination of Maas’ employment (employment agreement), with differing language.

The Court ultimately agreed with Fillpoint’s argument that the purchase agreement and employment agreements should be read together because both agreements were part of the same single business transaction, referenced each other, were between the same parties, and contained an integration clause, but the Court did not reach the result that Fillpoint expected would result from that conclusion.

(2) The Non-Competition Covenant in the Employment Agreement is Unenforceable Under Business and Professions Code Section 16600

The Court recognized that section 16601 permits the enforcement of non-competition covenants, executed in connection with the sale of a business, to protect an acquired company’s goodwill and guard the value of the property right that was acquired. The Court noted that the burden is on the buyer to prove that this exception applies.

The Court rejected Fillpoint’s argument that the fact the purchase agreement and employment agreement should be read together automatically meant the non-competition covenant in the employment agreement was enforceable under section 16601.

The Court found that the non-competition covenants in the two agreements were different by their very nature. The Court explained that “the purchase agreement’s covenant was focused on protecting the acquired goodwill of Crave for a limited time” and “[t]he employment agreement’s covenant targeted an employee’s fundamental right to pursue his or her profession.” In fact, the Court reiterated that the non-competition covenant in the purchase agreement was fully satisfied and expired when Maas resigned three years later. The Court found that Fillpoint conceded in its briefing that the two non-competition covenants were intended to “deal with the different damage Maas might do wearing the separate hats of major shareholder and key employee.” Thus, the Court concluded that the non-competition covenant in the employment agreement was unenforceable under section 16600 and failed to fit within the limited exception under section 16601.

The Court also found the non-solicitation provision in the employment agreement too broad and inconsistent with the purposes and terms of section 16600 and 16601 because it gave overly broad protection to the seller and extended beyond the business sold by barring Mass from selling to or soliciting the buyer’s potential customers. The Court cited with approval Strategix, Ltd. v. Infocrossing West, Inc. (2006) 142 Cal.App.4th 1068, which found that “nonsolicitation covenants barring the seller from soliciting all employees and customers of the buyer, even those who were not former employees or customers of the sold business, extend their anticompetitive reach beyond the business so sold” and that such “covenants would give the buyer broad protection against competition wherever it happens to have employees or customers, at the expense of the seller’s fundamental right to compete for employees and customers in the marketplace.”

The Court concluded that Maas satisfied his covenant not to compete for three years under the purchase agreement. The employment agreement’s covenant not to compete for an additional year, including its broad non-solicitation provision, cannot be reconciled with California’s strong public policy permitting employees the right to pursue a lawful occupation of their own choice.

What Fillpoint Means: The Takeaways

(1) Current agreements. Fillpoint may have a significant impact on companies who currently have different non-competition covenants contained within separate agreements that were executed pursuant to the sale of a business with sellers/key employees. While Fillpoint does not foreclose the ability to enforce non-competition covenants under section 16601, California courts may not enforce these covenants under this statute if the language of the agreement does not reflect a clear purpose to protect business goodwill. Companies should evaluate their non-competition agreements and recognize the risk that covenants within employment agreements may not be enforceable to the extent that they conflict with or have a broader scope than the terms of the covenants in the purchase or merger agreements and are not clearly and expressly calculated to protect the business goodwill of the selling company. Companies should also recognize that, while not at issue in this case, they may still attempt to argue that such covenants are enforceable because they are necessary to protect trade secrets under the so called “trade secrets exception” to Business and Professions Code section 16600. There remains a dispute as to whether such an exception exists and if so, what it means.

(2) Future agreements. Going forward, at a minimum, companies should include all non-competition covenants within the terms of the purchase agreements with sellers/key employees. As seen in the Gaddy case, a non-competition agreement that contains a latent tail (i.e. additional post-termination covenant triggered at an undetermined future date) may possibly be enforceable if contained within the terms of the purchase agreement. Some legal commentators, however, believe that latent tails that become effective many years after the sale may now be unenforceable. Companies should consider maxing out the duration of a permissible non-competition covenants in the purchase agreement with sellers/key employees. To the extent that companies include the non-competition covenants in employment agreements or other agreements, the non-competition provision should be identical to the non-competition provision in the purchase agreement and should contain clear language indicating that the purpose of the provision is to protect the business goodwill in connection with the sale of business. Any non-solicitation covenants in connection with the underlying transaction should be limited to customers and employees of the seller under the Strategix decision. The purchaser/new employer should also be able to prohibit the solicitation of employees that the key employee has contact with after joining the company under Loral v. Moyes (1985) 174 Cal.App.3d 268, for up to one year post-termination.

(3) This is only one Court of Appeal decision and other decisions may support a different result. This case’s holding that the non-competition covenant in the employment agreement did not fall under section 16601 because it focused on the “right to pursue a profession” appears to conflict with the Idaho Supreme Court in T.J.T., Inc. v. Mori  (Id. 2011) 266 P.3d 476 (applying California law) and other California decisions. The Idaho Supreme Court in T.J.T. found that a two-year non-compete agreement executed in connection with the sale of a business was enforceable under California law, despite the fact that the seller also became an employee of the purchasing company as a result of the sale. Even though the non-compete agreement referred to the employee/seller’s employment with the new employer/buyer to determine its duration and enforceability, the court found that such an “incidental” link does not necessarily mean the provision is unenforceable. Instead, the court reasoned that the employee’s employment only came about as part of the larger transaction–the sale of the business to a competitor–and was therefore enforceable. Interestingly, T.J.T. examined the same cases (Hilb, Rogal & Hamilton Ins. Services v. Robb (1995) 33 Cal.App.4th 1812 (containing a three year post-termination non-compete in employment agreement) and Alliant Ins. Services, Inc. v. Gaddy (2008) 159 Cal.App.4th 1292 (2008) (containing a five year non-compete and two year post-termination non-compete in asset purchase agreement and employment agreement) as Fillpoint but came to a different conclusion.

Also, the Fillpoint Court did not address two existing California Court of Appeal decisions that may also be instructive and lead to a different result. In Newlife Sciences v. Weinstock (2011) 197 Cal.App.4th 676, the California Court of Appeal, Second District, upheld a preliminary injunction based upon discovery issue sanctions entered against an employee who breached his non-competition agreement contained in an employment agreement with his new employer. The non-competition agreement was operative during his new employment and for five years after termination of that employment. The trial court determined that it was enforceable because it was part of the transfer of business and its goodwill by the selling employee.

Additionally, in Monogram Industries, Inc. v. SAR Industries, Inc. (1976) 64 Cal.App.3d 692, the California Court of Appeal, Second District, affirmed the entry of a preliminary injunction against an employee on a breach of a covenant not to compete. The five year covenant not to compete was contained in a consultant agreement executed in a connection with a purchase agreement. The court upheld the provision under a previous version of section 16601 reasoning that the purpose of section 16601 is to permit the purchaser to protect himself or itself against competition from the seller which competition would have the effect of reducing the value of the property right that was acquired. Some may consider this interest as the same side of the coin compared to the Fillpoint Court’s concern for the “employee’s fundamental right to pursue his or her profession.” The court also reasoned that there was an inference that business had a “goodwill” and that it was transferred where the covenant was executed as an adjunct of a sale of a business.

(4) California is unique regarding the enforcement of non-competes. This case reminds us that California is different from other states in its general prohibition and strong public policy against non-competes. In most states, the one-year non-competition covenant at issue in this case would likely be enforceable in whole or part. Companies may want to consider including out-of-state forum selection and choice of law provisions, coupled with consent to jurisdiction provisions, to attempt to increase the likelihood of successfully enforcing their non-competition agreements against business sellers/key employees provided the parties to the transaction have a sufficient connection to the outside forum state.

In a legal matchup involving some Hollywood heavyweights, Thomas Randolph filed suit in Los Angeles Superior Court recently, alleging he was defrauded out of his stake in a prominent 3-D movie technology venture.

Randolph sued William Sherak, the son of Motion Picture Academy of Arts and Sciences President Tom Sherak and a prior chairman of 20th Century Fox’s domestic film group; movie producer Christopher Mallick; actor Giovanni Ribisi, star of such films and television shows such as Avatar, My Name is Earl, and Cold Mountain; software developer Kuniaki Izumi; and William Morris talent agent David Phillips.

Randolph alleges that his company’s alleged trade secrets were stolen in violation of a non-disclosure agreement, he was not paid his share of company profits, and he was falsely accussed of self-dealing. Randolph also seeks damages for intentional interference with prospective economic advantage, intentional interference with contractual relations, fraud, negligent misrepresentation and breach of contract.

Mallick formed MRSF LLC, which was previously known as StereoD LLC in 2009. The company is one of the top 3-D conversion companies in the country, and its products include the films Captain America, Avatar and Thor. The company allegedly planned to market and sell Izumi’s software technology, and Randolph was allegedly hired to create the business plan for the company. Randolph, who was a principal at Kerner Technologies, a spin-off of George Lucas’ Industrial Light and Magic at the time, allegedly initially met with Mallick in late 2008. During their meeting, Mallick allegedly expressed interest in converting two dimensional movies to three dimensional movies. According to the complaint, Randolph told Mallick about VDX technology, and persuaded Izumi to combine that technology with Kerner’s CPX technologies, and then allegedly with Kerner’s consent, Randolph entered into an agreement with Mallick.

As alleged in the complaint, the parties verbally agreed that Randolph would be the company’s Chief Technological Officer, and would own a 5-10 percent stake in the company. Under the terms of the alleged agreement, he would also be entitled to license Kerner’s CPX technology freely. Randolph and StereoD entered into a non-disclosure agreement prohibiting Randolph from disclosing the company’s confidential information and business plan. Randolph alleges, however, that before the deal was even completed, Phillips began conspiring against him over finder’s fees, which he believed he was owed in exchange for introducing Randolph and Mallick. According to Randolph, Phillips allegedly double crossed him, notifying Ian Rose, Kerner’s general counsel, that Randolph was self-dealing, and trying to exclude Kerner from any future deals. Mallick, who also believed he was owed a finder’s fee, allegedly furthered the legend of Randolph’s self-dealing. After rumors allegedly arose that Randolph was breaching his fiduciary duty to Kerner in February 2009, Randolph resigned from the company 2009, after he was accused of failing to disclose the VDX deal to Kerner Technologies.

Following Randolph’s resignation from Kerner, Mallick, Ribisi, and Sherak ejected him from StereoD. According to the complaint, Randolph allegedly stayed in touch with Izumi, however, who assured him he would protect Randolph’s interests, and that Randolph would still receive a cut of the profits. Mallick, Ribisi, and Sherak allegedly ended up making tens of millions of dollars when the company was purchased by Deluxe 3-D for approximately $50 million. The company then allegedly proceeded to implement a business plan that was quite similar to the “structure, objectives, development strategy, production methodologies, revenue goals and exit strategy” Randolph had envisioned in 2009. Randolph alleges that after the company’s purchase, he discovered Izumi was part of the overall conspiracy against him, and that he himself lacked any equity or ownership interest in the company. Following this revelation, Randolph filed the lawsuit in July 2012.

Last year, talent agent David Phillips filed a similar lawsuit, against the company, alleging breach of oral partnership agreement, breach of contract, breach of fiduciary duty, and conversion. The case settled before trial for an undisclosed sum.

The interplay between Hollywood heavyweights, alleged breach of a confidentiality agreement, purported trade secrets, and white hot 3-D technology makes this new suit an interesting matter to follow and serves as an unfortunate reminder of how some business dealings can run astray. 

 

When confidential information or trade secrets are provided to a government agency in a bid for a public contract, they might wind up being disclosed to a competitor or others unless great care is taken by the bidder. Non-disclosure agreements are essential. Of course, all pages containing a trade secret should be designated as “confidential.” Examples of other protective measures that might be utilized include placing on each such page limitations on permissible access, and referring in all written and oral communications relating to any of those pages that they contain proprietary data. If there are mock-ups or models embodying a trade secret, a non-disclosure agreement should be obtained from anyone permitted to see them. When, of necessity, a trade secret needs to be disclosed in court papers, an attempt should be made to submit them under seal.

Under contract with school districts, Delcom designs and installs customized, interactive, and media-driven equipment used in classrooms. Delcom submitted two multi-million dollar bids in response to a RFP from a Dallas school district (“DISD”). A competitor, Prime, submitted one bid. Delcom was the highest ranked bidder, and contract negotiations with DISD commenced. About three weeks later, however, DISD notified Delcom that (a) the Texas Education Code disqualified the company because of its failure to disclose that one of its employees had been convicted of a felony, and (b) DISD intended to enter into contract negotiations with Prime.

Delcom promptly filed suit in a Texas court against DISD and Prime, asserting various tort and contract claims including misappropriation of trade secrets contained in Delcom’s bidding documents and in a model classroom it built as part of its RFP bid. Delcom asked for injunctive relief. In the course of a TRO hearing, Prime returned to Delcom all of its documents that Prime had received from DISD, and Prime assured the court that none had been used. For these and other reasons, the trial court denied Delcom’s request for injunctive relief against both of the defendants and dismissed the case against DISD. These rulings were affirmed on appeal. Delcom Group, LP v. Dallas Indep. School Dist., Case No. 05-11-01259-CV (Tex. Court of Appeals, Aug. 17, 2012).

Delcom’s litigation effort failed largely because of a number of facts unique to this case. The part of the decision most useful to attorneys and clients interested in trade secret law is the court’s discussion, summarized in the first paragraph of this blog, of actions that can be taken to protect confidential information contained in a bid submitted in response to a RFP.

 

By Matthew Werber

The Federal Circuit caught the attention of the ITC and trade secret litigators alike when it ruled in TianRui Group Co. v. ITC that the ITC can exercise its jurisdiction over acts of misappropriation occurring entirely in China.

The Commission initiated Investigation No. 337-TA-655 based on allegations that TianRui and a group of related respondents unlawfully accessed and used Illinois-based Amsted Industries, Inc.’s proprietary ABC process to manufacture imported steel railcar wheels. After unsuccessfully attempting to license the ABC process from Amsted, TianRui hired several employees from one of Amsted’s Chinese vendors. After being brought to TianRui, the former employees disclosed Amsted’s confidential information and enabled TainRui to begin using the ABC process to make steel railcar wheel parts bound for destinations in the U.S. The parties did not dispute that the acts of misappropriation occurred entirely in China. Following a trial before an administrative law judge, the Commission ultimately found that TianRui violated Section 337 and issued exclusion and cease and desist orders barring the subject TianRui wheel parts from entry in to the U.S.

On appeal, the Federal Circuit affirmed the Commission’s determination. The majority found that 19 U.S.C. § 1337 (“Section 337”) — the statute that governs the ITC’s jurisdiction to investigate patent, trade secret and other intellectual property matters — focuses on the nexus between the imported articles and the unfair methods of competition rather than on where the misappropriation occurs: the determination of misappropriation was merely a predicate to the charge that TianRui committed unfair acts in importing its wheels into the United States. In other words, the Commission’s interpretation of section 337 does not, as the dissent contends, give it the authority to “police Chinese business practices.” It only sets the conditions under which products may be imported into the United States.

Less than eight months after the TianRui decision, Complainant SI Group, Inc., a Schenectady, NY based chemical manufacturer, followed Amsted’s footsteps by requesting that the Commission investigate acts of misappropriation occurring entirely in China. SI Group alleges that Sino Legend (Zhangjiagang) Chemical Co., Ltd. and a group of related respondents (collectively referred to as Sino Legend) unlawfully accessed SI Group’s trade secret process for making rubber resins and uses it to make imported resins .

According to the complaint, Sino Legend poached a plant manager from an SI Group manufacturing facility in Shanghai who disclosed SI Group’s trade secrets to Sino Legend and enabled Sino Legend to bring the process in its own facility. On June 20, 2012, the Commission, after considering the complaint, announced their vote to institute an investigation, Certain Rubber Resins and Processes for Manufacturing Same (Inv. No. 337-TA-849). The parties are now engaging in fact discovery and the trial is scheduled to begin in February 2013.

Considering the ITC as a Trade Secret Litigation Forum.

There is no question TianRui opened the ITC’s doors to trade secret holders seeking to remedy misappropriation occurring abroad because some trade secret holders may find that the ITC is their only viable option. Most trade secret litigation occurs in state and federal courts (primarily state court). Yet, as a general proposition, the misappropriation must occur within the U.S. to fall within the state and federal court’s jurisdiction and even then the misappropriators may flee the country to prevent effective service of process. Some U.S. companies have sought remedies in the country where the misappropriation occurred. Such efforts have resulted in varying degrees of success, however. SI Group, for example, alleges it pursued relief from Chinese authorities and courts. Yet, the Chinese courts have not taken any action according to SI Group’s complaint. As such, many anticipate the number of Section 337 trade secret complaints to increase.

Trade secret holders considering filing a complaint in the ITC should be aware of certain considerations unique to the ITC litigation. For example, unlike district courts, the ITC generally does not have the power to order monetary relief. Instead, Section 337 gives the Commission authority to direct that infringing articles be “excluded from entry into the United States.” Exclusion orders are enforced, in part, by U.S. Customs Border Protection (“CBP”) officials who are instructed to identify articles subject to the exclusion order and prevent their entry into the U.S. While not a monetary award, an exclusion order is nevertheless a very powerful remedy. In TianRui, for example, the Commission issued an exclusion order prohibiting entry of the subject TainRui steel railway wheels for a period of ten years.

U.S. companies considering the ITC should also be aware that the ITC is subject to certain jurisdictional limitations that are not at issue in state or federal court litigation. For example, the trade secret holder must show the existence of a “domestic industry,” or, generally speaking, an industry within the U.S. being affected by the infringer’s alleged wrongful acts. In TianRui, the majority concluded Amsted satisfied the domestic industry requirement because the imported TianRui wheels could directly compete with wheels made by Amsted in its manufacturing facilities in the U.S. Yet, not all trade secret holders can meet this standard, particularly those with little or no U.S. presence. For more information on this interesting issue, please see the Seyfarth Shaw LLP webinar When Trade Secrets Cross International Borders.

A recent Alabama federal court decision discusses how to determine the “amount in controversy” when a state court trade secret misappropriation case is removed to federal court based on diversity of citizenship, but the complaint is silent as to the amount of damages demanded.

In order to place a value on the allegedly misappropriated trade secrets, courts take into account such factors as a reasonable royalty the plaintiff might have charged for licensing the trade secrets, the plaintiff’s lost income resulting from the alleged misappropriation, and the defendant’s gross or net revenue received because of the claimed misconduct. In addition, consideration may be given to the estimated amount of the plaintiff’s attorneys’ fees that might be awarded, and an estimate of potential exemplary damages if the applicable statute permits such an award.

Plaintiffs Molex Company, LLC, an Alabama corporation, and its Cayman Islands marketing subsidiary Pacific Mining Reagents, Ltd., filed a trade secrets misappropriation suit in an Alabama state court against a Texas resident. The defendant was a former consultant to, and later the business manager of, Pacific. The complaint did not specify the amount of damages sought. Asserting that there was complete diversity of citizenship and an amount in controversy in excess of $75,000 exclusive of interest and costs, the defendant removed the case to federal court. Molex and Pacific conceded that diversity was complete but moved to remand on the ground that the amount in controversy did not meet the jurisdictional minimum.

The Alabama trade secrets misappropriation statute provides for an award of actual damages plus the defendant’s profits and other benefits attributable to the wrongdoing. The defendant’s profits equal its gross revenues from the misconduct, unless the defendant demonstrates deductible expenses and elements of profit attributable to factors other than the misappropriation. If the defendant engaged in willful and malicious misconduct, exemplary damages of not less than $10,000, plus attorneys’ fees, may be awarded. The “amount in controversy” is the estimated sum of these amounts.

In determining whether it has subject-matter jurisdiction, courts consider whether the plaintiff could be entitled to more than $75,000 if liability is established. An assertion by the defendant in its removal petition that the “amount in controversy” exceeds the jurisdictional minimum usually will suffice unless it appears to have been pleaded “in bad faith” because, for example, the suit “obviously,” or “to a legal certainty,” cannot involve that much.

Although Molex and Pacific did not quantify their damages in the complaint, they did claim that the defendant used the misappropriated trade secrets to develop a product for sale to — that is, to “steal” — plaintiffs’ $300,000 per year customer. The court concluded that, therefore, even if the plaintiffs’ lost business were the only relevant criteria, the amount in controversy more likely than not exceeded $75,000. With the possibility of punitive damages and attorneys’ fees awards added, the requirements for diversity jurisdiction were held to be satisfied, and so the motion to remand was denied. Molex Co. v. Andress, Civil Ac. No. 5:12-cv-2098-CLS (N.D. Ala., Aug. 10, 2012).

The defendant also challenged the Alabama court’s personal jurisdiction over him since he maintained no office or residence in Alabama, he never set foot in that state or attempted to make sales to customers there, all face-to-face meetings with the plaintiffs’ personnel took place in Texas, and he was paid by the Cayman Islands company (Pacific), not by the Alabama corporation (Molex). However, the plaintiffs countered that in the course of doing business the defendant regularly communicated by phone, fax and email with Molex’s headquarters staff in Alabama. On balance, the court concluded that he purposefully conducted activities in Alabama, and that the alleged trade secret violations clearly were based in substantial part on his relationship with Molex. Therefore, he had sufficient “minimum contacts” with Alabama to warrant personal jurisdiction.

The opinion in this case provides a roadmap for supporting a claim that the “amount in controversy” meets the federal diversity jurisdiction standard when the complaint lacks specificity.

On August 9, 2012, a district court for the Western District of Michigan dismissed counterclaims of tortious interference with a business expectancy and conversion brought after the removal of a company’s Facebook page and the alleged loss of its more than 19,000 “fans.” (Lown Companies LLC v. Piggy Paint LLC, No. 11-cv–911 (W.D. Mich., Aug. 9, 2012)) . This case illustrates how courts struggle with determining the value of Facebook friends, Twitter followers, and other social media “assets.”

Plaintiff Lown Companies, LLC holds a registered mark “PIGGY POLISH” for nail polish products. Lown brought a trademark infringement action against Defendant Piggy Paint, LLC when Lown discovered that Piggy Paint was allegedly selling nail polish products under the mark “PIGGY PAINT NATURAL AS MUD.” Lown also sent a take down request to Facebook, requesting removal of Piggy Paint’s Facebook page on grounds of alleged copyright infringement (although it should have been brought based on alleged trademark infringement).

Facebook honored Lown’s request. Piggy Paint consequently lost access to its Facebook page and access to its 19,000 “fans.”

As a result, Piggy Paint raised several counterclaims against Lown, including tortious interference with a business expectancy and conversion. In particular, Piggy Paint alleged that it had a business expectancy in the more than 19,000 “fans” that “liked” its page. (Some commentators were surprised it had 19,000 fans in the first place – see Eric Goldman’s scholarly and humorous blog on this case). Moreover, Piggy Paint alleged that Lown intentionally exercised control over Piggy Paint’s mark by removing its page from Facebook.

The Court dismissed both counterclaims.

First, the Court found that “Piggy Paint has not and cannot show that the removal of the facebook page — which did not offer any means of placing orders or doing business — resulted in the loss of any business.” The Court held that Piggy Paint’s alleged business expectancy with its “fans” was “too indefinite to form the basis of an actual expectation of business.” Moreover, the Court recognized that Lown’s removal request was based on its desire to protect own mark, not out of malice.

Second, the Court recognized that Facebook, not Lown, took down Piggy Paint’s page. Thus, the conversion counterclaim was inapplicable to Lown to because Piggy Paint failed to allege that Lown had any authority or ability to control the page or force Facebook to remove it.

This case is important as the courts begin to address the ownership and value of social media “assets.” It demonstrates the need explain the damages or harm incurred when bringing claims for the loss of social media friends, fans, or followers. The Court seemed to suggest that Piggy Paint may have proceeded on its tortious interference counterclaim if it explained how the loss of its “fans” caused a loss of business.

This case is analogous to the currently pending–and closely watched–PhoneDog v. Kravitz case, which involves a dispute over a company’s alleged loss of its Twitter account and followers that were allegedly taken by a former employee. Similar to this case, the court in PhoneDog dismissed PhoneDog’s tortious interference with a prospective economic advantage claim on grounds that PhoneDog failed to allege any facts regarding how the loss of its Twitter account and followers caused it any economic harm. The court subsequently allowed PhoneDog’s claim to go forward once PhoneDog amended its complaint and explained how it lost advertising revenue from the loss of its Twitter account and followers: “there is decreased traffic to [the] website through the Account, which in turn decreases the number of website page views and discourages advertisers from paying for ad inventory on PhoneDog’s website.”

The Piggy Paint Court did not indicate in its opinion or order whether Piggy Paint’s counterclaims were dismissed with or without prejudice. If the dismissal was without prejudice, Piggy Paint may be able to bring a tortious interference with a business expectancy counterclaim if it can provide specific facts and explain how the loss of its Facebook “fans” caused the loss of any business. This case also reflects a growing trend where courts refuse to accept conclusory allegations that the mere loss of social media “assets” is sufficient to show damages or losses.

This case also reveals the potential dangers in the use of social media to conduct business and as a company’s primary marketing device. As seen in the PhoneDog case, issues will continue to rise regarding the ownership of social media accounts, connections through those accounts, and other valuable social media assets. In the recent Eagle v. Morgan case, a federal court in Philadelphia ruled an employer could claim ownership of a former executive’s LinkedIn Account, where the employer had significant involvement in the creation, maintenance and operation of the account. Earlier this year, a Colorado federal court in Christou v. Beatport, LLC allowed a plaintiff’s trade secret misappropriation claim based on the theft of MySpace “friends” to proceed.

These significant issues will continue to linger as the courts grapple with issues such as whether social media accounts and followers can be owned, misappropriated, converted, transferred, or assigned, who may be liable when someone loses access to their social media accounts and followers, and what damages, if any, are recoverable.

Companies who utilize social media for business should consider the different protections and risks associated with each social network. For example, Piggy Paint demonstrates how a company can lose access to thousands of “fans” with simple takedown request from a competitor, at least in Michigan. The recent Facebook (Piggy Paint, Michigan), Twitter (PhoneDog, California), LinkedIn (Eagle, Pennsylvania), and MySpace (Christou, Colorado) cases, at least at this stage as the law develops, may reveal different levels of protection for each network in each state and may influence whether a company focuses their marketing efforts on a specific network.

While you can’t put a price on friendship, it is becoming apparent that you may be able to in social media and sue for the loss or denial of that “asset”–so long as you provide specific facts and explain the actual value of the social media connection at least in some jurisdictions. We will continue to follow this rapidly evolving area.

 

By Robert Milligan and Grace Chuchla

The Missouri Supreme Court recently issued a decision, Whelan Security Co. v. Kennebrew, et al., 2012 Mo. LEXIS 167, reaffirming Missouri as a pro non-compete jurisdiction for employers.

The Court’s decision makes clear that Missouri courts applying Missouri law will enforce non-competition and customer non-solicitation and employee non-solicitation agreements that are reasonable and necessary to protect legitimate interests against Missouri employees and non-resident employees.

In December 2008, two employees of Whelan Security Company (a Missouri company with 38 branches in 23 states), – Charles Kennebrew and Landon Morgan – resigned from their positions in Whelan’s Dallas and Nashville offices, respectively. Curiously, Kennebrew was assigned to the Dallas office because of a non-compete agreement he had with his previous employer. Soon after their resignations, Kennebrew and Morgan allegedly joined forces to start their own small security company – Elite Protective Services. Trouble began to brew in November 2009, when Elite successfully solicited the business of Park Square Condominiums, one of Whelan’s Houston-based clients, and also hired some of Whelan’s employees.

Kennebrew and Morgan had signed non-solicitation and non-competition agreements during their employment with Whelan. Specifically, for a period of two years after his employment, Kennebrew’s agreement restricted him, in pertinent part, from the following actions:

1) Solicit, take away or attempt to take away any customers or the business or patronage of any such customers or prospective customer(s) whose business was being sought during the last twelve months of employee’s employment;

2) Solicit, interfere with, employ, or endeavor to employ any employees or agents of employer; and

3) Working for a competing business within a fifty mile radius of any location where employee provided or arranged for employer to provide services.

Morgan’s agreement contained the same provisions; however, his agreement had a one year, rather than two year, prohibition.

With these agreements in hand and following the events at Park Square, Whelan filed suit, seeking both damages and a preliminary injunction. Whelan alleged that Kennebrew and Morgan violated their agreements. Whelan alleged that Kennebrew solicited Park Square’s business and that Elite had signed a contract with Park Square. Whelan alleged that Morgan solicited Whelan’s Park Square employees and that Elite retained several of Whelan’s Park Square employees. The trial court denied Whelan’s request for a preliminary injunction, and both sides then filed motions for summary judgment. The court denied Whelan’s motion but granted the defendants’ motion, finding that “the employment agreements at issue in this case, as written, are overbroad, not reasonable as to time and space and therefore are not valid.”

Whelan appealed, and the Missouri Supreme Court returned a decision that is, on the whole, quite favorable to employers and their ability to enforce non-competition and customer and employee non-solicitation agreements against Missouri employees and non-resident employees. While the court found that some of the covenants were unreasonable as written, the Court modified the covenants and enforced them to give effect to the intent of the parties.

Specifically, with respect to Kennebrew’s and Morgan’s agreements, the Court found as follows:

1) The customer non-solicitation clauses (for both prospective and existing customers) were overbroad because they lacked geographic limitations. The Court recognized that the two employees could not have “had significant contact with a substantial number of Whelan’s customers throughout the nation.” The Court, however, only declared unenforceable the provision’s prohibition on soliciting prospective customers. The Court reasoned that the prospective customer non-solicitation clauses prevented the employees from soliciting any business that Whelan sought as a customer in any of its 38 branches. The Court found that preventing the employees from soliciting any prospective customers throughout the nation would not protect Whelan from “the influence an employee acquires over his employer’s customers through personal contact,” which was a protectable interest under Missouri law, but instead would impermissibly protect Whelan from competition altogether. The Court indicated that under certain scenarios a prohibition on the solicitation of prospective customers could be permissible if for a legitimate purposes and tethered to prospective customers that the employee actually solicited, rather than tenuous and detached relationships.

The Court permitted the existing customer non-solicitation clause to remain but modified it to apply only to those customers with which Morgan or Kennebrew had contact in the last year of their employment. The Court reasoned that although Morgan and Kennebrew had significant client contact in their respective branch offices and possibly in the Houston area, there was no disputed facts showing that they had significant contact with a substantial number of Whelan’s contacts throughout the nation such as to warrant a national prohibition.

2) Morgan’s one-year employee non-solicitation clause was reasonable and enforceable because it complied with Missouri Revised Section 431.202(4), which renders an employee non-solicit provision “per se reasonable if the duration is for a period of one year of less.” The Court found that there was a genuine factual dispute regarding the purpose of Kennebrew’s two-year prohibition that needed to be resolved by the trial court. On remand, Whelan will need to demonstrate that the clause is to protect “[c]onfidential or trade secret business information” or “[c]ustomer or supplier relationships, goodwill or loyalty, which shall be deemed to be among the protectable interests of the employer” under Revised Section 431.202(3).

3) Kennebrew’s non-competition clause was enforceable, but a factual dispute remained over whether Kennebrew’s actions violated the clause and specifically whether he provided services in Houston while working in Whelan’s Dallas office. You will recall that he was working out of the Dallas office to avoid a violation of his non-compete with a previous employer.

In the end, this mix of enforcing, modifying, and returning questions to the trial court brings to light several salient points regarding employee non-competes in Missouri:

1) Missouri is a state that is very friendly for employers wishing to enforce non-competes. As Ken Vanko astutely pointed out, the Court’s ruling “beg[s] the question of whether that [the] validated non-compete achieves the same purpose as the partially invalidated non-solicitation covenant.” Further, the Court stated that in analyzing non-compete agreements, “the protection of the employer, not the punishment of the employee, is the essence of the law.” Furthermore, Missouri courts are also willing to modify overly broad non-solicitation and non-competes in order to render them enforceable.

2) Non-solicitation of employee provisions shall be conclusively presumed to be reasonable if their post-employment duration is no more than one year. The Court stated that “even if an employee non-solicitation covenant seeks to protect interests not identified in Section 431.220(3), it is nonetheless per se reasonable if its duration is for a period of one year or less.”

3) That said, one year is not an absolute limit for employee non-solicitations provisions in Missouri. Even agreements that exceed one year “can still be reasonable based on the facts of the case.” When venturing into these grounds, employers would do well to clearly state the legitimate purpose of the provision under Section 431.220(3) in the agreement, as a lack of clearly defined purpose is what stymied the Court when analyzing Kennebrew’s two-year employee non-solicitation clause and the Court remanded that issue to the trial court.

4) Missouri courts may scrutinize prohibitions on soliciting prospective customers. Special care should be given to tethering such provisions to prospective customers that the employee actually solicited, rather than tenuous and detached relationships, as well as stating the legitimate purposes for such provisions in the agreement. The Court indicated that under certain scenarios a prohibition on the solicitation of prospective customers could be permissible if tethered to prospective customers that the employee actually solicited, rather than tenuous and detached relationships. Although the Court did reject the prospective customer non-solicitation clause in this case, in addition to recognizing that more narrowly tailored covenants may be enforceable, it also recognized that prospective customer information, if it rises to the level of a trade secret, is also independently protectable under Missouri’s trade secrets act.

5) Missouri courts will enforce non-compete and customer and employee non-solicitation agreements against non-resident employees for alleged violations occurring outside of Missouri.