On November 1, 2018, the California Court of Appeal, Fourth Appellate District affirmed a trial court’s ruling in AMN Healthcare, Inc. v. Aya Healthcare Services, Inc. et al., No. D071924, 2018 WL 5669154 (Cal. App. 2018), which (1) invalidated the plaintiff’s non-solicitation of employees provision in its Confidentiality and Non-Disclosure Agreements (CNDAs), (2) enjoined AMN from enforcing or attempting to enforce the employee non-solicitation provision in its CNDA with any of its former employees, and (3) awarded $169,000 in reasonable attorneys’ fees to defendants for plaintiff’s use of the provision.

The case is a significant decision which may impact some employers’ continued use of employee non-solicitation provisions with their California employees, at least in certain industries. There is now a split in California authorities and the issue is likely ripe for California Supreme Court guidance.

AMN and Aya are competitors in the business of staffing temporary healthcare professionals, namely providing “travel nurses” to medical care facilities across the country.  When former employees, named as individual defendants in the action and who worked as travel nurse recruiters in California, left AMN for Aya, AMN brought suit against Aya and the former employees, asserting 11 causes of action, including for breach of contract and trade secret misappropriation. Continue Reading California Appellate Panel Affirms Injunction Blocking Use of Employee Non-Solicitation Provision in Dispute Between Travel Nurse Providers

shutterstock_224796712By: Ofer Lion, Douglas M. Mancino, and Christian Canas

Unwelcome news for charities concerned with donor confidentiality

A recent court ruling1 upheld the position of the California Attorney General (AG) requiring that charities located or operating in California provide a copy of their unredacted Form 990 Schedule B, including the names, addresses and contribution amounts for all donors listed.  While the AG has indicated that the information will not be made publicly available, the ruling is unwelcome news for charities concerned about protecting donors’ identities.  The collection of sensitive donor information from charities appears to be a growing trend by state Attorneys General.  Affected charities, including out-of-state charities soliciting or otherwise operating in California should review their donor confidentiality policies and disclosures to ensure that their donors are aware of such requirements.

Regulation of Charities Located or Operating in California

Most California charities and certain out-of-state charities are required to register and file an annual report (Form RRF-1) with the AG’s Registry of Charitable Trusts.  Religious organizations, educational institutions, hospitals and health care service plans are exempt from this registration and reporting.

A copy of the charity’s annual return (Form 990) must be included with the annual report.  The AG recently began treating annual reports submitted without Schedule B (or with a redacted Schedule B) as incomplete.  Failure to file a complete report generally results in penalties, fees and the loss of California income tax exemption.

Several states, including New York, have a similar filing requirement.  Both the California and New York AGs note that their policy is not to disclose Schedule B to the public.  However, there is no guarantee that their disclosure policies will not change in the future and it is unclear if the donor information, once in the possession of a state’s AG, would be subject to a request for disclosure under that state’s public records act.

Schedule B – Donor Disclosure

Schedule B to the Form 990 is used to disclose to the IRS the reporting organization’s significant donors (generally those who contribute over $5,000 in cash or property), including their names, addresses, and contribution amounts.  Tax-exempt organizations are generally required to make available for public inspection and copying their three most recent annual returns, including copies of all schedules, attachments and supporting documents filed with these returns.  Most such returns are posted and publicly available at no cost on third-party websites, such as Guidestar.org.

However, except for private foundations (Form 990-PF filers) and section 527 political organizations, public disclosure of the names and addresses of contributors set forth on Schedule B generally is not required, and the Schedules B of those organizations typically do not appear when posted online.

The Center for Competitive Politics, a Virginia nonprofit registered with the California AG, challenged the AG’s unredacted Schedule B filing requirement.  It argued that the disclosure violates its and its supporters’ First Amendment rights to freedom of association and that certain nondisclosure rules under federal law preempt the state requirement.

The Ninth Circuit affirmed an earlier decision to deny the Center’s motion for a preliminary injunction, rejecting the Center’s arguments and concluding that the disclosure requirement bears a substantial relation to a sufficiently important government interest and is facially constitutional.2

However, the Court left open the possibility that the Center could show a reasonable probability that the compelled disclosure of its contributors’ names will subject them to threats, harassment or reprisals that would warrant relief on an “as-applied” challenge.  Such a challenge, Americans for Prosperity Foundation v. Harris,3 is pending in the Ninth Circuit.  So, the Court may soon carve such an exception out of California’s filing requirement, or not.

Out-of-State Charities with a California Presence Subject to Disclosure

Out-of-state corporations that are (1) “doing business” in California for charitable purposes or (2) “holding property” in California for such purposes are subject to the AG’s registration and filing requirements, as well as a whole host of other regulations generally applicable to California charities.4

“Doing business” is not a defined term, but generally requires that a corporation conduct some systematic or ongoing activity in California.  The AG has issued limited examples of activities that, if conducted in the state, would constitute doing business in California, including: (1) soliciting donations by mail, by advertisements in publications, or by any other means from outside of California, (2) holding board or membership meetings, (3) maintaining an office, (4) having officers or employees who perform work, and/or (5) conducting charitable programs.  Grantmaking in California, by itself, generally is not considered doing business in California.

The second basis for subjecting an out-of-state charity to the reporting and registration requirements is “holding property” in California for charitable purposes.  Unfortunately, the AG’s office has not issued guidance on the distinction between holding property for charitable purposes and holding property for investment or other non-charitable purposes other than a brief statement on its website that maintaining “financial accounts or investments at an office of a financial institution located in California” does not constitute doing business in California.

Out-of-state charities that may meet the above requirements and are not currently registered with the AG’s Registry of Charitable Trusts may wish to consider contacting local counsel for advice regarding their California operations to avoid or minimize potential penalties.

Conclusion

The recent Center for Competitive Politics decision exemplifies what we expect to be a growing trend by state Attorneys General to demand sensitive donor information from charities operating or soliciting in those states.  Charities should continue to heed the Schedule B instructions and not include Schedule B in filings with states that do not require it, as those states may inadvertently disclose the charity’s donor information to the public.5

___________________________

1 Center for Competitive Politics v. Harris, No. 14-15978 (9th Cir. May 1, 2015).

2 On May 15, 2015, the Center filed with the U.S. Supreme Court (Justice Kennedy) an application for an injunction to block the disclosure pending the filing and disposition of a petition for a writ of certiorari. In a setback to the Center, the application was denied without prejudice to renewal in light of any further developments.

3 Americans for Prosperity Foundation v. Harris, No. 2: 14-cv-09448-R-FFM (C.D. Cal. Feb. 23, 2015).

4 For a detailed discussion of California requirements that extend to out-of-state charities, see Mancino, “California Regulation of Out-of-State Charities,” 17 Taxation of Exempts 6 (May/June 2006).

5 Schedule B, Page 5 (General Instructions: Public Inspection), available at http://www.irs.gov/pub/irs-pdf/f990ezb.pdf.

A recent case in Massachusetts confirms that taking affirmative steps to protect the confidentiality of trade secrets is absolutely critical to litigating a claim for misappropriation. In C.R.T.R. v. Lao, Plymouth Superior Court Docket No. 2011-962 (Dec. 30, 2013), the plaintiff sued a former independent contractor for, among other things, misappropriation of the company’s trade secrets. The defendant moved for summary judgment on the grounds that the information allegedly misappropriated was not a trade secret, and that even if the information were a trade secret, the company had not taken adequate steps to protect the information. The court agreed with the company that there was a genuine dispute of fact over whether the information allegedly taken by the defendant constituted a trade secret, in light of the company’s identification of several trade secrets — including prices paid by the company and its customers, amounts sold and purchased, billing procedures, customer lists, business processes and work flow patterns, and processes for obtaining customers, among other things. The court also determined that the company had put forth sufficient evidence to suggest that the information provided the company with a competitive advantage, and that it was not generally known to those outside the business, both hallmarks of a trade secret.

But the court’s inquiry didn’t end there. Instead, the court determined that in order to support a misappropriation claim against the independent contractor, the company would have to demonstrate that it took adequate steps to protect its trade secrets. The court noted that the company had not required the defendant to sign a confidentiality agreement, and that the company did not even have a policy regarding the protection of confidential information. Additionally, the company’s customer lists were available on the company’s computer systems and certain contracts were advertised on the company’s website. In light of these facts, the court held that there was no evidence that the company had taken appropriate measures to protect its trade secrets, and accordingly granted summary judgment on the misappropriation claim.

This ruling should serve as a warning to employers — even if you are able to demonstrate that information obtained or accessed by a former employee, independent contractor, or other individual or entity is indeed a trade secret, a failure to “exercise eternal vigilance” in protecting those trade secrets will doom a misappropriation claim. Employers should not only implement and distribute policies regarding the protection of confidential information, but it should also require its employees, independent contractors, or other individuals who are granted access to such information to sign a confidentiality agreement. Failure to do so could be catastrophic to your business.

Soda cans

Shortly before leaving the employ of Swanel Beverage, Inc. (a manufacturer of soft drinks, juice products, and energy beverages), Bodemer — Swanel’s national sales and marketing manager who “was involved with almost every facet of Swanel’s business” — incorporated Innovative Beverage, Inc.  Right after Bodemer resigned from Swanel, Innovative commenced operations as a competitor.  Then, he and Innovative filed a declaratory judgment action in the Southern District of Indiana alleging that his confidentiality and non-competition agreements with Swanel were unenforceable and were not violated.  Swanel, of course, counterclaimed for breach of contract and violation of the Indiana Uniform Trade Secrets Act.  Following discovery, Bodemer moved for summary judgment with respect to both his complaint and Swanel’s counterclaim.  Federal Judge James Moody’s multi-faceted decision on Bodemer’s motion included the rulings mentioned in the title to this blog and others.  Bodemer v. Swanel Beverage, Inc., Case No. 2:09 CV 90 (S.D. Ind., July 31, 2012).

Swanel claimed that the mandated confidentiality was worldwide and lasted forever, and that it applied to every piece of information Bodemer had learned, and every document he had received, in the 15 years he had been employed by a corporation Swanel acquired and then by Swanel itself.  Thus, enforcement would confer confidentiality on much information and many documents that were not secret and would prevent Bodemer from being employed in the industry with which he was most familiar.  Judge Moody held that the agreement was invalid under Indiana law.  While recognizing that the state’s courts might be willing to enforce an unconditional promise to maintain business confidences if necessary in order to protect the employer’s reasonable interests, the confidentiality agreement here did not pass that test.  Further, it unduly restricted Bodemer’s future employment opportunities and was contrary to the public interest.

Swanel tried one more gambit, requesting the court to blue-pencil the confidentiality agreement by inserting appropriate restrictions.  According to Judge Moody, however, Indiana law authorizes a court to strike unreasonable provisions in a contract but not to add new ones.

The non-compete commitment provided a reasonable geographic limitation, 100 miles from the present location of the company, and it expressly permitted the court to modify that restriction if it was found to be unenforceable.  Judge Moody ruled that the agreement was not violated because the only Swanel customer Bodemer was accused of stealing was located more than 100 miles away.  (Swanel argued that, although the customer was more than 100 statute miles distant, it was closer than 100 nautical miles, but that argument was summarily rejected based on the “plain meaning” rule and because nautical miles are used only in sea and air navigation.)

Swanel had more success in resisting Bodemer’s summary judgment motion with respect to alleged misappropriation of Swanel’s list of distributors, the name of the vendor supplying Swanel with flavoring agents, Swanel’s recipe for drink products, and its pricing structure.  Bodemer insisted that these were not trade secrets, but the court held that a reasonable jury could disagree.  It could find that a competitor would have to make a substantial investment of time, expense and effort to create Swanel’s list of distributors.  There was value in identifying the source of the flavoring agents because replication of Swanel’s products by a competitor would be somewhat easier if the vendor’s name was public.  The fact that the name of the flavor house Swanel used was known to its employees was of no consequence because each had signed a non-disclosure agreement.

According to Judge Moody, since Swanel did not own the flavor house’s formula, it could not be the basis for a trade secret misappropriation case filed by Swanel.  However, notwithstanding Swanel’s president’s deposition testimony that the recipe for its drink products was “no big deal” because it simply consisted of the flavoring plus sugar and water, the court said that was just one man’s opinion and the jury had to decide whether the recipe was a trade secret.  Bodemer’s claim that he could not be said to have misappropriated Swanel’s pricing structure because he took no documents with him was rejected because that is not essential in order to prove misappropriation.

This case provides several lessons.  It reminds us that a confidentiality agreement lacking reasonable time, geographic and subject-matter limitations may be unenforceable as a matter of law.  Additionally, while some courts are unwilling to blue-pencil a contract under any circumstances, a court that will is more likely to exercise that power when the agreement can be made enforceable by modifying or excising provisions without adding new ones.  Perhaps Judge Moody’s very brief explanation for rejecting Swanel’s claimed right to sue Bodemer with regard to the secret formula — because Swanel did not own it — would have been different if Swanel proved that it was the exclusive purchaser of that flavoring and that its contract with the flavor house permitted Swanel to bring a misappropriation lawsuit despite not being the owner of the trade secret.  In that event, Swanel might have been held to have standing just as the holder of an exclusive patent, trademark or copyright license might have standing to sue for infringement, even though the licensee is not the owner of the patent, trademark or copyright, if the license includes a grant of the right to file such an action.

The Ohio 12th District Court of Appeals recently uphelda lower court’s injunction against two former employees and their new employer in light of defendants’ apparent breach of duty of loyalty, misappropriation of trade secrets, and tortious interference with business relations. DK Prods., Inc. v. Miller, Case No. CA2008-05-060, 2009 WL 243089 (Ohio Ct. App. 12 Dist. Feb. 2, 2009)

System Cycle, a branch of DK Products, Inc., located in Springboro, Ohio, distributes BMX bicycles, parts and accessories to bicycle retailers throughout the United States. System Cycle employed Matthew Miller and Charles Johantges until System Cycle learned that Miller and Johantges had disclosed sensitive financial information to vendors and attempted to broker distribution deals on behalf of Two Zero Distribution, Inc., a company created by Miller while Miller and Johantges were still employed by System Cycle (“Two Zero”). Per a Dayton Daily News articlediscussing the case, System Cycle learned about Miller and Johantges’s activities by intercepting an e-mail from the defendants to one of System Cycle’s customers.  

 The Ohio courts granted System Cycle ’s request for injunctive relief on each of the counts in the complaint, rejecting each and everyone of defendants’ counter-arguments. With respect to System Cycle’s tortious interference claim that defendants improperly interfered with System Cycle’s existing business relationships through improper disclosure of financial information, defendants argued that System Cycle had not showed evidence of malice on their part, but the Court of Appeals declined to find that malice is a necessary showing for a claim of tortious interference. Additionally, there was ample evidence of irreparable harm to System Cycle. Even defendant Miller admitted that his disclosure of confidential financial information regarding System Cycle was “pretty devastating.”

The courts also rejected Defendants’ challenge to the injunction as it related to the trade secret misappropriation claim. Defendants had asserted that the injunction was improper because System Cycle did not proffer evidence that they used System Cycle’s trade secrets Yet, the Court of Appeals pointed to Defendant Miller’s admission that he had discussed certain trade secret information with a vendor, which falls within the definition of “misappropriation” under the Ohio Uniform Trade Secret Act. 

Defendants’ final challenge was to the injunction as a remedy for the apparent breach of defendants’ duties of good faith and loyalty. The defendants contended that System Cycle failed to show irreparable injury in connection with this claim, but the defense fell on deaf ears. The Court of Appeals deflected that criticism by pointing to the very real potential for irreparable injury in connection with the other two claims.

As a result, the Court of Appeals affirmed the trial court’s order enjoining Defendants from solicitng System Cycle’s customers and from misappropriating System Cycle’s confidential information for the benefit of Two Zero. The case now returns to the trial court, where System Cycle may pursue a permanent injunction and money damages.

The key to System Cycle’s success likely had much to do with the early interception of the e-mail from Miller to a System Cycle customer. Procedures designed to prevent the loss of trade secrets through electronic means are becoming more commonplace and more important to protecting a company’s intellectual property.