Protecting Competitive Business Interests Through Non-Compete Clauses
Ryan Bewersdorf and Nicolas Ellis recently authored an article that explores what business interests can legitimately be protected through non-compete clauses.
Controlling The Message - The First Step
Whether its in politics, in advertising, or in a courtroom, persuasion is all about controlling the message. This is especially true in the classic non-compete case where the former employer is seeking to prevent a former employee from working for a competitor.
The themes used by trial lawyers in a non-compete case vary to some degree, but the message from each side is universal. From the employee's viewpoint, the message is some variant of the following: "I just want to work in my chosen profession and the employer is trying to use a contract I was forced to sign to prevent fair and legitimate competition." The employer, on the other hand, wants to convey the message that the former employee had access to valuable confidential business information or training and wants to trade on that training and information for a better job with the competition.
+ Read MoreSilguero v. Creteguard - California Employers Beware (Yet Again)!
For employers that are looking for yet another reason not to do business in California, Silguero v. Creteguard, a July 30, 2010 decision of the California Court of Appeal, serves as a stark reminder of the minefield California businesses face on a day-to-day basis.
In Silguero, the plaintiff, Rosemary Silguero, began working for Floor Seal Technology (“FST”) in 2003, as a sales representative. She claimed that in August, 2007, FST threatened her with termination if she did not sign a “confidentiality” agreement that among other things, prohibited her from “all sales activities following either departure or termination.” Though she apparently signed, FST still ended up terminating her in October, 2007.
Within a short time, Silguero found employment with Creteguard. FST then contacted Creteguard and “requested the cooperation and participation of [Creteguard] in enforcing the confidentiality agreement, including those provisions prohibiting Silguero from all sales activities for 18 months following Silguero’s departure or termination from FST.”
+ Read MoreTrade Secrets Protection
Many companies do little to protect their trade secrets. They fail to ask themselves “what information would I not like to have in the hands of my competitors?” If a company does not protect its trade secrets, neither will a court. Companies should craft specific physical, information technology and other security measures to protect trade secrets. These include: (i) having employees execute intellectual property agreements; (ii) controlling access to the company’s trade secrets; and (iii) establishing employee exit procedures.
Physically secure trade secrets:
- Prohibit non-employees from inside the plant.
- Secure parking lot and building entrances; use badges and a sign in confidentiality agreement and provide escorts to non-employees.
- Keep manufacturing in restricted area.
- Lock formulae in a cabinet.
- Restrict access to servers.
- Designate all documents containing trade secrets as “confidential”.
Secure computer data and software:
- Make sure all magnetic media is erased or destroyed before discarding them.
- Assign passwords to selected employees in order to access critical systems and software.
- Require a change in passwords at least every 60 days.
- Only 1 or 2 persons should know all passwords, and secure the list.
- Implement policies to monitor employee’s usage of the company’s computers and email.
Specific employee exit procedures:
- Immediately disable the accounts and access privileges of terminated employees, and change all passwords and remote access codes.
- “Unplug” a terminated employee’s computer and remove dial-up modems from their workstation.
- Examine the employee’s computer/laptop/PDAs and emails before they leave to determine if the employee has accessed, copied or sent sensitive information.
- Conduct an exit interview and remind the employee of his or her continuing duty not to disclose trade secrets and request that the employee return all company property.
- Send a follow-up letter to the employee and new employer.
From Trade Secrets to Newsletters, What Do Confidentiality Agreements Really Cover?
A recent case filed in federal district court highlights a common issue employers face when enforcing their confidentiality and non-compete agreements against former employees. In its complaint, the employer claims that the employee agreed to return company documents if he quit or was fired. What constitutes confidential documents and information? Was the employee required to return only confidential and proprietary documents that contained the company's trade secrets, or was he required to return any document he received during his employment?
+ Read MoreIs That A Pin Dropping? Limited Noise In The Months Following An Illinois Appellate Court's Rejection of the Legitimate Interest Test
Last Fall, the Illinois Fourth District Appellate Court ruled in Sunbelt Rentals, Inc. v. Ehlers, 915 N.E.2d 882 (Ill. App. Ct. 2009), that an employer does not need to establish a legitimate interest (e.g., a long-standing customer relationship or confidential information) to enforce a covenant not to compete. For well over 30 years, the "Legitimate Interest Test" had been the law in all of Illinois. When the Sunbelt Rental decision was issued, many wondered whether the sea had changed, or whether the Fourth District had merely placed itself in conflict with other jurisdictions in Illinois. As of now, it appears that there is only the conflict and no strong indications that a sea change has taken place. While three separate trial courts in Illinois have now cited the Sunbelt Rental decision, no other appellate courts have addressed the issue. No court has expressly agreed with the Fourth District, but as discussed below, the Southern District of Indiana comes pretty close.
The first court to recognize the Sunbelt Rental decision was the federal court for the Northern District of Illinois. In Aspen Marketing Services, Inc. v. Russell, 2009 WL 4674061 (N.D.Ill. Dec. 3. 2009), Judge Gettleman noted awareness of the decision, but found that "[t]he Illinois Supreme Court, the United States Court of Appeals for the Seventh Circuit, and this court, however, have not rejected the application of the legitimate business interest test." Id. at *4 fn6. Just a few days later, in Rayco Management, Inc. v. Lancaster, 2009 WL 6521389 (Cir. Ct. Cook Ct. Dec. Dec. 9, 2009), Judge Epstein of the Circuit Court of Cook County, Illinois likewise noted awareness of the Fourth District's rejection of the Legitimate Interest Test, stating that "[w]ithout taking any position on that interpretation, this court is bound by the precedent of the First District Appellate Court and therefore will only consider the traditional standard . . . ." Id. at p.5.
Earlier this month, the federal court for the Southern District of Indiana quoted an important portion of the Sunbelt Rental decision. Specifically, in CDW LLC v. Netech Corp., 2010 WL 2710626 (S.D. Ind. Jul. 7, 2010), the court, addressing the validity of a non-compete under Illinois law, quoted the Sunbelt Rentals court for the proposition that "when presented with the issue of whether a restrictive covenant should be enforced, [a court] should evaluate only the time-and-territory restrictions contained therein. If the court determines that they are not unreasonable, then the restrictive covenant should be enforced." Id. at *7 (quoting Sunbelt Rentals, 915 N.E.2d at 869). Is this significant? Perhaps.
What the CDW court did not quote or say about the Sunbelt Rental decision may reveal the fact that it does not itself believe it can go quite as far as the Fourth District Appellate Court of Illinois. Specifically, the CDW court did not include a quote of, or even discuss, the sentence immediately following the excerpt provided above. In that tellingly missing sentence, the Fourth District stated that "this court need not engage in an additional discussion regarding the application of the 'legitimate-business-interest' test because that test constitutes nothing more than a judicial gloss incorrectly applied to this area of law by the appellate court." The CDW court studiously avoids any discussion on this specific point, and also avoids discussion of the Legitimate Interest test altogether. Nonetheless, it is a fair reading of this decision to conclude that the Southern District of Indiana is favorably citing the Sunbelt Rental decision.
While the long-term significance of the Fourth District's rejection of the longstanding Legitimate Interest test remains unclear, the impact thus far has been relatively insignificant. The most traction the Sunbelt Rental decision has achieved is a positive citing by a federal court in the Southern District of Indiana. Even thought the CDW court was interpreting Illinois law, the court is not located in Illinois and will not be persuasive for the state of federal courts in Illinois. Accordingly, practitioners in Illinois must wait for further direction from another appellate court on the enforceability of restrictive covenants in Illinois.
Sticky Fingers Prove Costly for Departing Employees
When four employees left a Connecticut investment advisory firm to start a competing business, they made the “mistake” of downloading client information from their old employer’s customer contact data base, transferring it to a home computer, and then sending it to a brokerage firm engaged as an asset custodian for their new firm. That mistake proved to be costly when the old employer sued for violations of the Connecticut trade secrets act and the federal Computer Fraud and Abuse Act, and discovered the data transfer.
As often happens, the old employer found the misuse of its computer data only by obtaining discovery from a third party – the firm serving as asset custodian for the new investment business. Responding to a subpoena, the third-party produced communications with the defendants that the defendants themselves had failed to produce in response to direct discovery requests in the litigation. Those communications showed the transfer of the employer’s data. Compounding their error, the employees had refused the old employer’s demand that they voluntarily preserve image copies of their computer hard drives, and had actually discarded one computer that had been used in transferring data.
Upon learning of these facts on a motion to compel discovery, a federal judge in Connecticut ruled that the defendant employees and their new firm had to deliver all of their office and home computers and personal digital devices to a court-appointed computer forensic expert for imaging and data recovery. The court ordered the defendants to pay 80 percent of the cost of the expert’s work, and finding that the defendants’ resistance to the discovery motion had been unjustified, also ordered the defendants to pay the attorneys fees incurred by their former employer in bringing the motion. Genworth Financial Wealth Management Inc. v. McMullan, D. Conn., No. 3:09-cv-1521 (VLB) (order entered June 1, 2010).
In a subsequent ruling on the old employer’s motion for a preliminary injunction, the court ordered the defendants to refrain from communicating with any current client or known prospect of the former employer except to the extent that the client had already become a client of the new firm or the defendants could show that the client’s information was not included in the data downloaded from the old employer. Id. (order entered June 10, 2010).
The case provides a useful analysis of when imaging of whole computer drives may be an appropriate discovery technique, and illustrates how “sticky fingers” can saddle departing employees with costly litigation and legal restraints on their ability to compete.
Format Failure
As Marshall McLuhan once observed famously, "the medium is the message." Of course, he was a media theorist, not a law professor, so it comes as no surprise that his aphorism is flat wrong when applied to trade secrets, as a recent opinion by the U.S. Court of Appeals for the Second Circuit reminds us. (Nationwide Mutual Ins. Co. v. Mortenson, 2d Cir. , No. 08-5214-cv, 5/11/10) This case arose when a group of agents left the plaintiff insurance company, Nationwide, and began selling policies for a competitor. Nationwide filed suit, alleging among other things that the agents violated the Connecticut Uniform Trade Secrets Act by showing the competitor printouts of policyholder information from Nationwide's secure database.
The district court granted judgment for the agents and against Nationwide, finding that the policyholder information did not qualify as trade secrets or confidential information of Nationwide. (Indeed, that appears to have been the conclusion of several other trial courts in similar cases involving Nationwide.) Although the Second Circuit is not clear about the basis of the district court's ruling, it appears that one grounds was that the policyholder information was in physical files that were "readily available."
On appeal, Nationwide tried to overcome that hurdle by focusing on the printouts from its database, which was password-protected. The problem with this approach, as the Second Circuit pointed out, was that the information in the database was the same as the information in the physical files. Indeed, information was loaded into the database directly from the physical files. At most, the database--and hence the printout--organized the same information in a slightly different format.
The Second Circuit quickly dispatched this attempt to raise form over substance. Noting that the UTSA withholds trade secret status from information that is readily ascertainable to the outside world by proper means, the Second Circuit held that the information on the printouts could not be proprietary to Nationwide because it was available in an unprotected format in the physical files. Echoing McLuhan's famous aphorism, the Second Circuit concluded that "[i]t is not the medium that matters here, but whether the information itself was adequately protected--and it was not."
Illinois Bill Offers a Renewed Attempt at Creating a "Covenant Not to Compete" Act
A bill has been introduced in the Illinois Legislature to create an "Illinois Covenants Not to Compete Act" (HB 4923, introduced January 15, 2010 by Rep. Rosemary Mulligan), following a previous failed effort on the same topic last year (HB 4040, introduced also by Rep. Mulligan). While unlikely to be passed based on its current status (it has been re-referred in to the Rules Committee), as drafted it would introduce a few new twists into Illinois noncompete law.
The bill would codify that, in order to be enforceable, the noncompete clause must be "narrowly tailored to support the protection of a legitimate business interest" See Sec. 10, para. (c). However, it also attempts to introduce certain new provisions that undoubtedly would change the landscape somewhat.
For example, one of the provisions would require that any one-sided attorney fee provision for the benefit of the employer be construed as including a right to recover fees on the part of the employee, should he or she prevail in an action to enforce the covenant. Sec. 20, para. (b). This is all occurring in the context of a recent appellate opinion in Illinois which seemed to cast aside that familiar "legitimate business interests" test for enforceability. Sunbelt Rentals, Inc. v. Ehlers, 915 N.E.2d 862 (Ill. App. Ct. 2009).
+ Read MoreIn the News: March 14 - April 1, 2010
Cases and issues making the headlines*:
It's All Fun and Games Until... (April 1)
A man attending the Penny Arcade Expo (PAX) in Boston was reportedly arrested for allegedly stealing the code for a new game that has not yet released. The code is reported to be valued at $6,000,000. Story here.
China (April 1)
On January 23, we reported that employees of Australian company Rio Tinto Ltd had been arrested in China on charges of, among other things, trade secret misappropriation. (Check the In the News... archives.) Rio Tinto has now reportedly hired Henry Kissenger to assist it following a conviction of one of those employees. Story here.
EMC Files Two Noncompete/Trade Secret Law Suits This Week (March 19)
Data storage giant EMC Corporation has filed two different law suits this week claiming, among other things, breach of noncompetition agreements, misappropriation of trade secrets, and violation of the Massachusetts unfair competition law (G.L. c. 93A). Story about one of the lawsuits here and here.
Trade Secret Thief Convicted (March 19)
A former DuPont Co. exmployee reportedly pled guilty to stealing DuPont's trade secrets and disclosing them to a competitor. The man, Michael Mitchell was reportedly sentenced by a federal judge in Virginia to 18 months. Story here (subscription service).
Nuclear Fusion Trade Secret Trial (updated March 16)
General Nanotechnology and certain related parties are reportedly going to trial tomorrow (March 15) in their lawsuit again Lawrence Livermore National Security, LLC and others in California. According to PR Newswire, the plaintiffs claim, among other things, that the defendants stole trade secrets and breached a nondisclosure agreement when they allegedly used the plaintiffs' nuclear fusion technology to develop their own product. Story here and here.
19 Indicted Over Computer Chip Technology Allegedly Taken to Korea (March 14)
Ten employees from Applied Materials, Inc., four from Samsung Electronics, and five from Hynix Semiconductor Inc. have reportedly been indicted in Korea for theft of computer chip technology. Story here.
Illinois Upholds Forfeiture Clause (March 14)
In a recent decision issued by the Northern District of Illinois (Viad Corp. v. Houghton), the court upheld a forfeiture clause without engaging in a traditional noncompete analysis.
Wisconsin Continues New Approach to Noncompetes (March 14)
Following the Star Direct case (previously reported by us here), a Wisconsin Appellate Court reversed the trial court on the basis that a forfeiture provision requiring return of certain money expended for employee training could be recovered by the employer - notwithstanding that the noncompete provisions were unenforceable. Decision here.
Astro-Med, Inc. Collects on Noncompete Case (March 14)
After a favorable jury verdict and then decision from the 1st Circuit last year, Astro-Med reportedly received $1,495,000 in its noncompete lawsuit against a former employee and his new employer. Story here and here.
Philadelphia School District Accused of Violating the CFAA, ECPA, SCA (March 14)
A Philadelphia school district allegedly provided students with laptops equipped with webcams that, unbeknownst to the students, were remotely controlled by the school district. The school district has reportedly been sued under the Computer Fraud & Abuse Act, the Electronic Communications Privacy Act, and the Stored Communications Act, among other things. Story here.
When Noncompetes Expire... (March 14)
Noncompetition agreements are never unlimited. When they expire, the party who had been restricted is permitted to return to a competitive position. Unless there are additional restrictions (nonsolicitation agreements; no-raid/antipiracy/no-hire agreements; and/or nondisclosure agreements), the returning party is largely uninhibited in his competitive activities. Apparently, this is the plan of former advertising agency Cummins & Partner, whose noncompete will expire in early 2011. Story here.
Criminal Investigation Halts Trade Secret Lawsuit (March 14)
According to Blooberg.com (here), the Manhattan U.S. Attorney, Preet Bhara, asked the judge in the Starwood Hotels & Resorts Worldwide, Inc./Hilton Hotels Corp. trade secret case to halt the case while the U.S. Attorney investigates.
Attorney General Eric Holder Speaks About Trade Secrets (March 14)
PR Newswire reported that, on February 24, United States Attorney General Eric Holder spoke at the Rio De Janeiro Prosecutor General's Office about the need to protect intellectual property - including trade secrets. Story here.
Harvard Law Student Sues Google Buzz (March 14)
A law student has reportedly sued Google's new social networking service, Google Buzz, claiming violations of, among other things, the Computer Fraud and Abuse Act and the Stored Communications Act. Story here and here.
*For earlier stories, go to the In the News (archives) page.