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Non-Compete and Trade Secrets Report

Developments in protecting businesses against unfair competition

Some Clarity to What is Sufficient Consideration for Non-Competes in Illinois

Since the much-discussed Fifield case from the Illinois appellate court two years ago, all that could be said with confidence was that, unless someone was employed for at least two years after signing a restrictive covenant agreement, its enforceability was highly questionable. Practitioners in Illinois have been recommending that employers provide consideration in addition to employment, such as a “sign on” bonus tied to the restrictions or any other consideration that would not be given but for the individual’s agreement to the restrictions. In the next breath, practitioners have been telling their clients that even the additional consideration might not be enough to bind employees employed for less than two years. Uncertainty is everyone’s enemy in this area, and there has been great uncertainty for the past two years. But that uncertainty recently has been reduced by the same appellate court’s ruling in McInnis v. OAG Motorcycle Ventures, Inc. decided June 25, 2015 by the Illinois Appellate Court for the First District, albeit by a 3-judge panel different from the panel that decided Fifield.

In simplified form, the salient facts are as follows: Following his resignation from OAG, McInnis filed an action for a declaration that his agreement not to compete with OAG and not to solicit its customers was unenforceable under Fifield because he had remained employed “only” 18 months after his execution of the noncompete agreement. OAG counterclaimed to enforce the restrictions against McInnis, who had begun work at a competitor.

The trial court held that there was inadequate consideration for the noncompete agreement because (1) McInnis had not been given any additional consideration for the agreement (i.e., something beyond his hire and subsequent employment for only 18 months) and, therefore, (2) Fifield’s two-years-of-continued-employment rule controlled.

On appeal, the appellate court discussed Fifield and related cases at some length, concluding that Fifield does not mean that two years’ subsequent employment was the only consideration that would bind an employee to a restrictive covenant agreement. The court made clear its view, which it claimed also is the view of other Illinois appellate courts, that the Fifield rule comes in to play when there otherwise is no additional consideration given to the individual for agreeing to the post-employment restrictions. And in McInnis, the appellate court held that the trial court properly concluded that no additional consideration existed. Thus, it affirmed the denial of enforcement of the agreement.

The dissent attacked the majority’s acceptance of Fifield in the first place. The dissent would reject Fifield’s holding as it applies to new hires, and instead believes a totality of the circumstances test should be applied to the question of the adequacy of consideration. Alas, unless and until the Illinois Supreme Court addresses this issue, however, Fifield remains a significant obstacle to enforcement of noncompete agreements, at least where the employer has not provided distinct additional consideration beyond mere employment.

McInnis provides authority to argue that providing consideration separate and distinct from employment (and the salary and benefits that everyone in that position receives) — that is, consideration that the employee would not have been given had he refused to sign the non-compete agreement— makes Fifield inapplicable to any enforcement action.

Reminder From the 7th Circuit: Don’t Put the Cart Before the Horse (Establish your Legitimate Interest in Need of Protection Before you Complain About the Breach of a Non-Compete)

Seventh cirIn the rush to the courthouse after an executive leaves, takes people with her, and opens a competing business, the spurned employer often relies on the promise that executive made—the noncompete agreement—and the undisputed breach of that promise and believes the court will provide a remedy. “Not so fast,” is the takeaway from the 7th Circuit Court of Appeals decision in Instant Technology LLC v. DeFazio, et al., in which it applied Illinois law.

Instant Technology recruits and then seeks to place I.T. workers at companies in need for such workers. DeFazio was a V.P. of Sales and Operations at Instant Technology. She was terminated, opened a competing business, and solicited away several of her former colleagues from Instant Technology. They began seeking to place candidates at companies with which they had done business at Instant Technology; and some of the candidates they were trying to place were candidates who were in Instant Technology’s database. All of the defendants had signed restrictive covenant agreements at Instant Technology in which they had promised not to recruit Instant Technology employees to leave Instant Technology, not to solicit business from Instant Technology’s clients, and not to disclose Instant Technology’s confidential information. Instant Technology sued the defendants for breach of each of these contractual promises.

DeFazio admitted she poached the other defendants away from Instant Technology; and all defendants admitted to pitching candidates to clients who also did business with Instant Technology—but they denied that the restrictions were enforceable. They also denied using Instant Technology’s information, claiming that they obtained the names of the candidates from public sources, such as LinkedIn.

Following a bench trial, the trial court concluded that the defendants were not liable, because (1) there was no evidence that the defendants took information from Instant Technology or that they did not obtain it themselves from public sources or from cold calls, and (2) the no-solicitation of employees and client restrictions were unenforceable. The 7th Circuit affirmed. The ruling as to the unenforceability of the no-solicitation restrictions is what makes this case instructive.

The trial and appellate courts agreed that Instant Technology had not established a legitimate interest that was supported by the no-solicitation restrictions. The courts reminded Instant Technology that, before discussing the reasonableness of the restrictions themselves, it must first establish that the restrictions supported a legitimate business interest—without which the restrictions are naked (and unenforceable) restraints of trade.

Instant Technology argued that, in fact, it had proposed three legitimate business interests which the no-solicitation restrictions were designed to protect: confidential information; client relationships; and workforce stability. But it was not enough to simply identify the legitimate interests; Instant Technology was required to prove they existed. The courts ruled it had not done so.

First, the court reiterated that there was no confidential information at issue, as the defendants appeared to have obtained the information on candidates from public sources and cold calls. So this purported interest did not exist.

Second, the asserted interest in protecting client relationships was not valid because Instant Technology’s client were not loyal to it. The evidence demonstrated that the larger clients requested candidates from 5 to 10 staffing agencies at once. Moreover, Instant Technology placed only about 10% of the candidates it pitched to the clients. Thus, there were no protectable client relationships to support the no-solicitation-of-clients restriction.

Third, the asserted interest in workforce stability also was belied by the evidence. Of the employee complement that existed two years prior to trial, 77% had left Instant Technology by the time of trial. Thus, there was not a stable workforce that could be protected by the no-solicitation-of-employees restriction.

The takeaway here is that it is not enough merely to proclaim the existence of legitimate business interests that underpin restrictive covenants. You must be able to prove them. And before filing that complaint based on undisputed breaches of a noncompete agreement, it is prudent to take a moment and evaluate the evidence that will be used to support the claimed legitimate business interests that the restrictions are designed to protect.

Hawaii Bans Non-Compete and Non-Solicit Clauses in High-Tech Employment

hawaiiJackson Lewis Hawaii attorneys Andrew L. Pepper and Wayne S. Yoshigai have a post on the Jackson Lewis website about a new development in Hawaii non-compete law.  They write as follows:

Departing from the state’s normally pro-employer laws and judicial attitudes regarding non-compete covenants, a new law bars high-tech companies in Hawaii from requiring their employees to enter into “non-compete” and “non-solicit” agreements as a condition of employment. The new law, Act 158, went into effect on July 1, 2015.

Act 158 not only allows high-tech workers in Hawaii to switch allegiance and jump to employment with competitors of their current employer, but also to openly solicit their co-workers to do the same. Limitations on solicitation of clients are not addressed in the new law and, thus, employers may continue to include such in a client non-solicitation clause.

The new law applies to Hawaii employers in the technology businesses “that derive[] a majority of [their] gross sales from the sale or license of products or services resulting from its software development or information technology development, or both.” Such employers cannot require employees to execute employment agreements that:

prohibit an employee from working in a specific geographic area for a specific period of time after leaving employment; or

prohibit an employee from soliciting co-workers after leaving employment.

Act 158 does not change existing state and federal laws that allow companies to prohibit their workers from departing from a job with trade secrets that they use to compete against their former employers. Such “trade secret” prohibitions can extend for a reasonable period of time to protect the employer without imposing undue hardship on the employee.

A “grandfathering” clause protects existing employment agreements of technology companies with “non-compete” and “non-solicit” clauses. However, if the agreements are amended, revised, or extended, it is unclear whether such clauses will be void.

Hawaii courts traditionally have been zealous enforcers of non-compete agreements and the state Supreme Court has held that a three-year ban is not unreasonably long. Therefore, Act 158 is a significant departure for the state.

Alabama Amends Non-Compete Statute

alabama blueThe Alabama legislature recently passed changes to Section 8-1-1 of the Code of Alabama, the provision which contains the state’s non-compete statute. Governor Bentley signed the new version of the statute and it will become effective January 1, 2016. While the new version does not drastically change the landscape of non-competes, there are several changes which employers should be aware of.

Like the prior version, the revised statute retains language that places a general ban on all agreements that restrict one from engaging in “a lawful profession, trade, or business of any kind.” Nevertheless, the revised version provides six exceptions to the general ban, as follows: (1) agreements between an employee and employer prohibiting post-employment solicitation of the employer’s personnel; (2) agreements which prohibit a former employee’s solicitation of an employer’s current customers; (3) promises of an employee not to engage in a similar business within a geographic area; (4) agreements which limit competition in regards to the sale of a business; (5) agreements between persons or businesses which limit the commercial dealings between the parties; and (6) agreements which limit competition among business partners upon and in anticipation of the dissolution of a business. This guidance is intended to provide clarity on coverage of the non-compete statute.

A significant revision is the establishment or acceptance of “reasonable” time periods for certain types of agreements. Specifically, the new statute provides time periods that state a presumption of reasonableness. For instance, an agreement where an employee promises not to engage in a similar business of an employer within a geographic area is presumptively reasonable if the limitation is less than two (2) years. Also, non-solicitation agreements are presumed reasonable provided the duration is no longer than the greater of eighteen (18) months or the time period during which post-separation consideration is paid. The revised statue continues to allow for “blue penciling,” a judicial tool which allows the court to enforce reasonable portions of a non-compete agreement that is otherwise unreasonable.

Another new feature of the provision is an explanation of “protectable interest,” to include, but is not limited to, trade secrets; confidential information such as business strategies and techniques; employer’s commercial relationships with specific existing and prospective clients; and specialized training provided to an employee by an employer which involves substantial business expenditure. However, the statute specifically provides that “[j]ob skills, in and of themselves, without more, are not protectable interests.” Thus, in the context of skills, a “protectable interest” is only available when the employee receives specialized knowledge as a result of an employer’s use of substantial resources in training the employee.

Finally, a modification of significance in the revised version changes the burden of proof as to undue hardship. Previously, the plaintiff had the burden of proving the lack of undue hardship. Under the revised version, the party that opposes enforcement of the agreement is required to establish that such enforcement would cause them undue hardship.

Even though Alabama’s revised non-compete statute does not contain many substantive changes, the new provision provides clarity to this area of law. Moving forward, companies and attorneys can use the statute to protect the interests of employers. Outstanding issues will likely continue to be determined by the courts.

Thanks to Jay Malone, Law Clerk, for assistance with this post.

Minnesota Court Applies Texas Law, Proceeds to Blue Pencil Restriction

map 2 regionsThe District of Minnesota issued an interesting decision on June 9, 2015 in the case of BMC Software, Inc. v. Mahoney, No. 15-CV-2583 (PAM/TNL).  Mahoney was a Sales Manager for BMC and responsible for the Midwest Region. Around the time he was promoted into that role, he signed a non-compete agreement governed by Texas law, with a one-year restriction covering the United States.  He subsequently left BMC to join a direct competitor to lead its global information technology operations management business.  The new role would be national (or even global) with a sales component.  BMC sought a Temporary Restraining Order which, after extensive briefing, the Court treated as a motion for a Preliminary Injunction.

The Minnesota Court applied Texas law to its analysis of the contract, noting that, “Minnesota Courts traditionally honor choice-of-law provisions.” Under Texas law, it held, the contract was likely to be enforceable. Because Mahoney signed the agreement after he received his offer, applying Minnesota law might have resulted in a different outcome.

Because Mahoney’s previous duties only involved customers in the Midwest, however, the Court declined to impose a national injunction, noting that, under Texas law, “a reasonable area for purposes of a covenant not to compete is considered to be the territory in which the employee worked[.]”  At BMC, the court explained, “Mahoney was in charge of accounts in four to six Midwestern states.” At his new employer, he was “poised to lead the company’s business efforts globally.” The Court therefore got out its blue pencil and held that it would “modify the non-compete covenant to reach only his former accounts.” The final order stated that, “Mahoney is enjoined from working at [the new company] in any sales or marketing capacity related to BMC’s Midwestern customer accounts for which he was responsible until May 15, 2016.”

The situation of a company seeking to hire a sales employee from a competitor to move him or her from a regional job to a national position comes up surprisingly often. In this case, and other similar situations, the question that results from the Court’s order is whether the defendant will be able to assume the national position while carving out or removing himself from any sales activities in the Midwest, or for sales to customers based in Midwest. Constructing such an arrangement certainly would certainly appear to be challenging.

Wisconsin Non-Compete Waters Just Got Muddier

Wisconsin WatersOn April 30, 2015, the Wisconsin Supreme Court issued its long-awaited decision in Runzheimer Int’l, Ltd. v. Friedlen, settling a dispute in Wisconsin over whether continued employment alone was sufficient to bind an employee to a non-compete agreement. The case involved an important, if nuanced, distinction between (a) whether there is a legal “agreement” in the first place and (b) whether that legal agreement is enforceable. If there is no legal agreement, then there is nothing to enforce. If there is a legal agreement, the question becomes whether the restrictions themselves are enforceable (based on their reasonableness, etc.). The former question was addressed in Runzheimer.

Wisconsin always has found the initial agreement to hire an employee as sufficient consideration to create legal agreements; but Runzheimer answered the question of whether an existing employee could be required to sign a non-compete agreement without being given any additional consideration. (Runzheimer did not involve whether the agreement’s restrictions were themselves enforceable.)

The Court held that no additional consideration is required. The fact that an employer foregoes its right to terminate an at-will employee immediately is, in and of itself, the only consideration necessary to create a contract containing post-employment restrictions. The Court was unconcerned by the possibility that unscrupulous employers might force an employee to sign a non-compete and then fire the employee the next day and seek to enforce the non-compete. In the view of the Court, in such a circumstance the employee would have other means of contesting enforcement, such as claiming that he was fraudulently induced to sign the agreement, or that the employer acted in bad faith. If the decision had ended here, its effect would have been fairly clear. But it did not end here.

One member of the Court, in a concurring opinion, stated that the Court’s decision could be understood only if the employer’s promise not to immediately fire the employee constituted an implied promise not to fire the employee without cause for some (undetermined) period of time. This concurrence surely will create additional litigation down the road.

Wisconsin non-compete law has always been an outlier of sorts, and after Runzheimer it will continue to be so. In the first instance, employers now need to make sure they instruct incumbent employees whom they want to sign a non-compete that they will be fired immediately unless they agree to the newly imposed non-compete (and, presumably, must then actually fire them if they refuse to agree).  And the concurring opinion might create litigation over “wrongful discharge” of any employee who (1) was required to sign a non-compete after employment had commenced and then (2) was fired “without cause” relatively soon thereafter (how long before they lose the “cause” protection is anybody’s guess).

New Arkansas Law Permits Blue-Penciling of Employment Non-Compete Agreements

Arkansas has a new non-compete law.  James H. Stock, a shareholder in our Memphis office, has written an article on the Jackson Lewis website about these developments.  As he notes, the legislation signed by Arkansas Governor Asa Hutchinson will allow “a court to enforce the reasonable parts of a non-competition agreement, while deleting the overbroad, unenforceable provisions, rather than striking down the entire agreement.” The new law is scheduled to take effect on August 6, 2015.

Cases are easier to start than they are to finish: California Court awards $180,000 in sanctions for meritless trade secret misappropriation lawsuit brought in bad faith

sanctionsThe California Court of Appeal has upheld an award of monetary sanctions against a company that brought a lawsuit against its competitor that the court found was meritless and intended to stifle competition. Cypress Semiconductor Corp. v. Maxim Integrated Products, Inc., H038555 (Apr. 28, 2015). Cypress sued Maxim for trade secret misappropriation, alleging Maxim was attempting to hire its employees in violation of California law. Cypress pled two theories: (1) the names of its employees were trade secrets and Maxim wrongly obtained and exploited a list of its employees, and (2) Cypress was seeking to hire its employees to misappropriate their knowledge of Cypress’ touchscreen technology.  The trial court denied Cypress’ requests for preliminary relief, finding Cypress had no evidence to support its claims. One piece of telling evidence the court noted was a declaration submitted by Maxim’s attorney demonstrating she learned the name of nearly every Cypress employee who worked on touchscreen technology by spending an afternoon perusing LinkedIn. Facing an upcoming hearing on Maxim’s demurrer to its first amended complaint, Cypress voluntarily dismissed its lawsuit without prejudice. Maxim thereafter sought and was awarded $180,817.50 in sanctions on the ground Cypress had brought its suit in bad faith, which under California law has two prongs: (1) objective speciousness of the claim, and (2) subjective bad faith in bringing or maintaining the action, i.e., for an improper purpose.

The appellate court’s reasoning on the improper purpose prong is worthy of particular note. It found the following weighed in favor of a finding that Cypress brought and maintained its lawsuit for the improper purpose of intimidating Maxim and other Cypress competitors against soliciting Cypress’ employees under the threat of an expensive but unmeritorious lawsuit:

In a pre-lawsuit letter Cypress sent to Maxim, Cypress asserted claims of wrongdoing it could not support with evidence in the lawsuit;

  • In the pre-lawsuit letter Cypress wrote, “The next person you try to hire illegally from Cypress will not be cheap for your company, as Cypress will spare no effort or legal expense to protect its people and its technology” (emphasis added by court);
  • In a press release Cypress issued the day it dismissed its lawsuit, it claimed only that Maxim acted “unfairly,” not “unlawfully,” and in the press release Cypress did not point to any information tending to show that Maxim was doing anything more than seeking the most qualified candidates for openings in its own enterprise;
  • Cypress waited to amend its original complaint until the last day on which it could have filed an opposition to Maxim’s demurrer, requiring Maxim to file another demurrer, even though the amendments were not substantive;
  • Cypress took over four months to respond to Maxim’s demand for specification of the alleged trade secrets at issue;
  • In response to an interrogatory seeking the basis for Cypress’ claim that Maxim had misappropriated Cypress’ touchscreen technology, Cypress stated it was “in the process of investigating and compiling documentation regarding its allegations in its Complaint”;
  • Cypress’ attorney suggested counsel meet and confer over Cypress’ discovery responses in two weeks, but in the interim Cypress dismissed its lawsuit and did not notify Maxim until it issued its press release three days later; and
  • Cypress pursued a baseless motion to seal the declaration filed by Maxim’s attorney which contained the names of Cypress employees that the attorney compiled via perusing LinkedIn.

California law permits businesses to protect their trade secrets and other intellectual property from misappropriation by competitors. However, California also has a well-known public policy favoring lawful competition, which prohibits the use of unmeritorious lawsuits to stifle competition.

“Loyalty” Provision Actually an Unenforceable Restraint of Trade, Georgia Court Rules

LoyaltyMany employers require their employees sign agreements containing a “loyalty provision.” That is, a clause that requires the employee to devote all or most of his/her working time to the employer’s endeavors, while the employee remains employed by the employer. What many employers fail to realize, however, is that some states treat such loyalty provisions as restrictive covenants. Thus, as a recent decision from the Georgia Court of Appeals reminds, these loyalty provisions must comply with restrictive covenant law. See Early, et al v. MiMedx Group, Inc. 330 Ga. App. 652 (Feb. 10, 2015).

Background Facts

MiMedx Group, Inc. and ISE Professional Testing & Consulting Services, Inc. (“ISE”) entered into a Consulting Agreement, whereby Ryanne Early was to provide consulting services to MiMedx on behalf of ISE. The Consulting Agreement contained a “loyalty provision,” requiring Early to “devote her full working time (not less than forty (40) hours per week) to [the] performance of [her] duties” under the Consulting Agreement and in service of MiMedx. Notably, this clause addressed Early’s duties while she worked as a consultant, not after the termination of the Consulting Agreement.

Eventually, MiMedx terminated the Consulting Agreement and sued ISE and Early, alleging, among other things, that Early had failed to devote her full working time to the performance of her consulting duties under the Consulting Agreement; thereby, breaching the loyalty provision in the Consulting Agreement. In their defense, ISE and Early argued the loyalty provision was, essentially, a restrictive covenant and unenforceable under Georgia’s applicable restrictive covenant law.

Court of Appeals Rules Loyalty Provision is an Unenforceable Restrictive Covenant

Though the trial court rejected ISE and Early’s argument, the Court of Appeals reversed, holding that the loyalty provision entered into by the parties was a restraint on trade and, therefore, must comply with Georgia’s restrictive covenant law. (Unfortunately for MiMedx, the Consulting Agreement was entered into before the enactment of Georgia’s Restrictive Covenant Act, which is much more favorable to restrictive covenants than Georgia’s old law.) Specifically, the Court Appeals held the loyalty provision was unenforceable because it contained “no limitation at all concerning either scope or territory,” which is required of restrictive covenants in Georgia. Thus, any claim by MiMedx for breach of this unenforceable contractual provision was doomed.

Under Georgia’s current Restrictive Covenant Act (which applies to all agreements entered into on or after May 11, 2011), however, this loyalty provision would likely be enforceable.  Specifically, O.C.G.A. 13-8-56(4) states that restrictive covenants that operate during the term of an employment relationship do not need “any specific limitation upon scope of activity, duration, or geographic area, so long as [the covenant] promotes or protects the purpose or subject matter of the agreement or relationship[.]”  Therefore, agreements entered into on or after May 11, 2011 need not comply with the Court’s instruction in this decision.

Though most employers are aware restrictive covenants must be carefully reviewed to ensure compliance with applicable state law, this decision reminds that loyalty provisions should be similarly reviewed. If you have any questions about the enforceability of your current employee contracts, please contact the Jackson Lewis attorney with whom you regularly work.

Missouri Federal Court Reminds Employers that Non-Compete Agreements are not Automatically Assignable

The United States District Court for the Western District of Missouri has declined to enforce two employment agreements containing non-competition covenants because the employees who signed them had not contemporaneously assented to their assignment when their employer sold its assets to another company.  Symphony Diagnostic Services No. 1, Inc. d/b/a MobileXUSA v. Greenbaum, No. 13-4196 (W.D. Mo. March 16, 2015).  This case involved application of Missouri law pertaining to the assignability of non-competition agreements.

The first defendant began working as a part-time x-ray technician in 2007 for Ozark Mobile Imaging.  Contemporaneous with the start of her employment, she executed a covenant not to compete against Ozark.  Later she became a District Manager and began working full time.  The second defendant executed a similar non-compete agreement when she began working as a mobile x-ray tech for Ozark in October 2010.  Both agreements were silent on the issue of assignment.

In 2012, Ozark was sold in an asset purchase to MobileX USA.  Prior to the effective date of the sale, the employees were offered employment with the new company though on significantly less favorable terms.  Each was offered employment on a “PRN” or “as needed” basis which eliminated their eligibility for benefits.  The first employee was no longer to be a District Manager.  The employees refused the job offers which resulted in their termination.

After their employment ended the employees began to compete in apparent violation of their post-employment restrictive covenants.  MobileX USA filed suit seeking to enforce the agreements.  The former employees filed summary judgment arguing that because they did not consent to the assignment of their non-competition agreements contemporaneously with the asset sale, their agreements were not enforceable under Missouri law.  Judge Gaitan agreed.  In so holding, he relied on the Missouri Court of Appeals’ decision in Roeder v.  Ferrell-Duncan Clinic, Inc., 155 S.W.3d 76 (Mo. App. 2004).  In Roeder, the Court of Appeals held that employment contracts, including non-compete and confidentiality agreements, are not assignable absent consent.

Significantly, the court distinguished these facts from cases in which the employment agreement expressly permits assignment by the employer.  The court strongly implied that had the contracts at issue contained such a provision, the outcome would have been different.

This decision highlights the need for Missouri employers to ensure their employment agreements contain clauses permitting assignment.  Absent such language, employers run the risk that their contractual protections will be unenforceable in the event of a sale, acquisition, or other change in control.