Texas Court Reminds: Lost Sales Are Not Lost Profits

2000px-Texas_flag_map_svgProof of damages in restrictive covenant matters can be complicated.  In Rhymes v. Filter Resources, Inc., the Ninth Court of Appeals in Beaumont, Texas reminded parties that revenue and sales are not the same as lost profits, and expenses must be considered when developing a damage model.

George Rhymes (“Rhymes”) was employed by Filter Resources (“Filter”) as a Branch Manager.  In this role, he received confidential and proprietary information regarding customers, pricing, and margins, among other financial data.  Rhymes executed an employment agreement containing a twelve month customer non-solicitation covenant.  Rhymes resigned from Filter and started a competing company called Rhymes Industrial.

The evidence at trial showed that Rhymes Industrial was a direct competitor of Filter, and that all the customers of Rhymes Industrial were former customers of Filter that Rhymes serviced while employed by Filter.  Filter presented evidence that Filter’s annual revenue decreased over $1,000,000 since Rhymes left, and Filter offered expert testimony from a Certified Public Accountant claiming that Filter’s lost profits were $622,800.  Based on this record, a jury rendered a verdict finding that Rhymes breached his employment agreement and awarded Filter $620,000 in damages.

On appeal, the Beaumont Court of Appeals explained that to support a lost profit theory of recovery, the plaintiff bears the burden to demonstrate by competent evidence the amount of lost profits with “reasonable certainty.”  Exact calculation is not necessary, but the plaintiff must present evidence based on “facts, figures, or data” to reflect lost revenue as well as expenses.  The evidence presented at trial (expert and otherwise) reflected that Rhymes Industrial had between $638,000 and $732,000 in sales during the non-solicitation period.  However, this figure failed to account for expenses, such as payroll, the cost of goods sold, and related overhead.

The court explained that lost profit is not synonymous with lost sales, and lost profit evidence must demonstrate the lost net income to the plaintiff by accounting for expenses.  By failing to present evidence of net income, as opposed to simply lost sales, the plaintiff did not present evidence to support lost profits of $620,000 with reasonable certainty.  However, the court concluded there was evidence that Rhymes Industrial had expenses of approximately $403,000, and Filter avoided salary expenses of $28,000.  Based on $638,000 in lost revenue, and accounting for $431,000 in expenses, Filter suffered lost profits (or lost net revenue) of $207,000.  Accordingly, the court issued a remittitur of $207,000.

The lesson to remember is that when litigating a restrictive covenant matter, lost revenue is only half the calculation.  Parties must also develop and present evidence to reflect expenses (and avoided expenses) credibly to prove lost profits (or lost net income) with reasonable certainty.  Depending on margins, lost profits may only be a fraction of lost sales, but to sustain a verdict, parties must account for both revenue and expenses.  Alternatively, in some circumstances, an employer may choose to include a liquidated damages provision, which of course carry with them another set of issues – a topic for another conversation.

The Long-Arm of Minnesota Law Reaches Out to Adjudicate Claims Against an Out-of-State Employee

In Patterson Dental Supply, Inc. v. Vlamis (Sept. 6, 2016), the Minnesota Court of Appeals reminded that employees who reside and work outside of Minnesota may still be hailed into Minnesota courts to defend their actions.

Patterson Dental Supply (“Patterson”) is a corporation with its principal place of business in Minnesota. Theodore Vlamis worked for Patterson for 17 years in Scranton, Pennsylvania.  In August 2015, Vlamis resigned from Patterson and went to work for one of its competitors.  In a subsequent lawsuit, Patterson claimed Vlamis misappropriated confidential and proprietary information, and used removable storage devices and a personal Internet cloud storage account to copy, store, and access Patterson’s confidential information from a laptop computer provided by Patterson’s Minnesota office.  Patterson filed a lawsuit in Minnesota State District Court (Ramsey County) seeking to enjoin Vlamis from using the allegedly confidential and proprietary information.

Vlamis moved to dismiss the case for lack of personal jurisdiction. Specifically, Vlamis argued he never resided in Minnesota, never worked for Patterson in Minnesota, never solicited customers in Minnesota, and Minnesota was not part of his sales territory.  Thus, Vlamis argued he did not have sufficient contact with Minnesota to support personal jurisdiction.  The Ramsey County District Court denied Vlamis’s motion to dismiss, and Vlamis appealed to the Minnesota Court of Appeals.

The Court of Appeals affirmed the District Court’s denial of Vlamis’s motion to dismiss. The Court of Appeals began its analysis by reiterating the principle that out-of-state defendants may be sued in Minnesota when they have “minimum contacts” with Minnesota. Vlamis had consistently and continually been in contact with Patterson’s Minnesota office for his entire 17 year career, including by traveling to Minnesota at least annually for work conferences as a branch manager.  Moreover, Vlamis was paid his compensation and received his work benefits from Minnesota.  Finally, Vlamis reported to a supervisor in Minnesota.

The Court of Appeals also noted that Vlamis’s contacts with Patterson in Minnesota were at the heart of Patterson’s claims against him. The allegedly misappropriated information came from confidential business information provided to Vlamis during managers’ meetings in Minnesota, and from a laptop computer provided to Vlamis from Patterson’s Minnesota office.

Given the quantity, quality, and nature of Vlamis’s contacts with Minnesota, and the connection between Vlamis’s contacts with Minnesota and Patterson’s claims, the Court of Appeals held Vlamis was subject to the personal jurisdiction of Minnesota courts, which had a significant interest in providing Minnesota residents (like Patterson) with a forum for redressing and remedying any alleged injuries committed by parties such as Vlamis.

Finally, the Court of Appeals rejected Vlamis’s argument that Minnesota was an inconvenient forum for him on the grounds that such a defense to personal jurisdiction is only applicable in extreme cases where there are very few contacts between the defendant and Minnesota. Based on the quantity, quality, and nature of Vlamis’s contacts, this was not such a case.

The lesson for Minnesota employers wishing to protect their confidential and proprietary information is twofold. First, Minnesota employers should give serious thought to suing former employees in Minnesota, rather than automatically suing them in the state where they reside or work.  For a Minnesota employer, it is likely cheaper and easier to sue in Minnesota, and a Minnesota employer that has suffered an injury by a former employee is likely to get a fair hearing of its claims in Minnesota.

Second, Minnesota employers sharing confidential information with employees should disseminate such information from Minnesota and document this and other contacts between Minnesota and its employees. In this way, Minnesota employers can readily supply Minnesota courts with the facts necessary to justify exercising personal jurisdiction over out-of-state employees.

Illinois Statute Bars Non-Competes For Low-Wage Workers

2000px-Seal_of_Illinois_svgIllinois has a new non-compete statute that bans the use of non-compete agreements with “low-wage” employees.

Peter Bulmer in our Chicago office has written this article on the Jackson Lewis website analyzing the new law, which takes effect January 1, 2017, and explaining the context which led to its enactment:  Illinois Freedom to Work Act: One State’s Reaction to Overreaching Non-Compete Agreements.

As the article’s title suggests, this new law in Illinois is the latest effort to limit the use of non-competition agreements stemming from the perception that there is widespread overuse of such agreements by employers. The Illinois Attorney General, the New York Attorney General, the Treasury Department, and the White House have been active in this area. Of course, courts around the country for years have been carefully applying their state’s rule of reasonableness to determine whether non-competition agreements should be enforced. In Illinois, for workers earning less than $13.00 an hour, the courts will not have the opportunity to assess the reasonableness of a non-competition agreement.

The debate regarding these issues is certain to continue.

Wisconsin Court Finds Anti-Poaching Agreements to be Unenforceable

WISCONSINFor all the court decisions out there interpreting non-competition restrictions and customer or client restrictions, case law regarding non-solicitation of employees restrictions can be a little hard to find. At the link below is a report about a new decision from the Wisconsin Court of Appeals — written by our colleague in Madison, Sharon Mollman Elliott — construing an employee restriction just as it would a non-compete.

As always, careful drafting is key.  Here is the article, which appears at www.jacksonlewis.com:

Wisconsin Court Finds Anti-Poaching Agreements to be Unenforceable 

SEC Fines Company $265,000 for Severance Agreements that Potentially Chilled Whistleblowers

Our Corporate Governance Practice Group posted  this article regarding further activity by the Securities and Exchange Commission in response to confidentiality provisions it found might deter potential corporate whistleblowers under the Dodd-Frank Act.

Employers should be reminded to carefully draft non-disclosure of confidential information provisions clearly not to prohibit employees from reporting violations of law or cooperating with investigations by federal, state and local governmental entities. Jackson Lewis attorneys, and particularly our Non-Competes and Protection Against Unfair Competition Practice Group, are available to assist with reviewing and revising confidential information and non-disclosure agreements.


Groundhog Day for Massachusetts Non-Compete Reform

Once again, the Massachusetts legislature was unable to agree on non-compete reform legislation by the July 31, 2016, end of the current legislative session. The House and Senate had passed versions of non-compete reform that differed on key provisions. At the end of the session, however, the House and Senate failed to pass a compromise bill. (For details, see our article, Down to the Wire for Proposed Non-Compete Reform Legislation in Massachusetts.)

While efforts at non-compete reform are dead in the water until the process begins anew at the start of the next two-year legislative session in January 2017, non-compete reform legislation appears to have moved closer to approval with each legislative session. Given Governor Charlie Baker’s public statement in support of some type of non-compete reform, non-compete legislation may have the momentum needed to gain support early in the next legislative session.

The focus on non-compete reform in Massachusetts, the passage of the Federal Defense of Trade Secrets Act, and case-law developments in this area, should provide employers with ample incentive to review their agreements and related processes to ensure that current agreements provide the best opportunity for enforcement and protection of valuable company assets. Simple process changes, such as ensuring that a non-compete agreement is discussed before or at the time an offer is extended, and following consistent protocol as to which employees are required to sign such agreements and when, can avoid costly litigation over the enforceability of a non-compete, or at least give employers a better chance at prevailing in such litigation. Changes to the agreements themselves, such as increasing protections of non-disclosure and non-solicitation provisions, can minimize the risk associated with employee departures even if non-compete reform becomes a reality in Massachusetts.

Please contact Jackson Lewis if you have any questions about non-compete, non-disclosure, and non-solicitation agreements.


Accessing Database Violates Computer Fraud and Abuse Act and Economic Espionage Act – Ninth Circuit Affirms Criminal Conviction of Former Employee

The Ninth Circuit recently filed its latest installment in the saga involving David Nosal and his former employer, Korn/Ferry International, an executive search firm. Korn/Ferry maintains a proprietary database of executive candidates for its paying customers.  Nosal, a former Korn/Ferry executive, set up a competing business.  Allegedly desiring the information in Korn/Ferry’s database for his competing business, Korn/Ferry alleged that Nosal tried two methods to access it: (1) using his own user name and password to download information before his departure; and (2) after his departure, using the user name and password of a willing accomplice who was still employed by Korn/Ferry.

Nosal was charged with violating a criminal provision of the federal Computer Fraud and Abuse Act, 18 U.S.C. § 1030 (“CFAA”), which states, “[w]hoever…knowingly and with intent to defraud, accesses a protected computer without authorization, or exceeds authorized access, and by means of such conduct furthers the intended fraud and obtains anything of value…shall be punished.” This provision also provides for civil liability.  In a prior decision, United States v. Nosal (“Nosal I”), 676 F.3d 854 (9th Cir. 2012) (en banc), the appellate court held the CFAA does not prohibit Nosal’s first act—using his user name and password to obtain Korn/Ferry’s information during his employment—because using information in an unauthorized way is not “exceed[ing] authorized access.”

In United States v. Nosal, No. 14-10037 (9th Cir. July 5, 2016) (“Nosal II”), the court held Nosal’s second act—obtaining Korn/Ferry’s information by logging in to the database with the user name and password of a willing currently-employed accomplice—does violate the CFAA.  The panel, by a vote of 2-1, held such activity violated the unambiguous meaning of the phrase “access a protected computer without authorization.”  The court noted its holding is in accord with all other circuits to have addressed this issue: the Second, Fourth and Sixth Circuits.  Accordingly, the court affirmed Nosal’s conviction.

The dissent, which the majority largely ignored, would have held that because Nosal had the “authorization” of the willing accomplice, he did not violate the CFAA. The dissent was concerned that the majority’s broader reading of “authorization” may criminalize innocent acts—including what the dissent termed “password sharing,” such as a former employee who accesses his former employer’s database using a current employee’s credentials to assist his former colleague for a legitimate reason.

In a portion of the opinion that may be overlooked given the long-running drama over whether the CFAA should be interpreted broadly or narrowly, the Ninth Circuit also affirmed Nosal’s conviction for trade secret theft under the Economic Espionage Act, 18 U.S.C. § 1832 (“EEA”). Nosal appealed his conviction in part on the ground the information contained in the Korn/Ferry database was not a trade secret because it contained publicly-available information and was akin to a customer list.  The appellate court rejected Nosal’s contentions, and held – significantly – that a list of customers may qualify for trade secret protection.  Moreover, the court noted the database was more than a mere list of executive candidates.  The database contained information on over one million executives, including contact information, employment history, salaries, biographies and resumes, all compiled since 1995.  When launching a new search to fill an open executive position, Korn/Ferry could compile a “source list” of potential candidates, which was the result of a query run through a proprietary algorithm that generated a custom subset of possible candidates.  The court held the jury was permitted to find the database contained Korn/Ferry’s trade secrets.

Nosal II has two implications for the civil remedies available to employers to protect their trade secrets and other property. First, because the CFAA provides for civil causes of action, the decision affirms an employer’s right to sue a former employee who accesses its data by using someone else’s credentials.  Second, in light of the Defend Trade Secrets Act—which provides a civil claim for trade secret misappropriation under the EEA and relies on the same definitions supporting the EEA—Nosal II affirms that customer lists and related information deserve legal protection.

Jackson Lewis attorneys are available to answer questions regarding this case and other workplace developments.

Colorado Broadens Whistleblower Protection for State Employees Who Disclose Confidential Information

Tim Kratz and Kristen Baylis in our Denver office have reported on an important new law in Colorado, extending whistleblower protection to state employees who disclose confidential information in the context of reporting waste, mismanagement of public funds, abuses of authority or illegal and unethical practices to a designated “whistleblower review agency.”  To review the article, click here

This type of protection is in line with the whistleblower immunity provided by the new federal Defend Trade Secrets Act (to review our recent article regarding the new federal Defendant Trade Secrets Act, click here) and indicative of a trend placing limits not only on non-competition agreements, but also on the extent to which trade secrets can be protected.