Trade Secrets – Courts Won’t Protect You If You Don’t Protect Yourself!

A decision from the Northern District of Illinois is the latest to reiterate a stern warning we have long highlighted for employers: when insufficient steps are taken by an employer to protect its own proprietary information, courts will not provide trade secret protection when such information is misappropriated.

In Abrasic 90 Inc. v. Weldcote Metals, Inc., No. 18-cv-05376 (N.D. Ill. March 4, 2019), the plaintiff-company Abrasic 90 Inc. (“Abrasic”), a manufacturer of abrasives products, sued several of its former employees (including its former president) and a competing company they formed, Weldcote Metals, Inc. (“Weldcote”), for misappropriation of its trade secrets in violation of the federal Defend Trade Secrets Act of 2016 and the Illinois Trade Secret Act. Abrasic alleged its former president retained a flash drive from his employment with Abrasic that contained “a comprehensive summary of [Abrasic’s] transactional information, including sales data, prices, and costs for its products and the identities of its suppliers and distributors.” Abrasic also claimed that the other individual defendants possessed similar information to be used in their subsequent employment with the competing company. In addition to demanding monetary damages, Abrasic sought to enjoin Weldcote and the individual defendants from using the information at issue in the competing enterprise, as well as from doing business with Abrasic’s suppliers and distributors.

The Court denied Abrasic’s motion for a preliminary injunction, however, finding that Abrasic could not show that its information warranted trade secret protection. The Court chose this matter to reiterate a valuable—albeit sometimes painful—lesson for employers: if you don’t protect your trade secrets, neither will the courts.

The Court recounted the well-known rule that for information to be considered a trade secret, it must have been “sufficiently secret to impart economic value because of its relative secrecy,” and “reasonable efforts to maintain the secrecy of the information” must have been taken. The Court found the first factor was satisfied for purposes of the motion, because the information purportedly misappropriated consisted of business and financial information, and was compiled in such a manner that it would “require substantial time, effort, and expense to recreate the compilation.” But the Court held that Abrasic failed to establish the second factor because it “took almost no measures to safeguard the information that it now maintains was invaluable to its competitors.” The Court gave a litany of suggested steps that employers can and should take to protect their proprietary information sufficient to cloak such information with trade secret protection, including:

  • Requiring those with access to trade secrets to enter into non-disclosure and confidentiality agreements;
  • Establishing and implementing policies concerning the confidentiality of the company’s business information, including specifying the categories of information deemed by the company to be confidential;
  • Training company employees about their obligation to keep such categories of information confidential;
  • Ensuring all confidential information is returned to the company upon the cessation of employment of any employee with access to such information;
  • Ensuring that company employees with responsibility for maintaining sensitive company data and information are trained on data security, and that the company maintains and implements comprehensive data security policies and practices;
  • Restricting access to sensitive company information to employees on a need-to-know basis, such as giving employees a one-time-only password to access the information; and
  • Differentiating access to sensitive company information from access to non-sensitive company information.

While an employer does not necessarily need to take all of these example measures to confer trade secret protection, Abrasic allegedly failed to establish that it effectively implemented any such measures.  About the only protective measure Abrasic took, according to the Court, was to require some employees with access to the alleged proprietary information to agree to maintain its secrecy.  However, even that measure was ineffective, because Abrasic provided the same access to other employees and independent contractors without imposing similar conditions of non-disclosure.  Therefore, the Court held that the company could not show that its claims had a likelihood of success—dooming its preliminary injunction motion.

As this decision confirms, employers cannot rely on the courts to protect their valuable trade secrets, unless they have done their job to minimize the potential for misappropriation. To ensure that you are taking the appropriate steps to safeguard your trade secrets and confer protection in the courts, please contact a member of Jackson Lewis’s Non-Competes Practice Group.

Washington Governor Signs Non-Compete Law

On May 8, 2019, Washington Governor Jay Inslee signed into law HB 1450, described as “AN ACT Relating to restraints, including noncompetition covenants, on persons engaging in lawful professions, trades, or businesses[.]”  While the Act does not take effect until January 1, 2020, its restrictions apply retroactively to existing agreements signed before that date.

Our article discussing the law, which was posted just as Governor Inslee was signing the bill, can be found here.  Companies with questions about how to comply with the new law are encouraged to contact a Jackson Lewis attorney for further guidance.

Washington State Legislature Sends Comprehensive Non-Compete Bill To Governor’s Desk

On April 26, 2019, the two chambers of the Washington Legislature passed Engrossed Substitute House Bill 1450 (“HB 1450” or the “Non-Compete Act”), which regulates non-competition agreements with employees and independent contractors, and severely restricts franchisee no-poach agreements as well as policies against moonlighting. Governor Inslee is expected to sign the Act, which would take effect on January 1, 2020.

Introduction

Under the new law, a non-competition covenant would be void and unenforceable unless it meets the following conditions:

  • If the covenant is entered into at the commencement of employment, it must be disclosed in writing to the employee by no later than the time the employee accepts the offer of employment;
  • If the covenant is entered into at the commencement of employment but will not take effect until a later date due to foreseeable changes in the employee’s compensation, it must specifically disclose that it may be enforceable in the future;
  • If the covenant is entered into after the commencement of employment, it must be supported by additional consideration;
  • The worker’s annual earnings must exceed $100,000 in the case of an employee, or $250,000 in the case of an independent contractor (based upon the income reflected in Box 1 of an employee’s IRS Form W-2 or an independent contractor’s IRS Form 1099);
  • If the employee is laid off, the employer must continue paying “compensation equivalent to” his or her base salary (minus income from subsequent employment) during the period of enforcement; and
  • The covenant must have a post-separation duration of no more than 18 months, unless the employer can show clear and convincing evidence that a longer duration is necessary to protect its business or goodwill.

In addition to the above requirements, the new law includes the following key provisions:

Definition of Non-Competition Covenants

As defined under the law, the term “non-competition covenant” expressly excludes employee and customer non-solicitation covenants, confidentiality/non-disclosure covenants, and covenants relating to the purchase or sale of a business or franchise. To take advantage of these exclusions, employers should separate non-competition covenants from all other provisions, take extra care to narrowly draft the scope of non-competition terms on a case-by-case basis, and make sure to include severability clauses. Employers can also consider other types of agreements, such as those requiring employees to repay training expenses and other expenses if they leave a job before a specified period of time.

Adjustable Earnings Thresholds

The minimum salary thresholds of employees and independent contractors are adjusted each year for inflation. This adjustment may complicate enforcement of non-competition agreements continuing from one year to the next, because agreements that are initially enforceable may become invalid in subsequent years if pay increases do not keep up with inflation. Further, if an agreement becomes enforceable only at a date later than the commencement of employment, the employer must “specifically disclose[] that the agreement may be enforceable against the employee in the future.” This provision allows employers to require employees making less than the salary threshold to sign a non-competition agreement before it actually becomes enforceable.

No-Poach Agreements

In a diversion from non-competes, HB 1450 also bans anti-raiding provisions in vertical franchise agreements. Under Section 7 of the Act, “[n]o franchisor may restrict, restrain, or prohibit in any way a franchisee from soliciting or hiring any employee of” either the franchisor or another franchisee of the same franchisor. This provision furthers a concerted effort by the Washington State Attorney General to put an end to such practice, as addressed in our article dated August 22, 2018.

Moonlighting

In addition to the no-poach ban, the Act also veers away from non-competition covenants to crack down on moonlighting restrictions. Section 8 of the Act provides that an employer may not prohibit an employee earning less than twice the state minimum wage from having another job, unless the prospective moonlighting work raises legitimate concerns regarding safety, scheduling, and/or conflicts of interest.

Choice of Law or Venue Provisions

Under the new law, parties are prohibited from agreeing to litigate non-compete disputes outside of Washington, or from otherwise circumventing “the protections or benefits of” the law. HB 1450 would void any provision that violates that prohibition.

Remedies

Where an employer is alleged to have violated the Non-Compete Act, HB 1450 authorizes the State Attorney General as well as the aggrieved employee to initiate enforcement action. If such enforcement action is successful, the aggrieved employee is entitled to recover the greater of his or her actual damages or a statutory penalty of $5,000.00, plus attorneys’ fees, expenses, and costs. Further, while HB 1450 permits judicial modification or “blue penciling” of an overly broad non-competition covenant, such measures do not absolve the employer of liability for the above-referenced monetary payments.

Retroactive Application

Importantly, the Non-Compete Act applies retroactively to any active non-competition covenants entered into prior to January 1, 2020, subject to two caveats. First, the Non-Compete Act does not apply to any legal proceedings commenced prior to January 1, 2020. Second, “[a] cause of action may not be brought regarding a noncompetition agreement signed prior to the effective date of this section if the noncompetition covenant is not being enforced.”

With sweeping changes to existing state law, the Non-Compete Act will have a significant impact on companies operating in Washington. For assistance in responding to the potential passage of the bills, or to ensure compliance with the non-compete laws of other states, please contact a Jackson Lewis attorney.

Utah Amends Three-Year-Old Non-Compete Law For Second Time In Two Years

After enacting its non-compete law on April 7, 2016, Utah has twice amended the law to address additional restrictions on non-competes in the broadcasting industry. Governor Gary Herbert signed the second of those amended bills on March 22, 2019.

The Original Non-Compete Law

Utah’s original non-compete law, which we covered in an article dated April 7, 2016, imposed a one-year post-employment time limit on non-competes, except where the non-competes were part of a severance agreement or where they related to or arose out of the sale of a business.   The law also authorized employees to seek damages and attorney’s fees against employers who attempted to enforce invalid non-competes.

The 2018 Amendment

On March 27, 2018, the State amended its non-compete law to impose special restrictions with respect to employees in the broadcasting industry (see our related article, dated April 2, 2018). Specifically, the 2018 amendment provided that, for a non-compete agreement to be enforceable against an employee of a broadcasting company, the company had to establish the following elements:

  • The employee was paid a salary of at least $913 per week (i.e., $47,476 per year);
  • The covenant was part of a written employment contract of no more than four years; and
  • The employee was either terminated “for cause” or had breached the employment contract “in a manner that results in” his or her separation of employment.

In addition, the 2018 amendment prohibited non-competes from extending beyond the original term of the employee’s written contract.

The 2019 Amendment

On March 22, 2019, Governor Herbert signed into law House Bill 199, making a limited change to the provision on broadcasting employees. Specifically, the new law focuses on the year-old requirement that a non-compete in the broadcasting industry must be part of a written contract of no more than four years in duration in order to be valid. Eliminating the four-year written contract requirement, the law now provides that the non-compete must be “part of a written contract of reasonable duration, based on industry standards, the position, the broadcasting employee’s experience, geography, and the parties’ unique circumstances.”

There appears to have been limited media reporting regarding the newest amendment. However, legislators presumably believed the hard, four-year cap on written contract durations did not reflect the realities of the broadcasting industry. Consequently, the new law gives judges more leeway to evaluate the unique circumstances of individual parties, before determining whether a non-compete agreement is reasonable and enforceable.

Companies with questions about the enforceability of restrictive covenants in their jurisdictions are encouraged to contact a Jackson Lewis attorney for further guidance.

U.S. Senators Seek Formal Investigation Of Non-Compete Use And Impact

Earlier this month, a group of six United States Senators made a joint request for the Government Accountability Office (GAO) to investigate the impact of non-compete agreements on workers and the U.S. economy as a whole. This action suggests that the federal non-compete reform effort is not going away.

Recent Legislative Efforts

On February 18, 2019, we reviewed a new bill by Florida Senator Marco Rubio to prohibit non-competes for low-wage employees. That bill followed an effort in 2018 by Democrats in both houses of Congress to ban non-competes altogether. Although Senator Rubio’s bill represents a more limited attack on non-competes, we noted that it “suggests a level of bipartisan support that was not previously apparent.”

The Joint Letter

The recent joint letter to the GAO, issued on March 7, 2019, is signed by two Senators who were not involved in the prior legislative efforts: Democratic Senator Tim Kaine (VA); and Republican Senator Todd Young (IN). This represents additional evidence of bipartisanship on non-compete reform.

The joint letter does not formally oppose the use of non-competes. Nevertheless, from the Senators’ explanation for their request, it is clear that they believe the use of non-competes has become excessive, and that significant harm is being done to workers and the greater economy as a result.

In the letter, the Senators cite three ways in which non-competes allegedly are being abused:

  • The allegedly excessive imposition of non-competes on low-wage workers;
  • The alleged inability of workers to “engage in genuine negotiation over these agreements”; and
  • The belief that “most working under a non-compete were not even asked to sign one until after receiving a job offer.”

Further, the Senators allege that “[a]cademic experts and commentators from across the political spectrum have raised serious concerns about the use and abuse of these clauses[.]”

Based on the above-referenced concerns, the letter instructs the GAO to investigate the following questions:

  • What is known about the prevalence of non-compete agreements in particular fields, including low-wage occupations?
  • What is known about the effects of non-compete agreements on the workforce and the economy, including employment, wages and benefits, innovation, and entrepreneurship?
  • What steps have selected states taken to limit the use of these agreements, and what is known about the effect these actions have had on employees and employers?

Of note, these questions appear to address broader concerns about the use and impact of non-compete agreements than the discreet issues raised by the alleged “abuses” set forth above. The letter does not provide a deadline for the GAO to issue its report. However, the GAO’s explanation of how it handles investigation requests sets forth a six-step process, from Congress making the request to the issuance of the report. Further, while the GAO protocol does not offer a time-frame for every step, it does state that it “typically” takes “about 3 months” to simply design the scope of the investigation. Consequently, it would be reasonable to anticipate waiting months at least for the GAO to issue the report.

Where Does This Leave Us?

As noted above, the joint letter indicates that there is growing bipartisan support for restricting the use of non-competes on a nation-wide level. At the same time, by expressing the need for additional information about the use and impact of non-compete agreements on U.S. workers, the Senators may not move forward with further proposed non-compete legislation until they receive that information and take the time to fully digest its implications.

Employers with questions about the enforceability of restrictive covenants, including at the state level, are encouraged to contact a member of Jackson Lewis’s Non-Competes and Protection Against Unfair Competition Practice Group.

New Jersey Court Offers A Reminder That The Duty Of Loyalty Is Thicker Than Ink

Do employees in New Jersey owe a duty of loyalty to employers, even without a written employment agreement? Eliminating any possible doubt, the New Jersey Appellate Division answered, emphatically, yes.

In Technology Dynamics, Inc. d/b/a Nova Battery Systems v. Emerging Power, Inc. et al., Docket No. A-0952-17T3 (N.J. Sup. Ct. – App. Div. Feb. 26, 2019), the Appellate Division reinstated breach of duty of loyalty claims against two former key employees of Nova Battery Systems (“NBS”), Master and Beringer, who resigned from NBS to work at competitor Emerging Power, Inc. (“EPI”). In an eleven-count complaint, NBS asserted a number of claims, including counts for breach of duty of loyalty and tortious interference with prospective business, and sought injunctive relief – which was denied.

Notably, Master and Beringer did not have any employment contract or non‑compete agreement with NBS. Consequently, at the conclusion of the discovery period, EPI moved for summary judgment, based partly on the contention that NBS’s claims could not survive the absence of a written contractual agreement. The trial court agreed and dismissed the complaint.

On appeal, NBS argued that a written agreement is not required in order to establish claims of breach of the duty of loyalty and tortious interference. The Appellate Division agreed and issued a twenty-five page opinion tracing the history of the duty of loyalty claim.

The Court noted the 2001 New Jersey Supreme Court decision in Lamorte Burns & Co., Inc. v. Walters, 167 N.J. 285, 302 (2001), for the fundamental proposition that, contract or no contract, “[a]n employee must not while employed act contrary to the employer’s interest.” After acknowledging that an employee has the right to make preparations to start a competing business, the Court reminded us, by citing to the New Jersey Supreme Court decision in Cameco, Inc. v. Gedicke, 157 N. J. 504, 517 (1999), that “the employee may not breach the undivided duty of loyalty he or she owes to his or her employer while still employed by soliciting the employer’s customers or engaging in other acts of secret competition.”

The Cameco decision identified the following four-factor analysis relevant to determine whether an employee breached a duty of loyalty:

(1) The existence of contractual provisions relevant to the employee’s actions;

(2) the employer’s knowledge or, or agreement to, the employee’s actions;

(3) the status of the employee and his or her relationship to the employer, e.g. corporate officer or director versus production line worker; and

(4) the nature of the employee’s [conduct] and its effect on the employer.

Kaye v. Rosefielde, 223 N.J. 218, 230 (2015) (alteration in original) (citing Cameco, 157 N.J. at 521-22).

The Court noted that while the existence of a contract is a relevant factor to be considered in a breach of the duty of loyalty claim, it is not determinative. In reviewing the evidentiary record, the Court noted emails showing Master and Beringer intended to solicit their NBS customers while they were still employed by NBS. The emails further indicated that Master and Beringer planned to sell those customers an excess amount of NBS products before resigning their employment, so that the customers could manage any delays in servicing during the transition from NBS to EPI.

Therefore, relying on Lamorte – for the proposition that an employee may not breach the undivided duty of loyalty he or she owns to his or her employer while still employed by soliciting the employer’s customer or engaging in other acts of secret competition – the Appellate Division reversed the trial court decision and restored the breach of duty of loyalty and tortious interference counts of the Amended Complaint. This decision reminds us that breach of duty of loyalty claims are alive and well in New Jersey, and do not sink or swim on the existence of a written contract.  Nevertheless, there are many reasons why an employer concerned about competition by former employees ought to use some form of restrictive covenant agreement.

Companies needing assistance in non-compete matters or drafting restrictive covenant agreements are encouraged to contact a Jackson Lewis attorney for related guidance.

U.S. Senator Reignites Federal Non-Compete Reform Efforts With Bill Aimed At Protecting Low-Wage Employees

Last year, Democrats in the United States Senate and House of Representatives introduced bills — S.2782  and H.R.5631 — banning non-compete agreements in the vast majority of workplaces across the country. Although those bills failed to gain traction, the authors of this Blog anticipated a renewed effort at federal non-compete reform in 2019, with Democrats taking control of the House in the November 2018 elections. Sure enough, the Federal Freedom to Compete Act  (the “Act”) was introduced on January 15, 2019, but in a twist, the Act’s author is not a Democrat but rather Marco Rubio, Republican Senator from the State of Florida.

As explained on Senator Rubio’s website, the Act is focused on “entry-level, low-wage workers” and is designed to “empower these workers by preventing employers from using non-compete agreements in employment contracts.” Below, we take a closer look at the Act, including the types of agreements covered by the Act, as well as the scope of employees who would be subject to its protections.

Introduction

Drafted within the framework of the Fair Labor Standards Act (“FLSA”), the Act prohibits employers from entering into, extending, renewing, enforcing, or threatening to enforce “non-compete agreements” with respect to all employees except for FLSA-exempt executive, administrative, professional, or outside sales employees. Notably, this prohibition would apply retroactively to any agreements entered into prior to the Act’s enactment. Employers who violate such provisions “shall be liable for such legal or equitable relief as may be appropriate to effectuate the purposes of such section.”

What is a “non-compete agreement”?

As defined in the Act, a “non-compete agreement” means an agreement between an employer and employee “that restricts such employee from performing, after the employment relationship […] terminates …: (1) Any work for another employer for a specified period of time[;] (2) Any work in a specified geographical area[; or] (3) Any work for another employer that is similar to such employee’s work for the employer that is a party to such agreement.” In addition to this general definition, the Act expressly states that it does not preclude agreements that prohibit the disclosure of trade secrets.

We see three primary issues with this definition:

First, while it is true that most non-competes are limited to a specified duration, geographic range, and type of work, that is not always the case. Interpreted in its most literal sense, the Act does not account for restraints on competition that, intentionally or not, fail to include such specifications. For instance, an agreement that simply prohibits an employee from subsequently working for a competing business, while potentially overbroad and unenforceable on other grounds, would fall outside of the above-referenced definition and, therefore, would theoretically avoid coverage under the Act. The creation of this loophole was presumably unintentional.

Second, by defining “non-compete agreements” to include agreements that restrict work “for another employer” for a specified duration or in a specified capacity, the Act seemingly fails to cover agreements that prevent an employee from competing in a capacity other than as an employee (e.g., where an employee forms a competing business or works for a competitor as an independent contractor). Again, this distinction was presumably unintentional.

Third, while the Act expressly disclaims coverage over agreements that prohibit the misappropriation of trade secrets, it is unclear whether it applies to the use of limited restraints on competition, such as covenants that prohibit the solicitation of employees, the solicitation of customers, or the disclosure of confidential information that does not qualify as a trade secret.

Who does the Act protect?

As mentioned above, the primary intent of the Act is to increase the economic freedom of “entry-level, low-wage workers.” In order to meet that goal, the Act initially imposes a broad prohibition on non-compete agreements for all employees. The Act then adds the caveat that the prohibition “shall not apply with respect to any employee described in [FLSA] section 13(a)(1)[,]” which includes exempt executive, administrative, professional, and outside sales employees who meet heightened wage requirements.

By allowing non-compete agreements only for exempt executive, administrative, professional, and outside sales employees, one could safely argue that the Act’s non-compete ban extends to employees who are neither “entry-level” nor “low-wage.” At the same time, the Act would prohibit the use of non-compete agreements with anyone who is paid on an hourly basis. Consequently, as the Act gets increased attention, there will likely be efforts from pro-business forces to narrow the scope of the ban.

Conclusion

In light of last year’s Democrat-led efforts to regulate non-compete agreements at the federal level, Senator Rubio’s submission of the Federal Freedom to Compete Act suggests a level of bipartisan support that was not previously apparent. We will continue to monitor the Act to determine the extent of that support. Employers with questions about the enforceability of their restrictive covenants are encouraged to contact a member of Jackson Lewis’s Non-Competes and Protection Against Unfair Competition Practice Group.

Delaware Court Grapples With Enforcement of Choice of Law Provisions in Restrictive Covenant Agreements

When implementing restrictive covenant agreements in their workforces, companies often grapple with how best to handle the wide variation in the law from one state to the other. One solution is to include a choice of law provision that calls for all agreements to be construed under the laws of a single state. Still, there is no guarantee that courts will honor a choice of law provision, particularly where the purpose of the agreement conflicts with the public policy interests of a different state that shares an interest in the subject matter at issue.

Twice in recent months, the Delaware Chancery Court addressed the enforceability of Delaware choice of law provisions in restrictive covenant agreements involving out-of-state employees. In Cabela’s LLC v. Wellman et al., Case No. 2018-0607-TMR (Oct. 26, 2018), the plaintiff, a Delaware corporation with headquarters in Nebraska, sued four former director-level employees from its Nebraska headquarters. Meanwhile, the plaintiff in NuVasive, Inc. v. Miles, Case No. 2017-0720-SG (Sept. 28, 2018) was also a Delaware corporation but with business operations in California, and was suing to enforce a non-compete agreement against a similarly high-level employee in California. In both Cabela’s and NuVasive, the defendant employees resided, worked, and ultimately sought to compete with their former employers in Nebraska and California, respectively. In other words, virtually all relevant activities at issue in the cases occurred outside of Delaware. Nevertheless, the plaintiff former employers asked the Court to enforce their agreements under Delaware law, based on their inclusion of Delaware choice of law provisions in the relevant agreements.

While Delaware courts generally honor contractual choice of law provisions, the Court noted an important public policy exception to that rule. As the court explained in Cabela’s, “[w]here the parties enter a contract which, except for the choice of law provision, would be governed by the law of a [different] state, and that state has a public policy under which a contractual provision would be limited or void, the Restatement recognizes that allowing the parties to contract around that public policy would be an unwholesome exercise of freedom of contract.” (Internal citations omitted). To determine whether that exception should apply to the Cabela’s and NuVasive agreements, the Court examined the following questions:

      • Would another state’s laws apply in the absence of a choice of law provision?
      • If so, would enforcing the non-compete covenant violate a fundamental public policy of that other state?
      • If so, are the other state’s applicable public policy interests materially greater than the applicable public policy interests of Delaware?

In Cabela’s, the Court found that Nebraska law would apply in the absence of the Delaware choice of law provision, given Nebraska’s stronger contacts with the agreements. Second, the Court concluded that the defendants’ agreements, which were broadly drafted to prohibit ordinary competition, violated Nebraska’s fundamental public policy, which strictly prohibits such agreements unless they are narrowly tailored to prevent misappropriation of customer goodwill, confidential information, or trade secrets. Third, the Court held that Nebraska’s specific public policy against restraints on trade was materially greater than Delaware’s general public policy interest in freedom of contract. As the Court explained, where the contract at issue “is abhorrent and void” under Nebraska public policy, “and where, as here, the formation and enforcement of the contract relate overwhelmingly to [Nebraska], a general interest in freedom of contract is unlikely to be the equal of that public policy[.]” On those grounds, the Court refused to honor the Delaware choice of law provision.

Applying the same criteria, the Delaware Chancery Court reached the opposite conclusion in the NuVasive decision. Just as the facts in Cabelo’s related overwhelmingly to Nebraska, the facts in NuVasive related just as strongly to California. Further, it is generally understood that California law prohibits restrictive covenant agreements broadly. Section 16600 of the California Business and Professional Code strictly prohibits all restraints on competition in the employment context. Further, Section 925 of the California Labor Code prohibits employers from implementing choice of law or choice of forum provisions that circumvent California’s statutory protections or restrict access to a California judicial forum. The Court noted that these provisions reflect strong public policies against the enforcement of non-compete agreements against California residents.

Nevertheless, the NuVasive Court ultimately approved the choice of Delaware law provision due to one important distinguishing factor – the former employee was represented by an attorney in the negotiation of the non-compete agreement. The Court noted that although California Labor Code Section 925 generally prohibits parties from contracting around California substantive laws and California judicial forums, it carves out an exception with respect to employees who are represented by their own legal counsel during the contract negotiations. That carve-out exception, the Court concluded, demonstrated the California Legislature’s recognition “that in the limited subset of cases where the inequality of bargaining strength of the parties to an employment contract is buffered by the employee being represented by independent counsel, and where counsel participated in negotiation of the terms of a choice of law provision, California’s interest in freedom of contract outweighs interest in freedom of employment.” On that basis, the Court held that enforcement of the Delaware choice of law provision would not violate a public policy interest held by California.

The above decisions make clear that Delaware’s public policies may be outweighed by the public policies of a state with a materially greater interest in the litigation. If enforcement of the contract in the manner requested would be abhorrent to the public policies of the latter state, then Delaware courts will not enforce a choice of law provision requiring application of Delaware law. In Cabelo’s and NuVasive, the Court found that Delaware had a lesser interest in the subject matter than Nebraska and California, respectively. However, while the Court also concluded that Nebraska’s interest in the Cabelo’s litigation overrode the parties’ contractually-designated choice of law provision, the same could not be said for California’s interest in the NuVasive litigation, given that the NuVasive defendant negotiated the choice of law provision with the assistance of legal counsel.

Ultimately, the validity of a choice of law provision in a restrictive covenant agreement depends on a number of factors, including the facts at issue as well as the public policies of states that may have a material interest in the subject matter. This analysis should be performed with the assistance of counsel. And, in certain instances, it may be wise for the company to recommend that its prospective employees retain counsel when negotiating their agreements.

Companies needing assistance in the drafting of restrictive covenant agreements are encouraged to contact a Jackson Lewis attorney for related guidance.

State Attorneys General Step Up Antitrust Probes of Franchise Industry Hiring Practices

In the midst of a federal effort to ramp up antitrust prosecutions of companies agreeing not to recruit or hire each other’s employees (see previous articles dated November 9, 2016, January 25, 2018, April 25, 2018 and July 17, 2018), special scrutiny – and criticism – has been directed toward the use of no-poach agreements in the franchise industry.  State Attorneys General now lead the fight to limit the practice, and early indications suggest that their efforts are already producing results.

On July 9, 2018, Attorneys General from 10 states[1] and the District of Columbia launched a joint investigation into the hiring practices of certain national fast-food companies.  In a letter sent to the companies, the Attorneys General requested information regarding restrictive covenant language included in the companies’ franchise agreements which would inhibit the ability of employees to move from one franchisee to another.  According to the Attorneys General, such “no poach” agreements negatively restrict employees’ earning potential, and implicate state-based employee protection laws, as well as consumer protection and antitrust laws.  Responses to the letter were due on August 6, 2018.  As of the date of this post, there has been no official update on the status or content of any responses.

Since the joint investigation was announced, another state that did not join the initial letter revealed in two separate press releases that a number of franchises are already taking steps to curb the use of no-poach clauses in franchisee agreements. First, on July 12, 2018, the Attorney General for the State of Washington, Bob Ferguson, announced that following an investigation by its Antitrust Division, seven national fast-food companies agreed to no longer enforce such “no poach” agreements in their current franchise agreements, and to remove such language from future contracts.  More recently, on August 20, 2018, AG Ferguson announced that eight more fast-food chains entered into similar agreements.  According to both announcements, the concessions were made in order to avoid antitrust lawsuits by the State of Washington.  Significantly, the announcements emphasized that the concessions would take effect not just in Washington but on a nation-wide basis.

In the franchise industry, the use of “no poach” agreements typically provide that the franchisee will not recruit or hire employees (often management employees exclusively) from other franchise locations of the same franchisor. The rationale for such language is to protect franchisees from having their management employees recruited away to other franchise locations after the franchisee expended time and money training such employees.

The state-level probes come on the heels of increased criticism of no-poach agreements by the Department of Justice’s Antitrust Division. While no court to date has found such agreements to violate federal antitrust laws, the DOJ has repeatedly warned that it will treat these types of agreements as illegal restraints of trade, in violation of the Sherman Act, if they are not reasonably tailored to support a broader, legitimate business collaboration.

In this vein, the DOJ has acted aggressively to rein in “no poach” agreements by obtaining civil consent agreements and threatening criminal prosecution against companies who enter into such agreements. There also has been a spike in private class action lawsuits, which are particularly enticing to the class action bar given the potential for a large number of class members, as well as the ability to recoup treble damages, attorneys’ fees, and joint and several liability under the antitrust laws.  In fact, less than one month after the Washington Attorney General announced its first wave of settlements, a new class action lawsuit was filed in Washington State against Auntie Anne’s – one of the seven franchises listed in the initial announcement.

Companies are encouraged to contact a Jackson Lewis attorney with questions about compliance with antitrust laws as they relate to non-solicitation of employees agreements.

[1] Those states include California, Illinois, Maryland, Massachusetts, Minnesota, New Jersey, New York, Oregon, Pennsylvania, and Rhode Island.

California Non-Compete Law Renders Surgeon Settlement Agreement Unenforceable

Answering a question left from a previous appeal in the same case, a divided panel of the U.S. Court of Appeals for the Ninth Circuit has concluded that a settlement agreement provision between a physician and his former employer, the California Emergency Physicians Medical Group (“CEP”), constituted a “restraint of a substantial character” on the physician’s medical practice and therefore violated California’s non-compete provision, Cal. Bus. & Prof. Code § 16600. As a result, the entire settlement agreement was void and unenforceable. Golden v. California Emergency Physicians Med. Grp., No. 16-17354 (9th Cir. July 24, 2018).

Background

Dr. Golden worked for CEP as an emergency room surgeon. CEP terminated his employment in 2007, ostensibly because he lacked board certification.  He sued for race discrimination and, following mediation with a magistrate judge, the parties agreed in principal to settle the dispute.  However, Dr. Golden balked when CEP circulated a proposed written agreement containing the following restrictive covenants:

The parties agree that . . . Golden shall not be entitled to work or be reinstated at any CEP-contracted facility or at any facility owned or managed by CEP. The parties further agree that if CEP contracts to provide services to, or acquires rights in, a facility that is an emergency room as defined and regulated by California law at which Golden is employed or rendering services, CEP has the right to and will terminate Golden from any work in the emergency room without any liability whatsoever.  Similarly, the parties agree that if CEP contracts to provide services to, or acquires rights in, a facility at which Golden is employed or rendering services as a hospitalist, CEP has the right to and will terminate Golden from any work as a hospitalist without any liability whatsoever.

Dr. Golden refused to sign the agreement, claiming that this provision of the agreement violated Bus. & Prof. Code §16600. In response, his attorney withdrew and “moved to enforce the agreement so he could collect his fee.”  The district court granted the motion and ordered Dr. Golden to sign, reasoning that because these provisions would only prevent Dr. Golden from working for, not competing with, CEP, they were not a restraint on his medical practice and Section 16600 did not apply. Dr. Golden continued to refuse to sign the agreement and appealed.

The Decision

First, the Ninth Circuit reviewed state law precedent addressing the parameters of Section 16600, concluding that a restraint on future employment may be considered “substantial” even if it is reasonable or narrowly-tailored. In light of this “undemanding” standard, the Court first ruled that the clause restricting Dr. Golden from working at any facility owned or managed by CEP was lawful, “as it simply restates the obvious proposition that an employee does not have a general right to work for an employer without the employer’s consent” and, in any event, the restraint on Dr. Golden’s ability to practice his profession was minimal because CEP owned or managed only a few clinics.

However, the Court of Appeals found that the clauses purporting to bar Dr. Golden from working at CEP-contracted facilities, now or in the future, violated Section 16600 due to the extent of CEP’s current emergency room contracts in California (handling between 25% and 30% of all emergency room admissions in the state), as well as at facilities with which it may later contract, given its significant growth in the state during the previous decade.  The dissent contended that the majority was engaging in rank speculation in this latter respect, especially given that Dr. Golden had worked continuously during the decade-plus since his departure from CEP; had never been denied employment since the litigation began; and could not point to “any evidence that he would be fired, actually restrained, or barred from engaging in his profession upon signing the settlement agreement.”  Nevertheless, the majority noted that the restrictive covenant would “affect[] not only Dr. Golden’s employment at CEP itself, but also his [existing] and future employment at third-party facilities” where CEP provided services, even if the CEP services began after the commencement of Dr. Golden’s employment, and even if the CEP services did not compete with the services Dr. Golden provided.

The majority also rejected CEP’s argument that because Dr. Golden was no longer an ER surgeon, the restrictions in the settlement agreement would not substantially interfere with his ability to practice medicine. As the court noted, the agreement allowed CEP to terminate his employment at any facility where he worked in the ER or as a hospitalist.

Importantly, California courts have interpreted and applied Section 16600 and its related provisions strictly, noting that by its own language there are only two circumstances under which substantial restraints of trade are allowed: (1) where a person sells the goodwill of a business and (2) where a partner agrees not to compete in anticipation of dissolving a partnership.  Moreover, for decades California courts have held that, in light of the underlying policy favoring open competition and employee mobility, courts may reform (i.e. “blue pencil”) a contract only if a mistake was made and not to save an otherwise illegal contract.  Thus, because neither of the narrow exceptions to Section 16600 existed, the Ninth Circuit declared the entire settlement agreement void and unenforceable, and remanded the case to the district court to proceed accordingly.

The Takeaway

Golden reinforces, if not establishes, that even if they are contained within a settlement agreement, in California a restraint on future employment deemed substantial (basically, anything other than re-employment with the same employer) is not beyond the restrictive scope of Section 16600, regardless of whether it is “reasonable” or narrowly tailored.  Employers with operations in California must therefore be cautious in attempting to incorporate or enforce such provisions into a settlement agreement, even if such provisions would be wholly acceptable in other jurisdictions in which they operate.

Please contact the Jackson Lewis attorney with whom you work with questions about the decision or any other non-compete issues you may have.

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