Most employee restrictive covenant disputes arise as a result of an employer’s concern about the potential loss of customer relationships and customer goodwill. These disputes generally involve sales representatives or high level business executives that have relationships with key customers; these disputes also frequently involve defenses that the employees had pre-existing business relationships with the customers that should fall outside the non-compete or non-solicitation agreement at issue. These disputes can be very fact-driven and the subject of very different recollections. For these reasons, non-solicitation cases can be especially messy. Unfortunately, a recent case out of the U.S. Court of Appeals for the Sixth Circuit, Hall v. Edgewood Partners Insurance Center, Inc., Case No. 18-3481/3482, highlights a doctrine — that an employee has rights to clients he/she acquired on his/her own time and dime — that may make these cases more complicated, expensive and problematic. Continue Reading Whose Customer Is It Anyway? The Sixth Circuit Further Clouds New York’s Already Murky Law on Non-Solicitation Agreements
Here are the noteworthy trade secret and restrictive covenant posts from September and some of October:
- Massachusetts is once again contemplating multiple bills regarding non-competes as well as a possible adoption of what appears to be the DTSA advises Russell Beck in his Fair Competition Blog. Russell and his team also have summaries of legislative activity in Maryland, Maine, Michigan, New York, Oregon, Pennsylvania, Washington and West Virginia, among others.
Here are the noteworthy trade secret, restrictive covenant and cybersecurity posts from the month of August (warning, there are a lot):
Defend Trade Secrets Act
- Munger Tolles’ Miriam Kim, Carolyn Hoecker Luedtke and Laura Smolowe have put together another fine summary of the trends they are tracking under the Defend Trade Secrets Act. There are several interesting findings in the summary. For example, state courts and state law remain the preferred forum and substantive law for trade secrets claimants, at least at this time. According to the summary, while 378 DTSA cases have been filed in federal and state courts, more than 515 complaints with trade secret claims have been filed with no DTSA claims in federal and state courts throughout the U.S. I have to admit that I was surprised by this finding, as I expected that litigants would be eager to secure a federal forum using the DTSA. I suspect that most of those state law cases involve restrictive covenants and that the plaintiffs are more comfortable with a local judge enforcing a non-compete or want to avoid entanglements arising from the DTSA’s limitations on injunctions. Or it might be that they simply want to go with the law they know best, which would be the more developed state trade secret law regime. In any event, a very interesting finding.
- One of the more recent (and unexpected) developments under the DTSA has been the number of motions to dismiss challenging DTSA claims. Olga May has a post for Fish & Richardson’s Litigation Blog detailing those decisions on those motions, which range from challenges to the specificity of the trade secrets pleaded to whether the complaint comports with the standards under Twombly and Iqbal.
- For an update on the modest number of ex parte seizure order filings under the DTSA, see Michael Renuad of Mintz Levn’s article in the National Law Journal.
Here are the noteworthy trade secret, restrictive covenant and cybersecurity posts from the past month or so:
The Defend Trade Secrets Act
- The U.S. District Court for the Eastern District of Texas has found that certain deer registry information qualified as a combination trade secret under the DTSA and Oklahoma’s version of the UTSA, as explained by Michael Weil and Tierra Piens for Orrick’s Trade Secrets Watch blog.
- The issue of whether the DTSA applies to misappropriation that may have taken place prior to the DTSA’s enactment has been one of the more frequent areas of litigation under the DTSA. Jonathan Shapiro of Epstein Becker has a summary on these cases for Law360.
A recent opinion from the U.S. District Court for the Northern District of Illinois has stirred up a hornets’ nest of commentary because it appears to recognize the viability of the inevitable disclosure doctrine under the Defend Trade Secrets Act (DTSA). Those familiar with the DTSA will recall that the inevitable disclosure doctrine was supposed to be prohibited under the DTSA because of California Senator Diane Feinstein’s concern that the doctrine might be enforced against California residents. Now, in what appears to be the first federal appellate court opinion construing the DTSA, the U.S. Court of Appeals for the Third Circuit may have further muddied the waters about the inevitable disclosure doctrine in Fres-co Systems USA, Inc. v. Hawkins, Case No. 16-3591, ___ Fed. Appx. __ (3rd Cir. 2017), 2017 WL 2376568 (June 1, 2017) (a link to the opinion can found here). Continue Reading Fres-co Systems v. Hawkins: Did The Third Circuit Just Create More Confusion Around The DTSA’s Ban On The Inevitable Disclosure Doctrine?
When moving to enforce a non-compete, the last thing a litigator wants to do is to stumble out of the gates and struggle over a profound legal issue that could delay consideration of that normally urgent request. A new and little-talked-about section of the Defend Trade Secrets Act (DTSA), however, has the potential to trip up employers seeking to enforce non-competes if they are not prepared to address this new entanglement.
There has been a significant amount of commentary about the DTSA and its new amendments since President Obama signed the DTSA into law on May 11, 2016. The “whistle-blower” immunity and ex parte seizure order, for example, have generated the most discussion to this point. However, the section of the DTSA that may have the greatest future impact on litigation under the DTSA is 18 U.S.C. §1839(3)(A)(i)(1)(I), which prohibits injunctions that “prevent a person from entering into an employment relationship.”
That new provision, which I will refer to as the “No-Ban-on-Employment” provision, was intended to curb, if not eliminate, the use of the inevitable disclosure doctrine under the DTSA. However, it may have a significant unintended consequence–namely, it may complicate employers’ efforts to enforce non-competes through temporary restraining orders (TRO), the key legal mechanism for non-compete disputes. For the reasons below, employers may want to reconsider invoking the DTSA when they want to enforce their non-competes because of the potential complications of this section’s language and instead opt to file them in state court, at least in the short-term. As the DTSA is likely to overtake the Uniform Trade Secret Act (UTSA) as the dominant statutory regime for trade secret law, this DTSA provision may well set another blow in motion to the viability of the non-compete as an effective tool to protect trade secrets.
Continue Reading Does the Defend Trade Secrets Act Contain a Potential Roadblock for Non-Competes? Why the DTSA’s Limitations on the Inevitable Disclosure Doctrine May Complicate Enforcing Non-Competes
Today’s post wraps up the Trade Secret Litigator’s Five Golden Rules for on-boarding a new employee and, fittingly, falls on Halloween. Today’s remaining Golden Rules primarily address the steps an employer needs to take in managing the employee who has been hired, and, as the case law reveals, may prevent various tricks (and rarely treats) to the new employer.
Golden Rule No. 3. The Visentin Rule: Protect the Legitimate Business Interests of the Former Employer. Having taken the steps to avoid or minimize risk during the hiring process, an employer still has to properly manage the employee once he/she joins the company, especially if that employee has a non-compete or non-solicitation agreement with his/her former employer. Fortunately, one of the leading cases on managing an employee with a covenant not to compete provides a textbook example of how to handle this situation. That case, IBM v. Visentin, came out of the U.S. District Court for the Southern District of New York and was affirmed by the U.S. Court of Appeals for the Second Circuit in 2012. In Visentin, the new employer, Hewlett-Packard undertook a number of affirmative steps to ensure that IBM’s trade secrets were protected and agreed that the new employee would not solicit his former customers for the remainder of the term of the non-compete.
The Southern District and Second Circuit approved of these efforts and refused to enjoin the employee – a mid-level manager – from working at HP. In the absence of any proof of misconduct by the employee, those courts found that this was a proper way to protect IBM’s trade secret and customer relationship interests while balancing the former employee’s right to find proper gainful employment.
The Visentin approach was also applied effectively by Google earlier this year in a high-profile dispute over its hiring of a cloud computing services manager who had worked previously for Amazon.com and was subject to a non-compete. As in Visentin, the Washington district court found that in the absence of evidence of misconduct by the former employee, Amazon.com’s interests were adequately protected by the safeguards put in place by Google to protect its trade secrets.
Of course, this approach is not foolproof, as the holding in a recent Massachusetts case, Aspect Software v. Barnett, unfortunately demonstrates. In that case, despite similar good faith efforts by the new employer and former employee, the court still enforced the non-compete at issue, although it commended the new employer and former employee for their efforts.
At the end of the day, an employer will increase its odds of avoiding litigation or minimizing its risk in that litigation by taking affirmative steps to prevent the use or disclosure of the competitor’s trade secrets and minimize intrusion into legitimately protected customer relationships. I have found that these steps are particularly effective in the “cease and desist” letter stage because they serve to put the former employer on notice that it may not have a basis for a lawsuit and can effectively give that employer pause before initiating litigation.
Golden Rule No. 4: If Litigation is Possible, Preserve, Preserve, Preserve. Given the reality of BYOD and the overlap between work and personal time, it is practically inevitable that some confidential information will make its way onto an employee’s personal computer or devices. This sometimes puts an employee between the proverbial rock and a hard place: if the employee deletes the information, there may be a claim of spoliation of evidence or a claim of some nefarious purpose behind the deletion. Alternatively, if the employee does not remove or delete the confidential information, he or she will almost certainly be accused of having improperly used or taken it.
As a result, if there is a chance of litigation, it is critical to preserve what was on the devices before deleting it. This means that forensic computer consultant will need to be engaged and likely image all devices before the information is removed and the devices sanitized under the guidance of counsel and that consultant. The images will then need to be kept by outside counsel so that they can be produced in litigation, if necessary.
Golden Rule No. 5: Keep a Close Eye on Mass Hirings. As readers of this blog know, cases involving the hiring of a team of people from a competitor (especially a sales team) generate the greatest waves and present the greatest risk of trade secret litigation by a former employer. The group dynamics in these situations also seem to foster greater opportunities for mischief — i.e., more pressure on business units and new hires to perform, the fact that the team may have been hired for a specific product, client or opportunity, etc. This means that in-house counsel and HR administrators need to monitor, follow up on, and continue to train these teams on the importance of preserving the confidentiality of the legitimate trade secrets of their former employer.
Last year’s Allergan v. Merz case out of the U.S. District Court for the Central District of California illustrates the special dangers associated with hiring teams of people. In that case, a federal judge issued a permanent injunction enjoining the rollout of the cosmetic drug Xeomin for 10 months because he found that a sales team hired from Allergan had improperly used confidential marketing and customer information for Botox in connection with the prospective launch of Xeomin. Based on statements made at an early hearing, the outside and in-house counsel did not know about communications between the new sales team and its managers disseminating that confidential information and argued that Merz had no intention of using Allergan’s trade secrets. However, a year after defeating a TRO, Merz’s counsel produced documents that were contrary to those representations.
How can in-house counsel and outside counsel avoid this disaster? It starts with a culture of security and responsibility. Both in-house and outside counsel need to know that their business people have their back and that a culture respecting the rules outlined above will be enforced. In the Allergan v. Merz case, the disconnect between what was apparently going on at the Merz business level and what the lawyers understood was going on is striking. This suggests, at least to me, that the appropriate follow up was not done to ensure that counsel’s representations about not using Allergan’s trade secrets would be followed.
The best way to ensure new teams are following the rules of their new employer includes: (1) an emphatic initial face-to-face meeting communicating the importance of leaving the prior employer’s trade secrets behind, preferably chaired by the head of the business group, (2) periodic follow up, certifications and acknowledgements that no trade secrets or confidential information are being used or retained, and (3) training to reinforce those principles. However, all of the follow up in the world will be ineffective if managers and supervisors have not bought into these principles and do not enforce them among their team.
In sum, as these cases illustrate, courts will generally reward the employer who imposes safeguards and acts responsibly; conversely, the failure to on-board properly can be catastrophic.
A recent $6.9 million verdict by a Pennsylvania state court judge serves as a stark warning to employers that hire a group of employees who resign together en masse. The case, B.G. Balmer & Co. Inc. v. Frank Crystal & Co., out of Chester County in Pennsylvania arose out of claims that a group of insurance brokers violated the non-solicitation clause in their employment agreements with their former employer, B.G. Balmer.
These mass exodus cases happen frequently in the financial services industry and can be particularly dangerous cases, especially where the employees improperly solicit colleagues or clients to join them before leaving. These cases are notoriously contentious and emotional — think about your standard non-compete case, throw in a cup of betrayal, shake well, and then add a healthy jolt of steroids. I have not yet been able to locate the trial court’s opinion yet (I understand it may be filed under seal) but Gregory D. Hanscom has a fine post about the case in Fisher & Phillips ‘ Non-Compete and Trade Secrets Blog.
According to Gregory, the group of departing employees first began to consider switching insurance brokers from B.G. Balmer to Frank Crystal & Co. when they individually met with a recruiter in May 2003. Less than three months later, those employees all resigned from B.G. Balmer on the same day (never a great idea) and promptly started working for Crystal. After they left, about 20 of B.G. Balmer’s clients switched their accounts to Crystal.
After B.G. Balmer secured a preliminary injunction restraining the employees (affirmed on appeal by the Pennsylvania Superior Court), the dispute proceeded to a bench trial to determine the ultimate issues of liability and damages. According to Gregory’s account of the case, B.G. Balmer effectively painted a sinister picture of the employees’ actions. B.G. Balmer argued that the former employees engaged in a calculated and concerted effort to disrupt its business by resigning on the same day and attempting to induce a number of clients to switch insurance brokers. The trial court rejected the employees’ argument that the clients chose to switch insurance brokers on their own volition, and not because of any improper solicitation.
The trial court awarded $2.4 million in compensatory and $4.5 million in punitive damages, an unusual ruling since judges are generally perceived as being less willing to award punitive damages than juries.
Watch Out for Breach of Fiduciary Duty Claims. In addition to claims of the breach of a non-compete or non-solicitation agreement, one of the common claims that arise in these mass exodus cases is whether the former employees breached their fiduciary duties to their former employer when they planned to leave. Many states, including Ohio, impose a fiduciary duty of loyalty on an employee not to compete or harm his or her employer while he/she is on that employer’s payroll.
Most states do recognize that an employee has the right to prepare to leave his or her job. Consequently, routine preparations to compete — interviewing, leasing office space, hiring an accountant, forming a company, issuing business cards — are frequently permitted. So long as the employee takes those actions after hours and not at the office, those actions will generally found to be proper.
However, things can get more interesting when the employee recruits others to leave while they still share the same employer. In my experience, courts will tolerate 2 or 3 employees having conversations about leaving their job together. However, courts grow more suspicious as that number grows, particularly when the departures then appear timed to put the former employer in the lurch or cause it substantial damage. My experience and research indicate that the facts of each case dictate whether the employees acted inappropriately.
However, there is one line in the sand that will trigger a finding of a breach of the duty of loyalty: if the employee solicits a customer before leaving. In my experience, courts will tolerate some mistakes but it is the solicitation of clients before resigning, misconduct that is compounded exponentially in mass exodus cases, that sets courts off the deep end. The punitive award in the B.G. Balmer case is an important reminder of that fact.
Takeaways: For the employees looking to avoid a mass exodus claim against them, take heed of the Trade Secret Litigator’s Seven Deadly Sins of Departing Employees. These rules are particularly important to follow in mass resignation cases because as the B.G. Balmer case makes clear, every action may take on a more sinister note when it is coupled with the actions of other co-workers who are planning on leaving. The cumulative effect of this evidence can be devastating.
For employers taking on a group of employees, make sure that they follow their non-solicitation agreements, if they have any. If they do not have those agreements, make certain that they also do not solicit co-workers or clients until after they leave. Make sure they keep it clean.
Trade Secret and Non-Compete Posts and Articles:
- In yet another non-compete case involving a physician, an Illinois appellate court has affirmed a trial court’s rejection of a covenant not to compete because the employer, a medical clinic, lacked a protectible interest in the patient base at issue. Jeff Glass reports on the case, Gastroenterology Consultants of the North Shore, S.C. v. Meiselman, M.D., et al., for SmithAmundsen’s Labor and Employment Law Update. According to Jeff, the following facts caused the court to side with the doctor: prior to forming the corporation, he practiced for a decade in the area; after forming the clinic, he continued treating these patients and personally billed them, as opposed to the clinic; the clinic did not help him with advertising or marketing; and finally, his compensation depended on his independent practice.
- “U.S., China Aim To Curb IP Theft Standoff With Talks” reports Law360.
- Looking to protect your trade secrets under Chinese law? Then consult “Chinese Translation: Protecting Trade Secrets in China Requires Knowing Complex Layers of Laws and Practices,” by Mimiao Hu, Shelley Zang and Xiang Wang for Orrick’s Trade Secrets Watch.
- “Former engineer at Bergen County based company charged with stealing trade secrets,” reports NewJersey.com. Ketankumar “Ketan” Maniar planned to relocate to India with trade secrets stolen from his employer, Becton, Dickinson and Company, U.S. Attorney Paul J. Fishman said.
- For companies looking for a trade secrets lawyer, Kenneth Vanko has some fine practical advice, “The Employee’s First Client Meeting,” in his Legal Developments in Non-Competition Agreements Blog.
- In the sad but true column, “(Practically) No Comment: White House Plea for Public Input on Trade Secret Theft Draws 13 Responses advise L. Kieran Kieckhefer and Warrington Parker for Orrick’s Trade Secrets Watch Blog. For 2 of the 13 responses, see Peter Torren’s opinion here and my submission here.
- “New Oklahoma Law Clarifies Enforceability of Non-Solicitation of Employee Covenants” reports Daniel Joshua Salinas for Seyfarth Shaw’s Trading Secrets Blog.
- Jason Cornell of Fox Rothschild provides “A Comparison Of New York And Florida Law Governing Non-Compete Agreements” for Mondaq.
- “Can My Employer Enforce A Noncompete When We Get Our Customers Through Bidding?” asks Donna Ballman in her Screw You Guys, I’m Going Home Blog.
- A New York Federal “Court Finds Potential Liability For Sending Cease And Desist Letter reports Lauri Rasnick for Epstein Becker’s Trade Secrets & Noncompete Blog. For more on the risks of a claim of intentional interference from a cease and desist letter, see my post here.
- “District of Connecticut Addresses Trade Secret Act Preemption advises Eric Ostroff in his Protecting Trade Secrets Blog.
- “Why Non-Competes are bad for the economy,” advises Laura Ellerman for Frith & Ellerman’s Virginia Non-Compete Law Blog.
- “Public Policy Trumps Non-Compete in North Carolina,” reports Eric Welsh for Parker Poe’s Trade Secrets & Unfair Competition Reporter Blog.
- “Medical Device Manufacturer Bound By The Restrictive Covenants It Implemented,” reports Zachary Jackson for Epstein Becker’s Trade Secrets & Non-Compete Blog.
Cybersecurity Posts and Articles:
- In an interesting Op-Ed piece for The New York Times entitled “Elizabethan Cyberwar,” Jordan Chandler Hersch and Sam Adelsberg liken the current cyber conflict between China and the U.S. to the battle for the seas between Elizabethan England and Spain, arguing that China is sponsoring cyber-pirates to level the playing field with the U.S.
- “Facebook Urges Cooperation To Tackle Mobile Security Risks,” reports Law360.
- “Mobile Device Forensics – Are You in the Know?” asks James Whitehead in a guest post for Seyfarth Shaw’s Trading Secrets Blog.
- The IP Commission’s adoption of the “hack back” defense continues to stir controversy. GCN’s William Jackson asks “The hack-back vs. the rule of law: Who wins?” and Lisa Shuchman expresses concern in “IP Theft Report Offers Over-the-Top Solutions” for Corporate Counsel.
- And The Wall Street Journal’s Christopher Matthews chimes in as well, in “Support Grows to Let Cybertheft Victims ‘Hack Back.'”
- Public Interest “Group Backs FTC Authority In Wyndham Data Breach Case,” reports Law360.
Computer Fraud and Abuse Act Posts and Cases:
- “Recent Alleged Cyberattack By Ex-Employee Demonstrates Importance of Employer Diligence On Protecting Network Passwords,” advises Robert Milligan for Seyfarth Shaw’s Trading Secrets Blog.
In an important decision issued on Wednesday, a Massachusetts federal court has found that the absence of proof of actual use of the trade secrets was not fatal to claims brought by Advanced Micro Devices, Inc. (AMD) against four of its former employees. In AMD, Inc. v. Feldstein, Judge Timothy S. Hillman found that evidence that several of the employees downloaded and transferred significant data, coupled with other facts, was sufficient circumstantial evidence of misappropriation to justify an injunction. (A PDF of the court’s decision can be found below).
This decision cuts against other recent cases holding that a trade secret claimant must come forward with evidence of actual misappropriation to make its claim. I have detailed the forensic analysis below, because it was critical in making the circumstantial case that trade secrets were taken and likely being used, and rendered the versions presented by the employees implausible.
Background: AMD brought this case in January 2013 against former employees Robert Feldstein, Manoo Desai, Nicolas Kociuk and Richard Hagan, each of whom had each left AMD to join a competitor, Nvidia. AMD secured a temporary restraining on the strength of non-disclosure and non-solicitation clauses in the employees’ Business Protection Agreements that they had signed as a condition of employment with AMD and had moved for a preliminary injunction formalizing that TRO.
Feldstein, the most senior of the employees, was the first to leave and just before resigning in July 2012, he took a sabbatical during which time 8,148 files were copied from AMD’s intranet via Feldstein’s AMD-issued laptop. The files included a Gmail contacts file, a Microsoft Outlook inbox file and several business-strategy-related documents. He also downloaded a Technology Licensing Overview PowerPoint presentation that he later conceded was “problematic.”
Desai, a Senior Manager, joined Nvidia in December 2012 and forensic analysis showed that 7,899 documents were transferred from her AMD-issued laptop to a folder located on the external hard drive. The night before she left AMD, her husband downloaded all of these files at her request because she wanted to preserve “her personal files, including family photos, personal emails and tax information” and she claimed that she “instructed him not to take any confidential AMD information.” Desai accessed this information on her Nvidia-issued laptop later, but claimed she was searching for personal information. She obviously never returned the information.
Kociuk reported to Desai and was part of her integration team. Forensic analysis revealed that his user account was used to assist Desai in copying or transferring very large file systems for subsequent use (he said this was done only to help her erase her personal data from AMD). He admitted he used a utility application, Robocopy, to create duplicate images of the entire file structure of his two AMD-issued computers. More than — wait, let me lift my pinkie to my lips — one million files were copied onto a pair of external hard drives. Kociuk claimed that he did this to preserve copies of personal information and data. He left to join Nvidia on January 11, 2012, the event that triggered the lawsuit and TRO. After downloading the files, Kociuk signed an acknowledgement that he was not retaining any of AMD’s confidential information.
In addition, AMD presented evidence of some solicitation of then-current AMD employees by Feldstein, Desai and Hagan. None would admit that the conversations were actual solicitations but it appeared from emails and text messages that some informal solicitation may have taken place.
The District Court’s Reasoning: Judge Hillman addressed the split in authority in Massachusetts over whether acquisition of trade secrets by improper means is sufficient to establish misappropriation or whether, alternatively, a plaintiff is required to prove actual use above and beyond acquisition by improper means. He did not address the pros and cons of each line of cases, but instead, he simply elected to go with the line of cases permitting acquisition by improper means.
Judge Hillman recounted the forensic evidence outlined above and found that it was “compelling.” He noted that all of the former employees made copies of confidential information of AMD, retained that information, and immediately began working for significant competitor. He noted that Feldstein in particular had access to extremely sensitive business strategy and licensing agreement information which he acknowledged was “problematic.”
This circumstantial evidence, in the court’s view, destroyed the credibility of the alternative explanations offered by the employees as well as their other testimony that they did not intend to misappropriate the trade secrets or that they could not possibly use that knowledge to benefit Nvidia in their current position.
The Takeaways: From the employee side, what were these people thinking? Kociuk’s decision to copy one million files destroyed the believability of the employees’ protestations of misappropriation. The strength of the forensic evidence also spilled over into the issue of whether improper solicitations occurred, because the ambiguous signals and communications at issue there suddenly took on more sinister overtones against the backdrop of the massive downloading of these and other files.
On the employer’s side, forensic evidence saved the day here and was used to build a compelling story. Although there was no evidence of actual use of the trade secrets, the sheer amount of data transferred, the suspicious timing of the downloading and the timing of the employees’ departures to the same competitor led the court to conclude that these employees were likely already using or likely to use these trade secrets in the future.
As I noted at the outset, several courts have recently required parties to come forward with actual proof of misappropriation (a decision out of Georgia imposing this standard can be found here). This new standard, in my view, is incorrect and difficult, if not impossible, to meet. Evidence of the proverbial “smoking gun” rarely exists and it is unrealistic to expect a tortfeasor to fall to his or her knees and admit “I did it!” To the contrary, in the crucible of litigation, one can reasonably expect the tortfeasor’s story to harden now that he or she is confronted with tne consequences of his/her actions. Trade secret claims, like claims for fraud or unfair competition, are inherently based upon some degree of deceit and as a result, by their very nature, often can only be proven by circumstantial evidence.
Judge Hillman did not identify the particulars of the injunctive relief he was going to enter in the case, so I will keep you updated when he ultimately does issue that injunction.