Lost Profits Always Difficult to Prove In Trade Secrets Case (SKF USA v. Bjerkness)

You have established that your ex-employees copied thousands of files on storage devices before quitting.

You have proven they serviced your key customers after quitting.

You have even convinced a judge that those employees used the very purloined documents to service those same diverted accounts.

Slam dunk case on damages, right?

Not so. Damages often times are the tail wagging the dog in trade secrets cases. Even on those occasions when they are not, parties get bogged down in issues of proof.

In SKF USA v. Bjerkness, a federal district court again held that a plaintiff in a strong liability case could not prove lost profits relating to the defendants' use of trade secrets. The rationale has to do with proximate cause: the customers did not leave the plaintiff because the defendants used stolen documents. Rather, they left because of a change in the plaintiff's ownership and their relationship with the defendants. Absent a non-compete, there is "nothing illegal about that", the court said. Proof of lost profits therefore failed.

Of course, this does not mean that a defendant can simply walk without financial liability. It still must account for its unjust enrichment in a trade secrets case - the profits related to those customers taken and for whom secret information was used. Frequently, in start-up businesses, though, this is an exercise in futility. New businesses frequently are unprofitable, and a plaintiff simply cannot apply its gross margin to the defendant's start-up.

This was the defendant's problem in Bjerkness. Rather than counter evidence of an applicable margin rate, the defendant simply contended it was not liable at all. Accordingly, the court used the plaintiff's margin as a substitute and based unjust enrichment by applying that percentage the defendant's gross sales. The court did not have to accept this as an evidentiary basis for damages.

All this makes injunctive relief more critical in trade secrets cases. Damages are notoriously difficult to prove, at least in "soft secrets" cases. What I mean by that is the sort of operational business information that may contain or reference admittedly confidential information but is not the crown jewel of the company. How do you prove damages from someone's disclosure of an outdated financial statement.

Damages cases are much different when a "hard secret" is at issue. On that score, think of a key engineering drawing, proprietary source code or a product formula as a revenue-enhancing secret for which damages may be eminently more provable. If, for instance, a proprietary drawing is taken and used to engineer a competing product, all profits from sales of that unfairly developed product provide a sound evidentiary basis for damages.

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Court: United States District Court for the Northern District of Illinois
Opinion Date: 8/9/10
Cite: SKF USA Inc. v. Bjerkness, 2010 U.S. Dist. LEXIS 80776 (N.D. Ill. Aug. 9, 2010)
Favors: Employee
Law: Illinois

Broker Recruiting Protocol Provides Industry Standard

The Wall Street Journal today had an excellent overview of the Protocol for Broker Recruiting, an industry response dating back now several years to exploding litigation related to advisors moving from one investment firm to another. The Protocol is a recognition of the impact of broker-dealer restrictions on the public interest. In fact, the first line in the Protocol mentions clients' interest in privacy and "freedom of choice in connection with the movement of their Registered Representatives...between firms."

The Protocol had three founding members - CitiGroup, Merrill Lynch and UBS Financial - and since its inception many years ago the list has exploded as firms have clearly made the decision that the benefits they can obtain from recruiting and hiring registered representatives far outweigh the impact of losing advisors to competing firms.

For its part, the Protocol essentially establishes a set of conduct guidelines that allow advisors to avoid liability for switching firms even if a non-compete or non-solicitation agreement is in place. The idea behind the Protocol really centers on several basic principles:

(1) Certain, non-proprietary client information can be taken with the registered representative. This information includes basic contact information and account titles.
(2) Other, proprietary information is off-limits. This includes, most prominently, account numbers, account statements and notes. Courts routinely require an immediate return of such proprietary information in conjunction with TRO or injunction proceedings.
(3) The representative must tender copies of all client information he or she is taking at the time of resignation.
(4) A representative may not solicit clients prior to resignation.
(5) Upon resignation and compliance with the Protocol, the representative may solicit clients he or she serviced at the former firm.

Nothing in the Protocol would absolve a representative from pre-termination misconduct that could give rise to fiduciary duty liability. Restrictive agreements, mind you, still have relevance. If a representative fails to comply with the Protocol, then the agreement can be enforced. Further, if an advisor's new firm is not a signatory to the Protocol, then the Protocol does not apply and the agreements will still be binding.

In fact, earlier this year, U.S. Trust - a wholly owned subsidiary of Bank of America who was not a signatory to the Protocol - prevailed on a temporary restraining order proceeding when several representatives allegedly took certain client information from U.S. Trust and joined Citi Private Bank. Though the defendants argued their conduct complied with the Protocol, the court found it critical that U.S. Trust was not a signatory in issuing the TRO.

The Protocol exempts from protection so-called "raiding", though that term is not defined at all. Presumably, this means a representative could not raid a team of representatives or solicit a sales assistant prior to departure, but a wholesale raid on a partnership may be considered a "raid" even if the representatives attempt to comply with the terms of the Protocol. There certainly is some ambiguity here.

Representatives seeking to switch investment firms have a tremendous incentive to seek early legal advice. A properly conducted transition can enable an employee to avoid the terms of a non-solicitation agreement, while one that is poorly executed can result in unnecessary liability.

The Protocol also could have the effect of increasing a representative's potential monetary liability if it is not followed. If, for instance, a representative takes client information that is protected, he or she may be subject to a punitive damages award because investment firms have had some success arguing that such information qualifies as a "trade secret" under the law.

The key inquiry for obtaining punitive damages in a secrets case is whether misappropriation of such information was "willful." Arguably, the very existence of the Protocol has put representatives - hardly an unsophisticated bunch - on notice of what they can and cannot do. Failure to comply with the Protocol lends support to the argument that the representative knew what he or she was doing was unlawful.

Contempt Sanctions May Allow for Double Recovery (Mitchells Salon & Day Spa v. Bustle)

It is a truism most non-compete agreements get resolved well short of trial. To be sure, the settlement options available to parties in non-compete disputes are much more robust, since even the most vigorously fought, emotional contests don't necessarily result in large monetary exposure. Conduct restrictions, in myriad forms, are always potential settlement options. And usually better ones at that.

Given the frequent disparity in resources between the parties, a negotiated resolution sometimes results not just in a settlement agreement but also an actual agreed court order outlining what the ex-employee cannot do in the marketplace. From the employer's perspective, the specter of a court order is much more powerful given the potential for contempt sanctions if the ex-employee gets an irresistable itch to compete. On the other hand, documenting a restriction in a private settlement agreement means the ex-employer would need to sue for a violation on a separate contract claim.

The sanctions for violating a court order can be significant. A recent Ohio appellate case illustrates this. In a dispute between a high-end beauty salon and a hair stylist, the latter agreed to incorporate his non-solicitation covenant into a court order. He soon began violating the order and directly provided stylist services to many of his former clients.

The court's penalty upon a finding of contempt was disgorgement of the profits the stylist earned and extension of the covenant for an additional 11 months so that the salon obtained the benefit of its bargain. Arguably, this constitutes a double-recovery. The stylist also was ordered to pay the salon's legal fees in excess of $15,000 and private investigator fees of more than $52,000. Courts have much wider discretion to impose penalties for civil contempt. It should go without saying that parties have a much greater interest in complying with a court order than a private contract, but the Ohio case illustrates how sweeping those penalties can be.

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Court: Court of Appeals of Ohio, First Appellate District
Opinion Date: 4/30/10
Cite: Mitchells Salon & Day Spa, Inc. v. Bustle, 187 Ohio App. 3d 336 (Ohio Ct. App. 1st Dist. 2010)
Favors: Employer
Law: Ohio

Yes, Non-Compete Agreement Can Be Enforceable Against a Tattoo Artist (Atomic Tattoos v. Morgan)

Readers of this blog have become conditioned to seeing non-compete disputes in a range of sophisticated professional services industries. In fact, non-competes are the norm in fields such as insurance brokerage, technology services, veterinary services and many business-to-business industries that grow through long-term corporate client relationships.

But non-competes are prevalent in a wide range of businesses, even those that may be a surprise. I have counseled a fair number of health clubs who have personal trainers sign non-compete or non-solicit agreements. Case law reporters reveal a number of decisions that allow enforcement of restrictive covenant agreements against hair stylists. And the next exterminator to get sued for violating a non-compete won't be the first by a long stretch.

A recent Florida case even upheld the issuance of a temporary restraining order against an independent contractor tattoo artist, who violated a 15-mile covenant in his contract with Atomic Tattoos. The company developed a database that strongly suggested most of its customers lived within a short distance of the shop, and that many were repeat customers. (This should surprise absolutely no one.) Of course, Florida law concerning restrictive covenants is highly pro-business, as courts are not allowed to consider facts related to individual hardship and certain covenants are presumptively reasonable.

In many ways, non-competes in retail industries like those mentioned above are a bit easier to enforce. First, it is much easier to define the prohibited business. By way of example, most people understand a restriction that does not allow someone to perform "body piercing and tattoo artist services." Contrast this with trying to define a restriction in a complicated business-to-business technology field that changes every couple of months with new product offerings and niche marketing plans.

Second, a geographic restriction makes more sense in a consumer-centric retail business. Because individuals tend not to travel very far for personal services (how far would you drive to work out every day?), retail-oriented non-competes often contain a very tight prohibited area of competition and can be enforced fairly easily. In many business-to-business environments, a geographic restriction is much more difficult to enforce, since account executives may travel great distances to see clients and a home office location may mean very little in the sales process. In a retail business, the business' store location often has great value in and of itself.

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Court: Court of Appeal of Florida, Second District
Opinion Date: 9/10/10
Cite: Atomic Tattoos, LLC v. Morgan, 45 So. 3d 63 (Fla. Ct. App. 2d Dist. 2010)
Favors: Employer
Law: Florida

Non-Compete Signed After Acceptance of New Job Lacks Consideration (Drummond American LLC v. Share Corp.)

There are a fair number of states that strict, and sometimes goofy, rules regarding what types of consideration support non-compete contracts.

It is not in dispute that a non-compete agreement entered into at the beginning of the employment relationship needs no independent consideration to be enforceable. In some states, continuing employment, usually for a substantial period of time, suffices to validate the covenant.

In others, however, employers have to be careful. Minnesota is one such state. If an employee has commenced employment before signing a non-compete (a typical "afterthought" case), an employer must provide valuable consideration for it to be enforceable. This is not unusual, but courts in Minnesota have taken this rule to a the extreme: if an employee verbally accepts a job before the employer has informed her a non-compete agreement will be required, then new consideration must be provided for it to be enforceable.

As a result, many contracts governed by Minnesota law will recite that a nominal bonus (of say $2,500) is given in exchange for signing the non-compete agreement. Under the law, even a disproportionately low bonus probably is sufficient consideration. If some recitation is left out of such a contract, an employee may be able to argue that he or she accepted a position (even before starting) without first being told that a non-compete was required.

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Court: United States District Court for the District of Minnesota
Opinion Date: 7/23/10
Cite: Drummond American LLC v. Share Corp., 2010 U.S. Dist. LEXIS 81316 (D. Minn. July 23, 2010)
Favors: Employee
Law: Minnesota

Hewlett-Packard Suit Against Hurd Raises Issues Concerning Inevitable Disclosure, Trade Secrets Identification

Within a day of learning that ousted Chief Executive Officer Mark Hurd accepted employment with Oracle, Hewlett-Packard was in court claiming that Hurd's employment with Oracle will necessarily result in disclosure of H-P's trade secret information.

The suit is pending in California state court, meaning H-P will have an uphill battle to prevent Hurd from working for Oracle. California has a long-standing public policy that invalidates virtually all non-compete agreements. Hurd's several contracts with H-P do not contain any non-competition obligations, but rather purport to prevent disclosure of H-P's trade secret and confidential information.

California also has rejected the "inevitable disclosure" doctrine of trade secrets misappropriation, meaning H-P must allege that Hurd has actually misappropriated, or threatened to misappropriate, H-P's secrets in working for Oracle. The Complaint carefully avoids using the term "inevitable disclosure", but does allege that Hurd accepted "a position which will make it impossible to avoid disclosing or utilizing H-P's trade secrets or confidential information." H-P makes this allegation in the context of a "threatened misappropriation" claim, but identifies no specific threat by Hurd or anyone at Oracle apart from his acceptance of employment in an executive capacity. The defense certainly could attack the Complaint on the basis that it is a thinly veiled inevitable disclosure case, a theory not recognized under California law.

California also has a statutory provision requiring the plaintiff in a trade secrets action to identify with reasonable particularity the trade secrets it claims a defendant has misappropriated prior to taking discovery of the defendant. That, too, will be an issue in this case.

The Complaint alludes to categories of information that may be at issue in the suit. In particular, H-P seized upon public comments attributable to Hurd regarding Oracle's servers, which compete directly with server products from H-P's Enterprise Business group. In addition, H-P alleged that Hurd had access to "pricing, margins, customer initiatives, allocation of resources, product development, multi-year product, business, and talent planning, and strategies being used by H-P."

As is typical of trade secrets complaints, the categories of information at issue are broad and for obvious reasons do not reveal much. I would expect Oracle to fight over the identification of those trade secrets truly at issue in the case.

Regardless of whether the case settles quickly (as often happens in these types of departing executive cases), the one-time partnership between Oracle and H-P appears to be irretrievably broken as the two companies now compete directly for business hardware services.

California Court of Appeal Permits Royalty Damages Claim to Proceed Against E*Trade (Ajaxo v. E*Trade Financial)

In a long-running dispute involving E*Trade's unsuccessful attempt to develop wireless trading technology, a California Court of Appeals has allowed a wireless vendor to proceed against E*Trade on the theory of royalty damages.

E*Trade had previously been found liable for willfully misappropriating trade secrets related to wireless trading technology. However, E*Trade's jilted vendor - Ajaxo - had been unable to show either that (a) it suffered any lost profits from E*Trade's misappropriation of technology; or (b) E*Trade received some inequitable benefit. A California Superior Court refused to allow evidence of royalty damages to proceed, despite the lack of evidence of either lost profits or unjust enrichment damages. That, the appeals court, said was error.

The concept of royalty damages is not unique to trade secrets law, as it has been directly borrowed from patent law. This makes sense. Businesses often must decide whether they want to innovate and create a competitive advantage through secret information, or take the opposite approach and secure exclusive market rights through novel inventions. The common thread is the notion of exclusivity.

Royalty damages are most often applied when lost profits or improper gain cannot be proven by a preponderance of the evidence. This alternative theory is meant to reward a plaintiff's efforts at innovation, since it can hardly be punished if a trade secret is stolen but not deployed properly. This damages theory simply shifts risk to the misappropriator.

From the plaintiff's perspective, actual evidence of a reasonable royalty must be established, usually through experts. It cannot be presumed. A royalty is defined as a hypothetical, arms-length selling price between the trade secret developer and the misappropriator. Evidence of negotiations regarding license fees to use a secret (such as source code) certainly would be a starting point. Other factors tending to establish a royalty might be the value of the secret to the plaintiff's business or development costs associated with its creation. The evidence of royalties is likely to be very complex, depending on the nature of the secret taken and how important it is to the developer's core business.

From the trade secret plaintiff's perspective, counsel must be thinking about royalty damages from the outset of the case. The law on lost profits is often defense friendly, and an early halt to trade secrets misappopriation may mean that unjust enrichment simply is not provable.

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Court: Court of Appeal of California, Sixth Appellate District
Opinion Date: 8/30/10
Cite: Ajaxo, Inc. v. E*Trade Financial Corp., 187 Cal. App. 4th 1295 (Cal. Ct. App. 6th Dist. 2010)
Favors: N/A
Law: California