In Alabama, No Implied Covenant Not to Compete In Business Sale (Pinzone v. Papa's Wings, Inc.)

A few months ago I discussed New York's common law rule that in a sale of business, when goodwill is part of transferred assets, the law implies a covenant on the part of the seller not to solicit the patronage of his or her former clients. Under New York law, this is inextricably bound up with goodwill itself, such that even in the absence of an express non-compete in the business sale documents, courts will grant the purchaser one to protect the integrity of the deal.

In Alabama, the opposite is true. The Court of Civil Appeals held that the existence of a covenant not to compete cannot be implied even when the sale agreement includes the transfer of intangible goodwill.

As I have previously noted, even in more protectionist states like New York, it is far preferable to draft clear covenants and include them in the transaction documents. What these cases discuss are gap-filler rules at common law, which should be invoked sparingly. Parties always are free to contract for a wide array of covenants in connection with an arms' length transaction, and courts generally enforce them as long as they are not patently unreasonable.

--

Court: Court of Civil Appeals of Alabama

Opinion Date: 7/9/10

Cite: Pinzone v. Papa's Wings, Inc., 2010 Ala. Civ. App. LEXIS 189 (Ala. Ct. Civ. App. July 9, 2010)

Favors: N/A

Law: Alabama

Establishing Value From Being Secret Is the Most Difficult Part of any Trade Secrets Case

I was reading an article by the firm Drinker Biddle today which discussed trade secret protection over customer lists.

One particular comment caught me by surprise. The article suggests that establishing economic value over a trade secret is relatively easy to establish. I respectfully disagree. As my readers know, trade secret laws place a two-part burden on a plaintiff to establish the existence of a trade secret. A plaintiff must show that the information is economically valuable from being secret, and that the information is the subject of reasonable secrecy measures.

If you analyze the case law, it is actually far easier to establish the second prong of the test - secrecy measures. Most employers now are aware that protection of knowledge assets is important and deploy enough secrecy measures to establish that they acted reasonably. (Though of course there are plenty of cases out there where a plaintiff, after the fact, attempts to establish secrecy when information never was intended to be kept out of the public domain.)

The first part of the test, though, can be incredibly difficult to establish. In the case of a customer list (which the Drinker Biddle article discusses), an employer may be able to claim that a list is economically valuable in the sense that it spent money advertising and marketing to the customers on that list.

But is it really that easy to show that the list is economically valuable "from being secret"? I don't think so. A plaintiff may not be able to account for the fact that the details of its list frequently change or evolve, that key parts of the list (say contact information) may be gleaned from public sources, or that major parts of the list can be obtained from commercially available databases. This is particularly the case with a prospect or target list.

At a minimum, a trade secrets plaintiff must identify the witnesses who can establish that information is valuable because of its secrecy. That is to say, those witnesses (likely, experts) must be prepared to testify that comparable information is not known by competitors or being used in the industry, and that such information provides true competitive value in very specific ways.

The bottom line is that a trade secrets plaintiff carries a necessarily heavy burden. Courts rightly favor the free exchange of ideas and vigorous competition. Allowing a plaintiff to establish trade secret status over information that is merely valuable - as opposed to being valuable because of secrecy - would undermine this critical policy goal.

Attorneys Fees In Competition Disputes Often Disproportionate to Harm (SKF USA v. Bjerkness)

One of the inescapable truths about non-compete and trade secrets cases is the expense associated with litigating them. In many, if not most, cases, the actual legal fees necessary to pursue a claim and mount a defense are disproportionate to actual quantifiable loss.

This is particularly true where injunctive relief has successfully been obtained, and a defendant may have started competing but where he or she has not been able to pirate away key accounts.

On the one hand, the most practical remedy has been obtained, but going the extra mile and obtaining damages would be exceedingly difficult. This is why many disputes settle at or around the time of an injunction hearing.

For cases where injunctive relief is not pursued or obtained, trying to obtain an actual remedy is quite difficult and may be an exercise in futility. This is particularly true when a plaintiff cannot point to actual accounts it lost.

A recent federal district court case in Illinois demonstated just how out of hand attorneys fees can get in competition cases. In SKF USA v. Bjerkness, the plaintiff prevailed on a trade secret misappropriation claim and obtained a judgment of only $81,068. Prior opinions in the case suggested the plaintiff's damages presentation was not very convincing.

But the plaintiff obtained a key finding - that misappropriation was "willful." That finding allowed them to obtain attorneys' fees under the Illinois Trade Secrets Act. The fee petition sought $1.3 million, representing 2,700 billable hours of time (or about a year and a half worth of work for a normal Chicago attorney to bill). The bulk of that fee petition was granted.

Such a result is not that uncommon. Fees generally are high in unfair competition cases for several reasons.

First, there normally a number of legal issues to address, from enforceability arguments to proper trade secrets identification.

Second, these cases ordinarily are document intensive, both from parties and non-parties (such as customers).

Third, they are hotly contested, and sometimes provoke irrational litigation behavior among attorneys. It is a truism that non-compete and trade secrets cases often are fought just to be fought, and to obtain a greater competitive advantage outside the actual scope of litigation.

Any case assessment must begin with planning for these contingencies and advising clients on what other similar disputes actually can cost.

--

Court: United States District Court for the Northern District of Illinois

Opinion Date: 9/27/11

Cite: SKF USA Inc. v. Bjerkness, 2011 U.S. Dist. LEXIS 110275 (N.D. Ill. Sept. 27, 2011)

Favors: Employer

Law: Illinois

Ohio Among States Adhering to Dominant View of Trade Secrets Preemption (Office Depot, Inc. v. Impact Office Products, LLC)

The preemptive effect of the trade secrets can be relatively narrow or very broad depending on which state's law applies. As explained in prior posts, preemption is the concept that a state's trade secrets act displaces conflicting state law tort claims based on misappropriation.

There are a number of preemption-related questions that courts must resolve. One of the more significant ones involves whether the trade secrets preemption clause displaces state law tort claims for misappropriation of confidential information not rising to the level of a trade secret.

The dominant view among states is that it does. Preemption would displace any tort claim based not only on trade secret misappropriation (such as conversion or unjust enrichment), but also any similar claim to the extent it is predicated on misuse of confidential, proprietary or other commercially valuable information.

Last week, an Ohio federal district court reaffirmed this principle under the Ohio Uniform Trade Secrets Act. Several Ohio cases previously addressed this issue, and it is a state squarely within the majority class adhering to a broad view of preemption.

There are two general policy rationales supporting this view. First, a narrow view of preemption would enable a party simply to default to other tort claims to avoid having to prove the statutory elements of trade secret misappropriation. If a party can sue for misappropriation of confidential information, why would it ever undertake the burden of pleading and proving the elements of a trade secret case? This would undermine the statute's goal of uniformity among jurisdictions to protect commercially sensitive information.

Second, allowing a party to bring tort claims for misappropriation of confidential information would discourage it from employing the secrecy measures of information that the trade secrets laws require. A party simply could bypass enacting secrecy measures and sue in tort for misusing confidential information that is not widely disseminated or publicly available, but still known by others in the industry. This would lead to less certainty, discourage fair competition, and impede the development of commercial ideas.

States adopting a minority view, which would allow for tort claims based on misappropriation of confidential information, include: Wisconsin, Virginia, Missouri, and South Carolina.

States which adhere to the majority view include: New Hampshire, Ohio, Hawaii, Kentucky, Michigan, and California.

--

Court: United States District Court for the Northern District of Ohio

Opinion Date: 9/26/11

Cite: Office Depot, Inc. v. Impact Office Prods., LLC, 2011 U.S. Dist. LEXIS 109420 (N.D. Ohio Sept. 26, 2011)

Favors: Employee

Law: Ohio

Make Sure Your Employees Are Really Employees (Figueroa v. Precision Surgical, Inc.)

Trying to distinguish between who is properly classified as an independent contractor is way beyond the scope of this blog.

However, it apparently has some relevance in non-compete cases. I have not seen a case like this before, but the Third Circuit has affirmed a denial of a preliminary injunction motion in a non-compete case because the "independent contractor" really was treated as an employee.

Joseph Figueroa challenged the validity of his restrictive covenants with Precision Surgical, Inc. As part of his contention, Figueroa claimed that his status as an independent sales representative was not honored while he was engaged by Precision Surgical. Figueroa reasoned that Precision Surgical breached the underlying agreement (which contained a non-competition covenant) by treating him as an employee. The district court and Third Circuit agreed and found Precision Surgical was unlikely to succeed on the merits of its counterclaim for a non-compete violation.

Among the relevant factors in the court's determination:

(1) Figueroa was given the title "account executive"

(2) He was required to regularly report, attend sales meetings, and received instructions on how to dress.

(3) Precision Surgical made deductions on his commission payments.

(4) Precision Surgical terminated the relationship when Figueroa refused to convert to W-2 status.

As I have told clients before, a non-compete (or more likely, a non-solicit) covenant for an independent contractor can be enforceable. Problems generally arise, though, when a disgruntled former contractor applies for unemployment compensation, and questions arise as to whether he or she was misclassified.

For those employers who do use non-competes in connection with independent contractor agreements, make sure those agreements are followed and that you're not exercising undue control over your people.

--

Court: United States Court of Appeals for the Third Circuit
Opinion Date: 4/12/11
Cite: Figueroa v. Precision Surgical, Inc., 423 Fed. Appx. 205 (3d Cir. 2011)
Law: Pennsylvania
Favors: Employee