2011: Year-End Review, Part II

I decided to augment my year-end review this year with a different tone and message. In the past, I have confined my end of the year analysis to a true summary of what legal developments we saw in the area of non-compete law during the prior twelve months.

But upon reflection of the year that is now behind us, I wanted to share some personal thoughts about what I have seen representing clients in lawsuits and non-compete disputes.

In 15 years of practice, I have never been more bothered and disturbed by the role attorneys play in facilitating their clients' grievances, rather than resolving them. Competition disputes are a little bit different - actually, a lot different - than other ordinary suits. More than frequently, they are not about righting a wrong or recovering some liquidated debt. Rather, they are intensely personal, strategic, and improperly pursued. I have written before on the range of legal fees often generated in these cases and what factors go into those ranges. Clients and potential new clients are sometimes shocked to hear this, but it is much better for them to know at the outset.

In 2011, I tried three non-compete cases to final judgment - two victories and one defeat. And on each occasion, the court ultimately got it correct. The attorney I lost to was one of the finest and most honorable attorneys I have met, represented his client well, and worked well with me to get a non-compete case tried to final judgment in a remarkable 35 days. This is what lawyers should aspire to. I left the case sad for my client, but emboldened in my belief in the system and that some attorneys just "get it."

Along the way, however, I witnessed lawyering that was the complete opposite. To sum it up eloquently, the representation I saw this year from a wide range of lawyers was fucking horrendous.

Lawyers seem to forget that they have obligations not only to the clients they represent, but also to the court and opposing counsel. In competition cases, these considerations seem to get swept under the rug all too often. Competition suits have the potential to be strategic - that is, not meant to redress a true grievance, but to gain foothold in the marketplace and to impose litigation costs on a competitor. This in and of itself is wrong. Many lawyers, however, could care less.

The law provides some redress for parties who are the victims of frivolous or strategic lawsuits (and, that term means both suits that were not well-grounded from the start, but also - and especially - those that were filed and maintained for some ulterior purpose), but the avenues to gain just compensation are exceedingly narrow, difficult to prove, and cost inefficient. My experience is that courts are impermissibly hostile to fee-shifting petitions, wary of counterclaims, and unwilling to view the motive behind lawsuits with a jaundiced eye.

Just three illustrations from this year to show what I have experienced firsthand.

I litigated a trade secrets injunction case in state court where the plaintiff, my opponent, had no idea what its trade secret was and ultimately concluded it was his "overall business model." (It was about halfway through a preliminary injunction hearing when the plaintiff finally decided this.) Aside from the fact my client was not even in the same line of business and never took anything from the plaintiff, the plaintiff and its lawyer pursued us anyway and forced a young man to spend $20,000 in personal savings to clear his good name. The court denied our motion for sanctions, which the plaintiff did not even defend.

I also prevailed in a federal court non-compete/trade secrets case where my opponent could not identify how it was ever harmed or injured as a result of what turned out to be business activity in a completely separate market outside the geographic scope of my clients' non-compete agreements. My fee petition for $100,000 is now pending, and my adversary has bitched, whined and lied that I failed to disclose information about my opponent's damages (not sure how this is even possible) and that I confused a deposition witness (is this a compliment or a complaint?).

In another trade secrets case, my opponent filed a claim in a complex industry, claiming that certain technology know-how components (each of which were clearly in the public domain) gave rise to an inevitable disclosure case. The suit, in essence, was a forced hostile takeover of a corporate competitor by virtue of a dubious trade secret claim, and resulted in a large settlement just so the defendant could move on with its business and close its debt financing. At no point did the plaintiff show any interest in what its trade secrets were (its theory changed three times before the first witness was deposed), but the lawyers managed to rack up millions in legal fees.

Victims of lawsuit abuse can always pursue claims for attorneys fees, abuse of process, malicious prosecution, and antitrust violations. But they are hard to prove, perhaps intentionally so. More problematically, lawyers these days seem more interested in charging their clients, building their books of business, and collecting fees, rather than doling out sound advice and pursuing cases to recover compensation.

There are simply too many attorneys chasing too little work, encouraging clients to take on stupid lawsuits for the sole purpose of litigating. Too infrequently, lawyers give little thought to how they will win a case. Litigating is enough until they get their ass handed to them or force their client to settle (usually after most of the fees have been charged and collected) right before trial.

I don't want to give the impression that I won't pursue a case for a client who has been truly wronged. In the past two years, I have been lead counsel for a plaintiff on only five cases - a mere fraction of how many times I defend clients in competition suits. But in those five suits, I know what I am doing and my clients damn well know I investigated the case before I filed it. I don't pretend to know everything, and I have had my share of disappointments. However, I have never used a competition suit for some ulterior purpose. Unlike many of my opponents, I can look myself in the mirror and say that I understand what the profession means.

Faces of Lawsuit Abuse

2011: Year-End Review, Part I

I put a fair amount of effort into this blog, but I try to go the extra mile in my year-end review. I went back and read my material from prior years, and I am proud of the content I have provided my readers as we have turned the page on another year.

So this year, I am going a step further and dividing my column in two parts. This installment features some notable developments in competition law and some links to suggested reading. The second installment will be a lot different, and I hope you find it valuable too.

As I look back on 2011, there were five significant developments (four of which I wrote about) in non-compete and trade secret law.

1. Supreme Court of Illinois "Reaffirms" Reasonableness Test. Courts in Illinois have struggled for 3 or 4 years to determine what test to apply to non-compete agreements. Due to a district split, the Supreme Court had little choice but to take Reliable Fire Equipment v. Arredondo to clarify the law applicable to covenants. As it turns out, the opinion in Reliable Fire was not all that illuminating, but it reaffirmed the tripartite reasonableness test that is common to many states and further held that an employer must demonstrate a protectable interest. The biggest change is that the protectable interest is to be assessed under a "totality of the circumstances" approach - a notable departure from a rigid test that lawyers and courts frequently struggled with. I wrote about this decision earlier this month. The defendants in that case have petitioned the Court for a finding that the ruling applies prospectively only. I will update the blog when the Court rules on (denies) that motion.

2. Texas Supreme Court Expands Permissible Scope of Non-Competes. In July, I wrote about Marsh USA v. Cook, an important Texas Supreme Court case which completed a long revamp of Texas law. Essentially, Texas has now migrated away from an analysis based on whether a covenant was "ancillary" to an employment contract and focused more on whether it is reasonable to protect a legitimate business interest. In Marsh USA, the Court determined that the provision of stock options (as opposed to confidential information) was the type of consideration that could support a non-compete. The best part of the case, though, is Justice Willett's scholarly and beautifully written concurring opinion. It should be required reading for any judge before he or she examines a non-compete case.

3. Georgia's New State Law Takes Effect. After some fits and starts, Georgia's new non-compete statute took effect earlier this year. Though the law only applies to contracts entered into after a certain date, Georgia now goes from being a notoriously employee-friendly state to one more neutral in how it assesses non-competes.

4. Colorado Allows for Continued Employment to Serve as Valid Consideration. The issue of whether continued employment can serve as sufficient consideration for a non-compete is one of my top wedge issues - those that clients often don't grasp and which are the subject of disagreement among states. Earlier this year, Colorado joined a majority of states in concluding that continued employment can constitute sufficient consideration.

5. Massachusetts Courts Expand Trade Secret Proteciton. This is not an issue I wrote about, but it is worth reading Russell Beck's discussion on the Fair Competition Law blog of Specialized Technology Resources v. JPS Elastomerics. Massachusetts has not enacted the Uniform Trade Secrets Act, and Section 93A is its general unfair competition statute. This case appears to give employers some more ammunition for obtaining damages and attorneys' fees against employees who misappropriate trade secret material and use the same after the employment relationship ends. Prior case law had been unclear as to how (or whether) employers could invoke this statute against departing employees.

So that's it for the traditional year-end wrap. Next up, a different and more personal take on 2011.

Iowa Appellate Court Addresses First Sale of Business Non-Compete Case In Over 70 Years (Sutton v. Iowa Trenchless)

Sale of business non-compete cases do not often end up in the appellate courts because they are so frequently enforced. While the contract still technically amount to restraints of trade, the level of scrutiny applied by courts is far more lenient than in employment cases.

The Court of Appeals of Iowa took its first sale of business case in more than 70 years and reaffirmed the long-held principle that courts grant a greater "scope of restraint" in sale of business non-competes than in other adhesive contracts. Interestingly, the court stated the "reasonableness" test is the same, "it is only the application of the test that is different." The court even noted that as long as the area covered by the non-compete was coextensive with the company's line of business, an unlimited duration still could be acceptable.

The Iowa court's formulation of the reasonableness test is similar to that in other states. Some courts will, for instance, presume that a protectable interest exists. Many states shift the burden of proof to the party challenging the covenant, in essence requiring him or her to demonstrate unreasonableness. In a normal employer-employee context, the burden often is on the employer to show why the protections are needed.

Interestingly, in the trial court, the employee - Sutton - sought a declaratory judgment that the non-compete was unenforceable. The employer counterclaimed for breach of contract. Both the trial court and appellate court found that the employer failed to establish an actual breach because it could not prove damages.

In reversing the trial court's grant of declaratory relief, however, the court found that Sutton actually had to reimburse the employer's attorneys' fees under a prevailing party provision of the contract, even though the employer never established breach. Sutton, therefore, may have been better off waiting to see if his ex-employer sued him, rather than filing a preemptive suit for declaratory judgment.

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Court: Court of Appeals of Iowa

Opinion Date: 11/23/11

Cite: Sutton v. Iowa Trenchless, LLC, 2011 Iowa App. LEXIS 1359 (Iowa Ct. App. Nov. 23, 2011)

Favors: Employer

Law: Iowa

Missouri Among States Which Disapproves of Equitable Tolling (Whelan Security Co. v. Kennebrew)

One of the most important procedural issues in non-compete disputes is the idea of equitable tolling. This doctrine essentially allows a court to toll, or stay, the time remaining on a non-compete agreement during the period in which the employee is in breach.

There is a problem, however, with this doctrine. It's not always available, and the remedy is highly dependent on what state's law governs the agreement.

Lawyers need to look at two primary issues. First, does the agreement expressly provide for equitable tolling? If so, then basic principles of contract law should allow a court the power to toll the time remaining on a non-compete if an employee is found in breach. Second, if the agreement is silent on this issue, does the state common law allow for tolling as a default rule?

Ohio, for instance, is a state which allows equitable tolling. In Illinois, it seems as if the courts will not approve of it absent a clear contract provision, but at least one older case suggests the remedy might be available in certain circumstances. Many states simply hold the doctrine is not available.

Missouri is one of the states falling into this last category. The Court of Appeals of Missouri recently reaffirmed this principle in Whelan Security Co. v. Kennebrew, and cited several prior cases as support for its holding. The case, incidentally, also involved the reversal of a summary judgment in favor of the employee on the grounds that the non-compete was facially overbroad. Since the court had to consider the merits of the case, including the protectable interest at stake and the reasonableness of the agreement, the issue of injunctive relief came up in the court's opinion.

The court found that the employer still had a claim for damages, but that injunctive relief was not available given the lapse of the non-compete period. The court noted the equities of its reasoning: "This would avoid the injustice of penalizing Kennebrew by effectively terminating the security guard business that he has established and built since 2009."

For employers, it is essential to seek injunctive relief, if at all, right away. Waiting until a defendant has established its business raises numerous equitable issues, not the least of which is the potential harm to third-parties and the specter of a double recovery.

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Court: Court of Appeals of Missouri, Eastern District, Division One

Opinion Date: 11/29/11

Cite: Whelan Security Co. v. Kennebrew, 2011 Mo. App. LEXIS 1590 (Mo. Ct. App. Nov. 29, 2011)

Favors: Employee

Law: Missouri

Are Signatures Required on a Non-Compete Agreement? (U.S. Risk Mgmt. v. Day)

Readers might be surprised how often employers fail to tie up the loose ends on basic personnel matters. I have seen on more than one occasion a non-compete agreement which fails to contain one or even both signatures. Of course, when a dispute arises, it is difficult for lawyers to turn back the clock and figure out why this was the case.

A case from earlier this year in Louisiana addressed an employee's argument that his non-compete was not binding because the employer never signed it. The agreement even said that it was only effective upon "execution." The court held, however, that a genuine issue of fact concerning contract formation existed, and the suit could not be dismissed at the pleading stage.

A couple of thoughts on this, and similar issues:

First, as the Louisiana court held, "execution" of a contract can mean signing or performance by both parties. Therefore, just as a I wrote yesterday, I would not get too hung up on formalities.

Second, contract formation may be a bigger issue if the employee (rather than the employer) fails to sign. An employee after all is the party to be bound under a non-compete, and the employer's obligations are usually not extensive.

Third, it is important to look at extrinsic facts. If there truly were a dispute over whether the employee consented to the non-compete terms, then the failure to tie up formalities may express the intent that no agreement was ever reached.

On this last point, it would be important to examine pre-hiring communications, an employee's voiced objections to certain terms, and other similar facts. In many cases, the employee may balk at the proposed non-compete and begin work anyway. If the issue is left hanging without any resolution, the court could conclude no meeting of the minds occurred even if the employer subjectively believes the employee had to sign the non-compete to remain employed.

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Court: Court of Appeal of Louisiana, Fourth Circuit

Opinion Date: 9/28/11

Cite: United States Risk Mgmt., LLC v. Day, 73 So. 3d 1100 (La. Ct. App. 2011)

Favors: Employer

Law: Louisiana

Stealing a Non-Compete Agreement May Not Do You Any Good and It Could Land You In Jail

A man in Wisconsin who wanted to open up his own karate studio has been charged with a felony after trying to break into his former employer's work and steal a non-compete contract. The story can be found here.

Obviously, this was pretty stupid. But it likely would not have done much good even had this novice criminal pulled off his caper.

For starters, a missing non-compete hardly means a court cannot find one existed. I wrote about a similar case in Rhode Island exactly three years ago. A trial court certainly can consider evidence from knowledgeable people that an employee did in fact sign a non-compete. Helpful testimony would include the following:

(1) Facts indicating that a new employee must sign the contract as part of an established process at the time of hire;

(2) Evidence an agreement was sent to an employee;

(3) Evidence that personnel files were regularly audited to make sure agreements were on file; and

(4) Some admission by the employee that he signed the agreement.

My impression is that clients, particularly those who are new to litigation, are too enamored with formalities and technicalities. Courts (and rules of evidence) aren't that myopic.

I have had at least one case where my client (the employer) felt an ex-employee stole his non-compete agreement, and we have every reason to think he did. Of course, we did not have the direct evidence which landed our Wisconsin friend with a felony charge. But the judge in our case was willing to consider extrinsic evidence that an agreement was in fact reached.

The case of the missing non-compete, however, should not be an issue. Important documents should be saved (and backed up) electronically.

Supreme Court of Oklahoma Describes Limited Circumstances for Non-Solicitation Enforcement (Howard v. Nitro-Left Techs.)

Oklahoma is one of three states which bans non-competition agreements, the other being California and North Dakota. However, Oklahoma law allows for the limited enforcement of non-solicitation covenants.

The Supreme Court of Oklahoma in Howard v. Nitro-Lift Technologies recently clarified this standard, holding that a non-solicitation covenant may only restrict an employee's solicitation of "established" customers. This means that a covenant which bars solicitation of past customers, for instance, is overbroad. Interestingly, the Court also disapproved of a covenant which left undefined the term "customer," stating that it "might stretch to encompass temporary or single-event relationships." A market-based non-compete will never be enforced against an employee.

Employers in Oklahoma are on clear notice of what their covenants should look like. The state legislature and courts have clearly confined the restrictions to a narrow class of activity restraints. Based on the recent Howard decision, employers also should clarify their definition of "customers" so that it does not reach beyond "established customers" as required by Oklahoma law. While this may be unsatisfying for some employers, at least everyone knows the extent of what courts will enforce. The same cannot be said in virtually every other state.

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Court: Supreme Court of Oklahoma

Opinion Date: 11/22/11

Cite: Howard v. Nitro Left Techs., LLC, 2011 Okla. LEXIS 107 (Okla. Nov. 22, 2011)

Favors: Employee

Law: Oklahoma

Court Holds Pictures of Dead Bodies Are Not a Trade Secret (Kenyon Int'l Emergency v. Malcolm)

I have nothing more to add to this post than the title itself.

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Court: United States District Court for the Southern District of Texas

Opinion Date: 12/13/11

Cite: Kenyon Int'l Emergency Svcs., Inc. v. Malcolm, 2011 U.S. Dist. LEXIS 143437 (S.D. Tex. Dec. 13, 2011)

Favors: Employee

Law: Texas

California Court Summarizes Policy Behind Early Trade Secret Identification (North Am. Lubricants. v. Terry)

One of the big fights in trade secrets concerns proper identification of that which the plaintiff claims has been improperly taken, used, or disclosed.

Unlike the subject-matter of other intellectual property claims or contract claims, the trade secrets subject to protection are often unknown - even to the alleged misappropriator. For this reason, courts have noted that trade secrets cases are qualitatively different and impose on the plaintiff some obligations not seen in other areas of the law.

Many states have a common-law pre-discovery disclosure rule, and California has one by statute. Even those states which do not have hard-and-fast rules seem to suggest that a sequencing of early discovery is appropriate to allow a defendant to understand the claim in greater detail.

The policy justifications for early trade secrets identification were summarized succinctly in a discovery order in North American Lubricants Co. v. Terry. Identification serves four primary purposes:

(1) It promotes "well-investigated" claims and dissuades the filing of meritless trade secrets complaints;

(2) It prevents plaintiffs from using the discovery process as a means to obtain the defendant's trade secrets;

(3) It assists the court in framing the appropriate scope of discovery and in determining whether plaintiff's discovery requests fall within that scope; and

(4) It enables defendants to form complete and well-reasoned defenses, ensuring that they need not wait until the eve of trial to effectively defend against charges of trade secrets misappropriation.

In the North American Lubricants case, the court gave some examples of improperly identified trade secrets. They were: the plaintiff's "business model," its "business plan," and "marketing materials."

Defendants in trade secrets cases should take one of two approaches to identification. First, it could move for some sort of sequencing of early discovery to require that the plaintiff paint a clearer picture of its claimed trade secrets. Second, it should serve an early interrogatory on the plaintiff that at least requires the plaintiff to respond first and embark on the task of identification.

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Court: United States District Court for the Eastern District of California

Opinion Date: 11/18/11

Cite: North American Lubricants Co. v. Terry, 2011 U.S. Dist. LEXIS 133672 (E.D. Cal. Nov. 18, 2011)

Favors: Employee

Law: Arizona

Michigan Appellate Court Upholds 3-Year Injunction In Absence of Non-Compete (Actuator Specialties v. Chinavare)

My employer clients often ask whether competitive activity can be stopped in the absence of a non-competition agreement. My answer is always the same: unless you can show some truly "unfair" competitive activity, your chances of obtaining an injunction are about zero.

What does "unfair" mean in my standard response? Two things: (1) true competitive activity (such as diverting business) during the term of employment; and (2) improper taking of truly sensitive business information. This "headstart" injunction is hard to achieve and is usually reserved for cases which are highly one-sided in terms of the facts.

Under the Uniform Trade Secrets Act, a court has the power to enjoin business activity for a reasonable period of time to eliminate the competitive advantage caused by the misappropriation. This time period necessarily will vary based on the facts of each case. A recent case from Michigan illustrates that this headstart period can be quite lengthy.

In Actuator Specialties, Inc. v. Chinavare, the Court of Appeals of Michigan affirmed a three-year injunction which prohibited the defendant from working for a competitor after the evidence showed he had accessed computer files of his ex-employer close to the time of his termination. After the lawsuit was filed, and a TRO was entered, it appeared the defendant continued to upload these files to his new employer's server and copied allegedly the content of sensitive documents to fulfill customer orders. The court also noted that one of the USB drives onto which the defendant copied information could not be located.

In light of these facts, the court affirmed what effectively amounted to a three-year industry non-compete. These types of rulings are somewhat unusual (though not unprecedented). In my opinion, a trial court which enjoins competitive activity to this extent has to make a finding that a defendant has been less than forthright or demonstrated a willingness to ignore or circumvent court orders.

Courts in equity will often look to which party is wearing the "white hat", and in cases involving the systematic taking or use of truly confidential information, it is hard for the defendant to achieve this "white hat" status. In cases where a defendant has improperly accessed or taken data, it is best that counsel for the defendant put the issues to rest right away. This would involve returning information, scouring potential sources where such information may have been copied, and ensuring that no such information has been used in the business. Otherwise, a defendant will be hard-pressed to convince a trial court that his or her former employer needs no ongoing protection.

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Court: Court of Appeals of Michigan

Opinion Date: 12/1/11

Cite: Actuator Specialties, Inc. v. Chinavare, 2011 Mich. App. LEXIS 2133 (Mich. Ct. App. Dec. 1, 2011)

Favors: Employer

Law: Michigan

Assessing Reliable Fire and Non-Competes In Illinois

The Supreme Court's opinion in Reliable Fire Equipment was not much of a surprise. It seemed fairly clear the Court would establish that Sunbelt Rentals v. Ehlers was wrongly decided and that an employer needed to establish a legitimate business interest to support a reasonably drafted non-compete agreement.

The Court did just that, holding that the traditional three-part reasonableness framework holds and that courts must consider the totality of the circumstances in assessing whether the restraint is no greater than necessary for the employer's protection.

Though the decision left much to be decided and provided no real direction for future cases, a couple of principles were clarified.

First, the Court reaffirmed the long-held principle that total and general restraints of trade are void as against public policy. Therefore, an employer still must ensure that its non-compete agreements contain sensible limits in terms of activity, time, and territory. A complete ban on working in an industry will undoubtedly fall within Reliable Fire's purview of illegal "general" restraints.

Second, prior precedent in Illinois discussing legitimate business interests remain good law. Accordingly, employers may still rely on cases discussing the protectable interests of confidential information or customer relationships to demonstrate that a covenant is reasonable. They won't, however, be constrained by a rigid, formulaic test. Many cases, though, finding no protectable interest in ordinary customer relationships probably are of limited value.

Third, the Court stated that the three-part reasonableness test is "unstructured." In reality, this means trial courts will end up considering the following: (a) the language of the covenant; (b) its impact on the employee's livelihood; (c) whether non-parties or the public are harmed (this usually will involve a highly specialized service); and (d) whether the stated interest bears a nexus to the restrictions.

Employers will have some room to be creative in establishing a legitimate business interest. Such interests could include: (a) special training; (b) extraordinary or unique services (as in the case of a well-known CEO); (c) ability to influence critical vendor or supply chain relationships; or (d) disintermediation. In truth, employers have always asserted these interests, usually trying to bootstrap them into the categorical test, which is now just a guidepost rather than a dispositive inquiry. An article on the decision in Crain's can be found here.

Interestingly, last week the Supreme Court of Montana, in Wrigg v. Junkermier, Clark, Campanella, Stevens, P.C., addressed a very similar issue as that presented in Reliable Fire Equipment and held that an employer must "establish a legitimate business interest as a threshold step to [a court's] analysis of the reasonableness of the covenant." In that case, the Court held that an employer could not establish a protectable interest when the employee was involuntarily terminated. Prior decisions (of which there are few in Montana) did not come right out and discuss the protectable interest requirement, an issue similar to that in Illinois which led to the appellate district split.

I am not aware of any states which do not require courts to look at the protectable interest asserted.

Supreme Court of Illinois Reverses in Reliable Fire, Establishes Traditional Framework for Covenants Analysis

Today, the Supreme Court of Illinois reversed the lower court's decision in Reliable Fire Equipment v. Arredondo, the first non-compete case the Court has taken in five years.

The Court established the three-part reasonableness analysis as described in my previous blog post and held that courts in Illinois are not constrained to consider the two traditional protectable interests. Instead, Courts should examine the employer's legitimate business interest in light of each case's facts.

More on this case as the opinion of the Court becomes available.