Permanent Injunctions and The Erie Problem

God help us all!

I am discussing the Erie v. Tompkins case from 1938. This was like the fourth most annoying case from law school, and I thought I left it once and for all in Champaign, Illinois in 1997.

But it rears its head - fittingly so, perhaps - in the tragicomedy known as E.I. duPont v. Kolon Industries. The issue, though, is one that is likely to repeat, so if for no other reason than I feel an obligation to get this issue on the table, I have to discuss this. And it's somewhat surprising that I haven't seen it come up much before.

The issue, put simply, is this: does federal or state law apply to determining whether to issue a permanent injunction in a diversity case for violation of the trade secrets act?

Why is this issue important? For injunctions arising under federal law, courts apply the so-called eBay test that requires a court to examine four factors before awarding a permanent injunction: (1) irreparable injury, (2) inadequate remedy at law, (3) balance of hardships favoring the plaintiff, and (4) that the public interest is not disserved by issuing an injunction.

This differs from the state-law approach. In many states, courts have held that if a statute authorizes a court to issue an injunction, then a plaintiff need not prove irreparable harm. Demonstrating success on the merits is enough.

Trade secrets law is governed by state law. And every state that has adopted the Uniform Trade Secrets Act (47 states) allows for injunctions to issue in trade secrets cases.

So in Kolon Industries, the Eastern District of Virginia found that the Erie doctrine applies, and a federal court must apply state substative law to determine whether a permanent injunction remedy is appropriate in a trade secrets case. Erie basically says this: on a matter of substance, a federal court must apply the law of forum state. On procedural issues, federal law applies.

My problem is not so much with the Erie-based holding in Kolon Industries, because it is hard to see a permanent injunction order as anything other than substantive. But state laws that do not apply an eBay-like test, to me, make no sense. It should never follow that because a legislature has authorized an injunction for a violation of a state statute, that the injunction should automatically be entered.

This is particularly the case when the plaintiff has damages remedies available to it. In the Kolon Industries case, DuPoint obtained compensatory damages of $919.9 million. I can see where an injunction should automatically follow if the statutory violation does not allow for the recovery of damages, such as in the case of some deceptive trade practices statutes. Or in the case of a prophylactic law applicable to a regulated industry.

But when a damages remedy is available (and indeed has been awarded), it is short-sighted to rely on the fact that a statute has authorized injunctive relief to award injunctive relief. This is not to say, of course, that Kolon Industries was wrongly decided on DuPont's entitlement to an injunction, which was clearly warranted on the facts.

Non-Compete Radio Is Back: Episode 2 Link

It was either watch the debate or finish Episode 2 of my podcast. The first few minutes of the debate were excruciating.

So, after 6 months, Episode 2 of Non-Compete Radio is on the air. You can listen directly to Remedies in Non-Compete Litigation by clicking below. And remember to subscribe to Non-Compete Radio in the iTunes store.

Next week, I will be interviewing Bill Tarnow of Neal Gerber & Eisenberg, a great non-compete lawyer who recently was named one of Chicago's "40 Under 40" attorneys to watch. Bill and I are going to discuss mistakes we see in non-compete and trade secret litigation.

I look forward to having other guests join me in future episodes.

Listen to this episode

The Reading List (No. 12)

We start this week's Reading List with two entries from a site I need to visit more often.

Burr & Forman's non-compete blog has a very interesting article on potential antitrust implications when competitors settle non-compete disputes.

Also from the Burr & Forman blog, a report on how Tennessee courts employ the "rule of reason" analysis when modifying non-compete agreements. This post discusses the various approaches courts have taken and also warns employers not to fall in love with the idea that a court will backstop an overbroad or poorly written non-compete.

John Marsh has tackled the legendary case of E.I. DuPont v. Kolon Industries in a number of posts, and this week reports on the federal indictment of Kolon and several executives for trade secrets theft. John hales from Columbus, Ohio (where I went to school), and hopefully he can figure out Ohio State football's porous defense as well as he has the DuPont litigation.

For those trending to an intellectual bent, Judge Richard Posner writes this week on the interplay between "luck" and financial wealth. This is as esoteric as it gets, but what interested me is Judge Posner's somewhat dismissive attitude towards Ayn Rand. For some reason, this surprised me.

Robert Milligan of Seyfarth Shaw has an in-depth and excellent post on the sports agent kerfuffle involving Aaron Mintz and Mark Bartlestein. This feels to me like two petulant kids playing in the sandbox.

Later this week, I will write more on the Supreme Court of Illinois' decision in Lawlor v. North American Corporation, provide a case law update, and link to the (long overdue) second podcast from Non-Compete Radio. That's a lot to tackle, but after a short vacation, I'm feeling up to it.

A Lesson In How Not to Do It: Vibra-Tech Engineers v. Kavalek

Competition disputes fascinate me partly because of the ways people manage to screw things up.

For my employee clients who are looking to leave and compete, the advice I often end up giving is simple and straightforward. In a nutshell...

1. Don't take anything when you leave.

2. Be honest and forthright on your way out the door.

3. Know your contractual obligations.

4. Don't compete before quitting.

Of course, there are the inevitable line-drawing exercises that have to be hashed out, as I end up answering countless "what if I do this" questions. But as long as employees can stick to these four basic rules, things can't go too terribly wrong.

Scott Kavalek stuck to none of these rules.

The case is Vibra-Tech Engineers, Inc. v. Kavalek, and if nothing else, it is first-rate primer on how not to compete. Earlier this year, a federal court entered a judgment against Kavalek, his wife, and their two companies in the amount of $3.39 million. The suit was a not-so-garden variety non-compete and duty of loyalty action that Vibra-Tech brought in New Jersey. And the facts were startling to read.

Vibra-Tech is in the business of measuring vibrations in construction, quarry, and mining operations, and it also performs related consulting services. Kavalek was a high-level executive and corporate officer of Vibra-Tech who, years before his termination, set up two competing businesses and actively competed with Vibra-Tech while employed by it.

Among Kavalek's actions:

1. Hiring then-current Vibra-Tech employees to work for a competing entity.

2. Diverting several large customers to his own company, costing Vibra-Tech business.

3. Setting up another company as a "supplier" of geotechnical equipment and causing Vibra-Tech to purchase equipment from this supplier at inflated rates.

4. Lying at the time of termination of his involvement in these companies.

5. Tampering with sales invoices produced in discovery in an effort to hide Kavalek's sales activity with diverted customers.

6. Causing his attorneys to make repeated false representations in court about the production of documents and his association with corporations he controlled.

In a case such as this, contractual obligations almost seem to take a back seat. And indeed, the district court in rendering its judgment makes only passing references to the non-compete's enforceability. To be certain, if Kavalek never signed a contract, the outcome would have been the same.

The only real interesting legal issue to come out of the case is that the district court applied a disgorgement theory of damages, largely under the principles of agency associated with fiduciary duty law. Vibra-Tech had offered alternative damages theories, based on both lost profits and disgorgement. Ultimately, the court had little trouble finding that punitive damages also were appropriate.

--

Court: United States District Court for the District of New Jersey

Opinion Date: 3/29/12

Cite: Vibra-Tech Engineers, Inc. v. Kavalek, 849 F. Supp. 2d 462 (D.N.J. 2012)

Favors: Employer

Law: New Jersey

Case Law Update: The Remedies and Civil Procedure Edition

This is a much overdue case law update, so it's a little lengthy. But on the upside, it touches on a number of different subjects from around the country.

Lost Profits

A federal district court in Indiana excluded significant parts of an expert's lost profits testimony in the hotly contested case of CDW, LLC v. NETech Corp. The case arose out of an allegation that NETech lifted out CDW's Indianapolis branch office and suffered millions in losses in "advanced technology" revenue. On a Daubert motion, the district court excluded a financial expert's "yardstick" methodology for predicting what CDW's Indianapolis branch would have earned but for the alleged wrongful conduct by the ex-employees. The ruling effectively excluded opinions that would have established lost profits of over $17,000,000. The district court allowed an alternative formulation of lost profits in a much lower amount to go to the jury.

Equitable Extension

The extension of non-competes past their expiration date (as measured from the date of termination of employment) is one of the most controversial, hotly contested remedies in litigation. As a federal district court in Idaho noted a few weeks ago, judges normally impose this remedy - when it's available - after a jury finding of breach or after a favorable ruling on summary judgment for the enforcing party. But in unusual cases, like that in MWI Veterinary Supply Co. v. Wotton, 2012 U.S. Dist. LEXIS 131784 (D. Idaho Sept. 14, 2012), the court can issue an extension remedy at a TRO or preliminary injunction phase. That finding was important in the Wotton case since the court had to find extension was appropriate to determine likelihood of success on the merits of the case. The non-compete, which arose out of the sale of a business, expired by the time the court addressed the preliminary injunction motion.

Temporary Restraining Orders

An Ohio court refused to grant a temporary restraining order against a departed sales executive in Chart Industries, Inc. v. Spagnoletti, 2012 U.S. Dist. LEXIS 140102 (N.D. Ohio Sept. 28, 2012), because the non-competition covenant contained no geographic or job-scope limitations. Though careful to note that such covenants were not per se unenforceable, the court stated it was important that the employer did not ask the court to impose any sort of limitation on the covenant at the TRO stage that would make it reasonable. The case demonstrates the continued difficulty courts have enforcing non-competes that contain no limiting language whatsoever. Delaware law applied.

Necessary and Indispensable Parties

In non-compete cases, the plaintiff sometimes will elect to forego suing the new employer and will proceed simply against the employee. There are a number of strategic and substantive reasons why this may be the case. The ruling in OneCommand, Inc. v. Beroth, 2012 U.S. Dist. LEXIS 122587 (S.D. Ohio Aug. 29, 2012), shows that a new employer is not a necessary party who must be part of the litigation under Federal Rule of Civil Procedure 19. Even if the plaintiff has potential claims against a new employer (for interference, trade secrets theft and the like), it is not necessary to make that company a party to a breach of contract suit with the employee.

Jury Trial Waivers

The right to a jury trial can be waived by contract if the waiver is knowing and voluntary. Generally, such waivers are strictly construed, however. One question that frequently arises is how far the contractual waiver extends to non-contract claims, like trade secrets misappropriation. A Delaware court concluded that a jury waiver provision in an asset purchase agreement encompassed related tort claims of trade secrets theft, conversion, and common-law unfair competition - reasoning that the "arising out of" language in the agreement was sufficiently broad to include torts intrinsically related to the contract action. The case is Coface Collections North Am., Inc. v. Newton, 2012 U.S. Dist. LEXIS 124342 (D. Del. Aug. 31, 2012).

Attorneys' Fees

Non-compete litigation can sometimes perpetuate itself solely because of fees that are incurred. An illustration of this problem comes from the case of Cumulus Broadcasting v. Okesson, 2012 U.S. Dist. LEXIS 124836 (D. Conn. Sept. 4, 2012). After the parties settled, they left it to the district judge to award attorneys' fees under a provision of the employment agreement that enabled the plaintiff to recover fees enforcing the non-compete.

The court, seemingly none-too-pleased (particularly since it was not allowed to see the terms of the parties' settlement agreement (?)), significantly pared back what the plaintiff thought it was owed. It essentially limited its fees to those incurred to obtain a preliminary injunction. And even that apparently gave the plaintiff only a small slice of what it wanted. The court ripped about $10,000 in fees off what it cost to take the matter to hearing.

The fee award was $80,317 (inclusive of some $21,000 in costs) - about 1/4 of what the plaintiff incurred and claimed it was entitled to. If nothing else, the case highlights for clients what a preliminary injunction can cost. And it further shows that weak non-compete cases can cost a lot more than the value of the benefit received.

The Reading List (No. 11)

I have not done a formal "Reading List" for a while, so I included a number of different subjects into the mix. Tomorrow or early next week, I'll have a case law update.

From the Volokh Conspiracy, Orin Kerr writes on the circuit split over the Computer Fraud and Abuse Act, as well as current legislative activity that may resolve issues inevitably destined for the Supreme Court.

John Marsh discusses the indemnification and advancement suit filed by Sergei Aleynikov in his ongoing $2.5 million legal fee adventure with Goldman Sachs. I wrote about this late last week and just happen to be dealing with this same issue in two suits of my own.

Today's Crain's Chicago Businesses discusses two non-compete disputes over doctors (urologists and obstetricians) pending in Cook County.

Epstein Becker & Green's blog discusses an unusual Texas case in which an employer lost a non-compete case due, at least in part, to its failure to sign the document. Another take on the same case from Seyfarth Shaw's blog...

Judge Richard Posner suggests on the Becker-Posner Blog reforms to both patent and copyright law. He previously wrote for The Atlantic on similar issues following dismissal of the Apple/Motorola Mobility suit, in which he sat as a trial judge by designation.

Also from the Seventh Circuit, Judge Diane Sykes' address to Marquette Law School featured comments on the late Judge Terence Evans, who died unexpectedly not long ago. Her remarks were very interesting and describe Judge Evans' clear, pragmatic style. The article can be downloaded from this site for free.

Cook County Order on Attorneys' Fees Illustrates Factors Used to Assess Bad Faith

Earlier this year, Judge Mary Anne Mason in the Circuit Court of Cook County awarded attorneys' fees to a prevailing defendant under Section 5(i) of the Illinois Trade Secrets Act. That provision allows for a defendant to recover legal fees if a claim of misappropriation is made in bad faith.

A copy of Judge Mason's Memorandum Opinion and Order in Portola Packaging, Inc. v. Logoplaste USA, Inc. is embedded below. This was not an employee defection case, but rather one which arose out of the ashes of a failed business transaction. I have a similar bad faith fees issue currently pending in the United States Court of Appeals for the Seventh Circuit in the case of Tradesmen Int'l, Inc. v. Black (Nos. 11-3715 and 12-2032). In that case, my clients petitioned the district court for an award of fees following entry of summary judgment.

By and large, the standard by which to examine "bad faith" under the ITSA (or any of its uniform act counterparts) is somewhat ad hoc. Many courts adhere to a two-part objective/subjective test very similar to that discussed in last week's post concerning the Leadscope case out of Ohio.

Judge Mason's opinion is very interesting in that it shows how a trial court judge, following the conclusion of a trade secrets case, will go back over the evidence and compare it to what the allegations revealed. For instance, one of the factors Judge Mason examines is the plaintiff's failure to retrieve copies of confidential information from the proposed acquiring company after negotiations broke down. During the course of the lawsuit, Portola had continued to insist that it did not demand retrieval of confidential documents because it held out hope of rekindling a business relationship with Logoplaste. As no documents revealed Portola's interest in this "rekindling", Judge Mason was not buying the argument.

This demonstrates that factors other than what is pled in the complaint are highly relevant to the bad-faith inquiry. Further illustrative of this is Judge Mason's reliance on evidence of pre-litigation communications where Portola had examined a litigation strategy because "new suppliers that are caught up in litigation can scare potential customers." This type of evidence, arguably irrelevant to what the allegations say, illustrates motive to pursue a competitor not for the hopes of winning a suit, but simply to deter competition altogether.

Portola Packaging v. Logoplaste - Order on Fees