Jury Verdict Highlights Dangers of Destroying Evidence

Those of us practicing unfair competition law often find ourselves in a unique spot. When we counsel clients - really, departing employees - we can help shape the facts of a potential lawsuit.

Imagine for a second you're a lawyer (bear with me...) and have been hired to counsel a business executive or sales manager on how to make a clean departure with the looming specter of a competition lawsuit. You must give clear, proper advice on at least three issues:

(1) The meaning of any contracts that could impact employment with a competitor.

(2) The best, worst, and most realistic outcomes should a dispute arise - with conservative estimates of what kind of legal fees are likely to accrue.

(3) The need to avoid misappropriation of company information - trade secret or otherwise.

Now, on point (3), you have to go the extra mile. You must advise your client not to delete or impair any company data when leaving. And to go even another mile, you must advise your client not to delete any evidence of misappropriation if such a taking has already occurred before you could advise your client.

On this last point, it's awfully tempting for employees to try and hide their tracks - to cleanse a hard drive or an email account, or even to go old school and shred paper documents. But the consequences can be severe.

For starters, the client will be behind the proverbial eight-ball during litigation because the court will conclude there was something to hide. Every benefit of the doubt or close call will go against the client.

And the consequences can be severe.

Take the case of Janet Murley, a former Hallmark Cards executive who was terminated from her role as Vice-President of Marketing and inked a $735,000 severance package in 2002. Years later, Murley hooks on with Recycled Paper Greetings and discloses a wide range of Hallmark confidential documents.

And the key...hallmark...of that case?

Murley destroyed industry analyses, consumer buying information, and other strategic data a mere 48 hours before an internal investigation (commissioned by RPG's investor) would have revealed the extent of her misappropriation.

So what did a Missouri jury do with that information? It bought Hallmark Cards' theory of damages - forfeiture of the entire severance package - without reservation. And it clearly accepted the adverse inference instruction the district court gave it.

The Eighth Circuit Court of Appeals affirmed a judgment that forfeited Murley's $735,000 severance pay for the improper disclosure. On the legal side, the Eighth Circuit held that the jury properly received an adverse inference destruction - which essentially means the jury was able to conclude that what Murley destroyed would have shown she misappropriated confidential documents of her ex-employer.

Think about it this way. A reasonable jury could have concluded Murley honored other essential terms of the contract - the non-compete, for instance. But her conduct apparently rankled her peers enough that the jury determined she should give back the entire severance amount. Hallmark Cards' damages theory was simple (and obviously cheap to prove), risky, and (in the end) quite effective.

As lawyers, we have obligations to give our clients tough advice. No doubt Murley's attorneys advised her properly when she left, and as sophisticated as she was, Murley had to know what she did was improper.

When lawyers are called on to manage a departing employee's transition, we can shape the facts in such a way to avoid these data spoliation issues and eliminate this thread of evidence from the case entirely. And attorneys ought to document the precise advice they've given, so there is no misunderstanding as to what we have told our clients.

Tait Graves Asks: Do Non-Competes Appropriately Regulate Intellectual Property?

For those of you interested in the academic side of non-compete agreements, the article I have embedded with this post is a must-read.

Tait Graves is a partner at Wilson Sonsini and has written a ton of great stuff on trade secret law. In his latest, he poses a pretty reasonable question that - to him - hasn't received a satisfactory answer:

Does it make sense to use non-compete agreements to regulate intellectual property?

I have a few observations on this article:

(1) I agree with the general proposition that when enforced non-competes can protect too much information if the asserted protectable interest is, in fact, trade secrets. I think, almost by definition, that every employee has something to offer besides access to, or knowledge of, trade secrets. So a lock-up period necessarily means that a new employer is going to lose the benefit of some skill that fails to rise to the level of a trade secret.

(2) I don't agree that trade secret law is a better (or at least as good of a) protector of intellectual property law than the non-compete. The problem with using trade secret law instead of a non-compete is that it fails to put employees and prospective new employers on notice of what is actually prohibited. More problematically, for the trade-secret holder, discovery of a misappropriation can come too late and compromise the secret altogether. A non-compete allows for a more objective way to protect the trade secret at the outset.

(3) I absolutely agree that training is a poor justification for using a non-compete. The argument Tait rejects is the Law and Economics argument that firms won't provide training if they can't count on non-competes. Or, more appropriately, that firms will pay a lower wage if non-competes are not available. This doesn't square because firms have every interest to properly train their workers anyway, and whether a non-compete is part of the equation or not, companies will need to invest in the appropriate training to stay competitive. Simply put, it's hard to see how this asserted interest is really appropriate for upholding a non-compete.

What this article does not cover - and indeed does not try to cover - is the use of activity restraints, like non-solicitation agreements, to protect other business interests typically tied to restrictive covenants.

This is an excellent, theoretical read that asks some very important questions.

Analyzing the Non-Competition Covenant as a Form of Intellectual Property Regulation by Ken Vanko

EBay Moves to Dismiss DOJ Antitrust Complaint

Last November, I posted about the Department of Justice suit against eBay for its alleged illegal hiring pact with Intuit. The DOJ contended that the eBay-Intuit agreement not to poach each other's employees violated both the rule of reason and a per se analysis under Section 1 of the Sherman Act.

Predictably, eBay struck back, filing on Tuesday a broad motion to dismiss the case. The motion sets forth a three basic problems with the DOJ theory: (1) the Complaint did nothing more than allege a conspiracy between eBay officers and directors, which is not actionable; (2) the DOJ never attempted to establish any economic harm or anticompetitive impact from the hiring pact; and (3) the pact does not meet the test for a per se Sherman Act violation.

The last point is the most relevant as it relates to non-compete law. EBay's point seems to be that traditional no-hiring pacts have to be judged by a reasonableness standard, and that there is no precedent to equate them with price-fixing or bid-rigging schemes. Essentially, eBay is saying that a no-hiring pact is akin to a non-compete arrangement (though, in fact, it's narrower and rarely subject to marketwide abuse). Non-competes are judged according to whether they're reasonable. And that should be the standard in the DOJ's case. It's pretty clear under the Complaint the DOJ is bypassing any sort of market analysis for why the hiring pact was impermissibly anticompetitive.

A copy of eBay's motion is embedded below.

EBay Motion to Dismiss Antitrust Case by

South Carolina Appellate Court: Physicians' Liquidated Damages Clauses Enforceable

I have written frequently on this blog concerning the subject of liquidated damages. A pre-determined formula or amount of damages is particularly appropriate for non-compete disputes for three primary reasons.

First, proving lost profits can be difficult and requires a company to develop a sustainable, sensible damages model (in my experience, too many plaintiffs never think about this until it's too late).

Second, it eliminates the transaction costs associated with proving lost profits. This requires company time and effort, and often the retention of an expert in the field.

And third, liquidated damages helps solve the time-tested riddle of whether pursuing non-compete litigation is an economically viable outcome for a company. By pre-setting damages, a plaintiff can eliminate some inherent risk and uncertainty surrounding a traditional damages presentation.

Of course, there's a downside. Liquidated damages clauses aren't easy to uphold and are frequently struck down by courts as penalties.

The Court of Appeals of South Carolina just upheld a liquidated damages provision in a physician shareholder agreement that was unlike any I've ever seen. It had several components:

If the physician violated a 20-mile non-compete tied to his or her interventional cardiology practice, then the physician:

(1) forfeited $60,000 in deferred compensation (the payment meant to provide fresh consideration for the new contract);

(2) owed 100 % of the physician's prior year's income with the medical practice;

(3) was divested of a defined share of accounts receivable owed the medical practice; and

(4) was divested of earned but unpaid salary.

If the physician paid the amounts, then he or she was free to compete.

The amounts subject to the liquidated damages clause, as might be expected for the profession, were several hundred thousand dollars per physician. But the Court of Appeals upheld the contract, reasoning that the economic impact from competing in violation of the contract was inherently difficult to calculate and further reasoning that the formulas were tied to what the practice could have expected to receive had the physicians complied with the terms of the agreement.

The kicker for the Court of Appeals seemed to be the impetus behind the non-compete in the first place. The medical practice took out a $5 million loan to finance construction of a new medical office. After the physicians left to compete, the office was not fiscally sustainable - and closed.

The lesson to be learned for corporate counsel is that it is worth considering a robust liquidated damages clause and - more importantly - developing a rationale for why the formula approximates lost profits upon competition. Well thought-out clauses can add a great deal of value to actual or threatened litigation and mitigate the risk associated with developing a damages model.

The case is Baugh v. Columbia Heart Clinic, P.A., 2013 S.C. App. LEXIS 5 (S.C. Ct. App. Jan. 16, 2013).

The BYOD Thicket: Some Basic Steps to Take for Businesses

One of the hot-button issues for business clients in 2012 was the advent of "Bring Your Own Device" policies. The idea behind BYOD in the workplace is that employees who are allowed to use their own cell phones, tablets, and other storage devices may be more productive. And, of course, it may cut down on technology and training expenses for the company as well.

How does BYOD relate to non-competes? Because a substantial amount of potentially relevant evidence can be found on these personal devices. An obvious example is the use of text messaging to contact or solicit customers.

It is not clear if BYOD is a fad. The numbers on data security are fairly alarming, and corporate-owned devices may be in vogue if business owners feel as though relinquishing control over devices is too much of a risk.

But, for now, at least, I have had several clients who want to implement BYOD. Below are some key features of the BYOD agreement I use:

1. Registering the Device. It is not enough for a company simply to allow an employee to use his own cell phone for business purposes. The company must know what it is to ensure the security settings and installed software are consistent with company practice.

2. Security Maintenance. A strong BYOD policy has at its core the specific security requirements the company deems necessary. These include, at a minimum: implementing password protection, updating the device with security patches, and prohibiting the installation of unapproved software.

3. Account for Cloud Storage. Employees increasingly want to back-up a device to a cloud-based storage program. This may be acceptable to the company, but if it is, the company must have a means and procedure to ensure data is removed from the program upon termination of employment.

4. Remember Federal Law. This can come up in three circumstances. First, the BYOD policy should ensure that the device is not used in a manner that could lead to discrimination or harassment suits. Second, the employer can't inadvertenly run afoul of the Fair Labor Standards Act. Specifically, non-exempt employees should not be permitted to use the device during non-working hours for work purposes. Third, with the National Labor Relations Board cracking down on the use of social media policies, a comprehensive BYOD should specifically provide that the policy does not preclude employees from discussing the terms of their employment, or anything else that can be described as concerted activity under the NLRA.

5. Confidentiality Policies Must Apply. Any employer policy, whether expressed in a handbook or agreement, must relate to personal devices. If a company implements BYOD, it should place the employee on notice that confidentiality and proprietary rights restrictions apply to covered devices as well.

Every BYOD is different and should be tailored to achieve company objectives. My personal feeling is that BYOD will remain hot for a while until companies decide that the policies are too much of a security risk. I doubt BYOD ever will be held to undercut a claim that a company takes reasonable steps to protect its trade secrets. But a strong, clearly worded policy would certainly help eliminate that risk.

Maryland Legislation Would Ban Certain Non-Competes

Many of you likely have been clamoring for an update on what's happening in the Maryland legislature. So here goes...

As luck would have it, there is pending legislation relevant to non-competes! And it's yet another of example of unneeded legislative meddling, in this author's opinion.

The text of Senate Bill 51 is provided below, but the essence is pretty easy to distill. The bill was introduced last week and states that a non-compete is not enforceable if an individual is found eligible to receive unemployment insurance benefits. If passed, the law would apply prospectively so it's not of immediate concern to any employers. For now, at least, folks in Maryland can concentrate on Ravens football.

There are obvious problems, both from the face of the statutory language and the incentives it creates.

First, the Senate has not seen fit to define "noncompetition covenant", so it's unclear if the bill applies to customer or employee non-solicitation clauses, forfeiture-for-competition provisions, or other types of activity restraints that may impair, but not bar, competitive conduct.

Second, the bill encourages employers to challenge unemployment appeals by laid-off workers when they otherwise might not. Suppose an employer discharges a sales employee for not meeting sales quota. If the employee files for unemployment (which he almost certainly would), the employer would not necessarily feel compelled to challenge that determination if there were no law like SB 51. However, if the employer is faced with an automatic trigger that would invalidate the non-compete, it has every incentive to mount a challenge to an employee's rights to receive unemployment benefits.

The bill is set up to cause employers to spend unnecessary resources fighting unemployment claims they might not otherwise think to contest. That adds transaction costs and brings down wages and benefits for other employees. It also ends up hurting employees who ultimately could lose their unemployment claims if an employer mounts a successful challenge whose real purpose is to save the underlying covenant. It's hard to see how this is a win for anyone. And it's just impossible to believe that unemployment hearing officers - not normally known as the world's most sage arbiters of justice - are left with, essentially, deciding the validity of non-competes for a certain class of employees.

Courts are equipped to handle this, because they can always determine under the prevailing reasonableness test that a non-compete should not be enforced. Creating bright-line rules like SB 51 proposes undermines this well-established balancing test.

In the event this legislation goes anywhere, and it clearly shouldn't, there is one obvious fix in order for employers. They'll need to make sure their employment contracts adequately define "good cause" for termination. If they can fit a reason for termination into a specific contractual definition of "good cause" (e.g., failure to meet established sales goals), then it would seem to be much more difficult for an unemployment officer to determine eligibility.

Senate Bill 51 by Ken Vanko

Playing the California Card Doesn't Always Work

Anyone familiar with non-competes knows that California is somewhat of an outlier state. Non-compete agreements, even non-solicitation agreements, are highly disfavored and almost always unenforceable except within a narrow band of cases.

One issue that has arisen frequently over the last several years in non-compete disputes is the forum fight involving California. This usually arises when California has some, but not a complete, connection to the dispute. How does that connection arise? Usually in one of two ways:

1. The party bound by the non-compete lives or is domiciled in California.

2. The prospective business opportunity somehow bears a substantial relationship to California. An example? The new employer is based there. Or, even better, the employee's job calls for him to move to California.

Employees seeking to void non-competes have been aggressive in recent years in filing preemptive declaratory judgment actions in California courts when that state has some arguable connection to the parties' business relationship. And, in many cases, California courts have issued judgments that invalidate the contract as an illegal restraint under California's Business and Professions Code.

But the problem is more nuanced when another state also has a substantial interest in the case. For instance, a national company with a footprint in many states may use one form agreement calling for another state's choice of law, or even a forum selection clause. If an employee lives in California, the presence of choice-of-law and choice-of-forum clauses would undercut California's interest in the dispute, since another state (most likely, that where the employer maintains its nerve center) has an equal interest in regulating its out-of-state affairs on a uniform, consistent basis.

So these competing interests can lead to forum fights? What to do?

I am probably in the minority on this, but I happen to feel that the New York court got it right in the Aon Risk Services v. Cusack decision this past week when it refused to dismiss a suit on venue grounds in favor of a pending California case. Even though the defendant, Peter Arkley, was a California resident working for an Aon subsidiary principally in California, Illinois law governed his employment agreement (it contained a narrow, 2-year non-solicitation covenant). And Aon commenced injunction proceedings in Illinois (and later New York state court) right after Arkley's preemptive strike suit in California. Arkley was enjoyed in Illinois and in New York, despite the presence of his California action.

Fights over venue when there is a California connection are not easy to resolve, and courts have to be respectful of litigation in other states. But in my opinion, courts should take a pragmatic approach and decline to override choice-of-law provisions in all but a narrow set of cases. It makes little sense why a New York entity can't have one state's laws govern all of its contracts, unless that choice is completely arbitrary.

There's also an easy fix to this. If a state decides that choice-of-law clauses over its residents' non-compete agreements should not be enforced, then it can pass a law making this established public policy. I happen to think that venue and choice-of-law fights are unfortunate, expensive distractions in cases demanding a quick resolution. This is one of many reasons that the presence of choice-of-law and choice-of-forum clauses ought to command great deference.

Industry Custom May Be Basis for Establishing Secrecy Measures Under Trade Secrets Act

Trade secrets claims are highly dependent on the plaintiff's ability to prove one essential fact: that it used reasonable efforts to keep confidential its identified trade secrets.

Over the past 20 years or so, the concept of "security measures" has changed drastically in the workplace. Early trade secrets cases often discussed whether file cabinets were kept under lock and key, who had access to certain file rooms, and whether a building or office had a requirement that visitors acknowledge confidentiality restrictions for site access.

Now, the focus of trade secrets disputes has shifted. We now look at computer passwords and other digital security protection efforts, including whether personal devices are inventoried and scrubbed at the time of termination.

But let's not lose sight of Old Economy business practices just yet. A federal district court in Illinois ruled last week that a business may establish it used reasonable security measures to protect its company secrets by introducing testimony of knowledgeable people that there was an unwritten custom and practice within the industry to keep certain data technical data confidential, even if there was no binding agreement between the customer and vendor.

The case is von Holdt v. A-1 Tool Corp., No. 04 C 04123 (N.D. Ill.), and Judge Chang looked at declaration testimony concerning "industry custom" to conclude that the plaintiff could show it exercised reasonable security measures over molds used to produce plastic buckets and lids. The testimony became essential because the plaintiff could not establish that it had confidentiality agreements with its customers concerning the technical mold information the plaintiff claimed to be a trade secret.

There are a few important takeaways from Judge Chang's summary judgment opinion.

First, the concept of what's reasonable in terms of security measures is very fact-specific. What may be reasonable for a high-tech business dependent on the exchange of digital information may be irrelevant for an Old Economy business like a tool-and-die manufacturer. In the same vein, a large sophisticated company will be expected to implement broader protections than a small mom-and-pop store. For those large companies, the marginal cost of adding security measures is relatively low.

Second, business ethics are worth something. Most judges are fairly pragmatic. It is awfully difficult for a court to reason that the existence of a formal agreement is a precondition to showing that a party tried to protect its data. If the industry custom suggests that there is a gentleman's understanding that you don't disclose certain data to others, that should carry some weight.

And, in the real world outside the courtroom, vendors don't like presenting customers with formal agreements because that may imperil the entire relationship. There's no reason why industry practice can't trump the formalities of a contract in certain cases.

The case perhaps has limited significance, but it does emphasize the need for a plaintiff to consider every possible security measure when pursuing a trade secrets claim - even if those security measures aren't the type of Digital Age precautions we're used to seeing.

Let's Start Year 5: Amazon.Com Loses Preliminary Fight Over Non-Compete Agreement

So 2013 starts, and what better way to kick off Year 5 of this blog than discussing Amazon.com's effort to enforce a non-compete against an executive who left for Google.

In mid-2012, Daniel Powers was terminated from his position with Amazon.com as a vice-president in Amazon Web Services. This is not the Amazon.com we all know and love. It was a segment that the retail consumer does not see and dealt with Amazon's effort to sell cloud computing services to businesses.

Powers, like most Amazon.com employees, signed a broad non-competition agreement that contained a number of restrictions. When Google hired him several months after his departure, it limited his job role to avoid any potential problems with Amazon.com. Nonetheless, it seems clear he was providing cloud computing services to Google, even if the parties disputed whether Google's products actually competed with those offered by Amazon.com.

After Amazon.com filed a preliminary injunction motion, a federal judge in Washington granted it very limited relief to enforce only that part of the contract that forbade Powers from working with Amazon.com's business customers. It did not enforce a broader non-compete restriction and found that Amazon.com had not submitted evidence to support an "inevitable disclosure" of trade secrets theory.

From my perspective, there are two interesting elements to this opinion.

First, the court specifically found that there was no evidence that Powers had intended to violate the customer non-solicitation covenant. Yet, it enforced it anyway by way of injunctive relief. This was a mistake. It is unclear to me how Amazon.com could establish a likelihood of success on this claim if there is no evidence of breach. The court's rationale was that Powers resisted the preliminary injunction motion, which suggests he might want to solicit his former business customers. But this proves too much, because any party could then go into court and base its request for an injunction solely on the fact that its opponent contests the motion.

Second, the court seemed to suggest that this non-solicitation covenant gave Amazon.com the protection it needed, and that a further ban on employment (the non-compete covenant) was not necessary. This is best summed up in the following passage:

"[Amazon's] ban on working with former customers serves to protect the goodwill it has built up with specific businesses. A general ban on Mr. Powers' competing against Amazon for other cloud computing customers is not a ban on unfair competition, it is a ban on competition generally."

When a business aims to protect customer goodwill, often times a general non-compete stretches too far. As the Powers court recognized, a customer non-solicitation is often the right fit to protect this interest.

The case is Amazon.com, Inc. v. Powers, C12-1911 (W.D. Wash.). A copy of the Order and Opinion on Amazon.com's preliminary injunction motion is contained below.

Amazon.com v. Powers - Order