Another Court Construes the CFAA Narrowly and More of My Thoughts on the Statute

After last year's important Ninth Circuit decision from U.S. v. Nosal, I discussed my take on the ongoing debate within our federal courts over how to interpret the Computer Fraud and Abuse Act - and in particular, whether the statute addresses claims related to employee misuse of business information obtained from a computer to which they properly had access.

The debate has only intensified with the Fourth Circuit following the Ninth, and a spate of seemingly endless district court cases and commentary on the subject.

Perhaps most surprising is that the Second Circuit - which encompasses New York - has not had the chance to decide whether to follow the narrow view of Nosal or adopt the broad view from earlier cases decided in the First, Fifth, Seventh, and Eleventh Circuits. New York is home to a great deal of competition litigation, particularly in the financial services sector. And district courts within the Second Circuit have come out both ways on how to interpret the CFAA.

The fashionable trend among courts, New York included, is to follow Nosal. As JBCHoldings NY, LLC v. Pakter, 2013 U.S. Dist. LEXIS 39157 (S.D.N.Y. Mar. 20, 2013), shows, courts seem more persuaded by the narrow view (the right view, in my opinion) of the CFAA's reach.

It's not worth rehashing all the arguments that have been blogged ad nauseum, both pro and con on the narrow view. Pakter runs through them all in a thoughtful, thorough analysis.

There's one argument, however, I don't find convincing.

Pakter, and other courts, have looked at the definition of "loss" under the CFAA and found that it strongly suggests the statute is not intended to guard against misuse of proprietary information. They reason that "loss" is defined rather narrowly and is intended to compensate for damage assessment, data recovery, or damages due to an interruption in service. Courts have not extend this definition to include lost profits or other business damages typically associated with trade secret theft.

But for a party bringing a civil claim under the CFAA, it has to show either "loss" or "damage." And while "loss" is fairly limited, the term "damage" isn't. It includes impairment to the integrity or availability of data or information. So whatever the myriad reasons are for taking a narrow view of the CFAA, the rather limited definition of "loss" shouldn't be one of them.

Plaintiffs' Attorneys, Rest Easy: Cease and Desist Letters Likely Aren't Defamatory

Non-compete disputes often follow a similar pattern. And part of that pattern involves the dreaded "cease-and-desist" letter.

These letters are precursors to litigation, and they can be either effective or damaging, depending on the context in which they're sent.

From my perspective, cease-and-desist letters serve one of four general functions:

1. They can start a dialogue between the parties to resolve a burgeoning dispute before it hits the courthouse steps.

2. They place a new employer on notice of the departing employee's restrictions, which helps establish the "knowledge" element of a tortious interference with contract claim.

3. They serve as a proxy to a lawsuit, as they often slow down an employee who may be thinking of competing in a manner that violates a contractual obligation.

4. They remind the employee of the extent of his or her obligations, thus removing a potential "I didn't know I signed it" argument in court (which isn't very effective anyway).

Cease-and-desist letters can also backfire. They can cost an employer a forum fight, if the letter itself leads to an employee filing a declaratory judgment claim. And, if they are loaded with facts that haven't been thoroughly investigated and sent to a new employer, they could form the basis for a tortious interference claim.

But, not to worry...rarely do they form the basis for defamation claims. An employee generally will not be able to claim libel or defamation against a former employer or its counsel if they send a cease-and-desist letter containing faulty or inadequate representations of fact (which are exceedingly common in these types of disputes).

For starters, the litigation privilege protects statements made in the course of litigation and those reasonably leading up to litigation. A cease-and-desist letter will be the type of communication covered by the litigation privilege. Also, a properly drafted non-compete will contain a provision that allows an employer to send a copy of the agreement to potential new employers. If it does, the defense of consent will bar a defamation claim arising out of a cease-and-desist letter as long as the distribution of the letter is limited to those with a legitimate need to see it.

Episode 4 of Fairly Competing: Mistakes Employers Make With Non-Compete Agreements

Our fourth Fairly Competing podcast, Mistakes Employers Make With Non-Compete Agreements, is now available.

In this episode, John Marsh, Russell Beck, and I discuss common errors companies make in drafting non-compete agreements and in enforcing covenants through litigation. Topics include the proper scope of non-compete agreements for various types of employees, damages, and poor decision-making under the pressures of emergency litigation.

You can listen to the podcast by clicking on the link below. You can also visit the podcast website or subscribe to Fairly Competing on iTunes.

Listen to this episode

U.S. v. Nosal: Back In the District Court, the Defendant Isn't as Fortunate

One of 2012's most important competition law cases involved the Ninth Circuit's decision in United States v. Nosal, which narrowly construed the Computer Fraud and Abuse Act. Nosal determined that an employee did not violate the CFAA when he accessed a protected computer with permission but with the intent to use the information gained from that access in violation of a use agreement (in that case, an employer policy).

Nosal generated considerable discussion and handwringing among commentators, with the only universal point of agreement seeming to be the disappointment that Nosal did not spur a Supreme Court case that would lead to some uniformity over the CFAA's application. On Episodes 1 and 2 of the Fairly Competing podcast, John Marsh, Russell Beck, and I discuss Nosal at length.

Nosal is back in the district court now, where the defendant tried to get additional counts of the indictment dismissed following the Ninth Circuit's ruling (the Ninth Circuit did not address each count of the indictment - only a few). This time, he met with decidedly less success.

The district court refused to toss three CFAA counts against Nosal based on Section 1030(a)(4) of the CFAA, which generally makes it a crime or a civil offense to access a protected computer without authorization, or in a manner that exceeds authorized access, with the intent to defraud. In one of those counts, the court closed a potentially gaping loophole on the meaning of the term "access."

Here's the scenario: Employee A has a valid, existsing password to a protected database. Employee A then logs in with that password to allow Ex-Employee B to obtain information out of the secure database. Employee B has no authorization on her own to use the database. Is Employee B's use of the database following the proper login "access" within the meaning of the CFAA?

The answer's yes. And the rationale isn't all that difficult to understand. As the court logically reasoned, this fact pattern is no different than if A gave B the password to log in on her own. That clearly would be unauthorized access to a system. In the court's own words, "access encompasses not only the moment of entry, but also the ongoing use of a computer system."

It's relatively safe to say CFAA cases will continue to generate controversy, discussion, and calls for legislative action.

Mobile App Now Available for Fairly Competing Podcast

For those of you who have listened to our Fairly Competing podcast, we now have a Mobile App that you can install on your iPhone.

Follow these simple steps:

(1) On your iPhone, go to fairlycompeting.podbean.com/mobile/

(2) At the bottom of your screen you will see a Quick Launch icon (it looks like a window pane with an arrow pointed to the right).

(3) Click on that icon, and then touch "Add to Home Screen."

(4) You can then enter a name for your App (it defaults to "FC Podcast"). Keep the name to 12 characters or less, whatever you choose.

(5) You will now be able to listen to podcasts directly from this app, without subscribing to iTunes or Stitcher.

Next week, the Fairly Competing team - John Marsh, Russell Beck, and I - will discuss common mistakes employers make with non-compete agreements. We should have Episode 4 available by Thursday.

Episode 3 of Fairly Competing: The 2013 Legislative Update

Our third Fairly Competing podcast, The 2013 Legislative Update, is now available.

In this episode, John Marsh, Russell Beck, and I discuss pending legislative proposals to regulate non-compete and trade secrets law in Massachusetts, Minnesota, Michigan, and Texas. We offer our thoughts on the policy behind the bills and the relative chances each will become law.

You can listen to the podcast by clicking on the link below. You can also visit the podcast website or subscribe to Fairly Competing on iTunes.

Episode 4 is coming next week.

Listen to this episode

A Brief Commentary on Illinois' Proposed Noncompete Agreement Act

As readers of this blog may know, a few years ago I drafted Illinois' proposed Covenants Not to Compete Act.

Several legislators had determined, at that time, that a bill was necessary to regulate the use and enforcement of employment-based non-competes. One of the primary drivers of that legislation was the perception that employees should have advanced notice of covenants before starting work, and that broad non-competes should not be enforced against employees discharged without cause. I don't believe it was a reflection of my drafting efforts, but the legislation didn't advance very far.

Fast-forward to 2013, and Rep. Thomas Morrison has introduced HB 2782 (text below), the Employment Noncompete Agreement Act, which I was not involved with. The bill is generally more employer-friendly in some respects, but it also would fail to protect companies in others.

The highlights:

(1) The bill would provide that "all employers" have vested interests in protecting their client bases through the use of non-compete agreements.

(2) Noncompetes would be valid if they meet three general criteria: (a) the contract must be in writing signed by both parties; (b) it may limit the solictation of an employer's existing customers, "identified prospective customers", or employees during the term; and (c) it must be time-limited between 6 and 18 months, depending on the annualized compensation the employee earns before termination.

(3) The bill would entitle a prevailing party to attorneys' fees and expenses, and it would require a subsequent employer to honor the agreement.

(4) The bill would apply to agreements entered into on or after its effective date.

My thoughts:

(1) By implication, it seems the bill would ban general non-compete arrangements, along the lines of the California statute or the proposed Minnesota bill. The interesting twist is that HB 2782 is written in reverse - it defines what's permitted, not what's banned.

(2) I've written before that true non-competes serve as an intellectual property protection device and a prophylactic means to avoid the potential disclosure of trade secrets. A non-compete, therefore, is more suitable for technical employees, product developers, those with highly unique skill-sets, and high-level management, while a non-solicitation covenant (the type of agreement HB 2782 would allow) are really more appropriate for sales employees.

(3) The bill does not differentiate between employees who are terminated and those who voluntarily leave their employment. Nor does it govern non-competes contained in independent contractor arrangements, partnership or LLC agreements, or a sale-of-business contract.

(4) Passage of the bill could discourage companies from auditing or updating their agreements. Contracts that were signed before passage would be governed under the common law rules set forth in Reliable Fire Equipment Co. v. Arredondo. Employers who have broader non-competes would be less inclined to amend those agreements, because any new contract would be subject to new rules.

(5) Courts would have to apply different rules for employees depending on when their contracts were signed. This could cause some judges to interpret the common-law, or apply it to a given set of facts, in a way that is consistent with the language of the new legislation. It's generally not good for similarly situated employees to have different outcomes in litigation, all other things being equal.

(6) The legislation removes a powerful argument in an employee's arsenal - that a covenant does not protect a legitimate business interest. You see employees advance this argument by claiming customers are fluid, switch companies with relative ease, or can be ascertained through public sources. Though not entirely clear, this bill would foreclose that inquiry and focus only the terms of the agreement - something that a few Illinois courts moved towards before Reliable Fire case reversed that trend. I am one who firmly believes that while the legitimate business interest inquiry is a strong tool for employees to use in defense, it often results in more expensive litigation. In that regard, the increased fees associated with litigating the issue hinder settlement talks and prolongs the suit.

HB 2782 - Employment Noncompete Agreement Act by

Minnesota Legislation Would Ban Most Non-Competes

About a month ago, a proposed bill was introduced in the Minnesota House of Representatives that would dramatically impact non-compete law in that state.

H.F. No. 506 would take effect immediately and ban a contract that prohibits a party "from exercising a lawful, profession, trade, or business" except in three circumstances:

(1) A seller of goodwill could agree to refrain from competing with the buyer in a specified territory as long as the buyer carries on a like business in the same area;

(2) Partners "dissolving a partnership" can agree not to compete in areas where the partnership conducted business; and

(3) Members of a limited liability company can agree not to compete following dissolution or termination of their membership interest.

The bill is very similar to legislation that already exists in Montana and California. In both of those states, true non-compete agreements are invalid. The difference in those states, however, concerns non-solicitation covenants, which limit, but do not bar, competition.

A narrowly constructed non-solicitation covenant will be upheld in Montana, but not California. Should this bill pass, Minnesota courts would have to choose which path to take. A true textual interpretation of a bill like this would allow for limited, activity restraints that prohibit solicitation of certain customers or employees, because those covenants do not prevent anyone from exercising a trade. California courts have gone a step further, as readers of this blog well know, and interpreted a statute worded very similar to this to ban any type of non-solicitation covenant.

I have doubts this bill will go anywhere. Minnesota has a number of companies in the medical device and imaging fields that likely would lobby hard against this bill. Those companies have enforced non-compete agreements successfully in the past, and there's a fairly robust body of cases that serve as powerful precedent in those industries. Depending on what other forces push a bill like this, that's going to be a pretty tough lobby to shake.

The text of H.F. No. 506 can be found here.

Trade Secrets Injunction Order Demonstrates Difficulty of Balancing Competing Interests

One of the more difficult aspects of trade secrets law is determining how long to enjoin competitive conduct that infringes trade secret rights of the owner.

Consider one of the landmark trade secrets cases of the last 20 years, PepsiCo v. Redmond. In that case, PepsiCo was able to enjoin the work of a high-level executive who had no non-compete agreement, but whose subsequent employment with a competitor threatened to result in the disclosure of a wide range of strategic business information. Despite the broad protection afforded PepsiCo in the case, the injunction was limited in duration; it lasted a mere 5 1/2 months. That is the most overlooked part of the PepsiCo decision.

This arguably illustrates the importance non-compete agreements play as a procedural device to pre-determine the length that trade secrets will be protected from disclosure. Some rightly note that this could result in the overprotection of trade secrets, but the common law rule of reasonableness serves as a deterrent to non-competes of excessive duration. And when companies overprotect, they often lose enforcement actions.

A district court order from Nebraska, well-reasoned and thorough, is another good example of a PepsiCo-like injunction issued in the absence of a non-compete. The case follows a familiar factual matrix, as a number of employees of a freight brokerage organization called West Plains, LLC left to form a competing organization. The departure effectively gutted West Plains and left it with little manpower to service clients. The aggravating circumstance for West Plains was pretty clear from the order. The competitor was formed by the owner of a freight brokerage West Plains had bought just months earlier. The employees left to join him and took with them a wide range of customer-oriented documents, such as contact information and a spreadsheet of freight hauling rates. The evidence of improper pre-termination conduct was compelling.

Having concluded the information likely constituted trade secrets of West Plains (it could be redeveloped, but only through significant, time-intensive efforts), the court struggled with the length of injunctive relief. It ultimately concluded that a preliminary injunction of two months was sufficient to enable West Plains to hire a replacement staff and "meet its customers' needs on an even playing field." It also felt this two-month standstill period was appropriate to enable the defendants to develop information necessary to service customers from public sources.

The order was designed to protect trade secrets, and so it went beyond a garden-variety "use" prohibition and some obligation to return company data. It barred the defendants from contacting West Plains' customers with whom they dealt as West Plains employees. The trade secrets that were misappropriated were intimately tied to those customers. So any order, to be effective, had to limit customer contact and solicitation in some meaningful way.

The injunction order is included below.

West Plains v. Retzlaff Grain Co. - Injunction Order by Ken Vanko