The Yardstick Method and Non-Compete Damages

One of the most difficult tasks for a plaintiff in non-compete litigation is the need to focus on a remedy. I was reading an interview Judge Richard Posner gave to Stout Risius Ross recently concerning patent litigation, and some of his comments and criticisms about that type of suit ring true with respect to non-compete and trade secrets claims.

Judge Posner was highly critical of the plaintiff's bar for its laser-like focus on establishing liability. He said - and I agree wholeheartedly - that when it comes time to assessing the viability of a remedy, the plaintiff tends to lose steam. Normally, this isn't much of a problem at the injunction phase. My experience is that plaintiff's counsel generally has a decent handle on what it wants for interim, injunctive relief.

The problem is the next step.

Several years ago, I wrote a law journal article emphasizing the need for businesses to consider using liquidated damages clauses in non-compete agreements for this very reason. I tend to think most lawyers do a really bad job at figuring out damages issues. There are two main factors at force here. For starters, an increasing number of lawyers have very little business or economics background. They're more comfortable proving historical facts - did X solicit the business from Y? - than they are modeling an economic picture of lost profits that has even a basic degree of smarts behind it. And just as important, lost profits require effort - real effort, not just poring over documents. Just deriving a theory can be a tough task to undertake.

There are a number of different methodologies for proving lost profits. Say a non-compete defendant has undoubtedly competed and taken business away. Even if a plaintiff sustains a claim for injunctive relief, that may not be enough to mollify his or her client. There's real economic loss. But how to prove it, that's the challenge.

Modeling is complex stuff, and even settling on an accepted method only solves part of the problem. Take the "yardstick" method of showing lost profits. This method, widely approved and used in
antitrust cases (overall a good analogy for non-compete claims), measures the plaintiff's financial performance against a substantially similar business (this comparator being the "yardstick"). Based on that comparison, the plaintiff should be able to draw inferences about how its business would have performed but for the contract breach (the use of a customer list, diversion of clients, and the like).

But gauging the appropriate yardstick - in essence, data sampling - is the trick. Suppose the defendant raids a branch office of the plaintiff. It takes its top three sales employees, steals the customer list associated with that branch office, and causes widespread disruption in the branch's ability to operate day-to-day. The yardstick approach may be a viable candidate to model damages as long as the plaintiff can find a comparison point. But the plaintiff has a lot of work to do to select the right yardstick.

What can go wrong? Several factors. Assume the plaintiff chooses to pick the financial performance of one of its other branch offices that wasn't raided. Presumably it will pick one that is doing very well. The selected yardstick may not be comparable or provide a reliable indicator of damages. The experience of its employees may be different. The yardstick location may have a super-competent branch manager. It may operate in a geographic location with different organic growth levels. The yardstick location may face a lower level of competition.

The plaintiff would have to run a very intense analysis to show how the comparable location is truly similar in most material respects to the one impacted by the unfair competition. This is no easy task and requires the plaintiff to tease out a lot of factors that may cause it to present an inaccurate, unreliable financial picture during a damages presentation.

My personal preference is to avoid the yardstick method in most non-compete cases. I think that it has some applicability as long as you can draw a reliable comparison, but it is very easy for a defendant to question the data assumptions and point to other yardsticks that may be more appropriate. On that score, it tends to make discovery very expensive.

When Do I Have to Turn Over My Devices?

Defendants in competition cases quickly realize that the discovery battlefield often sits in the land of electronic information. Devices such as smart-phones, laptops, tablets, thumb drives, and cloud storage programs potentially contain relevant information that may bear upon both liability and damages issues. Many times in these types of disputes, an employee's retention of actual paper is minimal, so that discovery may not appear at first blush to be that much of a burden on the employee and its counsel.

However, when an employer requests access to devices, the landscape changes. Employers - often rightly so - are suspicious that an employee has kept information electronically and may not have the digital footprint to track data to a particular device. An employee often reacts viscerally and may be surprised that such a request is even proper.

So under what circumstances will courts order the inspection of devices?

There are some important groundrules and principles to consider. Let's start with the basics, which tend to favor (at least initially) an employee's resistance to turning over devices for inspection:

(1) Many courts find that imaging and production of devices is an exercise that should be undertaken sparingly.

(2) Courts will deny requests for inspections where the request is too broad.

(3) If the employer does not make a connection between the device and the factual underpinning of the claim, then a court will be hesitant to order imaging of the device and inspection.

(4) Courts will frequently put in place protocols to ensure an employee's personal records are kept private and not otherwise exposed (for instance, to protect disclosure of personal photos, financial information, or tax records).

(5) Absent bad faith, employers bear the cost of the imaging.

So with that general landscape in mind, under what circumstances will a court likely order some production of devices for inspection?

(1) There is specific evidence tying a misappropriation of records to the particular device. An employer may, for instance, learn through an examination of a work computer that an employee inserted an external hard-drive the day she left. This would likely justify an inspection of the device by a third-party expert.

(2) An employee has destroyed information in violation of a court order or a duty to preserve evidence. For instance, if an employee admits tossing out a stolen customer list after receiving a summons, a court likely won't have much sympathy for any objection to a device inspection request. The Court would seem to have the inherent authority to order the inspection to see if other vestiges of the list remain somewhere.

(3) An employee's document production has been inadequate. If an employee obfuscates during discovery, then an employer legitimately could claim that the only way to ensure a complete production is to inspect devices to see if the employee has sent information elsewhere that he has failed to account for.

Having considered these general principles, what are the best practices for an employer to obtain an inspection of devices?

(1) Try to learn specific facts tying the claim to a device.

(2) Propose a fair, even-handed protocol for inspection that accounts for an employee's privacy concerns. Attach a draft protocol and order to a motion seeking such an inspection.

(3) Follow the discovery rules. A request for inspection is nothing more than a discovery request. Don't short-circuit the process by filing a motion. Understand - and follow - procedures for resolving discovery disputes (including meet-and-confer efforts with opposing counsel).

(4) Keep the request narrow. Don't ask for all devices kept within the employee's control or possession. A court won't order the production of a 12 year-old's iPod.

(5) Learn other facts first. Often times, the best approach is to take an employee's deposition first to lock him or her into testimony about how a particular device may have been used or what it may contain. At that point, the employer will be on stronger factual footing to request an inspection with specific admissions and testimony backing up the reasonableness of the request.

Trade Secrets, Litigation Funding, and the Fall of Champtery

The rise of third-party litigation funding presents a quandary of legal, ethical, and economic issues, which commentators have tried to sort through for many years. With the importance of trade secrets to many businesses, it's no surprise that this facet of intellectual property litigation has drawn the interest of litigation financiers.

Yet, despite this reality, very few courts have had the opportunity to examine the legal issues that come into play when a third-party funds a trade secrets plaintiff. One of the more high-profile Chicago-area trade secrets cases, however, deals with this new paradigm. The case is Miller UK v. Caterpillar, Inc. - now several years old. It is a typical business-to-business trade secret case, which features a dispute arising from the fracturing of a long-term business relationship when Caterpillar allegedly began offering a product derived from Miller's confidential information. Most non-employment trade secrets cases feature some variation on this fact pattern.

It turns out Miller had concerns about its capability - financially, that is - to litigate against Caterpillar. And, as everyone knows, trade secrets litigation ain't cheap.

Enter the funding company. Caterpillar cried foul. And a discovery dispute arose, raising significant issues that likely will arise time and again. Are discovery disputes interesting? Not really, but this one worked its way in to the Wall Street Journal a few weeks ago.

The dispute presented two significant legal questions that I feel are important to address (many others seemed secondary and aren't worth commenting on).

First, do litigation funding agreements violate laws against champtery? Those ancient statutes generally bar third-parties from stirring up lawsuits by helping others to promote litigation in an officious manner.

The Miller court answered that question with an emphatic "no." In a lengthy opinion by Magistrate Jeffrey Cole (somewhat renowned for his lengthy, well-cited opinions), the court held that Caterpillar couldn't obtain the litigation funding agreements between Miller and its litigation sugar-daddy because they weren't relevant. In particular, those documents couldn't help Caterpillar establish any sort of defense or counterclaim, since the champtery statutes did not apply to litigation funding arrangements.

Second, the attorney-client privilege does not protect documents that the trade secrets plaintiff and its counsel share with the actual or potential funders. Since the privilege does not extend to business arrangements, a plaintiff cannot cloak communications with the privilege even if they somehow relate to the litigation process.

Importantly, this does not preclude a trade secrets plaintiff from precluding disclosure of information under the work-product privilege, which may offer greater protection. Disclosure of mental impressions, internal memos and the like to a third-party does not destroy the privilege, and in Miller's case it at least was able to show that it took some steps to guard against disclosure of its counsel's case memos even though potential funders received them.

Magistrate Judge Cole's opinion is embedded below.

Miller UK v. Caterpillar - Opinion on Litigation Funding (00189411xAF516)