The federal case of Instant Technology LLC v. DiFazio is somewhat of a rare breed in that the parties tried the case to the end. Most business disputes settle, frequently after an initial injunction hearing, and this generally holds true when the case arises from an acrimonious divorce (as was certainly the case with the key players in DiFazio).
I wrote last year on the case, primarily because the district court followed the Illinois Appellate Court's ruling in Fifield v. Premier Dealer Services, Inc. and invalidated several non-compete agreements on the grounds that the employees were not employed for the required two years to vest the contracts with consideration. (Remember, for at-will employees in Illinois, Fifield established the two-year rule if the sole consideration was the job itself.) On the facts in DiFazio, the case appeared to have some strengths for the plaintiffs, but like many non-compete disputes, the facts only get you so far. There's still the law to deal with, not to mention judicial distaste for these types of cases. Instant Technology had trouble during its bench trial on a number of fronts, including its presentation of damages.
Seeing that the case went up on appeal, I was interested to see what role the Fifield rule would play in the Seventh Circuit. Instant Technology's brief is now in.
Fifield appears to have taken a back seat, though that's not to say the Seventh Circuit won't issue some kind of analysis or statement about how the Supreme Court of Illinois might weigh in. The brief is long, but only a few pages mention Fifield. And the analysis seems intentionally thin. The reason could be that the employees who presented Instant Technology with a Fifield problem appear to be secondary players. Many appellate lawyers will abandon issues on appeal so that the reviewing court does not get too lost in a sea of issues.
Interestingly, Instant Technology shifted gears after losing its bench trial and hired a new law firm, Much Shelist, to represent it on appeal. That firm, ironically, represented the winning party in Fifield and helped create the two-year rule that now presents some problems for Instant Technology.
Instant Technology detoured around Fifield in an interesting way. Essentially, it argued the Supreme Court might use its overall "totality of the circumstances" to assess not only whether the covenant is reasonable, but also whether the contract has sufficient consideration. It gave an example from the facts of the case itself. One of the employees apparently had a prior stint with Instant Technology. In the employer's view, this prior employment should be a factor bearing on whether the new contract contains enough consideration.
I find it fairly unconvincing that a court would use the overall reasonableness test to assess the adequacy of consideration because it conflates two separate inquiries. The "totality of the circumstances" approach is a judicial check to weigh the contract terms with the asserted business interest. There's nothing from the Supreme Court's precedent that suggests it's meant to apply to an issue of contract formation. Furthermore, combining the consideration argument in the manner Instant Technology proposes would allow an enforcing party to use the same facts for multiple purposes. This is improper bootstrapping. Put another way, the facts that help an employer illustrate a protectable interest cannot also help it show the contract was formed properly.
Consideration should address what an employer gave up or what an employee gained by signing the contract. Fifield holds that the job itself only sometimes can be consideration because that job can be taken away. Take an example: if an employer agrees the employee only can be terminated for cause (with severance rights for a termination without cause) for a period of two years, then it's giving up a core element of the traditional at-will relationship. That's consideration. Determining whether the employee received access to customers or confidential information is not a consideration issue because it's tied intrinsically to whether the covenant terms are reasonable. Instant Technology's position would meld the two, and I think that's inappropriate.
I have said before that I am no great fan of Fifield, but I don't think we can fix it by creating more confusion in this area of the law.
Thursday, October 23, 2014
Thursday, October 16, 2014
Aleynikov Strikes Out in the Third Circuit
About a year ago, I wrote about Sergey Aleynikov's win against Goldman Sachs Group (at least as far as legal fees are concerned). The ex-Goldman computer programmer won an expedited summary judgment proceeding in New Jersey federal court on a claim for fee advancement. His advancement claim related to an ongoing state court criminal case arising out of his alleged theft of Goldman's computer source code, which was used to run its high-frequency trading operation.
"Advancement" is a fancy way of saying that a corporation, under some circumstances, agrees to front legal fees to an officer or director who is part of a proceeding related to his corporate service. Think of a shareholder derivative suit brought against individual directors, in which the claim is for breach of fiduciary duty arising from a proposed business sale. Those directors need assurances not only that the company will cover their expenses if they win but also that the company will pay fees as they're incurred. That's advancement.
Aleynikov's advancement claim against Goldman was somewhat (though only somewhat) unusual since he was in an adverse position to Goldman. After all, they have claimed Aleynikov stole source code with malicious intent. Actually, more than "claimed." His litigation journey (in several states, civil and criminal) is nothing short of remarkable. And for those interested in the non-Goldman side of this, read Michael Lewis' Vanity Fair piece which was published around the time Aleynikov scored his initial win on legal fees. Aleynikov's story inspired Lewis' fantastic new book Flash Boys, which explores the rise of high-frequency trading and the "Army of One" IEX dark pool exchange.
Aleynikov's victory in New Jersey was predicated upon the specific language of Goldman's bylaws, which provided advancement rights to its "officers." Unfortunately, the bylaws weren't terribly clear, and the district court had to contend with competing interpretations of who qualified as an "officer." Aleynikov won in no small part due to Goldman's own drafting problems. This normally is a fair trade. Ambiguities are construed against the drafter; no one even participates in drafting bylaws except the company so there's no apportioning of blame. Arms' length contracts they are not.
The Third Circuit, though, reversed the grant of summary judgment and held that a jury must sort this ambiguity out. That is, did Goldman really intend to include Aleynikov as an officer? It would seem that Goldman will have the upper hand on this question, particularly if Judge McNulty admits evidence of his underlying "offenses" against Goldman (which he shouldn't).
Without belaboring the reasoning, the circuit court effectively found Aleynikov could not benefit from the "no ambiguities" rule because the rule doesn't resolve whether a party has any rights to a contract in the first place. It's only intended to supplant a dispute over the extent of those rights.
The ruling is muddled, confusing, and leaves more questions than it answers. For one, it's not clear how a fact-finder is supposed to sort through this ambiguity. The case is almost uniquely unsuited to a jury's fact determination. Both Goldman and Aleynikov can offer self-serving testimony about what the intent of the provision should be. But that's likely a wash. There are no negotiations to fall back on, since bylaws are not negotiated.
The closest the Third Circuit could come to providing guidance is this bizarre passage: "...resort to extrinsic evidence regarding course of dealing and trade usage to resolve the ambiguity does not seem inappropriate even where Goldman unilaterally drafted the agreement." What this "course of dealing" possibly could be is anyone's guess. The clause "does not seem inappropriate" is hardly a ringing endorsement.
Corporations have great control over how to draft indemnification and advancement provisions. Allowing a case like this to proceed to trial not only undermines the advancement remedy (for it must be expedited to be worth anything) but it encourages poor drafting. It's hard to see how any individual officer or director ever could supply evidence of "course of dealing" to counter what a company would offer in terms of its drafting intent.
Aleynikov lost this one. But he shouldn't have.
"Advancement" is a fancy way of saying that a corporation, under some circumstances, agrees to front legal fees to an officer or director who is part of a proceeding related to his corporate service. Think of a shareholder derivative suit brought against individual directors, in which the claim is for breach of fiduciary duty arising from a proposed business sale. Those directors need assurances not only that the company will cover their expenses if they win but also that the company will pay fees as they're incurred. That's advancement.
Aleynikov's advancement claim against Goldman was somewhat (though only somewhat) unusual since he was in an adverse position to Goldman. After all, they have claimed Aleynikov stole source code with malicious intent. Actually, more than "claimed." His litigation journey (in several states, civil and criminal) is nothing short of remarkable. And for those interested in the non-Goldman side of this, read Michael Lewis' Vanity Fair piece which was published around the time Aleynikov scored his initial win on legal fees. Aleynikov's story inspired Lewis' fantastic new book Flash Boys, which explores the rise of high-frequency trading and the "Army of One" IEX dark pool exchange.
Aleynikov's victory in New Jersey was predicated upon the specific language of Goldman's bylaws, which provided advancement rights to its "officers." Unfortunately, the bylaws weren't terribly clear, and the district court had to contend with competing interpretations of who qualified as an "officer." Aleynikov won in no small part due to Goldman's own drafting problems. This normally is a fair trade. Ambiguities are construed against the drafter; no one even participates in drafting bylaws except the company so there's no apportioning of blame. Arms' length contracts they are not.
The Third Circuit, though, reversed the grant of summary judgment and held that a jury must sort this ambiguity out. That is, did Goldman really intend to include Aleynikov as an officer? It would seem that Goldman will have the upper hand on this question, particularly if Judge McNulty admits evidence of his underlying "offenses" against Goldman (which he shouldn't).
Without belaboring the reasoning, the circuit court effectively found Aleynikov could not benefit from the "no ambiguities" rule because the rule doesn't resolve whether a party has any rights to a contract in the first place. It's only intended to supplant a dispute over the extent of those rights.
The ruling is muddled, confusing, and leaves more questions than it answers. For one, it's not clear how a fact-finder is supposed to sort through this ambiguity. The case is almost uniquely unsuited to a jury's fact determination. Both Goldman and Aleynikov can offer self-serving testimony about what the intent of the provision should be. But that's likely a wash. There are no negotiations to fall back on, since bylaws are not negotiated.
The closest the Third Circuit could come to providing guidance is this bizarre passage: "...resort to extrinsic evidence regarding course of dealing and trade usage to resolve the ambiguity does not seem inappropriate even where Goldman unilaterally drafted the agreement." What this "course of dealing" possibly could be is anyone's guess. The clause "does not seem inappropriate" is hardly a ringing endorsement.
Corporations have great control over how to draft indemnification and advancement provisions. Allowing a case like this to proceed to trial not only undermines the advancement remedy (for it must be expedited to be worth anything) but it encourages poor drafting. It's hard to see how any individual officer or director ever could supply evidence of "course of dealing" to counter what a company would offer in terms of its drafting intent.
Aleynikov lost this one. But he shouldn't have.
Monday, October 13, 2014
My 500th Blog Post
The original title of this post was simply: "Thank you and goodbye."
I have a lot of other stuff I want to do. Write law journal articles. Perhaps start another blog. Do more pro bono work. Learn how to ski. Experiment with vegan cooking.
So ending this at number 500, nearly 6 years after I started, seemed like the right thing to do. And it seemed like the right time, as I just concluded a big trial with immensely satisfying results. (Read here for the news story.)
But I am not ready to let go just yet. So I've decided my readers are stuck with me for a little bit longer. It may be for another 100 posts. Maybe until the end of the year. Who knows? This blog is mine, and I get to decide when I've said all I wanted to say.
So for Number 500, I get to say some things that are on my mind. I'll keep it big and profound.
The Future of Non-Competes
I believe we're close to an inflection point. Having observed the proliferation of non-compete cases and non-compete contracts, I worry about fatigue. I am not "for" or "against" non-competes in the sense that many attorneys are. There are two sides to the difficult questions these contracts pose, and I recognize the arguments are compelling. And when I speak of "fatigue," I am concerned that courts are so accustomed now to these disputes that they view them with less urgency. In this respect, companies don't think through what they're trying to protect and how they're going about it. This is true of both large and small companies, though more so with small ones. Drafting errors abound, and it's somewhat disheartening to see a standard form used for employees with vastly different responsibilities. This, more than anything, causes judges to roll their eyes.
In terms of the inflection point I see on the horizon, I believe the law may be pivoting towards a closer analysis of consideration for at-will employees. Those of us in Illinois can blame the Fifield decision for helping spur this on, but perhaps it's not a bad debate to have. Corporate counsel need to start thinking carefully about the overall structure of non-compete arrangements, and how the issue of consideration might look in an enforcement action. Merely invoking "continued employment" may not be good enough as courts continue to scrutinize enforceability. I personally believe that employers will have to start providing truly meaningful consideration to obtain non-compete agreements. Though consideration costs money, the more thoughtful use of consideration may actually eliminate disputes, as employees will be less apt to challenge the contract on enforceability grounds.
Trade Secrets and the Federal Question
The question of whether we will have a federal trade secrets statute is the hot topic for me and other nerds in my industry. It's truly a debate only a lawyer could love. I believe we'll get some federal legislation in the near future, and the difference between the House and Senate trade secret bills is not significant enough to comment on further. If we get a very watered down bill passed, then perhaps many trade secrets claims will remain in the state courts.
Trade secrets law historically has been the domain of state courts, and I'm somewhat concerned about removing this wholesale (in effect) to federal court. As a practical matter, though, a sizable number of these cases are ending up in federal court anyway under either diversity jurisdiction or as part of a computer fraud case.
Expanding trade secrets law into a federal claim, though, in effect will dump most non-compete cases into federal court, too, since the two theories often go hand-in-hand and the non-compete actions will be part of a federal court's supplemental jurisdiction.
Federal courts may be better equipped, particularly with good magistrates, to handle the increasingly complex discovery issues that trade secrets cases present. Most state courts don't have the resources to manage fast-moving discovery fights or block out time for emergency injunction hearings. Federal courts are busy, but they have the capacity to handle difficult trade secrets cases better than state courts.
Blogging
The amount of blogs on the subject of non-compete and trade secret law really has exploded. I am not sure how I feel about this. This probably is related to the vast interest in this area of the law, the number of interesting topics on which to write, and the fact lawyers seem now to understand the impact blogging can have.
I started this blog in 2008, so I'm a relative veteran but I now find my voice is fairly diluted. Most bloggers end up quitting fairly quickly; others run out of things to say; and for still others, the demands of the job simply cause the blog to get shifted down the priority list. At times, I worry about falling in the last category. I don't ever want this blog simply to be exclusively a sort-of law school case analysis, where I simply talk about a decision. I'd rather comment on the practical impact of disputes, how issues affect clients, and important developments.
I think blogging for lawyers, in this area or otherwise, is definitely here to stay. This is still a great tool for lawyers and, more importantly, for clients to learn the basics of the law without paying legal fees.That's why I will, in the relatively near future, post my last entry here and start a blog. I may start a new blog, because I love to write. I just don't want this site to retread old ground and say things I've already said.
Lawyers
Finding a non-compete specialist is not necessarily that critical for clients. In my opinion, the qualities that make a good attorney by and large carry over to those who represent individuals or companies in competition suits. I do believe that in this area of the law an attorney who writes well is essential. Having someone who is a good trial attorney and presents will in court is crucial, but because many injunctions are decided on the paper, clients need to have counsel who write clearly and understandably.
Also, lawyers have to develop a deeper understanding of the business that is the subject of the dispute. Unlike many areas of the law, competition suits require that the lawyer have a thorough knowledge of the industry and how the pertinent facts fit into the competitive landscape. I frequently see lawyers fumble around with terminology or key business concepts that tend to diminish their credibility. Unfortunately for clients, it does cost a bit more for the attorney to feel as though he or she is sufficiently knowledgeable about the industry as a whole to represent well in court.
Judges
This is an area of the law that continues to divide judges, state and federal alike. Many judges have visceral feelings about enforcing non-competes. This is part of the reason so many non-compete suits settle relatively soon after they start. The lawyers often appear in court quickly after the case is on file, and they then have an excellent opportunity to gauge the judge's reaction to the merits. Contrast a typical Title VII case where a judge may not have an opportunity to assess the merits for 2 years from the filing date.
So a judge's perception of the merits may be colored by where he or she falls on the policy continuum: freedom to compete vs. freedom of contract. Unquestionably, though, the judge will look to whether one of these three crucial factors is at play: (1) the misuse of confidential data or trade secrets; (2) whether there is some bad-faith activity by the employee during the exit process (such as diverting business or parking new clients on the sideline); or (3) the presence of direct solicitation of valuable accounts post-termination in violation of a contract provision.
When one of these facts is in the lawsuit, the defense will have a tougher time prevailing. When all three are absent, the plaintiff is going to face an uphill battle explaining what the injury is and how it is damaged.
Thank You
For those of you who continue to read, thank you. Keeping this blog fresh and full of new content after 6 years and 500 posts is a lot of work but a rewarding challenge. If you have any suggestions or comments, I always invite feedback. Feel free to e-mail me directly at vanko@ccmlawyer.com.
I have a lot of other stuff I want to do. Write law journal articles. Perhaps start another blog. Do more pro bono work. Learn how to ski. Experiment with vegan cooking.
So ending this at number 500, nearly 6 years after I started, seemed like the right thing to do. And it seemed like the right time, as I just concluded a big trial with immensely satisfying results. (Read here for the news story.)
But I am not ready to let go just yet. So I've decided my readers are stuck with me for a little bit longer. It may be for another 100 posts. Maybe until the end of the year. Who knows? This blog is mine, and I get to decide when I've said all I wanted to say.
So for Number 500, I get to say some things that are on my mind. I'll keep it big and profound.
The Future of Non-Competes
I believe we're close to an inflection point. Having observed the proliferation of non-compete cases and non-compete contracts, I worry about fatigue. I am not "for" or "against" non-competes in the sense that many attorneys are. There are two sides to the difficult questions these contracts pose, and I recognize the arguments are compelling. And when I speak of "fatigue," I am concerned that courts are so accustomed now to these disputes that they view them with less urgency. In this respect, companies don't think through what they're trying to protect and how they're going about it. This is true of both large and small companies, though more so with small ones. Drafting errors abound, and it's somewhat disheartening to see a standard form used for employees with vastly different responsibilities. This, more than anything, causes judges to roll their eyes.
In terms of the inflection point I see on the horizon, I believe the law may be pivoting towards a closer analysis of consideration for at-will employees. Those of us in Illinois can blame the Fifield decision for helping spur this on, but perhaps it's not a bad debate to have. Corporate counsel need to start thinking carefully about the overall structure of non-compete arrangements, and how the issue of consideration might look in an enforcement action. Merely invoking "continued employment" may not be good enough as courts continue to scrutinize enforceability. I personally believe that employers will have to start providing truly meaningful consideration to obtain non-compete agreements. Though consideration costs money, the more thoughtful use of consideration may actually eliminate disputes, as employees will be less apt to challenge the contract on enforceability grounds.
Trade Secrets and the Federal Question
The question of whether we will have a federal trade secrets statute is the hot topic for me and other nerds in my industry. It's truly a debate only a lawyer could love. I believe we'll get some federal legislation in the near future, and the difference between the House and Senate trade secret bills is not significant enough to comment on further. If we get a very watered down bill passed, then perhaps many trade secrets claims will remain in the state courts.
Trade secrets law historically has been the domain of state courts, and I'm somewhat concerned about removing this wholesale (in effect) to federal court. As a practical matter, though, a sizable number of these cases are ending up in federal court anyway under either diversity jurisdiction or as part of a computer fraud case.
Expanding trade secrets law into a federal claim, though, in effect will dump most non-compete cases into federal court, too, since the two theories often go hand-in-hand and the non-compete actions will be part of a federal court's supplemental jurisdiction.
Federal courts may be better equipped, particularly with good magistrates, to handle the increasingly complex discovery issues that trade secrets cases present. Most state courts don't have the resources to manage fast-moving discovery fights or block out time for emergency injunction hearings. Federal courts are busy, but they have the capacity to handle difficult trade secrets cases better than state courts.
Blogging
The amount of blogs on the subject of non-compete and trade secret law really has exploded. I am not sure how I feel about this. This probably is related to the vast interest in this area of the law, the number of interesting topics on which to write, and the fact lawyers seem now to understand the impact blogging can have.
I started this blog in 2008, so I'm a relative veteran but I now find my voice is fairly diluted. Most bloggers end up quitting fairly quickly; others run out of things to say; and for still others, the demands of the job simply cause the blog to get shifted down the priority list. At times, I worry about falling in the last category. I don't ever want this blog simply to be exclusively a sort-of law school case analysis, where I simply talk about a decision. I'd rather comment on the practical impact of disputes, how issues affect clients, and important developments.
I think blogging for lawyers, in this area or otherwise, is definitely here to stay. This is still a great tool for lawyers and, more importantly, for clients to learn the basics of the law without paying legal fees.That's why I will, in the relatively near future, post my last entry here and start a blog. I may start a new blog, because I love to write. I just don't want this site to retread old ground and say things I've already said.
Lawyers
Finding a non-compete specialist is not necessarily that critical for clients. In my opinion, the qualities that make a good attorney by and large carry over to those who represent individuals or companies in competition suits. I do believe that in this area of the law an attorney who writes well is essential. Having someone who is a good trial attorney and presents will in court is crucial, but because many injunctions are decided on the paper, clients need to have counsel who write clearly and understandably.
Also, lawyers have to develop a deeper understanding of the business that is the subject of the dispute. Unlike many areas of the law, competition suits require that the lawyer have a thorough knowledge of the industry and how the pertinent facts fit into the competitive landscape. I frequently see lawyers fumble around with terminology or key business concepts that tend to diminish their credibility. Unfortunately for clients, it does cost a bit more for the attorney to feel as though he or she is sufficiently knowledgeable about the industry as a whole to represent well in court.
Judges
This is an area of the law that continues to divide judges, state and federal alike. Many judges have visceral feelings about enforcing non-competes. This is part of the reason so many non-compete suits settle relatively soon after they start. The lawyers often appear in court quickly after the case is on file, and they then have an excellent opportunity to gauge the judge's reaction to the merits. Contrast a typical Title VII case where a judge may not have an opportunity to assess the merits for 2 years from the filing date.
So a judge's perception of the merits may be colored by where he or she falls on the policy continuum: freedom to compete vs. freedom of contract. Unquestionably, though, the judge will look to whether one of these three crucial factors is at play: (1) the misuse of confidential data or trade secrets; (2) whether there is some bad-faith activity by the employee during the exit process (such as diverting business or parking new clients on the sideline); or (3) the presence of direct solicitation of valuable accounts post-termination in violation of a contract provision.
When one of these facts is in the lawsuit, the defense will have a tougher time prevailing. When all three are absent, the plaintiff is going to face an uphill battle explaining what the injury is and how it is damaged.
Thank You
For those of you who continue to read, thank you. Keeping this blog fresh and full of new content after 6 years and 500 posts is a lot of work but a rewarding challenge. If you have any suggestions or comments, I always invite feedback. Feel free to e-mail me directly at vanko@ccmlawyer.com.
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