Supreme Court of Nevada Rejects Blue-Pencil Doctrine

Non-compete law continues to evolve at the state level, both in terms of targeted legislation and judicial refinement of common-law principles. For the most part, the decided trend is for lawmakers and judges to pare back the use of broad non-competes and to make specific public-policy based exceptions (or create categorical limits), as in the case of covenants impacting emerging technology workers and health-care providers.

I have often remarked, both here and in presentations to colleagues, that if we're going to get serious about the proper use of non-compete agreements then we ought to hone in on two very specific concepts: ensuring the adequacy of consideration (preferably at the outset of a lawsuit) and discarding the notion that courts should be reforming overbroad contracts that are carelessly and gratuitously written.

This month, the Supreme Court of Nevada rejected the blue-pencil doctrine and held that courts may not rewrite a non-compete agreement to make it reasonable. The case is Golden Road Motor Inn, Inc. v. Islam, 132 Nev. Adv. Rep. 49 (a link to the docket page is available here). Briefly stated, the case involved a casino manager who signed a one-year, post-termination covenant (apparently well after she started working for Atlantis Casino Resort) that broadly prohibited her from working in any gaming business within 150 miles of her employer. The effect of the restriction rendered her unemployable in Nevada's largest casino market.

The Court, in a 4-3 opinion, rejected the blue-pencil doctrine as inconsistent with Nevada law on reformation of contracts. In a passage that is sure to be cited in future cases, the majority rejected the dissent's endorsement of the blue-pencil rule where appropriate and said:

"Our exercise of judicial restraint when confronted with the urge to pick up the pencil is sound public policy. Restraint avoids the possibility of trampling the parties' contractual intent...Even assuming only minimal infringement on the parties' intent, as the dissent suggests, a trespass at all is indefensible, as our use of the pencil should not lead us to the place of drafting. Our place is in interpreting. Moreover, although the transgression may be minimal here, setting a precedent that establishes the judiciary's willingness to partake in drafting would simply be inappropriate public policy as it conflicts with the impartiality that is required of the bench, irrespective of some jurisdictions' willingness to overreach."

Apart from these public policy principles, the Court defaulted its legal analysis to general principles on contract reformation. Generally, courts can reform contracts if one shows mutual mistake by clear and convincing evidence. That is an awfully tough showing, reserved for cases where a writing does not reflect what the parties intended. The blue-pencil rule has nothing to do with conforming a contract to the parties' mutually-held intent, but rather fashions a judicial rewrite of an agreement after-the-fact under the guise of fairness.

The Court then parsed reformation further, focusing on procedure. That discussion is crucial for lawyers to understand. What the Court in Golden Road Motor Inn was saying is that courts often reform or blue-pencil non-competes in the context of awarding preliminary injunctions. It didn't endorse that approach, to be sure. But once a case reaches final judgment on the merits, the employer must demonstrate the agreement is reasonable on its face and not plead for judicial reformation.

It is interesting to see the Court make this nuanced distinction. The thinking apparently is that an injunction is in fact equitable in nature and courts have the ability to fashion appropriate relief at an emergency hearing, subject of course to the possibility that the court later may find the agreement is unreasonable. But at a preliminary stage, a court does not make ultimate fact determinations and so is not ruling definitively on enforceability. Conceivably, a court could say it is likely the agreement is reasonable but that the injunction requested seeks too much. Therefore, we'll just blue-pencil for now.

That may be what happens in practice, but I don't think so. To be certain, the cases don't read this way. And therein lies the problem. The blue-pencil rule has become a crutch, used to deter fair competition and used to bless poor drafting and (in many cases) an intent to restrain trade for no valid reason.

On this score, the Golden Road Motor Inn dissent's argument that the blue-pencil rule "also favors the employee by appropriately limiting the restriction" is pure nonsense. My experience is that employees sure as hell don't feel that way. The next employee who comes into my office and is excited by an overbroad agreement and the potential for judicial modification (after expensive litigation) will be the first.

Does Nosal II Solve "Without Authorization" Question?

The trade-secrets community has awaited the follow-up decision to the long-running prosecution of former Korn/Ferry executive, David Nosal, based in part on the controversial Computer Fraud and Abuse Act. And with the Ninth Circuit's decision on July 5 in United States v. Nosal, the question remains whether we have answered any questions about the CFAA's potential reach.

Nosal I, a 2012 decision, was largely pro-employee and restricted the scope of the CFAA's most controversial provision - the so-called "exceeds authorized access" prong of Section 1030(a)(4). As a result of Nosal I, the consensus seems to be building that violations of use policies do not mean that a user exceeding his authorized access of a protected computer. In other words, it is not sufficient to base an (a)(4) claim on misuse.

But Nosal I did not address the other part of (a)(4). One cannot obtain anything of value out of a protected computer if he accesses a protected computer "without authorization." And that's where Nosal II squarely lands. The Ninth Circuit upheld Nosal's conviction on multiple CFAA claims under this aspect of (a)(4) under a fact paradigm that is well-known to trade-secret practitioners. Nosal and two ex-employees of Korn/Ferry obtained the password of a then-current Korn/Ferry employee to access a database containing valuable information on executive search candidates.

Was that access "without authorization" under (a)(4)? Yes, said a divided panel of the Ninth Circuit.

The case predictably has produced a lot of commentary, but the most essential read is Orin Kerr's lengthy analysis. The crux of the case hinged on whether it mattered that the current employee gave Nosal's co-conspirators the database password. The majority felt it crucial that Korn/Ferry said that the employee could not disseminate log-in credentials, while the dissenting judge examined whether the employee said yes when her former co-workers asked for the password.

I agree with Professor Kerr that the court reached the right result and that Nosal's accomplice liability conviction was appropriate. But as I read the dueling analyses before Kerr's cogent summary, it was quickly apparent that the case had the chance to be an extremely limited one. For starters, the case doesn't really seem to establish a rule for future application. As Judge Reinhardt notes in dissent, the holding seems to rely heavily on employment-related facts but the CFAA is not an employment law at all.

Professor Kerr then offers his take on where the case should have gone analytically and how the court could have bridged the two opinions. His take is that the  password sharing in the context of the "without authorization" standard really should have embraced an "agency/non-agency" distinction. In other words, because Nosal's co-conspirators used the current employee's password for their own purposes, there was no agency relationship among them. Kerr's argument looks principally to the initial delegation of authority (in Nosal II, that would be the computer access granted from employer to employee) and then to the subsequent conduct and whether it's outside the agency of the initial account holder. This, Kerr argues, would solve the "parade of horribles" laid out by the dissent, which extrapolate innocuous conduct into federal crimes. And in Nosal II itself, it would establish why the employee's grant of her log-in credentials to the ex-employees was "without authorization" - they couldn't have had an agency relationship at that point.

The CFAA, of course, remains a controversial law. Its use in garden-variety employment disputes may be waning in light of the federal Defend Trade Secrets Act. But it is still a potent weapon. What is notable about the plight of David Nosal is that it's not all that far removed from many fact patterns we see in civil cases. The conduct at issue was brazen, to be sure. Still, it seems awfully arbitrary that he has endured criminal prosecution for conduct that many others like him never would face. And on that score, the dissenting opinion's cautionary tale about the influence that Korn/Ferry's firm was able to muster is worth a read in its own right.

New Legislation in Connecticut and Massachusetts Serves to Limit Non-Compete Enforcement

For non-competes, courts and legislatures often have taken incremental steps to chip away at the default reasonableness test. These steps usually are in response to some larger public-policy issue. Two more states are moving to reform the law of non-competes, and both are attempting to curtail their use.

Connecticut is the first, and it has enacted legislation (Public Act No. 16-95) that limits the enforceability of physician non-competes. For any non-compete "entered into, amended, extended or renewed on or after July 1, 2016," the new Connecticut law establishes bright-line enforceability rules. In particular, a non-compete may not exceed one year in duration (presumably post-employment, though the law oddly does not say this) and may not extend beyond a 15-mile radius from where the physician primarily practices (I am simplifying here a bit). Further, an employer may not enforce a non-compete if the physician is terminated without cause.

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Massachusetts law has not been changed, at least as of yet. But the long-in-the-works legislative changes appear to be gaining steam. Last week, the Massachusetts House of Representatives unanimously passed a bill to impose stringent limits on non-compete agreements and to adopt (at long last) the Uniform Trade Secrets Act. House Bill 4434 accomplishes several things:

(1) The UTSA piece is unremarkable, but it does require the identification of the subject trade secret "with sufficient particularly under the circumstances of the case" before beginning discovery. This is a legislative endorsement of what many courts already require, but it contains needed flexibility that enables a court to establish discovery parameters.

(2) The bill also would establish the Massachusetts Noncompetition Agreement Act, which would require:

• At least 10 days' advance notice of the non-compete;
• For existing employees, independent "fair and reasonable" consideration independent from the continuation of employment (along with 10 days' advance notice);
• A maximum 1-year duration (except in cases of breach of fiduciary duty or theft, in which case the maximum may be 2 years);
• A reasonable geographic reach, which is presumptively established if the restricted area is consonant with the employee's sphere of influence within the last 2 years of employment;
• Garden-leave payment of at least 50 percent of the employee's highest base salary within the 2 years preceding termination or other "mutually-agreed upon consideration" (which is undefined.

Finally the proposed Act would bar enforcement if an employee is terminated without cause and would ban non-competes for non-exempt workers under the Fair Labor Standards Act.

There are some definite quirks in the proposed Massachusetts law, which is to be expected after the long slog this bill has been through. The next step would appear to be a vote in the state senate.

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UPDATE (at July 12, 2016):

Apparently, my post was timely. The Massachusetts Senate has acted. I defer to Russell Beck's excellent summary. The Boston Globe article can be found here.

Trade Secret Specificity and Inevitable Disclosure

For good reason, the "inevitable disclosure" doctrine has been the focus of much discussion among those in the nerd blogosphere (that's a term of endearment, for I am a charter member and wear the nerd label proudly).

The reason is that the Defend Trade Secrets Act, recently enacted by Congress, disapproves of the doctrine. In truth, so do many states and the doctrine itself always was meant to apply to a very narrow slice of trade-secrets cases. To be sure, the doctrine nominally was available to a discrete subset of injunction cases where the plaintiff had some indicia of bad faith that stopped short of an outright threat to steal.

Like many facets of the law, this narrow carve-out turned into a sledgehammer for reasons that are not particularly altruistic. The very use of the inevitable disclosure theory ought to raise judicial hackles, for it surely can be a weapon improperly deployed and not easily disabled.

Which got me thinkin'...

Assume a plaintiff decides to embark on the inevitable disclosure path (and therefore eschews the DTSA as a means of recovery). How does this fit within another secondary trade secrets principle - that the secrets themselves must be identified with reasonable particularity? Put another way, is there - or should there be - a heightened specificity requirement when a plaintiff uses the inevitable disclosure theory of misappropriation?

I think the answer must be yes, for a few reasons. First, if "inevitability" is a benign form of a threat, then the plaintiff must have a pre-existing factual basis for what that threat is. Otherwise, there simply is no claim and no sense of inevitability of a legal wrong occurring. Second and relatedly, if the plaintiff alleges only general categories of trade secrets and claims inevitable disclosure over them in an undifferentiated way, it suggests implausibility over the act of misappropriation. Another way to say this is that the plaintiff really is just fearful of unfair competition but can't state that fear beyond mere generalities.

The difficult part of this inevitable disclosure/specificity problem is procedure. Courts understandably don't require plaintiffs to set forth the details of their actual trade secrets in a complaint, so it's hard to dismiss cases on the pleadings when the claimed deficiency is a crummy attempt at identifying the actual secret. But hiding details and demanding specificity are not incongruous concepts. Here, I think courts need to take a much more pragmatic approach and assess generally what the theory of misappropriation is and what the plaintiff is claiming the trade secret is. If the claim is based on inevitable disclosure and the plaintiff is unable or unwilling to plead its secrets in a narrow, particular way, then the claim becomes presumptively implausible.

One way to tell is to see if the plaintiff is offering up only broad categories - strategic plans, for instance, as opposed as to a particular launch date in a particular market. Remember, the details of the secret need not be in the pleading, but the allegations must give enough notice to the defendant and the court to inform the ultimate theory of the case.