Competition Claims: Federal versus State Courts

This post largely is inspired by a YouTube video I watched recently by Jonathan Pollard, who discusses the importance of litigating trade secrets in federal court - particularly if you're a defendant.

Jonathan's 15-minute discussion is a great way for clients - particularly individuals - to understand some of the procedural aspects of litigation. Often times, it is the procedure where disputes like this are decided. And unfortunately, in the world of litigation, procedure tends to be opaque and something we as lawyers merely gloss over.

Having litigated non-compete and trade secret claims for nearly 20 years, I can say with a fair amount of certainty that my work has been split equally in state and federal court. I suspect that the enactment of the Defend Trade Secrets Act last year will slowly start to tilt that equation towards federal litigation.

Here are the biggest differences I have noticed over the years between litigating competition claims in federal versus state courts:

1. Attention to the Merits. The quality of judges in the federal system is - on the main - higher than in state court. This is a pretty uncontroversial generalization to make. Many state court judges are terrific, and some of the best judges I've ever appeared before are products of the state court system. Apart from that, however, state court judges have a higher case load than their federal counterparts. Many state court judges in Illinois have nearly 1,000 cases assigned to them. By contrast, the average number of cases filed per judgeship in federal court is 412. Many judicial districts vary in terms of the time from filing to disposition. But on average, it is fair to say that a federal court judge has fewer assigned cases to her docket than does a state court judge. Therefore, they can devote more attention to fewer cases.
2. Help. Federal judges also have a staff of law clerks, which Jonathan describes in his video. This is an enormous benefit to litigants in emergency injunction proceedings. Quite honestly, even the most astute well-intentioned state court judge isn't going to have the time or resources to evaluate a TRO or preliminary injunction submission with the kind of attention it probably deserves. This certainly is the case with disputes in highly-technical fields or which require analysis of electronic evidence.
3. Hearings. Part of the reason state court judges seem so busy is that they spend more time on routine hearings, status calls, and motions in court. This clogs up the available time for review of documents in chambers, legal research, and thoughtful analysis of contested cases. State judges have no one to draft written orders or opinions, and very rarely do so even on contested dispositive motions. For that reason, too, status court judges are generally much more reliant on oral argument and on in-court presentations by the litigants. In federal court, even contested preliminary injunctions may be resolved solely on the papers rather than on in-court live witness testimony. This, mind you, is not necessarily a benefit of federal court proceedings, though it certainly reduces cost. Often a strong case can come alive in a courtroom and appear more milquetoast solely when considered on the written submissions.
4. Presumptions. The best point Jonathan makes in his video is that many state court judges start with a firm presumption that the plaintiff is correct. One of the reasons this is the case is that state courts are filled with rather form-oriented and even mundane disputes (often with pro se litigants on the other side) where the merits are not contested. Examples are collection disputes, evictions, and mortgage foreclosures. For judges who handle those calls, it's understandable to have a pro-plaintiff bent when the plaintiff is almost invariably the winner. Non-compete and trade secret cases are not susceptible to easy handicapping, and if anything, the merits may tip in favor of the defense.
5. Scheduling. Federal courts operate with a set of procedural rules that are clear, demanding, and inflexible. The rules require early conferencing and discussion of proposed case management, and courts enter scheduling orders that can be changed only on good cause. State courts are notorious for continuances and delays, although that trend seems to be changing. In Illinois, most practitioners ignore our nominal case management rule (sort of a hybrid between Federal Rules of Civil Procedure 16 and 26). Judges seem not to care too much about it.
6. Cost. Because of the demands in federal court (such as for pre-trial orders and expert witness disclosures), many view federal litigation as more expensive. My experience is precisely the opposite. I think the clear nature of the procedural rules, combined with judges' reluctance to blindly continue cases and fewer mundane court appearances, creates a construct in which attorneys can and should litigate disputes more efficiently. Federal courts also have magistrate judges before whom parties to a civil case can consent to have the case heard. 
7. Fee-Shifting. Federal court tends to work better because the defense has greater opportunities for fee-shifting. State court judges are elected officials and face retention every six years. They invariably are the product of local bar associations and simply are loathe to ruffle feathers and sanction intransigent litigants. Federal court judges are appointed for life and have no allegiance to counsel. The Federal Rules of Civil Procedure also contain a number of different mechanisms that make fee-shifting appropriate, particularly when parties are unreasonable in serving or responding to discovery. This deterrent effect tends to reduce litigation cost because parties and counsel simply do not want to expose themselves to fee-shifting - even for discrete discovery dust-ups. In state court, sanctions are handed out so infrequently that delay and distraction seem to be the norm. When a party faces a disparity of litigation resources, this can be crippling.

Is there a clear-cut solution to where a plaintiff or defendant would rather litigate? It would seem to lean pretty strongly towards federal court. But as Jonathan notes, it's particularly crucial for defendants. 

Employee Training and the Value Proposition of Non-Competes

The best part of the current debate over non-compete agreements is not that we're nearing a consensus: it's that we're having the debate.

With the White House's Call to Action, and the research that led to this unprecedented move, commentators have begun to explore why firms have non-competes in the first place. The answer usually is that many view non-competes as protecting trade secrets, customer relationships, or training investments.

In the main, those all sound rational, depending of course on the firm's line of work and the employee's ability to inflict damage after leaving. My personal views on this largely have not changed in the nearly 20 years I have been practicing in this field. I summarize them as follows:

1. Non-competes should not be per se invalid and should be reserved for those at the highest levels of the company.
2. Businesses use them indiscriminately without considering their benefits and drawbacks.
3. A garden-leave approach, which provides tangible benefits to employees during the restricted period, is economically efficient and the preferred template for businesses to use.
4. Courts should not enforce non-competes when there is a termination without cause.
5. The judicial reformation or "blue-pencil" doctrine is inappropriate and creates poor incentives. It should be banned.
6. Less onerous restraints, such as non-disclosure agreements, most often provide sufficient protection.

What is notable about my list, though, is that it doesn't really account for the employers' incentive to train workers. Do non-competes actually facilitate training by encouraging firms to devote scarce resources to developing employees' skills? Would firms continue to train employees if non-competes were not allowed?

There are a couple of different viewpoints on this.

In a Wall Street Journal op-ed, Jason Furman and Alan B. Kruger discussed "monopsony" power and the use of non-competes. They note that "[i]f monopsony power creates barriers to workers switching jobs, it can slow labor turnover, reducing dynamism and innovation." They then cite the now-commonly approved benchmark that nearly 20% of workers have signed a non-compete agreement. (There are about 1,500 non-competes suits per year, according to Evan Starr.) Noting that nowhere near that many workers have access to trade secrets, Furman and Kruger conclude that "[t]here is no reason why employers would require fast-food workers and retail salespeople to sign a noncompete clause - other than to restrict competition and weaken worker bargaining power."

The counter to this monopsony argument focuses on the employer's inability to recapture training costs without a non-compete agreement in place. The analysis does not focus on trade secret access.

Hoover Institute fellow, David Henderson, summarizes his thoughts in a rebuttal to the Furman/Kruger rationale. Simply put, Henderson notes that an employee who receives training may be able to obtain a higher wage elsewhere than that which the employer is willing to offer. While carefully stating that he is not endorsing non-competes, Henderson clarifies the "training" rationale for why a low-wage worker may be subject to a non-compete.

However, I find this theoretical rationale misses the mark. First, American businesses long have assumed the responsibility for educating their employees. It seems illogical that they would fail to do so merely because of the possibility of future competition. Second, formal training is no panacea. Most effective training occurs on the job, through the collective experiences of day-to-day work and a general exposure to the marketplace. Courts long have concluded that general skills and knowledge are not protected interests.

Quantifying training, too, is nearly impossible and cannot be reduced to a mathematical equation that will conclusively demonstrate whether non-competes incent or deter training. If quantification were possible, then training repayment agreements - or quantifying damages based on such a hypothetical contract between market competitors - would seem to be a better solution than broad non-compete enforcement. Could we even envision a new regime where a repayment model supplants an enforcement model? I doubt it, but it makes for an interesting discussion.

The bigger problem, though, may be reciprocal use of non-competes and the development of industry standards, using some sort of an anti-trust "relevant market" analysis. A firm, for instance, may not be inclined to use a non-compete but does so only in response to its direct competitors' pre-existing inclination to do so. In that sense, the reluctant firm is only trying to avoid the free-rider problem: if competitors see that the reluctant firm has no non-compete regime with its workforce, those competitors will be less willing to invest in appropriate employee training, thereby lowering production costs. This explanation for why firms use non-competes in a blanket fashion actually seems to prove what Furman and Kruger are saying: monopsony power stems from artificial means to restrict competition, that being an industry-wide practice of using non-competes in the first instance.

If anything, therefore, the attempt to justify non-competes on the basis of protecting training costs seems to explain why so many workers without the ability to harm their employers are subjected to them. 

No-Poaching Agreements, Antitrust Guidance...and DJT

A few years back, the Department of Justice launched an antitrust action against several technology giants, including Apple, Google, Intel, Pixar, and others. The action was based on the Sherman Act and alleged that these employers committed a "per se" violation of the antitrust law when they agreed not to cold-call each other's employees.

These so-called no-poaching agreements were bilateral agreements that, according to the DOJ, eliminated a form of competition - the market to retain and hire employees. Those agreements reduced employee mobility and deprived workers of the opportunity to achieve higher wages and benefits. The particulars of the  restraints were embarrassing for a number of big names in the technology industry (and featured a couple of famous e-mails from the late Steve Jobs). The significance of the horizontal no-poaching agreements was particularly acute for many workers (who later filed a civil class action), since California bars vertical non-competition agreements between employer and employee.

In October of this year, the Department of Justice's Antitrust Division, in conjunction with the Federal Trade Commission, released its Antitrust Guidance for Human Resource Professionals. That document clarified the DOJ's intent to criminally investigate "allegations that employers have agreed among themselves on employee compensation or not to solicit or hire each others' employees." The DOJ's guidance also makes repeated reference to "naked" agreements not to poach employees, meaning those that "are separate from or not reasonably necessary to a larger legitimate collaboration between the employers." Those naked restraints are per se invalid, a violation of antitrust law, and will be deemed so "without any inquiry into [their] competitive effects."

So what does this mean in practice? While the parameters of the DOJ's guidance are not set in stone,  I think it's possible to glean a few guiding principles for typical no-poaching scenarios.

1. M&A Due Diligence. No-poaching agreements are fairly common when an acquirer begins its due diligence of a potential target. Term sheets, letters of intent, and even transactional non-disclosure agreements often contain some form of no-hire clauses. These should be outside the DOJ's antitrust framework. However, the better approach is to limit the scope of these no-hire arrangements to key employees who play a material role in the due diligence process and to a reasonable period of time - say, 6 to 9 months past the time the deal falls apart.
2. Litigation Settlements. No-poaching agreements very frequently arise during litigation (or threatened litigation) between competitors, usually over trade-secret theft allegations or a dispute over a group of employees' non-compete agreements. Nearly all of those cases settle before trial. In many settlement agreements, a plaintiff demands that the defendant employer agree not to hire the plaintiff's employees for a period of time. These types of agreements likely are unlawful. Nothing in the DOJ guidance contemplates that this type of restraint is "reasonably necessary to a larger legitimate collaboration," and indeed it would seem to be the very type of horizontal agreement with a vertical impact - on non-party employees.
3. Business-to-Business Transactions. Somewhere in between these two paradigms are more run-of-the-mill contractual arrangements between companies who aren't necessarily competitors. Many technology staffing contracts feature some iteration of no-hire/no-poaching clauses. Others do as well, including some service-oriented relationships that look like a poor-man's joint venture. A number of my clients, for instance, provide professional consulting services that require their employees to work closely with a manufacturer or supplier to enhance or develop new products. Because of the close relationship developed among the two companies' employees (and their exposure to each other's business), the perceived need for a no-poaching agreement becomes obvious. I think these will likely be okay, but again a narrow scope with a short time limit is essential. Moreover, each beneficiary of a no-poaching agreement will need to illustrate why the no-poaching agreement is critical to the relationship. That these agreements are usually not between competitors is helpful to, but not dispositive of, the antitrust analysis, since the relevant market is the employment marketplace - quite broad indeed.

The DOJ's guidance is helpful to an extent, but like much of antitrust law, the parameters are not well-defined. With the incoming administration and the change in leadership at the DOJ, there is even greater uncertainty whether no-poaching agreements will warrant serious civil or criminal scrutiny. My belief is they probably won't because DJT seems to be a fan of broad and obviously invalid non-compete agreements. But the new President has (at least publicly) taken some populist positions as it concerns antitrust law.  

A Response to the Jackson Lewis White Paper on Non-Compete Reform

I was quite interested to read a self-styled "white paper" publication this week from the management-oriented firm Jackson Lewis. That publication, titled White House Continues Attack on Non-Compete Agreements, was of obvious interest to me since I wanted to see how other practitioners viewed the Call to Action released last week. And in particular, I was interested to see how thought-leaders would respond to the White House's suggested calls for reform at the statewide level concerning non-compete enforcement.

Before reading the Jackson Lewis publication, I was encouraged by the tone and substance of other posts, including one from Eric Ostroff's excellent blog, in which he acknowledged the overuse of non-compete agreements. Eric suggested deploying an evidentiary presumption against certain non-competes, rather than categorical bans. While I disagree that this is sufficient, it is certainly an alternative, incremental step towards reform that state legislators may consider in the coming years.

A lengthier read comes from Russell Beck, who holds great leverage on this issue since he is one of the premier private practitioners in the field and one whose work the White House has cited in its reports. In his post, Russell even offers a number of links to terrific empirical research studies on the use of non-competes, which themselves discuss litigation trends statistically, the growth of non-compete use in the workforce, and the true economic impacts of non-competes on employee incomes.

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Against that backdrop, the Jackson Lewis paper was a disappointment. The publication seems less interested in provoking thought and reasoned discussion on non-compete reform, and more intent on sending the message that reform is unnecessary in the first place because everything seems to be working just fine. Blog posts that serve to advertise a firm and cater to a client base are what they are (and there's a f**king lot of them); I just happen to think they're not worth anyone's time.

The paper contains a number of unsupported or overly simplified conclusions, a couple of which are worth a further look. For starters, the post concluded that the May 2016 White House Report (titled Non-Compete Agreements: Analysis of the Usage, Potential Issues, and State Responses) "mostly excoriat[ed] employers' use of non-compete provisions in the United States." That's obviously wrong and a misread of the White House Report.

The report sought to identify the main areas of non-compete misuse (and if Jackson Lewis thinks there's no misuse, its lawyers have their collective heads in the sand) and to provide an analytical framework for how to balance two twin concepts: the freedom to contract and the freedom to work. Pointing out the misuse of non-competes is part and parcel of the difficult balance courts and legislatures struggle with. And all attorneys have an obligation to understand this.

The White House report's conclusion even noted that "non-compete agreements can play an important role in protecting businesses and promoting innovation. They can also encourage employers to invest in training for their employees." The document is far from an excoriation on non-competes in the main, but rather an excellent synthesis of data and state practice to see how to balance interests that lie in tension. That balancing efforts starts with incremental reform at practices that foster abuse and misuse.

The Jackson Lewis paper then says the White House's more recent Call to Action (which largely relied on the May 2016 report) "appear[s] more conclusory than based on empirical evidence." Earlier, the post even noted the reliance on limited, non-public studies. The authors, however, must not have looked at the Administration's publications. In fact, the more detailed report identifies a number of research studies (that are actually well-known and widely-discussed in the field), which directly led to the White House's conclusions and suggested areas of reform. In short, the White House report is not a half-cocked one-off. It's based on significant empirical research.

On this score, a couple of studies are worth mentioning. The obvious starting point for anyone interested in a serious discussion of reform is AnnaLee Saxenian's 1994 work called Regional Advantage: Culture and Competition in Silicon Valley and Route 128. That publication notes the disparate paths taken by the Boston research corridor and Silicon Valley, stemmed in large part by knowledge flows and spillovers that spurred innovation in California. My favorite read in this area followed Saxenian's book. Matt Marx and Lee Fleming published Non-compete Agreements: Barriers to Entry ...and Exit?, which you can find here. I have attended talks by Professor Marx, who is not a lawyer but who captivates a room full of them on the most esoteric of material. The Marx/Fleming paper is enormously influential and it looked at the significant financial cost to engineers who were bound by non-competes. It should be required reading for CEOs - and the lawyers they hire.

And finally, if anyone is interested in synthesizing the research to determine the true impact non-competes have on economic liberty, I highly recommend Alan Hyde's article called Should Noncompetes Be Enforced? The Hyde paper, available through the gold-standard Cato Institute, discusses the Silicon Valley experience at length but also extols the benefits from knowledge spillovers that employees can bring when changing firms. (Word to the wise: knowledge spillovers ain't bad, and contrary to what many lawyers think, free-flowing information does not equate to misappropriation.)

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In the larger picture, non-compete enforcement presents one of the most difficult balancing exercises required in the law between two freedom-oriented concepts: contracting and employee mobility. And one of the largest problems in reconciling this balance is that one of the players (the average worker) faces an enormous disparity in bargaining power. That reality necessitates an honest, intelligent discussion on reform to restore balance.

Reform can come by engaging in the very type of debate the White House has advocated. Reform, too, may come from a different source that is mentioned only rarely. Industries can create their own set of best practices to facilitate the competition for talent while balancing rights to "excludable" or secret information. We have seen this with the financial services' Protocol for Broker Recruiting, a sort of private legislative solution meant to drive down legal fees and set the parties' expectations ex ante. In my opinion, this - along with targeted reforms (garden-leave and red-penciling) - is the best answer to balance out the competing interests at stake when regulating employee mobility. Perhaps this too is part of the reform the White House wants to initiate. Lawyers can play a large role in facilitating private legislation. But they need to start acknowledging the problem and be part of the solution.

It is not a viable option, however, for law firms that represent management to downplay the need for reform in the first place. In large part, those firms have contributed to the skepticism of non-competes by failing to understand the countervailing interests that are at play. The irony is that their management-driven practices, and the fees that keep the law firm engine running, could imperil non-competes altogether.

Louisiana's Rather Unusual Non-Compete Exemption

My last post, and many other fine posts circulating in the blogosphere, commented on the White House's call to action concerning non-compete reform. That effort was a thoughtful initiative that should drive discussion at the state level for the foreseeable future.

Of all the areas of reform the White House suggested, the one that is relatively undefined is the idea that certain classes of workers should be exempt from non-competes altogether. The "public health and safety" language the White House used clearly is meant to include nurses and physicians, but there's very little meat on the bone beyond this very broad principle.

I can tell you one occupation that I believe the White House did not mean to include by way of a categorical exemption: car salesmen.

Yet, oddly enough, in Louisiana, car salesmen are indeed exempt - statutorily - from enforceable non-competes. Louisiana is a relatively exacting state when it comes to non-competes in the first place. But just how the legislature decided that car salesmen merited their own exemption is a true oddity. This week, the Third Circuit Court of Appeal held that a dealership could not circumvent the statutory language by claiming a former employee was performing sales management duties. In addition to relying on the plain language of the statute (and the clear legislative intent), the court noted that all sales employees perform at least some management duties.

I truly hope this is the last time I feel compelled to discuss the nuances and interpretations of this particular statute.