Non-Competes Are Not for Everyone

March 24th, 2017

If properly drafted and used, restrictive covenants (non-competition agreements) can be terrific and enforceable tools.  However, recent government scrutiny of their use and impact on employee mobility and wages make it clear that their use should be limited to key employee and executive personnel and/or those with significant client and marketplace relationships.

The intent behind a non-compete is to provide protection for a limited period of time against the transfer of an employer’s relationships and or know-how to a competitor.   Non-Competes only have value if they are treated (1) as special agreements involving limited groups of employees; (2) carefully tailored to the circumstances of a given employment relationship,  industry, and job duties; and (3) found to be worthy by the courts.  If they are devalued by being issued to every employee in a company regardless of the material nature of the employee’s position, they may slightly improve employee retention, their use may come under scrutiny, their effect diluted, and their enforcement difficult to achieve.

As discussed in an earlier HNRK Blog post, when deciding the seminal case of Reed, Roberts Assoc. v. Strauman, 40 N.Y.2d 303, 307-08 (N.Y. 1976), the New York Court of Appeals made it clear that restrictive covenants “will only be subject to specific enforcement to the extent that they are reasonable in time and area, necessary to protect the employer’s legitimate interests, not harmful to the general public and not unreasonably burdensome to the employee.” Id. Legitimate interests of the employer, according to the Reed, Roberts court, would include the protection of trade secrets or confidential information, or preventing competition when “an employee’s services are unique or extraordinary.”  Id. at 308. This ruling and judicial policy statement strongly suggests that a company should use great discretion when requiring execution of a restrictive covenant as a condition of employment and make sure that the employee, officer, or director are engaged in activities that to preclude unfair competition, deserve shielding from a competitor.

Federal and local governments have grown increasingly sensitive to the misuse of restrictive covenants.    In May 2016, the White House released a report on the use of non-competes and their potential misuse by employers and the negative effects it may have on the economy by limiting wages and employee mobility. (“Non-Compete Agreements: Analysis of the Usage, Potential Issues, and State Responses.” See October 2016 Blog entry.)

Similarly, New York State Attorney General Eric Schneiderman, has called out employers for abuse of non-competes, which in some settings, have become so ubiquitous that even fast-food companies are requiring line workers to sign them.  Tracking New York law, Schneiderman states that, “Unless an individual has highly unique skills or access to trade secrets, non-compete clauses have no place in a worker’s employment contract.” He continues, “Unscrupulous non-compete agreements not only threaten workers seeking to change jobs, they also serve as a veiled threat … Workers … should be able to change jobs and advance their careers without fear of being sued by their prior employer.”

In what was a first, the NYAG used the power of his office to challenging non-compete agreements between companies and their employees.  The NYAG settled two investigations brought pursuant to Section 63(12) of the New York Executive Law, which authorizes the NYAG to investigate and redress “unconscionable contractual provisions.” In June 15, 2016, the NYAG announced a settlement with Law360, a prominent legal news outlet, restricting its use of non-compete agreements with members of its editorial staff.  Before the settlement, the publisher required all of its editorial employees to sign agreements preventing them from working for a “direct competitor” for one year after leaving Law360. Given that Law360 is a national publication, the contract effectively prevented employees at all levels of seniority from taking another job.  Under the settlement agreement, Law360 will no longer include non-compete provisions in its agreements with most editorial staff members, and it will alert former employees who left the publisher in the past year that their non-compete provisions will not be enforced.

A second settlement was with Jimmy John’s Gourmet Sandwiches (“Jimmy John’s”).  In a classic case of overreach,  Jimmy John’s franchisees based in New York will cease requiring its sandwich makers to sign non-compete provisions in connection with their employment and will void all such agreements currently in effect.  Jimmy John’s also will cease including sample non-compete agreements in the hiring packets that it sends to franchisees, and it will alert franchisees that the NYAG believes that such clauses are unlawful.

Significantly the NYAG has not challenged the employment agreements between senior, technical, sales, or other personnel who were more likely to have access to confidential information and trade secrets or whose relationships with clients and vendors are significant.

In sum, non-competes and other forms of restrictive covenants, including non-solicitation and no raiding provisions, are in fact alive and well and enforced by New York State and Federal courts.  They are an essential tool against unfair competition and the protection of key relationships.  But, they should be used sparingly and only for certain classes of employees who have knowledge of material information which could be used by a competitors to unfairly enter the market, operate at a lower cost, on a faster schedule and thus to unfairly compete.

Data Misappropriation–Where to Sue

January 10th, 2017

Determining where your data is stored for purposes of “venue” (where you can bring suit) is a relatively new issue not resolved in current case law. Traditionally, courts have focused on the location of the relevant server. But in this age of the cloud, where there are multiple and redundant servers to enhance access and security, we argue that the place where data is managed and controlled is the locus of the property and proper venue.

Consider the following scenario: You are the president of a company that is headquartered in New York City. The company’s IT function is run out of New York, including all management, software, hardware design, vendor selection, employee access and operations.  You receive word that company trade secrets, captured in numerous Word and Excel documents residing on your central computer system, have been misappropriated by an employee in your company’s Chicago office who just resigned to join a competitor.  You quickly want sue the offender in federal court for misappropriation of trade secrets and violation of the federal Defend Trade Secrets Act. But where to sue?

The federal venue statute 28 U.S.C. § 1391 (b), offers a plaintiff some choices.   Under this statute, venue, meaning the proper court to hear and try your case (in other words where you may file your complaint), is the judicial district where:  (1) the defendant resides; or (2) the events took place that gave rise to the claim; or (3) a substantial part of the property that is the subject of the action is situated.  The purpose of these statutory restrictions is to protect the defendant against the risk that a plaintiff will select an unfair or inconvenient place for trial.  Leroy v. Great W. United Corp., 443 U.S. 173, 184 (1979).

The first two grounds are pretty simple. Find the employee’s address, locate the nearest federal courthouse in the same state, and that’s where you can file. Similarly, if the employee logged onto a local computer terminal in the Chicago office and or sent himself the misappropriated materials from there, then that is where the “events giving rise to the claim arose.” But, that means filing suit in Chicago. Your home turf is New York and your lawyers are in New York.  Thus, the company would rather sue in New York.

That brings us to the last basis for venue: “where a substantial part of the property is located” and whether such language allows the company to sue in New York federal court.  If the data was maintained on specific hard drives or servers located in a fixed location, say the company’s IT office in New York, then the answer is straightforward.  In Argent Funds Group, LLC v. Schutt, No. 3:05CV01456, 2006 WL 2349464, (D. Conn. June 27, 2006), the Court found that Connecticut was an appropriate venue and that it was immaterial that the defendant accessed the plaintiff’s confidential information remotely because the “Connecticut file servers . . . played a central role in the events that gave rise to the claim, and were one of the means by which the defendant allegedly stole the information.” The Court further found that even if a substantial part of the events or omissions giving rise to the claim had not occurred in Connecticut, venue would still be appropriate in Connecticut pursuant to section 1391(b) because a substantial part of property that was the subject of the action was situated on servers in Connecticut. See also EMI Corp. v. Opal, No. 1:15 CV 1257, 2015 WL 5782069, at *2 (N.D. Ohio Sept. 29, 2015) (courts have found that where a defendant accesses trade secret information out of state, stored on a computer located in the forum state, venue is proper where the computer servers are located. Citing The Premier Group v. Bolingbroke, No. 15-CV-01469, 2015 WL 4512313 (D.Col. July 27, 2015)).  Other cases have turned on where the bad acts occurred.  See Crayola, LLC v. Robert Buckley, 179 F..Supp.. 3d 473 (E.D. Pa. 2016).

But what If the “property” is stored in the cloud and your host has server farms located in multiple locations for security and your data is spread out across the country.  Most of the current crop of data/venue cases are pre-cloud or don’t address the issue.  Moreover, the drafters of the venue rules likely never heard of cloud storage, for that technology did not exist in operative form in 1976 when the “location of the property” rule was enacted.  Thus, Courts have to date, focused on server location because (1) that was the current technology and (2) because they are tangible, fixed, identifiable items that are physically present in the jurisdiction in which the case is to be tried.

In cases where data is stored in the cloud and decentralized, the management and control situs is a rational test that can give effect to the spirit of the “property location” portion of the venue statue.  It satisfies the element that the judicial district is a fair and appropriate location to hear the suit because it is likely where the relevant documents and witnesses will be, where control over the data is exercised (for example to save, categorize, print, or delete), as well as the location of the decision makers who determine what is and what is not a confidential trade secret and why.  Thus, it may be an even more appropriate location for a trial then simply a remote location in which an employee has accessed a “dummy” terminal to effectuate the misappropriation.  Moreover, as one court has recognized in dicta: “Given cloud storage and the ubiquity of internet use,” the venue rules, “would offer little protection for defendants if they could be hauled into any district where their data passes through or is remotely stored.” Crayola, 179 F. Supp. 3d at 479.   The management and control test precludes this result while maintaining the purpose of the rule, to permit venue where relevant IT control, documents, and witnesses reside.

HNRK Obtains First Seizure Order Under The Defend Trade Secrets Act

September 8th, 2016

Until passage of the federal Defend Trade Secrets Act (the “DTSA”), previously discussed in this blog, employers had limited access to the federal courts when their trade secrets were misappropriated.  We pointed out that the DTSA allows employers to file a civil suit in federal court for theft of trade secrets and obtain injunctive relief against the misuse of those secrets as well as damages and attorneys’ fees.  In extraordinary circumstances, the DTSA allows for the ex-parte seizure of trade secrets by law enforcement to prevent their propagation or dissemination.

Our article proved most prescient for in late July 2016, we were called by a NYC real estate finance company that suspected that an employee had misappropriated its trade secrets.  We confirmed those suspicions via forensic examination and soon thereafter obtained the very first DTSA ex-parte seizure order in the US in the United States District Court for the Southern District of New York.  (Mission Capital Advisors LLC v. Romaka, Case No. 16 civ. 5878 (LLS)).

The Facts      

The employee in the case, Romaka, a debt and equity finance specialist, was accused of downloading confidential company files including contacts and deal documents.  Originally cooperative, Romaka allowed a forensic examination of his personal desktop.  That review revealed that he had downloaded a multitude of company files.  Thereafter the employee, who lived in Manhattan, went to ground, thus thwarting Mission’s efforts to obtain the return of the misappropriated data.  Mission Capital, Romaka’s employer, needing to protect the integrity of its trade secrets, quickly filed a complaint in the Southern District seeking both an injunction against disclosure and seizure under the DTSA.

The case was tailor-made for the DTSA because its facts satisfied the statute’s elements.  The misappropriated information constituted trade secrets, the defendant had wrongfully taken and downloaded the material by improper means through electronic espionage, and the employer had suffered economic loss as a result. As a result the court granted the employer emergency ex-parte relief.[1]         After a temporary restraining order hearing, the court granted Mission injunctive relief (barring Romaka from accessing, disclosing, coping or otherwise conveying plaintiff’s contact list) which, given his disappearance, was served on him via email.  When Romaka did not acknowledge service or the TRO, and subsequently failed to respond to us or appear in court on the TRO hearing date, thereby ignoring the court’s directive that he appear, the matter became ripe for seizure so as to protect disclosure or misuse of Mission’s trade secrets.

We demonstrated to the court that any form of equitable relief other than seizure would be inadequate because Romaka’s own actions showed that he was likely to misuse the purloined data and would evade, avoid or otherwise not comply with the court’s directive, and that Mission was at risk of immediate and irreparable injury should the misappropriated materials be disseminated.  While the court was concerned about protecting Romaka’s privacy and the integrity of Romaka’s non-Mission related computer content, we addressed those concerns, identifying with specifics the exact computer files that needed to be seized, their location, and a reasonable method for seizure. As a result the court issued a seizure order directing the US Marshals Service to “as soon as possible” seize “i.e., copy onto a storage medium and delete the file on Defendant’s computer…”

On August 4, 2016, five days after the Seizure Order and three days after the court approved a computer expert, the defendant was woken in his apartment by three US Marshals in bulletproof vests. The “seizure” took almost all day as appropriate files were copied and then deleted from the employee’s computer.  But that did not end the matter because the DTSA requires the court to hold a post-seizure hearing to give the defendant an opportunity to further challenge, modify or dissolve the seizure. Again, neither Romaka, nor a lawyer acting on his behalf, attended the hearing so the Order remained in place.

Conclusion

The DTSA gave the employer in this case a new forum and set of tools to obtain the return of misappropriated trade secrets. The court and the Marshals Service moved quickly to establish protocols intended to give effect to the statute and at the same time protect the interests of the defendant employee.  To maximize the chances that an employer will prevail in a DTSA action our experience in Romaka suggests that a party seeking DTSA injunctive relief that may result in seizure be armed with the following:

  1. Evidence of misappropriation or misuse of trade secrets.
  2. An improper taking of those trade secrets.
  3. Proof that was taken is indeed a trade secret.
  4. Evidence that a defendant, absent seizure, is likely to misuse or propagate the seized material or will evade the court.  E.g.: defendant intends to leave the country or sell or disclose the misappropriated material.
  5. The ability to identify with specificity what is to be seized.
  6. The location of misappropriated material.
  7. Ability to post a bond.
  8. Ability to pay the Marshals’ fee.
  9. The identity of an expert who may need to accompany the Marshals.
  10. Information that will be helpful to the Marshals about the nature and location of the property to be seized and the plaintiffs who may be in possession of the misappropriated material.

 

 

[1] Of course, that took some lawyering for this was the first time the court was faced with an action under the brand new DTSA and there was absolutely no precedent. Knowing this, and to make the court’s job easier, we were sure to bring with us copies of the statute and the Congressional Bill Report (No. 114-529, 114th Congress, 2d Sess) to distribute to the judge and his law clerks.

 

 

The Defend Trade Secrets Act–A Sea Change in the Fight Against the Misappropriation of Trade Secrets

June 1st, 2016

By Richard Reice, Partner.

Summary

Until just this past Wednesday, May 11, 2016, when President Obama signed into law the federal Defend Trade Secrets Act (the “DTSA”), employers had limited access to the federal courts when their trade secrets were misappropriated.  The DTSA changes that in dramatic fashion.  In an historic shift, this new statute (which, despite today’s political climate, passed the House 410-2) allows employers to file a civil suit in federal court for theft of trade secrets and obtain injunction relief against the misuse of those secrets, as well as damages and attorneys’ fees.  The law also allows, in extraordinary circumstances, a court to order the ex-parte seizure of trade secrets by law enforcement to prevent their propagation or dissemination. The result is that the DTSA will radically alter trade secret litigation. While non-competes and breach of non-solicitation cases will continue to be litigated primarily in state court, trade secret litigation will likely shift to the federal courts. Note, though, that the DTSA does not preempt state law, and thus many DTSA cases filed in federal court will contain multiple causes of action, including state law unfair competition tort claims and claims for breaches of non-solicit and non-compete provisions.

One particularly valuable aspect of the DTSA is that it will allow, where warranted, much of the new federal court trade secret litigation to take place under seal. The statute states that the court “shall enter such orders and take other action as may be appropriate to preserve the confidentiality of the trade secrets,” thus paving the way for complaints and related court filings to be made under seal—an  enormous relief to companies that were often forced to balance the conflicting interests of disclosure and enforcement.  One negative aspect of the DTSA, however, is that it provides new protections for whistleblowers who take their employers’ trade secrets and turn them over to the government or their legal counsel for the sole purpose of reporting or investigating a suspected violation of law.

For more detailed information about the DTSA, read below.

The Fine Print

The DTSA amends the existing federal Economic Espionage Act (the “EEA”) (18 U.S.C.A. § 1831, et. seq.), which previously allowed only for criminal prosecutions. The EEA was aimed primarily at industrial espionage by companies, foreign governments and their agents.  With the DTSA amendments, individuals or entities who knowingly and intentionally steal, take without authorization, copy, or knowingly receive a misappropriated trade secret related to a product or service used in or intended for use in interstate or foreign commerce are subject to a civil suit for damages and injunctive relief.  Double damages can be awarded in instances where “the trade secret is willfully and maliciously misappropriated.” DTSA § 1836 (b)(3)(C).

The DTSA provides for the possibility of attorneys’ fees if the other side engages in bad faith when claiming misappropriation or opposing the claim of misappropriation. DTSA §§ 1831, 1836.

What constitutes trade secrets under the DTSA is the same as it was under the EEA, which defined trade secrets to include formulae, programs, devices, techniques, codes, or processes, etc., regardless of its medium, if:

(A) the owner thereof has taken reasonable measures to keep such information secret; and

(B) the information derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable through proper means by, another person who can obtain economic value from the disclosure or use of the information

DTSA § 1839 (3)(A).

Injunctive Relief and Seizure

The DTSA is revolutionary for the range of injunctive relief available to a plaintiff.  DTSA § 1836 provides for injunctive relief and, in extraordinary cases, the ex-parte seizure of the misappropriated trade secret, meaning without notice to the party in possession of the trade secret.   Injunctive relief may granted provided that it does not “prevent a person from entering into an employment relationship, and that conditions placed on such employment shall be based on evidence of threatened misappropriation and not merely on the information the person knows; ”  DTSA § 1836(b)(3)(A).  This language indicates that the DTSA will not provide for injunctive relief based on the inevitable disclosure doctrine.  Additionally, it appears that it will be a challenge to enjoin an employee who has stolen trade secrets from competing if the injunction is based only on the stolen trade secrets; rather, other “conditions” will be placed on such employment.

In those rare cases where more traditional forms of injunctive relief will be ineffective, the court may issue an order providing for the seizure of trade secret property necessary to prevent its loss or dissemination. While the materials seized remain in the custody of the court, the court may further appoint a special master to “locate and isolate all misappropriated trade secret information” to facilitate its return.  DTSA §1836(b)(2)(D)(i) and1836 (b)(2)(D)(iv). The statute sets forth the elements that must be satisfied to obtain a seizure order and the burden is high, not surprising given the drastic nature of the remedy and the need for US Marshall or police involvement.  Yet, this remedy will no doubt prove invaluable in high risk situations.  A hearing will then be held within seven days of the seizure order.  DTSA § 1836(b)(2)(B)(v).  As a brake on the abuse of this provision, if a seizure is deemed wrongful or excessive, the individual subject to the seizure can seek damages, such as lost profits. DTSA § 1836(b)(2)(G). Similarly, if a claim of misappropriation is made in bad faith, the accused may recover his or her reasonable attorneys’ fees from the plaintiff.  DTSA 1836 § (a)(3)(D).

Employers in highly competitive industries will further appreciate DTSA § 1835, which is titled: “Orders to Preserve Confidentiality.” This provision requires district courts to permit a trade secret holder to file a brief under seal to explain why its trade secrets should be kept confidential by the court. Furthermore, a court “may not authorize or direct the disclosure of any information the owner asserts to be a trade secret unless the court allows the owner the opportunity to file a submission under seal that describes the interest of the owner in keeping the information confidential.”  Given the statute’s cognizance of the need to maintain the confidentiality of this information, it is reasonable to assume that obtaining a confidentiality order will not be overly challenging.

Plaintiffs will have three years to file suit under the DTSA.  The limitations period begins to run once the misappropriation is discovered or reasonably should have been. The DTSA also applies to misappropriation that has occurred outside the United States, if the offender is a US citizen or “an organization organized under the laws of the United States.” DTSA §1837.

Whistleblower Protection

Most great things have a downside and the DTSA is no exception. In keeping with the current fashion of protecting, if not encouraging, whistleblowers, the DTSA provides an exception to itself: a safe harbor to individuals who turn over their employer’s trade secrets to the government to investigate potentially illegal activity.  The statute grants them both civil and criminal immunity. DTSA § 1833.  In addition, an individual who files a lawsuit for retaliation by an employer for reporting a suspected violation of law for example, the Foreign Corrupt Practices Act or Title VII, may disclose their employer’s trade secrets to their attorney and use it in a future court proceeding if the material is sealed.  DTSA § 1833(b)(2).

What may make employers squirm is the DTSA’s requirement that employers must “provide notice of the foregoing immunity provision in any contract or agreement with an employee that governs the use of trade secrets or other confidential information,” for example a restrictive covenant agreement or employee handbook.   DTSA § 1833(b)(2).  The good news is that an employer shall be in compliance with this notice requirement if the employer merely provides a “cross-reference” to a policy document provided to employees that fully recites the immunity provision. Thus, a company can put the notice provision in its employee handbook and any subsequent contracts or confidentiality statements or warnings can merely refer to that handbook.  For example: “This Confidentiality Agreement shall incorporate the notice provisions of the DTSA as set forth in the Company Employee Handbook.” Failure to provide employees with notice of immunity will deprive the employer of the ability to seek double damages and attorneys’ fees.  Accordingly, timely consultation with legal counsel is highly recommended so that employer-employee contracts, employee handbooks and company policies can be appropriately revised.

Conclusion

The DTSA is now in effect. It will greatly impact the practice of trade secret litigation and the remedies available to employers.  Whether it increases litigation or simply moves it to a different forum, is something time will tell.  Despite the whistleblower immunity provision which may prove challenging should it be publicized, the DTSA provides employers with a new arsenal of remedies to combat the misappropriation of trade secrets. While it will take time for the courts to generate the case law that will provide the additional guidance and clarity needed to fully round-out the scope of the DTSA, it should happen relatively quickly given the volume of trade secret ligation that will now be diverted from state to federal courts. One can easily foresee the day when trade secret law instead of varying from state by state, becomes replaced by a more uniform body of federal law.

Of course, we stand to assist you to adjust your company policies to fully take advantage of the DTSA and to answer any questions you may have.

Restrictive Covenant Employment Guide For Employers

September 25th, 2015

If you are an employer in a highly mobile and competitive industry, whether it is banking, tech, staffing or otherwise, obtaining a valid restrictive covenant agreement is a key step in protecting yourself from unfair competition if your employees are poached by rivals or otherwise seek to compete with you after leaving.   But unless it is properly- and narrowly-drafted and the circumstances under which it is obtained are appropriate, the agreement and the employer’s ability to enforce the agreement will be subject to challenge, and that agreement for which the employer paid good money may prove unenforceable.

Our Blog recently informed our readership about the New York Court of Appeals case, Brown & Brown v. Johnson (HNRK Blog dated June 12, 2015).  To save readers the trouble of looking, we discussed the fact that the circumstances under which an employee signs a restrictive covenant agreement may impact its enforceability.  In Brown, one of the issues was the validity of a non-solicitation clause and whether the [former employer/former employee] was entitled to summary judgment even though the clause was overbroad on its face because it purported to ban the former employee from working with any of the former employer’s customers, including those with whom the former employee had no contact. Yet, the court resisted either blue penciling (redrafting the agreement to make it more reasonable and thus enforceable) or eliminating the clause entirely.  As we reported:

The court further considered whether it could partially enforce the clause—i.e., give effect to the restriction only to the extent necessary to protect a legitimate employer interest.  A New York court may modify a restrictive covenant, but only if the agreement was not the result of coercion, over-reaching, or other misconduct. In Brown & Brown, the Court held that summary judgment was not appropriate on this point because fact questions remained regarding the propriety of the former employer’s conduct.  In particular, the Court noted that there was conflicting evidence as to whether the former employer may have used coercive bargaining power when it asked the employee to sign the employment contract after she had resigned from her prior position.

There is a Time and Place for Everything

To ensure the enforceability of your restrictive covenant agreements, we suggest attention to the following issues:

  1. Are the restrictive covenants narrowly drawn?

a. Ensure that the non-compete and non-solicitation provisions are limited in duration and reasonably tied to the employee’s employment, industry, and compensation level.

b. Limit the geographical scope of the non-compete or be prepared to defend in a courtroom the reasons for a broader or unlimited territory.

c. Limit the non-solicitation provision to clients/accounts that are actually serviced or managed by the employee signing the agreement.

d. State in the agreement the legitimate interests that require protection for the employer, for example: key client relationships arising from the employee’s employment, or trade secrets such as trading algorithms, etc.

2. Are the conditions for signing appropriate?

To be safe, an employer should take the following steps when presenting a prospective or current employee with a restrictive covenant.  As we noted in our earlier post [hyperlink], the Brown & Brown court identified as an issue of fact whether the employer improperly coerced the employee into signing the agreement.  We recommend that an employer follow—and carefully document—the following steps:

3. Use skilled legal counsel to draft the agreement.

There are plenty of restrictive covenant forms on the web to copy from and adapt to a given business. We don’t, however, suggest generating home-brewed contracts.  Protection of trade secrets and guarding against unfair competition should be an essential element of a company’s business plan and operation. There is an art to drafting restrictive covenant agreements and having local knowledge of the law and the courts is critical to the proper drafting and enforcement of a restrictive covenant agreement.

New York Court of Appeals Invalidates Choice-of-Law Provision in Restrictive Covenant Case

June 12th, 2015

The enforceability of restrictive covenants depends, to some degree, on which State’s law applies to an employment agreement. Many employment contracts have a choice-of-law provision, but a recent case from New York’s highest court makes clear that the parties’ choice of law will not always be honored.

Brown & Brown v. Johnson

In Brown & Brown v. Johnson, a Florida corporation called Brown & Brown, Inc. recruited Theresa Johnson away from her post at Blue Cross/Blue Shield to work at Brown & Brown’s New York office.  On her first day of work, Brown & Brown presented Johnson with an employment contract that included a Florida choice-of-law clause as well as a non-solicitation agreement that barred Johnson from servicing any customers of Brown & Brown’s New York office for two years after her termination.  After several years, Brown & Brown terminated Johnson, prompting her to join a competitor. At the competitor, Johnson worked with former clients of Brown & Brown, and Brown & Brown sued to enforce its non-solicitation agreement.

There were two issues for the Court of Appeals. First, was the Florida choice-of-law provision valid?  Second, was the non-solicitation clause enforceable?

The Florida Choice-of-Law Clause Was Unenforceable as Contrary to Public Policy

The Court of Appeals held that enforcing the Florida choice-of-law provision would violate New York public policy because Florida’s method of assessing restrictive covenants in employment agreements is contrary to New York’s public policy in three principal ways.

First, Florida law places a far lighter burden on employers’ attempts to demonstrate that a restriction on competition is reasonable. In Florida, an employer need only make a basic case for why the agreement is necessary to protect a legitimate business interest in order to shift the burden to the former employee to prove why the agreement should not be enforced. Brown & Brown opinion at 5.  In New York, however, the initial burden is on the employer to show that the agreement protects a legitimate interest, does not harm the employee, and does not harm the general public. If the employer fails to meet any of the three requirements, then courts will not enforce the covenant.

Second, Florida courts only consider the extent to which the agreement protects the employer’s interests without any concern for hardship to the former employee. New York courts, on the other hand, weigh any damage to the former employee’s livelihood when deciding whether to enforce restrictive covenants.

Third, if the language of the agreement is ambiguous, New York courts will read it as narrowly as possible. In Florida, however, courts will read ambiguous language as broadly as is necessary to protect the legitimate interests of the employer.

In short, the court held that “Florida’s nearly-exclusive focus on the employer’s interests, prohibition against narrowly construing restrictive covenants, and refusal to consider the harm to the employee” were so contrary to New York’s emphasis on balancing the interests of the employer, employee, and general public that the former employee in this case had carried the “heavy burden” of showing that the choice-of-law clause was invalid. Brown & Brown opinion at 7.

The Non-Solicitation Clause was Overbroad, but the Court Left Partial Enforcement on the Table

The court next decided whether the non-solicitation clause was valid under New York law. It found that the clause was overbroad on its face because it purported to ban the former employee from working with any of the former employer’s customers, even those with whom the former employee had no contact.

The court further considered whether it could partially enforce the clause—i.e., give effect to the restriction only to the extent necessary to protect a legitimate employer interest.  A New York court may modify a restrictive covenant, but only if the agreement was not the result of coercion, over-reaching, or other misconduct. In Brown & Brown, the Court held that summary judgment was not appropriate on this point because fact questions remained regarding the propriety of the former employer’s conduct. In particular, the Court noted that there was conflicting evidence as to whether the former employer may have used coercive bargaining power when it asked the employee to sign the employment contract after she had resigned from her prior position.

 

 

2014-2015 Restrictive Covenant Cases of Note (NY, NJ, CT)

June 2nd, 2015

By Michael A. Naclerio and Richard M. Reice

Employers often include restrictive covenants in their employment agreements in an effort to protect investments in employees, trade secrets, and customer information. These covenants can restrict a former employee’s ability to work for competitors, prevent solicitation of past clients, and otherwise limit the former employee’s labor rights. This post surveys how courts in New York, Connecticut, and New Jersey have enforced restrictive covenants in 2014 and early 2015.

New York

In the employment context, New York courts only enforce restrictive covenants that are reasonable in duration and geographic scope, necessary to protect the employer’s legitimate interests, not harmful to the public, and not unreasonably burdensome on the employee. See BDO Seidman v. Hirshberg, 93 N.Y.2d 382 (1999).

Identifying a Legitimate Employer Interest

New York law recognizes four broad and exclusive categories of interests that justify enforcement of restrictive covenants: protecting trade secrets, preserving confidential customer information, protecting a client base, and preventing irreparable harm that would result when the departing employee is highly specialized or unique.  In 2014 and 2015, courts applying New York law further elaborated what interests fit into these broad categories.

Veramark Technologies, Inc. v. Bouk, 10 F. Supp. 3d 395 (W.D.N.Y. 2014) and Fewer v. GFI Grp. Inc., 458, 2 N.Y.S.3d 428 (N.Y. App. Div. 2015) clarified what types of employees a court would consider “unique.” In Veramark, the Western District of New York rejected the employer’s argument that Mr. Bouk was “unique” solely by virtue of his top sales rank. The court in Fewer maintained that the company could no longer argue that an employee was unique after they had demoted him from the position that employed his unique skills.

In DS Parent, Inc. v. Teich, no. 5:13-CV-1489 LEK/DEP, 2014 WL 546458 (N.D.N.Y. Feb. 10, 2014), the United States District Court for the Western District of New York clarified what interests can be valid and protectable “trade secrets.” The court determined that general knowledge of strategy only merits protection as a trade secret when it accompanies a technological trade secret or if the strategy “involve[s] detailed information about new products.” Id at *9.

Partial Enforcement When the Restriction is Unreasonably Broad

When New York courts find that a restriction is unenforceable, they may still partially enforce it by striking only the unreasonable or overbroad clauses. In the past year, courts have hesitated to use this practice, known as “blue penciling.”

In Brown & Brown, Inc. v. Johnson, 980 N.Y.S.2d 631 (4th Dep’t 2014), the court declined to partially enforce an overbroad restriction, holding that blue penciling was only appropriate where the plaintiff could demonstrate “an absence of overreaching, coercive use of bargaining power, or other anti-competitive conduct.” In this case, the court inferred coercion, because the employer offered the employment agreement containing the restrictive language only after the employee had resigned her previous job in order to work for Brown & Brown.

“No Hire” Agreements

New York Courts apply the same test to “no hire” agreements that they apply to restrictive covenants. In Reed Elsevier Inc. v. TransUnion Holding Co. Inc., No. 13 CIV. 8739 PKC, 2014 WL 97317 (S.D.N.Y. Jan. 9, 2014), the United States District Court for the Southern District of New York applied the same three-prong reasonableness standard analysis used to assess non-compete clauses to determine the enforceability of the no-hire agreement between the two companies. The court neither completely nor partially enforced the two-year term of the no-hire agreement, because Reed Elsevier Inc. could not show that the agreement protected any legitimate interest. The court also rejected Reed Elsevier Inc.’s assertion that preventing attrition of current employees could be a legitimate protectable interest.

Connecticut

Connecticut courts balance the competing needs of the parties and the public, including the employer’s desire to protect legitimate business interests, the employee’s need to find alternative employment, and public policy virtue of ensuring a competitive labor pool. See Scott v. Gen. Iron & Welding Co., 171 Conn. 132 (1976). Unlike New York, Connecticut courts have tended to favor employers in restrictive covenant disputes.

In early 2015, the Superior Court of Waterbury strictly enforced a covenant not to compete against a nail salon technician in Imperial Coast, Inc. v. Hong Nga Nguyen, 59 Conn. L. Rptr. 709 (2015). The court declined to examine whether the restraint was necessary to protect legitimate employer interests, focusing instead on the burdens to the employee. The covenant only banned competition within a ten mile radius of the plaintiff’s nail salon, a distance that the court determined did not unduly burden the former employee.

The United States District Court for the District of Connecticut enforced a two-year, 100-mile noncompetition and non-sales agreement against a former employee of a building materials distributor in A.H. Harris & Sons, Inc. v. Naso, No. 3:14CV304 AWT, 2015 WL 1420132 (D. Conn. Mar. 30, 2015). Ms. Naso had challenged both restrictions on the grounds that previous courts had deemed even weaker restrictions unreasonable. The court rejected this argument, citing evidence that the industry was especially dependent on strong relationships between suppliers and customers to suggest that the covenants were reasonable to protect the employer’s interests.

New Jersey

Like New York, New Jersey courts will only enforce reasonable restrictive covenants that protect an employer’s legitimate interests, do not impose an excessive burden on the employee, and are consistent with public policy. In 2014 and 2015 the United States District Court for the District of New Jersey made several rulings on restrictive covenant issues.

In American Financial Resources, Inc. v. Money Source, Inc., No. CIV.A. 14-1651 JLL, 2014 WL 1705617 (D.N.J. Apr. 29, 2014), the court clarified that an employer could have a legitimate business interest in information that was generally available to the public. Even though the public could readily discover American Financial Resources’ customers and mortgage rates, the previous employees had used such knowledge about specific rates offered to specific clients to gain an unfair competitive edge at their new company.

The District Court of New Jersey partially enforced a broad non-compete agreement in Interlink Group Corp. USA, Inc. v. American Trade and Financial Corp, No. CIV.A. 12–6179 JBC, 2015 WL 733469.  The court determined that a five year non-compete agreement effective anywhere in the world was unreasonable, but the judge elected to partially enforce the competition restriction as a three year ban on competing in countries in which the plaintiff operates.

Conclusion

While New York, Connecticut, and New Jersey courts did not make any radical doctrinal changes in 2014 and 2015, they did give important signals about how they will apply existing law to new cases.  Courts in New York remain hesitant to wholly or partially enforce restrictive covenants, while Connecticut and New Jersey maintained a more employer-friendly view.

The Tyranny of the Litigation Hold Process

April 28th, 2015

In the past, restrictive covenant disputes often began with a boiler-plate cease-and-desist letter from an aggrieved former employer.  The letter usually began: “We have been retained by….and it has come to our attention…” and then reminded the former employee and perhaps his or her new employer of the former employee’s non-solicitation, confidentiality, and non-compete agreements.  The letter often ended with a demand that the employee cease all breaching conduct and a never-accepted invitation to “feel free” to contact the sender “should you have any questions.”  More often than not, such letters were ignored and thrown away.

Today, when most of our information is stored on disc drives and servers, not drawers and filing cabinets, cease-and-desist letters arrive with a set of lengthy and detailed instructions on how to initiate a “litigation hold” to preserve all evidence relating to hiring, employment, and commercial activities.  The chilling effect of these letters—which are often aimed at individuals with little legal expertise—is considerable.  Now, instead of circularly filing a cease-and-desist letter, the recipient is faced with a litigation-like obligation to locate and safeguard relevant documents and the often unwelcome prospect that internal documents related to recruiting and hiring may one day be open to scrutiny by others.  Thus, instead of hiring an employee who can hit the ground running, the new employer is faced with multiple complications.  Most employers don’t like complications.

The Duty to Preserve

The duty to preserve documents that may be relevant to a probable litigation started with a series of discovery-related decisions in the Southern District of New York case Zubalake v. UBS Warburgh LLC.  In addressing the plaintiff’s discovery requests relating to certain digital files and UBS’s spoliation (destruction) of certain backup tapes, Judge Shira A. Scheindlin articulated several standards that have become the norm across the country.  In her decision, Her Honor explained that “[o]nce a party reasonably anticipates litigation, it must suspend its routine document retention/destruction policy and put in place a ‘litigation hold’ to ensure the preservation of relevant documents.” 220 F.R.D. 212, 218 (S.D.N.Y. 2003).  In a later related decision, Judge Scheindlin explained that this requires counsel to communicate directly with the “key players” in the litigation regarding their preservation duties and issue periodic reminders.  Counsel should also “instruct all employees to produce electronic copies of their relevant active files” and “make sure that all backup media which the party is required to retain is identified and stored in a safe place.”  229 F.R.D. 422, 434 (S.D.N.Y. 2004).

Failure to preserve documents in the face of probable litigation can result in spoliation sanctions that could have a severe impact on one’s case.  In New York, a party may be sanctioned if the other side can show that evidence (regardless of form) was not maintained and that (1) the spoliating party had an obligation to preserve the evidence; (2) the evidence was destroyed with a culpable state of mind; and (3) the lost evidence was relevant to the other side’s claim or defense.  Sanctions can include an adverse inference or even a judgment against the spoliating party.

What To Do?

If an individual or a company receives a cease-and-desist or a demand letter that threatens legal action, it is likely that they are now under an affirmative obligation to initiate a litigation hold.  What are the issues to be sensitive to?  First, the recipient of a cease-and-desist letter should understand whether a duty to preserve evidence has been triggered.  Was the letter actually threatening litigation or just a “friendly” reminder about the terms of a restrictive covenant?  A duty to preserve arises under the former; under the latter, where litigation is possible but not necessarily probable, the recipient’s counsel should review case law in the relevant jurisdiction to understand the scope of any obligation to preserve.

Second, the recipient needs to consider what information to preserve.  To begin with, relevant evidence likely includes all documents relating to the employee’s sourcing, hiring, job duties, documents (electronic and hardcopy) brought over from his former employer, the hard drives on the new hire’s computers (both at home and at the office) and PDAs, and emails generated by the employee and the employer that relate to the employee’s job duties.  This obligation is ongoing until the requirement to preserve no longer exits.  Relevant documents should be preserved in their native format, be it hardcopy or electronic.

Third, how long must the recipient preserve relevant evidence?  The duty to preserve does not last forever, but it may well last the duration of the restrictive covenant and a reasonable period of time thereafter.  If some sort of arrangement is reached with the former employer and the threat of litigation is lifted, then the duty to preserve would be lifted as well.  Of course, if the cease-and-desist letter turns into actual litigation, then the relevant evidence should be preserved for the duration of the case.

Conclusion

Zubulake has spread like wildfire through local, state and federal courts and has resulted in new rules regarding electronic discovery.  In restrictive covenant cases, former employers are using it to put teeth to their cease-and-desist letters.  No longer just words on page, the letters now require action that may cost money, disrupt the normal operations of a business, and make that new hire—who may have come with some risk already—even more problematic.