Do Noncompetes Stifle or Encourage Innovation? Should you care?

The New York Times published an article yesterday discussing the increased use of noncompete agreements in nontraditional industries. The article starts by talking about a 19-year-old college student who had a job offer to work as a summer-camp counselor withdrawn as a result of a noncompete agreement she signed at another camp:

Colette Buser couldn’t understand why a summer camp withdrew its offer for her to work there this year.

After all, the 19-year-old college student had worked as a counselor the three previous summers at a nearby Linx-branded camp in Wellesley, Mass. But the company balked at hiring her because it feared that Linx would sue to enforce a noncompete clause tucked into Ms. Buser’s 2013 summer employment contract.

The article also talks about a lawn-maintenance person, an entry-level social-media marketer,  and a hairdresser, all of whom had to sign restrictive covenants.

As more and more employers require restrictive covenants, there has been increased push-back. Against the backdrop of Massachusetts’ proposed ban on noncompetes, the article goes on to discuss arguments for and against employee restrictive covenants. Some argue that noncompetes stifle innovation:

“Noncompetes are a dampener on innovation and economic development,” said Paul Maeder, co-founder and general partner of Highland Capital Partners, a venture capital firm with offices in both Boston and Silicon Valley. “They result in a lot of stillbirths of entrepreneurship — someone who wants to start a company, but can’t because of a noncompete.”

Employers argue that the opposite is true:

“Noncompetes reduce the potential for poaching,” said Mr. Hazen, whose company makes scratch lottery tickets and special packaging. “We consider them an important way to protect our business. As an entrepreneur who invests a lot of money in equipment, in intellectual property and in people, I’m worried about losing these people we’ve invested in.”

There has always been a dispute about restrictive covenants’ effect on macro-level economic health. From my perspective, I am more concerned about using restrictive covenants to my clients’ benefit, as opposed to resolving this dispute; the policy implications of restrictive-covenant law are irrelevant to companies trying to protect their proprietary information. But the article leaves out a real-world benefit: increased certainty for employers and employees.

When permitted to use restrictive covenants, employers and employees have a better understanding of what will happen when the employer/employee relationship terminates. Employers can more comfortably share proprietary information with their employees, knowing that the restrictive covenants protect the employers’ interests. And employees know the precise limitations on their future employment, which can better inform their employment-related decisions.

Regardless, as I’ve discussed over and over, companies seeking to protect their proprietary information need to consider whether to require restrictive covenants. As long as the applicable jurisdiction permits them, restrictive covenants are often a company’s most powerful weapon to prevent unwanted disclosure.

Novel Legal Strategy Deflates Employer’s Trade-Secrets Case

Recently, in Putters v. Rmax Operating, LLC, 2014 WL 1466902 (N.D. Ga. April 15, 2014) (opinion linked below), the court dismissed a counterclaim for trade-secrets misappropriation, brought in response to a declaratory judgment action filed by the defendant’s former employee. When I first read this opinion, I thought that the defendant did not move fast enough, thereby allowing the plaintiff to select the forum. When I dug further, however, I found out I was wrong.

In this case, the defendant is a Texas company that manufacturers insulation materials. The plaintiff worked for the defendant for 26 years in Georgia as a sales manager, and had access to the defendant’s confidential information. After the plaintiff left the defendant to work for a competitor, the defendant discovered that the plaintiff “had downloaded documents containing proprietary and confidential information to an external hard drive.”

While not clear from this opinion, the complaint gives the back story. A copy is linked below. The defendant originally filed suit in Texas state court and obtained an ex parte temporary restraining order prohibiting the plaintiff from working for his new employer.

After that, the plaintiff made an interesting legal maneuver. He filed this lawsuit in Georgia state court, seeking a declaration that he is permitted to continue working for his new employer, and an injunction prohibiting the defendant from prosecuting the Texas action, since Texas courts did not have personal jurisdiction over him.

This maneuver worked. The case (after being removed to federal court) is proceeding in Georgia federal court, where the court dismissed the defendant’s counterclaim and denied the defendant’s request for a TRO.

Normally, when a defendant believes that there is no personal jurisdiction over him, he will simply litigate that issue in front of the court where the plaintiff filed the lawsuit. Here, the employee took an entirely different course and successfully redirected the litigation to a different forum. And he was able to get the case in front of a judge with much more favorable views of his case.

Takeaway: Companies should be wary of personal-jurisdiction issues when filing trade-secrets lawsuits. The last thing you want is to be bogged down in a personal jurisdiction fight before the court will even hear a temporary injunction motion. Or, even worse, you could end up like the employer in this case, who spent time and money getting a TRO, only to be whisked away to a Georgia court with a very different view of the employer’s arguments.

Also, had this company simply had its employees sign restrictive covenants (including a venue and jurisdiction clause), they would be in a far better legal position.

Order

Complaint

CREATe.org/PwC Report Makes the Case for Investing in Trade-Secret Protections

“Historically, . . . [trade secret protections] have been viewed as a cost, not an investment.” CREATe.org and PwC recently released a report titled “Economic Impact of Trade Secret Theft: A framework for companies to safeguard trade secrets and mitigate potential threats.” If you read this blog, you should read the report.

Next week, I will be interviewing for this blog one of CREATe.org’s principals responsible for the report. (CREATe.org is a non-profit “dedicated to helping companies and their suppliers and business partners reduce counterfeiting, piracy, trade secret theft and corruption.”)

The report seeks to change the mentality described in the above quote. It starts by estimating the cost of trade-secret theft, and concludes (based on a review of various proxies for trade-secret theft) that economic losses based on trade-secret theft amount to between 1 and 3 percent of GDP. Hopefully, numbers like this draw greater attention to the real risks companies face.

It next outlines of categories of “threat actors” — those who seek to steal trade secrets. These include nation states, malicious insiders (including current and former employees, third-party consultants, and suppliers), competitors, transnational organized crime, and hacktivists (who try to use corporate information for political or social purposes).

Regarding employees, the report notes that “cultural and technological factors may heighten the insider threat in coming years . . . The nature of U.S. employees’ loyalties to their employers is changing because of the much higher rate of lifetime job changes.” The report also identifies “bring your own device” policies as an increased risk.

The report presents a framework for companies to identify and evaluate their trade secrets, audit their current protections, and make value-based improvements to these protections based on measuring ROI. This approach involves key stakeholders, educates them about the risks of trade-secret theft, and helps make the business case for protections.

While I have some issues with the framework (which, if handled improperly, could create documents that may undermine litigation efforts, and would likely need to be altered for many small mid-sized businesses), it provides a comprehensive, incredibly useful starting point and roadmap.

Next week, I’ll examine the report in greater depth when I interview CREATe.org.

New Year, New Trade-Secrets Issues

Now that New Year’s is behind us, companies face one of the riskiest times of the year for protecting their trade secrets and proprietary information.

As I’ve discussed in the past, employee departures present perhaps the greatest risk of unwanted trade-secret disclosure. And many employees who want to leave wait until after they receive their year-end bonus. With this increased employee movement comes an increased risk of misappropriation.

This is a great time of year to review employee intake and exit procedures. Departing employees need to be made aware of their legal obligations regarding the company’s proprietary or confidential information. This is best done through an exit interview. Whenever possible, a departing employee should sign an acknowledgement of her obligations.

During the exit interview, the company should learn as much as possible about where the employee will be working next. This helps identify situations where proprietary information is at risk. In such situations, an attorney should be consulted. For more details about exit interviews, see this prior post.

Similarly, when hiring new employees, companies need to make sure the new employees will not be violating any restrictive covenants signed with former employers. During the hiring process, potential new hires need to be asked directly whether they have signed any such agreements. And once hired, they should confirm this in writing. If a company wants to hire someone who signed a restrictive covenant with a former employer, the company must consult with an attorney first.

If the new employee will be bound by a restrictive covenant such as a noncompete, make sure it is actually signed. (This may seem obvious, but it’s not uncommon for a noncompete agreement to go unsigned.)

By improving employee intake and exit procedures, companies can significantly reduce the risk of trade-secret misappropriation and expensive litigation.

Trade-Secrets Trial Post-Mortem

Several months ago, I tried a trade-secrets case in front of a jury and obtained a liability verdict in my client’s favor. This week, the case settled in advance of Monday’s scheduled damages trial. (Thus explaining the shortage of posts lately; I’ve been preparing for trial.) Now that it has settled, I’m going to write a series of posts about this case, since it illustrates how companies can better protect their proprietary information and the consequences of failing to do so.

My client provides services to hotels and is the largest company in its industry within its geographic market. After its sales director quit, my client found out that for at least the prior two years, he had been secretly setting up a competing company. Shortly thereafter, the sales director’s new company took my client’s largest and most important client. Since then, his company has become our largest competitor.

While we had a compelling story, we also had some problems. In particular, the sales director was not subject to a noncompete agreement. And we had limited direct evidence that his company was using my client’s proprietary information. But there was plenty of circumstantial evidence.

We sued for violations of Florida’s Trade Secrets Act, tortious interference with business relationships, and violations of the Florida Deceptive and Unfair Trade Practices Act. From the outset, we knew we would have difficulty proving misappropriation of trade secrets, though we certainly had a good-faith basis for bringing that claim. Since there was no noncompete and we had limited hard evidence, we were hesitant to seek a temporary injunction. Instead, we proceeded with discovery. Because civil cases in Florida state court proceed slowly, it took four years between complaint and verdict.

At trial, the court directed a verdict against my client on the Trade Secrets Act claim, but allowed the tortious interference and deceptive-and-unfair-trade-practices claim to go to the jury. They took less than an hour to enter their verdict in our favor.

Had my client simply required its key employees to sign noncompete agreements, this case would have ended much earlier. We would have immediately moved for, and likely won, injunctive relief. In fact, with a noncompete, I believe the defendant never would have tried to open a competing company (he was being paid handsomely by my client). Instead, my client lost significant business, and had to suffer through and pay for years of litigation. While the ultimate result was very favorable for them, no company wants to endure this type of process.

So the critical lesson from this case, as has been repeated often in these pages, is that companies need to have their key employees sign restrictive covenants, including noncompte and nonsolicitation agreements.

In future posts, I’ll discuss some unique aspects of this case, including how we used a consumer-protection statute to get around the lack of a noncompete, and why we were unable to prove our misappropriation claim. I’ll also talk about how we were able to use a bifurcated liability and damages trial to our advantage.

Trade Secret Injunctions Are Not Automatic — Beware of Equitable Defenses

Companies bringing lawsuits based on a noncompete or misappropriation of trade secrets routinely seek an injunction. For example, a former employer seeking to enforce a noncompete will often ask the court to block the former employee from working for a competitor.

Because an injunction is an equitable remedy—as opposed to a legal remedy, such as seeking money damages—the defendant is permitted to raise certain equitable defenses not available when the plaintiff is solely seeking money damages. This includes the defense of unclean hands, under which a plaintiff is not entitled to equitable relief—like an injunction—if it has acted inequitably or in bad faith. (Important point: these defenses can vary from state to state.)

So if the former employee can convince the court that the former employer acted inequitably, the injunction motion is likely to be denied. As part of their equitable defenses, defendants often argue that they were coerced into signing a noncompete, or that the former employer did not mention the noncompete until after the former employee had quit his prior job.

While it’s impossible to prevent a defendant from lobbing unfounded accusations, employers can take steps as part of the hiring process to circumvent these equitable defenses.

If an employer is going to require a noncompete or other restrictive covenant, inform prospective employees early in the hiring process. If there is a job posting, consider including this requirement. Of course, the employer needs to balance the risk of deterring applicants with the risk of increased difficulty obtaining an injunction. Consider giving prospective employees a handout at the initial interview describing the position and disclosing that any job offer will be subject to signing restrictive covenants. Certainly, any offer letter should make clear that it is subject to the employee entering into all required restrictive covenants.

Too often, companies assume that their restrictive covenants will automatically protect them, without thinking proactively about making sure that they are putting themselves in the best position to enforce these agreements down the road. Taking these simple steps can make a big difference if it becomes necessary to litigate.

I Forgot About My Noncompete!

Recently, I was retained by a client with an all-too-common story: one of its former employees, who signed a noncompete agreement, was working for a competitor and soliciting the client’s customers. I sent the former employee and his new employer a cease-and-desist letter, attaching the signed noncompete.

The next day, I got a call from the former employee. He said that he had forgotten that he had signed the noncompete years before. And he told me that he had quit his job with the competitor (which I had him and the competitor confirm in writing), and that he would no longer do work in my client’s field.

I have no idea whether the former employee really forgot about the noncompete, though I doubt it. More likely, he knew he had signed a noncompete, but he just hoped that my client wouldn’t enforce it. Regardless, this situation shows how important it is to address a departing employee’s noncompete obligations before he leaves the company.

The most efficient, effective way to handle this is through an exit interview. During the interview, the departing employee should be given a copy of his noncompete agreement and asked to sign an acknowledgement of his noncompete obligations. This sends the message that the company is serious about enforcing the agreement, hopefully deterring the departing employee from otherwise disregarding his obligations.

The exit interview also gives a company an opportunity to gather intelligence about whether there is a risk that the departing employee may violate his noncompete. If a departing employee refuses to sign the acknowledgement, or is evasive when asked about his next job, it may be worth consulting with an attorney to figure out how to proceed.

In my client’s case, there’s a good chance that had they conducted an exit interview, the former employee never would have accepted a job with their competitor.

PR in Trade Secrets Lawsuits

In my last few posts, I’ve been discussing issues in the noncompete lawsuit filed by 50 Eggs, a Miami restaurant group, against one of its former executive chefs. This case not only has a lot of interesting legal issues, but it shows some of the out-of-court risks accompanying this type of lawsuit. In particular, 50 Eggs and its founder, John Kunkel, have opened themselves up to some bad PR.

This lawsuit has received a good amount of press coverage locally. The initial stories focused on 50 Eggs’ accusations against Chef Bee. Now, Chef Bee’s attorneys have fired back with a PR campaign of their own, including apparently circulating their colorful motion to dismiss (linked below) to the press. They take aim at both 50 Eggs and Kunkel, including the following passage, which has appeared in the Miami Herald and other local publications:

“To Kunkel” is acquiring a hire – liar – fire cache in the Miami restaurant business, as that appears to be 50 Eggs’ pattern with its executive chefs: to hire them, accuse them of lying, and then fire them (or cause them to quit) . . . None of the original chefs or original equity partners in the 50 Eggs organization has survived; thus, if it is true that “the executive chef is designated as the ‘face’ of the restaurant” . . . , 50 Eggs has de-faced all of its restaurants. Now, Chef Bee too has been Kunkeled.

This is just one example of how the defendant is now using PR to build public support and attack 50 Eggs/Kunkel.

While there are certainly circumstances when a lawsuit is necessary to protect critical proprietary information, there are many others where the decision to file a lawsuit is a closer call. In these situations, it is worth considering whether there are out-of-court risks that tilt the scale one way or another.

PR issues can be one such consideration. Trade-secrets and noncompete lawsuits can attract media attention, particularly if one party seeks it out. Even if 50 Eggs’ claims are successful (and it faces significant legal hurdles, including an unsigned noncompete), it has suffered some damage to its reputation. At a minimum, companies considering whether to file a noncompete or trade-secrets lawsuit should consider whether the opposing party has ammunition to use in a PR fight.

Chef Bee’s Motion to Dismiss

Restaurant Noncompete Lawsuit, Part 2

Previously, I gave some background on the lawsuit filed by 50 Eggs Restaurant Company against its former chef, Chef Bee. I also discussed a hurdle 50 Eggs will have to overcome, namely that Chef Bee never electronically signed the noncompete agreement. Now, let’s take a closer look at 50 Eggs’ employment agreement.

Attached to the complaint (linked below) is 50 Eggs’ Nondisclosure and Noninterference Agreement. This contains strict nondisclosure obligations that broadly describe the types of information that must be kept confidential. While this agreement does a good job giving general examples of confidential information, there are no restaurant-specific examples. Nondisclousre agreements should include categories of information that are important in the relevant industry. So here, 50 Eggs could have included, for example, proprietary recipes in the definition of confidential information.

The agreement also contains a two-year nonsolicitation clause. In the restaurant industry, it is important to keep a departing chef from bringing other employees with her. This is particularly true in the case of a celebrity chef, who may have significant sway over more junior chefs.

50 Eggs also had Chef Bee sign a “nondisparagement and brand protection” covenant. While this contains typical nondisparagement obligations, it also addresses the critical role social media plays in the restaurant business. This agreement prohibits the chef from directly or indirectly referring to the restaurant on any social media, unless authorized by 50 Eggs.

As social media has evolved, companies have used varying strategies to address employees’ social-media use. 50 Eggs takes a very restrictive approach. While this may prevent employees from saying negative or damaging things about the restaurant on twitter, etc., it also stifles social media “buzz.” When employees are enthusiastic about the restaurant, they are likely to share this enthusiasm on their personal social media accounts, which can be forwarded by their friends, and so on. By prohibiting social-media use, 50 Eggs is losing potentially valuable word of mouth.

The agreement also contains several riders, including the noncompete agreement. I’ll examine these in a future post.

Complaint – 50 Eggs Restaurant (01330302)

Restaurant Noncompete Lawsuit, Part I

In a recent post, I talked about how a Miami restaurant group, 50 Eggs Restaurant Company, dealt with the departure of a “celebrity chef,” known as Chef Bee, from its restaurant Khong River House. Now, 50 Eggs has filed a lawsuit against Chef Bee. A copy of the complaint is linked below.

This lawsuit pulls back the curtain on the development and opening of a high-profile restaurant. And it offers insights into and lessons about protecting proprietary information in the restaurant industry. This is the first in a series of posts discussing the lawsuit. I’m going to start by giving some background on the dispute (as alleged in the complaint) and then discussing one major hurdle 50 Eggs will need to overcome.

50 Eggs is a restaurant group based in South Florida. The complaint describes its marketing philosophy when opening a new restaurant: “the restaurant’s executive chef is designated as the ‘face,’ that is, the spokesperson, for the restaurant.” This is done because “diners generally know of the position ‘chef’ and thus equate everything about a restaurant with whoever is the chef.”

But 50 Eggs says that “the concept for a restaurant may come from a person who is not the executive chef.” Here, 50 Eggs’ CEO John Kunkel’s experience living in Thailand inspired the Khong River House concept.

While Kunkel was originally in negotiations with a New York chef to serve as Khong’s executive chef, he changed course when a local Miami chef he had befriended, Chef Bee, told Kunkel that Bee’s Thai restaurant was having financial difficulties and needed to close. Kunkel ended up hiring Chef Bee.

Chef Bee signed an offer of employment, which referenced the requirement that he sign 50 Eggs’ “standard non-compete agreements.”

50 Eggs uses a system that allows employees to electronically sign documents. Here’s where 50 Eggs may have a problem. The restrictive covenant agreement has several riders, including the noncompete provision. When Chef Bee electronically signed, he did not check the boxes to sign the riders, and thus his electronic signature was not included on those riders. I’ll discuss this in a moment.

After hiring Chef Bee, 50 Eggs “made substantial investments in public relations for the restaurant and making Chef Bee the ‘face’ of the restaurant.” But in the lead up to the restaurant’s opening, bizarre issues started to arise with Chef Bee. He was not contributing to the creation of recipes. He disappeared, only to be found working at his old Thai restaurant. Chef Bee said “he would get sick and break out in hives if he had to cook.” 50 Eggs also discovered that Chef Bee could not cook Thai dishes or run a professional kitchen, so it spent significant time training him by rotating him through Khong River House’s food stations. (It seems strange to me that a restaurant group like 50 Eggs would hire a chef without knowing that he could actually cook and operate a sophisticated kitchen. Perhaps we will learn more about this as the litigation progresses.)

Shortly after the training completed, Chef Bee resigned to open a restaurant in nearby Coral Gables. 50 Eggs now accuses him of taking 50 Eggs’ proprietary information and breaching the noncompete and nonsolicitation covenants. It alleges a number of contractual, tort, and statutory claims. It seeks damages and an injunction.

Back to the electronic signature. In Florida, the restrictive covenant statute provides that “A court shall not enforce a restrictive covenant unless it is set forth in a writing signed by the person against whom enforcement is sought.” Sec. 542.335(1)(a), Fla. Stat. Per the complaint’s own allegations, Chef Bee never signed the noncompete provision. This could present a significant obstacle. 50 Eggs is using several strategies to get around this problem, such as seeking to have the contract reformed based on either mutual or unilateral mistake. Time will tell whether the court will enforce the noncompete.

Using electronic signatures is becoming more and more common. But if companies are going to use this type of technology, it is critical to make sure that employees actually sign all necessary documents. If not, the company will likely face legal hurdles if it becomes necessary to enforce the contracts.

In future posts, I’ll discuss other interesting legal and factual issues in this case.

Complaint – 50 Eggs Restaurant (01330302)

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