Can Filing for Bankruptcy Invalidate a Noncompete?

Guest post by Solomon B. Genet.

Debtors and their lawyers sometimes use a bankruptcy filing as an offensive tool. In a recent case, a debtor tried to use his prior bankruptcy to shed his non-compete obligations. While this attempt was not successful, non-compete practitioners should be aware of this effort.

In In re Capps, a July 26, 2018 decision from the District of Kansas Bankruptcy Court, the individual debtor sold his company and signed an employment agreement with the buyer, agreeing to a series of non-compete, non-solicit and confidentiality obligations. The debtor later filed for bankruptcy, and the buyer fired him soon thereafter.  The buyer then discovered that the debtor was breaching his restrictive covenants and brought an action for declaratory relief in the bankruptcy court seeking a finding that the bankruptcy process and discharge did not relieve him of these obligations.

Bankruptcy Judge Nugent agreed with the plaintiff-buyer and rejected the debtor’s arguments, reasoning that: (1) the debtor’s breaches of the restrictive covenants occurred post-bankruptcy, and gave rise to “equitable” (i.e., injunctive) relief and not “a right to payment,” so the debtor did not discharge any debts arising from the agreements; and (2) the restrictive covenants were not “executory” contracts (material obligations on both sides), and therefore could not be rejected through the bankruptcy process.

The Capps debtor was unsuccessful in shedding his obligations.  But—hypothetically—a strategic legal counselor could use the Capps debtor’s arguments in a case with more favorable facts (and perhaps different applicable law) to assist a person subject to a non-compete to obtain relief long before his contracted time-period for his non-compete obligations expired.

A copy of the opinion can be downloaded here.

Federal Court Addresses Defend Trade Secret Act Immunity

The Defend Trade Secrets Act, 18 U.S.C. 1030, et seq., provides immunity from liability for misappropriation of trade secrets in certain circumstances, namely if the disclosure:

(A) is made–

(i) in confidence to a Federal, State, or local government official, either directly or indirectly, or to an attorney; and

(ii) solely for the purpose of reporting or investigating a suspected violation of law; or

(B)  is made in a complaint or other document filed in a lawsuit or other proceeding, if such filing is made under seal.

Since the DTSA was enacted in May 2016, there have not been many cases analyzing this portion of the statute. The Eastern District of Pennsylvania examined it in a recent opinion, Christian v. Lannett Co., Inc., E.D. Pa. Case No. 16-963 (the opinion can be downloaded below).

Christian is an unusual trade-secret case, as it started when the plaintiff asserted claims for employment discrimination. During discovery, the defendant learned that the plaintiff had retained a company laptop, which led to the plaintiff producing 22,000 pages of documents. Per the defendant, these contained trade secrets.

The defendant then filed a counterclaim under the DTSA, as well as other related claims, based on the plaintiff’s disclosure of trade secrets. But there was apparently no evidence of disclosure to anyone except the plaintiff’s lawyer, who only received the documents to produce them in the litigation.

The court concluded that “Plaintiff’s alleged disclosure was made to Plaintiff’s counsel pursuant to a discovery Order of this Court, within the context of a lawsuit regarding violations of Title VII, the ADA, and the FMLA,” and applied the immunity provision above to bar the DTSA claim.

The court did not specifically cite the immunity provision. And a strict application of that provision would seem to exclude the plaintiff from its protection, since the disclosure was not “solely for the purpose of reporting or investigating a suspected violation of law.” But the court’s decision is well within the spirit of the DTSA, which should not be used to prevent parties in litigation from communicating freely with, and providing discoverable documents to, their counsel.

Christian v Lannett

 

Will Two Lawyers Go to Jail for Asserting Trade Secrets in Bad Faith?

Two South Florida lawyers are facing possible jail time, in part because of allegedly asserting in bad faith that documents contained trade secrets. They supposedly wanted to prevent disclosure of documents that proved their witness testified inaccurately. In a case pending in Miami-Dade County Circuit Court, Green Tree Servicing v. Sibon, the judge decided yesterday to go forward with an arraignment for the two lawyers representing the plaintiff, a large loan servicer, on charges of indirect criminal contempt.

This started as a mortgage foreclosure case. The defendants asserted defenses relating to the plaintiff’s “loan boarding” process, i.e., how the plaintiff uploads information from prior servicers’ records, including borrowers’ payment history.

During a deposition, the plaintiff’s representative testified that the company’s training manuals included protocols for verifying this information, including a flow chart showing the process. But the plaintiff had not previously produced those manuals. Not surprisingly, the defendants’ lawyers demanded their production.

The court entered an order requiring production of the manuals and a further deposition of the plaintiff. Three days before the deposition, the plaintiff filed an emergency motion, asserting that the manuals contained trade secrets and work product. The next day, the court entered an order ruling that the motion was not an emergency and directed the plaintiff to set the motion for a hearing (the usual protocol in Miami-Dade Circuit Court for having a judge rule on a motion).

The deposition went forward without production of the manuals. But the plaintiff never set its emergency motion for hearing. Several months later, the court entered an order requiring production of the manuals by noon that day. At 11:59, the plaintiff produced them.

Apparently, the manuals contradict the witness’s testimony. According to the judge, “the document does not contain any ‘flow chart’ that mentions ‘red flags’ that prevent loans from boarding as Mr. Ogden testified he reviewed. To the contrary, it appears from the document produced that [the plaintiff] boards the prior servicer’s records . . . and makes the loan live on its system before any verification process would even begin.”

And then it got interesting. The judge entered an order to show cause, which can be downloaded here. That order informs both the witness and the plaintiff’s attorneys that “this is now a criminal matter” and directs them to appear to show cause why they should not be held in indirect criminal contempt:

It appears that [the plaintiff] and its counsel willfully and contumaciously ignored this Court’s order by refusing to turn over the training materials. Moreover, it appears [the plaintiff] and its counsel improperly sought to have the records deemed confidential to avoid disclosure of the fact that its witness gave grossly inaccurate testimony[.]

According to an article in the Daily Business Review, yesterday, the new judge handling the case (the prior judge recused himself) “ruled that [the witness] was ‘operating at the will of the lawyers’ and dismissed him from the criminal contempt proceedings.” But she will be going forward with the criminal case against the lawyers, pending an appeal.

If true, this is an egregious abuse of the trade-secrets laws. It’s one thing to be over broad when asserting trade-secret protection. It’s another thing entirely to assert trade secrets when none exist, solely to hide a witness’s inaccurate testimony. It will be interesting to see whether these lawyers are sanctioned, and if so, how harshly.

Florida Companies: Are Your Non-Competes Missing This Critical Provision?

Under Florida’s restrictive-covenant statute, Section 542.335(f), a restrictive covenant is only enforceable by a successor entity or third-party beneficiary if the agreement so provides. This provision can become very important following corporate merger or sale transactions. Or in the due-diligence period leading up to those transactions.

In a recent Florida case, Collier HMA Physician Mgmt, LLC v. Menichello, the plaintiff almost fell victim to this statutory requirement. A copy of the opinion can be downloaded here.

In this case, the plaintiff owns a healthcare business employing approximately 40 doctors. It also operates two hospitals and clinics. The defendant, a physician, previously worked for the plaintiff, where he signed a non-compete agreement prohibiting him from working for certain of the plaintiff’s competitors. After his departure, he accepted a position with one of those competitors, and the plaintiff filed suit.

The physician argued that a merger transaction involving the plaintiff’s corporate parent triggered the statutory provision above. Per the physician, since the agreement did not expressly provide for enforcement by successors, the merger invalidated the non-compete. The trial court agreed and granted summary judgment in the defendant’s favor.

The appellate court reversed. To reach that conclusion, it interpreted the term “successor” in the statute as “a corporation that, through amalgamation, consolidation, or other assumption of interests, is vested with the rights and duties of an earlier corporation.”

The court found that “the status of [the plaintiff] after the merger does not comport with the standard definition of a successor as it relates to corporations or other business entities.” In particular, there were several tiers of corporate entities between the plaintiff and the parent company that was subject to the merger. While the ownership of the ultimate parent company changed, “nothing about the corporate structure or ownership of [the plaintiff] was different after the merger”; it “continued in existence as a single member limited liability company.”

In the end, the plaintiff here was able to enforce its non-compete agreement. But all of this trouble could have been avoided. This leads to a very simple takeaway: when drafting restrictive covenants in Florida, include a provision allowing their enforcement by successors and assigns. Florida companies with existing restrictive-covenants should have a lawyer review them for compliance with this statute.

Similarly, anyone considering acquiring or merging with a company with Florida employees/independent contractors needs to have a lawyer review any restrictive covenants for this purpose.

The failure to include this provision could lead to all sorts of problems. For example, it could impede a later merger or sale of the company. But any Florida company can avoid these problems by having a lawyer conduct a simple review.

 

ABA Ethics Opinion: Trade-Secrets Lawyers Need to Encrypt Emails

By definition, lawyers working on trade-secrets issues, whether in litigation or otherwise, have access to their clients’ most confidential information. And, of course, these lawyers routinely communicate with clients via email, including about the trade secrets. Sometimes, even the trade secrets themselves are exchanged via email.

This raises ethical issues. Recently, the ABA Committee on Ethics and Professional Responsibility issued a formal opinion addressing lawyers’ ethical obligations when transmitting confidential client information. The opinion can be downloaded here.

All lawyers who deal with trade-secrets issues should read the opinion. But here are some highlights:

The opinion recognizes that law firms are hacking targets because:

(1) they obtain, store and use highly sensitive information about their clients while at times utilizing safeguards to shield that information that may be inferior to those deployed by the client, and (2) the information in their possession is more likely to be of interest to a hacker and likely less voluminous than that held by the client.

It then discusses applicable ethical rules, concluding that “lawyers must exercise reasonable efforts when using technology in communicating about client matters.” So what are reasonable efforts?

What constitutes reasonable efforts is not susceptible to a hard and fast rule, but rather is contingent upon a set of factors. In turn, those factors depend on the multitude of possible types of information being communicated (ranging along a spectrum from highly sensitive information to insignificant), the methods of  electronic communications employed, and the types of available security measures for each method.

The opinion specifically mentions lawyers who deal with trade secrets, since those matters “may present a higher risk of data theft.” The fact-based analysis is often relatively simple in trade secrets cases: if you are transmitting your client’s trade secrets or related information, you may need to use “particularly strong protective measures”:

A fact-based analysis means that particularly strong protective measures, like encryption, are warranted in some circumstances. Model Rule 1.4 may require a lawyer to discuss security safeguards with clients. Under certain circumstances, the lawyer may need to obtain informed consent from the client regarding whether to the use enhanced security measures, the costs involved, and the impact of those costs on the expense of the representation where nonstandard and not easily available or affordable security methods may be required or requested by the client. Reasonable efforts, as it pertains to certain highly sensitive information, might require avoiding the use of electronic methods or any technology to communicate with the client altogether, just as it warranted avoiding the use of the telephone, fax and mail in Formal Opinion 99-413.

There is a simple takeaway for all trade-secrets lawyers: think very carefully about how you are transmitting confidential client info. This requires an open dialogue with the client. You need to figure out how you will be protecting this data while in transit (and at rest, but that’s a separate issue). At my firm, we have the capacity to encrypt individual emails on-demand, which can allow for secure transmission of sensitive data.

But this sensitive data isn’t only shared with clients. Often, it will need to be produced in litigation. Lawyers spend a lot of time negotiating protective/confidentiality orders with attorney’s eyes only (AEO) protections. But don’t forget to securely transmit AEO documents to the other side. For example, my firm uses a secure/encrypted document sharing platform.

Trade-secrets cases often move fast. But this ABA opinion shows that regardless of how intense the litigation becomes, lawyers must be cognizant of their obligations to protect clients’ confidential information.

Florida’s Restrictive Covenant Statute: The Power of Presumption

Florida has one of the most employer-friendly restrictive-covenant statutes in the country, Section 542.335, Fla. Stat. For example, the statute prohibits judges from considering any hardship suffered by the person against whom enforcement is sought. The statute also contains a rebuttable presumption that a violation of an enforceable restrictive covenant creates irreparable injury. Yesterday, Florida’s Third District Court of Appeal (which covers Miami-Dade County) issued an opinion showing the power of this presumption. The opinion, in Allied Universal Corp. v. Given, can be downloaded here.

Allied manufactures and distributes water-treatment chemicals. Defendant Given worked as a regional sales manger for Allied and signed a non-compete agreement. As part of his employment, he received training regarding various aspects of Allied’s business. Given resigned from Allied to work for Univar, a company that competes with Allied. Allied filed suit and sought a temporary injunction, which the trial court denied on the grounds that Allied failed to show irreparable harm.

The appellate court focused on the rebuttable presumption of irreparable injury and described the evidence offered by Allied:

At the evidentiary hearing on the motion for temporary injunction, Allied presented unrebutted evidence of the existence of statutorily legitimate business interests to be protected and evidence that Given had substantial relationships with specific prospective or existing Allied customers. Allied’s president, Mr. Palmer, testified that his company had trained Given, over the course of Given’s six-year employment, in its manufacturing and production techniques, marketing strategies, and confidential pricing strategies. In addition, Given had knowledge of existing and prospective customers, and had been sent to several trade meetings to cultivate these contacts.

Thus, the court concluded that Allied had successfully shifted the burden to Given to establish the absence of irreparable injury. But Given “failed to present any such evidence.”

Interestingly, Given argued that because he had not yet begun actively working for Univar, he had not breached the noncompete and no damages were incurred. But he admitted that if he were not enjoined, he would start working for Univar. The court rejected this argument, noting that “the only focus at the preliminary injunction stage is to maintain longstanding relationships and preserve the company’s goodwill.” In the future, plaintiffs can use this language to highlight the need to maintain the status quo.

Given Florida’s employer-friendly restrictive-covenant statute, noncompete and related agreements are powerful tools for Florida companies seeking to protect trade secrets and proprietary information. Cases like Allied show how this statute makes it easier for an employer to obtain an injunction prohibiting violations of a restrictive covenant.

Another Federal Court: No Heightened Pleading Standard in Defend Trade Secret Act Cases

Previously, I wrote about a decision from the District of New Jersey that declined to apply a heightened pleading standard to Defend Trade Secret Act claims. Now, another federal court has reached the same conclusion. A copy of the opinion can be downloaded below.

In Aggreko, LLC v. Barreto, pending in the District of North Dakota, the plaintiff and one of the defendants, Elite Power, are competitors in the generator-renting industry. Defendant Barreto previously worked as Aggreko’s sales manager. Aggreko alleges that Barreto resigned under false pretenses, thereby hiding his intention to work for Elite Power. And on the way out, Barreto allegedly downloaded Aggreko’s trade secrets and confidential information. Aggreko sued Elite Power and Barreto for violations of the Defend Trade Secret Act, among other claims.

The defendants moved to dismiss, arguing that Aggreko failed to plead its misappropriation claims with sufficient particularity. The court rejected this argument:

All that is required at this stage of the proceedings is an allegation that Barreto misappropriated Aggreko’s trade secrets sufficient to put the defense on notice as to the nature of the claim. Aggreko has alleged Barreto wrongfully acquired its trade secrets and provided them to Elite Power. Aggreko describes its trade secrets as including customer lists and information regarding Aggreko’s operations, customers, business proposals, pricing strategy, client preference and history, and proprietary pricing models known only to Aggreko; a description which the Court finds is clearly adequate under Rule 8. The discovery process will provide the parties with the details relevant to the claims, most of which are known to Barreto.

In this case, it sounds like the plaintiff only offered high-level allegations of the trade secrets at issue. And those allegations survived a motion to dismiss. This, along with the case discussed in my prior post, should be encouraging to trade-secret plaintiffs who are leery of a possible heightened pleading standard in federal court.

Aggreko v. Barreto Order

Federal Court Denies Expedited Discovery In Defend Trade Secret Act Case

Trade-secret-misappropriation cases can move fast. Often, the plaintiff files a motion for temporary restraining order alongside its complaint. Sometimes, the plaintiff has enough evidence already to justify a TRO. Other times, the plaintiff needs to take discovery before the TRO hearing.

But the typical discovery deadlines in the rules of civil procedure are not well suited for these TRO proceedings. Thus, plaintiffs regularly seek expedited discovery. In my experience, the parties are often able to agree to an expedited discovery schedule, since defendants usually want to take discovery as well. But when the parties cannot agree, the court needs to get involved. A recent case out of the Middle District of Florida shows the importance of narrowly tailoring expedited discovery requests, particularly when asking a judge to permit this type of discovery.

In Digital Assurance Certification, LLC v. Pendolino, the plaintiff works with municipal bond issuers to comply with various SEC regulations. The plaintiff alleges that the defendant, a former employee, left to work for a competitor. And in his final week of work, according to the plaintiff, the defendant used a USB drive to access every document on the plaintiff’s shared drive. Thus, the plaintiff brought claims for violations of the Defend Trade Secret Act and the Florida Uniform Trade Secrets Act, among others, and filed a motion for a TRO.

In advance of the TRO hearing, the plaintiff filed a motion for expedited discovery. The court denied the motion. A copy of the order can be downloaded below.

The court first set forth the standard for determining whether the plaintiff had demonstrated good cause for expedited discovery:

Factors the Court considers in deciding whether a party has shown good cause include: (1) whether a motion for preliminary injunction is pending; (2) the breadth of the requested discovery; (3) the reason(s) for requesting expedited discovery; (4) the burden on the opponent to comply with the request for discovery; and (5) how far in advance of the typical discovery process the request is made.

Here, the court focused on the second factor, the breadth of the plaintiff’s requests. The court took issue with the scope of the plaintiff’s requests, noting that “while these matters may be relevant to the issues raised in DAC’s complaint, they go far beyond what is needed for the hearing on the motion for a temporary restraining order.”

Take away: When bringing a motion for a TRO, the plaintiff’s lawyers need to figure out quickly whether the parties will be able to agree to an expedited discovery schedule. If not, the plaintiff needs to draft discovery requests that are laser focused on the issues relevant to the TRO hearing. In my experience, judges will allow this type of discovery, as long as the requests are reasonable. Conversely, judges will protect defendants from overbroad discovery.

Digital Assurance Certification, LLC v. Pendolino

Federal Court: No Heightened Pleading Standard Under the Defend Trade Secrets Act

As more plaintiffs bring claims under the shiny new Defend Trade Secrets Act, we continue to learn about how courts are interpreting this statute. On Tuesday, the District of New Jersey answered an open question: whether the statute, in conjunction with Twombly/Iqbal, requires a heightened pleading standard for misappropriation. In Chubb INA Holdings, Inc. v. Chang, the DNJ declined to apply such a standard. A copy of the opinion can be downloaded below.

In this case, Chubb sued its former employee and its competitor Endurance, alleging that the former employee worked with Endurance to solicit a large number of employees from Chubb’s real estate and hospitality division. The goal was to hire enough Chubb employees to create a “turnkey” operation for Endurance. In the process, Chubb alleges, the former employees took Chubb’s confidential information. Chubb sued for, among other things, violations of the Defend Trade Secrets Act.

The defendants moved to dismiss, arguing that Chubb did not offer sufficient allegations of actual misappropriation, as opposed to inevitable disclosure. In denying this motion, the court found that Chubb alleged “more than the mere possibility of misconduct,” citing to Ashcroft v. Iqbal. The court also focused on the pleading standard:

Plaintiffs “need not make out specific allegations as to exactly how Defendants used or disclosed Plaintiff[s’] trade secrets; there is no heightened pleading standard for a misappropriation claim, and Plaintiff[s are] entitled to seek discovery to support [their] allegations setting forth a prima facie claim.”

The court was quoting from a case interpreting a New Jersey state-law claim for trade-secrets misappropriation.

This is obviously a plaintiff-friendly interpretation of the statute. It allows plaintiffs to plead misappropriation more generally, and then obtain discovery to sharpen the details.

Interestingly, the court’s approach here—relying on reasoning from a court in its state interpreting that state’s trade-secrets law—could result in state-by-state differences in how the DTSA is interpreted.

Chubb v. Chang MTD Order

Shark Tank and College Football Non-Competes

Two recent stories show why all companies should at least consider implementing non-compete agreements or other restrictive covenants.

First, here’s a link to a short interview with Shark Tank’s Robert Herjavec, talking about his first company. Unbeknown to Robert, his sales manager had set up a side business, to which he funneled half of Robert’s customers. Robert only found out because another employee broke down and told him during her exit interview.

Robert finishes the interview with good advice: “The minute you hire the first employee, you have to be careful.”

We don’t know if the sales manager had signed a non-compete or non-solicitation agreement. Such an agreement could have given Robert far better legal options.

Also, Robert trusted that his employees would be loyal. While it’s obviously good to trust your employees, it’s far better to trust and also have them sign appropriate restrictive covenants.

I also read about how an assistant coach of the Arkansas Razorbacks football team left for the University of Georgia. Bret Bielema, Arkansas’ head coach, was not happy. Apparently, his recently hired coaches signed non-compete agreements that prohibited them for coaching for other SEC schools. But the coach who had left had been hired earlier, and he did not have a non-compete.

Of course, Arkansas should have had its coaches sign non-competes from the outset. And once they decided to require new coaches to sign one, they should have at least attempted to have the older coaches sign as well.

These stories show how non-compete agreements can have value across diverse industries. It’s worth speaking with an attorney to figure out whether your company can benefit from implementing restrictive covenants, or improving existing agreements.

 

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