Trade Secret / Noncompete : Business, Employment, Intellectual Property, and Litigation Attorneys Focused on Trade Secret/Noncompete Issues

Last Fall, the Illinois Fourth District Appellate Court ruled in Sunbelt Rentals, Inc. v. Ehlers, 915 N.E.2d 882 (Ill. App. Ct. 2009), that an employer does not need to establish a legitimate interest (e.g., a long-standing customer relationship or confidential information) to enforce a covenant not to compete.  For well over 30 years, the "Legitimate Interest Test" had been the law in all of Illinois.  When the Sunbelt Rental decision was issued, many wondered whether the sea had changed, or whether the Fourth District had merely placed itself in conflict with other jurisdictions in Illinois.  As of now, it appears that there is only the conflict and no strong indications that a sea change has taken place.  While three separate trial courts in Illinois have now cited the Sunbelt Rental decision, no other appellate courts have addressed the issue.  No court has expressly agreed with the Fourth District, but as discussed below, the Southern District of Indiana comes pretty close.

The first court to recognize the Sunbelt Rental decision was the federal court for the Northern District of Illinois.  In Aspen Marketing Services, Inc. v. Russell, 2009 WL 4674061 (N.D.Ill. Dec. 3. 2009), Judge Gettleman noted awareness of the decision, but found that "[t]he Illinois Supreme Court, the United States Court of Appeals for the Seventh Circuit, and this court, however, have not rejected the application of the legitimate business interest test."  Id. at *4 fn6.  Just a few days later, in Rayco Management, Inc. v. Lancaster, 2009 WL 6521389 (Cir. Ct. Cook Ct. Dec. Dec. 9, 2009), Judge Epstein of the Circuit Court of Cook County, Illinois likewise noted awareness of the Fourth District's rejection of the Legitimate Interest Test, stating that "[w]ithout taking any position on that interpretation, this court is bound by the precedent of the First District Appellate Court and therefore will only consider the traditional standard . . . ."  Id. at p.5. 

Earlier this month, the federal court for the Southern District of Indiana quoted an important portion of the Sunbelt Rental decision.  Specifically, in CDW LLC v. Netech Corp., 2010 WL 2710626 (S.D. Ind. Jul. 7, 2010), the court, addressing the validity of a non-compete under Illinois law, quoted the Sunbelt Rentals court for the proposition that "when presented with the issue of whether a restrictive covenant should be enforced, [a court] should evaluate only the time-and-territory restrictions contained therein.  If the court determines that they are not unreasonable, then the restrictive covenant should be enforced."  Id. at *7 (quoting Sunbelt Rentals, 915 N.E.2d at 869).  Is this significant?  Perhaps.

What the CDW court did not quote or say about the Sunbelt Rental decision may reveal the fact that it does not itself believe it can go quite as far as the Fourth District Appellate Court of Illinois.  Specifically, the CDW court did not include a quote of, or even discuss, the sentence immediately following the excerpt provided above.  In that tellingly missing sentence, the Fourth District stated that "this court need not engage in an additional discussion regarding the application of the 'legitimate-business-interest' test because that test constitutes nothing more than a judicial gloss incorrectly applied to this area of law by the appellate court."  The CDW court studiously avoids any discussion on this specific point, and also avoids discussion of the Legitimate Interest test altogether.  Nonetheless, it is a fair reading of this decision to conclude that the Southern District of Indiana is favorably citing the Sunbelt Rental decision.          

While the long-term significance of the Fourth District's rejection of the longstanding Legitimate Interest test remains unclear, the impact thus far has been relatively insignificant.  The most traction the Sunbelt Rental decision has achieved is a positive citing by a federal court in the Southern District of Indiana.  Even thought the CDW court was interpreting Illinois law, the court is not located in Illinois and will not be persuasive for the state of federal courts in Illinois.  Accordingly, practitioners in Illinois must wait for further direction from another appellate court on the enforceability of restrictive covenants in Illinois.

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When four employees left a Connecticut investment advisory firm to start a competing business, they made the “mistake” of downloading client information from their old employer’s customer contact data base, transferring it to a home computer, and then sending it to a brokerage firm engaged as an asset custodian for their new firm. That mistake proved to be costly when the old employer sued for violations of the Connecticut trade secrets act and the federal Computer Fraud and Abuse Act, and discovered the data transfer.

As often happens, the old employer found the misuse of its computer data only by obtaining discovery from a third party – the firm serving as asset custodian for the new investment business. Responding to a subpoena, the third-party produced communications with the defendants that the defendants themselves had failed to produce in response to direct discovery requests in the litigation. Those communications showed the transfer of the employer’s data. Compounding their error, the employees had refused the old employer’s demand that they voluntarily preserve image copies of their computer hard drives, and had actually discarded one computer that had been used in transferring data.

Upon learning of these facts on a motion to compel discovery, a federal judge in Connecticut ruled that the defendant employees and their new firm had to deliver all of their office and home computers and personal digital devices to a court-appointed computer forensic expert for imaging and data recovery. The court ordered the defendants to pay 80 percent of the cost of the expert’s work, and finding that the defendants’ resistance to the discovery motion had been unjustified, also ordered the defendants to pay the attorneys fees incurred by their former employer in bringing the motion. Genworth Financial Wealth Management Inc. v. McMullan, D. Conn., No. 3:09-cv-1521 (VLB) (order entered June 1, 2010). 

In a subsequent ruling on the old employer’s motion for a preliminary injunction, the court ordered the defendants to refrain from communicating with any current client or known prospect of the former employer except to the extent that the client had already become a client of the new firm or the defendants could show that the client’s information was not included in the data downloaded from the old employer. Id. (order entered June 10, 2010).

The case provides a useful analysis of when imaging of whole computer drives may be an appropriate discovery technique, and illustrates how “sticky fingers” can saddle departing employees with costly litigation and legal restraints on their ability to compete.

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As Marshall McLuhan once observed famously, "the medium is the message."  Of course, he was a media theorist, not a law professor, so it comes as no surprise that his aphorism is flat wrong when applied to trade secrets, as a recent opinion by the U.S. Court of Appeals for the Second Circuit reminds us.  (Nationwide Mutual Ins. Co. v. Mortenson, 2d Cir. , No. 08-5214-cv, 5/11/10)  This case arose when a group of agents left the plaintiff insurance company, Nationwide, and began selling policies for a competitor.  Nationwide filed suit, alleging among other things that the agents violated the Connecticut Uniform Trade Secrets Act by showing the competitor printouts of policyholder information from Nationwide's secure database.

The district court granted judgment for the agents and against Nationwide, finding that the policyholder information did not qualify as trade secrets or confidential information of Nationwide.  (Indeed, that appears to have been the conclusion of several other trial courts in similar cases involving Nationwide.) Although the Second Circuit is not clear about the basis of the district court's ruling, it appears that one grounds was that the policyholder information was in physical files that were "readily available." 

On appeal, Nationwide tried to overcome that hurdle by focusing on the printouts from its database, which was password-protected.  The problem with this approach, as the Second Circuit pointed out, was that the information in the database was the same as the information in the physical files.  Indeed, information was loaded into the database directly from the physical files.  At most, the database--and hence the printout--organized the same information in a slightly different format.

The Second Circuit quickly dispatched this attempt to raise form over substance.  Noting that the UTSA withholds trade secret status from information that is readily ascertainable to the outside world by proper means, the Second Circuit held that the information on the printouts could not be proprietary to Nationwide because it was available in an unprotected format in the physical files.  Echoing McLuhan's famous aphorism, the Second Circuit concluded that "[i]t is not the medium that matters here, but whether the information itself was adequately protected--and it was not."

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A bill has been introduced in the Illinois Legislature to create an "Illinois Covenants Not to Compete Act" (HB 4923, introduced January 15, 2010 by Rep. Rosemary Mulligan), following a previous failed effort on the same topic last year (HB 4040, introduced also by Rep. Mulligan).  While unlikely to be passed based on its current status (it has been re-referred in to the Rules Committee), as drafted it would introduce a few new twists into Illinois noncompete law. 

The bill would codify that, in order to be enforceable, the noncompete clause must be "narrowly tailored to support the protection of a legitimate business interest"  See Sec. 10, para. (c).  However, it also attempts to introduce certain new provisions that undoubtedly would change the landscape somewhat. 

For example, one of the provisions would require that any one-sided attorney fee provision for the benefit of the employer be construed as including a right to recover fees on the part of the employee, should he or she prevail in an action to enforce the covenant.  Sec. 20, para. (b).  This is all occurring in the context of a recent appellate opinion in Illinois which seemed to cast aside that familiar "legitimate business interests" test for enforceability.  Sunbelt Rentals, Inc. v. Ehlers, 915 N.E.2d 862 (Ill. App. Ct. 2009). 

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Cases and issues making the headlines*:

It's All Fun and Games Until... (April 1)
A man attending the Penny Arcade Expo (PAX) in Boston was reportedly arrested for allegedly stealing the code for a new game that has not yet released. The code is reported to be valued at $6,000,000. Story here.

China (April 1)
On January 23, we reported that employees of Australian company Rio Tinto Ltd had been arrested in China on charges of, among other things, trade secret misappropriation.  (Check the In the News... archives.) Rio Tinto has now reportedly hired Henry Kissenger to assist it following a conviction of one of those employees. Story here.

EMC Files Two Noncompete/Trade Secret Law Suits This Week (March 19)
Data storage giant EMC Corporation has filed two different law suits this week claiming, among other things, breach of noncompetition agreements, misappropriation of trade secrets, and violation of the Massachusetts unfair competition law (G.L. c. 93A). Story about one of the lawsuits here and here.

Trade Secret Thief Convicted (March 19)
A former DuPont Co. exmployee reportedly pled guilty to stealing DuPont's trade secrets and disclosing them to a competitor. The man, Michael Mitchell was reportedly sentenced by a federal judge in Virginia to 18 months. Story here (subscription service).

Nuclear Fusion Trade Secret Trial (updated March 16)
General Nanotechnology and certain related parties are reportedly going to trial tomorrow (March 15) in their lawsuit again Lawrence Livermore National Security, LLC and others in California. According to PR Newswire, the plaintiffs claim, among other things, that the defendants stole trade secrets and breached a nondisclosure agreement when they allegedly used the plaintiffs' nuclear fusion technology to develop their own product. Story here and here.

19 Indicted Over Computer Chip Technology Allegedly Taken to Korea (March 14)
Ten employees from Applied Materials, Inc., four from Samsung Electronics, and five from Hynix Semiconductor Inc. have reportedly been indicted in Korea for theft of computer chip technology. Story here.

Illinois Upholds Forfeiture Clause (March 14)
In a recent decision issued by the Northern District of Illinois (Viad Corp. v. Houghton), the court upheld a forfeiture clause without engaging in a traditional noncompete analysis. 

Wisconsin Continues New Approach to Noncompetes (March 14)
Following the Star Direct case (previously reported by us here), a Wisconsin Appellate Court reversed the trial court on the basis that a forfeiture provision requiring return of certain money expended for employee training could be recovered by the employer - notwithstanding that the noncompete provisions were unenforceable. Decision here. 

Astro-Med, Inc. Collects on Noncompete Case (March 14)
After a favorable jury verdict and then decision from the 1st Circuit last year, Astro-Med reportedly received $1,495,000 in its noncompete lawsuit against a former employee and his new employer. Story here and here.

Philadelphia School District Accused of Violating the CFAA, ECPA, SCA (March 14)
A Philadelphia school district allegedly provided students with laptops equipped with webcams that, unbeknownst to the students, were remotely controlled by the school district. The school district has reportedly been sued under the Computer Fraud & Abuse Act, the Electronic Communications Privacy Act, and the Stored Communications Act, among other things. Story here. 

When Noncompetes Expire... (March 14)
Noncompetition agreements are never unlimited. When they expire, the party who had been restricted is permitted to return to a competitive position. Unless there are additional restrictions (nonsolicitation agreements; no-raid/antipiracy/no-hire agreements; and/or nondisclosure agreements), the returning party is largely uninhibited in his competitive activities. Apparently, this is the plan of former advertising agency Cummins & Partner, whose noncompete will expire in early 2011. Story here.

Criminal Investigation Halts Trade Secret Lawsuit (March 14)
According to Blooberg.com (here), the Manhattan U.S. Attorney, Preet Bhara, asked the judge in the Starwood Hotels & Resorts Worldwide, Inc./Hilton Hotels Corp. trade secret case to halt the case while the U.S. Attorney investigates.

Attorney General Eric Holder Speaks About Trade Secrets (March 14)
PR Newswire reported that, on February 24, United States Attorney General Eric Holder spoke at the Rio De Janeiro Prosecutor General's Office about the need to protect intellectual property - including trade secrets. Story here.

Harvard Law Student Sues Google Buzz (March 14)
A law student has reportedly sued Google's new social networking service, Google Buzz, claiming violations of, among other things, the Computer Fraud and Abuse Act and the Stored Communications Act. Story here and here.

*For earlier stories, go to the In the News (archives) page.

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Given the public policy arguments that courts so frequently use when analyzing noncompetes, as well as the perceived unequal bargaining power between employers and employees, it might be surprising to note that some courts are willing to enforce forum selection clauses that choose a forum other than where the employee lives and works. For instance, in Georgia, a state which certainly has its own unique noncompete law (at least until this November's elections), it has been held that a forum selection clause in a noncompete case is enforceable even if such clause would be inconvenient to the employee. Iero v. Mohawk Finishing Products, Inc., 534 SE 2d 136 (Ga. Ct. App. 2000). But see Dentsply Intern., Inc. v. Benton, 965 F. Supp. 574 (M.D.Pa. 1997). But c.f., Hulcher Services v. RJ Corman R. Co., 543 SE 2d 461 (Ga. Ct. App. 2000).

A typical forum selection clause is as follows:

Employee agrees that any claim or action relating to or otherwise arising out of this Agreement shall be subject to the exclusive jurisdiction of the state courts of the [State/Commonwealth/District] of ________ or the federal district court for the ______ District of ________ and Employee hereby submits to the exclusive jurisdiction of those courts.

As with most noncompete issues, the law in this area can vary state by state.  Accordingly, it is important to never simply use a form.  You should always check applicable law in your state first.

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In response to the significant and growing interest in the Massachusetts noncompete reform bill, this post will aggregate links to articles and information about the bill.  It will be updated regularly, so please check back.

• Massachusetts Noncompete Bill is Reported Out of Committee
• Protecting Your Confidential Information While the Noncompete Debate Continues
• A small business perspective on non-compete agreements (text and audio)
• Mass. non-compete culture to change? (text and video)
• Marblehead rep files noncompete bill
• Marblehead rep co-sponsors overhaul of non-compete agreements
• Swampscott rep co-sponsors overhaul of non-compete agreements
• Legislators Hear Testimony on Non-Compete Restrictions
• Update on the Massachusetts Noncompete Hearings
• Massachusetts Noncompete Bill Set for Hearing
• House Bill 1799 An Act relative to Non-compete agreements

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Blogs like this (ones that are so focused on a specific area of law) may cause readers to wonder why the authors spend so much time writing about so many different aspects of the topic.  For the TSN blog, the reason is that we care.  (Nice, huh?)  Okay, but why do we care?  Simple:  the numbers. 

In doing some basic "back of the envelope" so-called "research" for a class I teach (Trade Secrets and Restrictive Covenants at Boston University School of Law), I searched Westlaw to see whether my (and others') suspicion that trade secret/noncompete litigation is on the rise is in fact true - or were we only so steeped in those types of cases that our perspective was too skewed to properly perceive reality.  The answer?  While our perspectives may indeed be skewed, the numbers confirm (in a very - and let me reemphasize - very unscientific way) that trade secret litigation is on the rise.  The chart to the right shows that from 2000 to 2009, the number of reported trade secret and/or noncompete cases more than doubled - from 1010 to 2366 - over the last decade. 

So, how does that relate to the TSN Blog?  The answer is that one of the goals of this blog has been to educate its readers about the issues and how to reverse this trend.  Indeed, that was the (I hope) plain goal of the post, "An Ounce of Prevention... ." 

All of that to say that the trend toward litigating trade secret/noncompete disputes is real and growing.  Accordingly, we urge all of you, our readers, to learn the necessary steps to insulate your trade secrets as much as reasonably possible within your corporate culture, to implement those steps, and to thereby prevent (or at least minimize the effects of) problems before they arise.  Will this eliminate all problems and all litigation?  No.  But, it will put you in the best position to avoid it and, when it can't be avoided, to respond to it quickly and effectively.

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It is official:  The Massachusetts noncompete bill (of which I am the principal draftsperson) has been reported out of committee.  A copy is available here or by clicking on the picture to the right.

Upon a quick read, it appears that garden leave clauses have been removed.  Otherwise, the bill remains largely the same as the September version of the so-called "compromise bill."  More to follow after a more thorough review.

Other changes are likely, particularly as we have received some outstanding input from many different people since the bill was initially submitted to committee.

For more information, please contact either of the two state representatives who have been leading the charge - Lori Ehrilich and Will Brownsberger - or me.  (Click on our names for our information.)

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