Enforcing Non-Competes and Protecting Trade

Secrets. 

By:Charles H. Wilson

Cozen O’Connor P.C.

PART 1:PART 1:Introduction Introduction

ScenarioScenario

You have a star employee who works for You have a star employee who works for or starts a competing company and or starts a competing company and convinces the entire sales team to join convinces the entire sales team to join him. They lure away most of your him. They lure away most of your company’s clients.company’s clients.

3

ScenarioScenario

A General Manager decides to help a A General Manager decides to help a competitor develop business, while still competitor develop business, while still working for your company. She downloads all working for your company. She downloads all of your customer data onto a thumb drive and of your customer data onto a thumb drive and provides it to the competitor. She sends provides it to the competitor. She sends critical financial and marketing information to critical financial and marketing information to her personal email account before resigning.her personal email account before resigning.

4

PART 2:PART 2:Elements of a Valid Covenant Elements of a Valid Covenant

Not to CompeteNot to Compete

A COVENANT NOT TO COMPETE IS…A COVENANT NOT TO COMPETE IS…• Contractual restrictionContractual restriction

• Limits or prevents an employee from competing during or Limits or prevents an employee from competing during or after employmentafter employment

• Usually restricts an employee from working for a competitor Usually restricts an employee from working for a competitor for a certain period of time after termination of employmentfor a certain period of time after termination of employment

• Used to protect customer relationships, confidential Used to protect customer relationships, confidential information, trade secrets and goodwillinformation, trade secrets and goodwill

• Non-Solicitation agreements, or agreements to refrain from Non-Solicitation agreements, or agreements to refrain from soliciting customers or employees during and after soliciting customers or employees during and after employment, are also frequently treated as a covenants not employment, are also frequently treated as a covenants not to compete in Texasto compete in Texas

• Covenants Not to Compete are controlled by statute in Covenants Not to Compete are controlled by statute in TexasTexas

6

TEXAS BUSINESS & COMMERCE CODETEXAS BUSINESS & COMMERCE CODE

Section 15.50(a):Section 15.50(a):

““A covenant not to compete is enforceable if it is…A covenant not to compete is enforceable if it is…

1.1. ancillary to or part of an otherwise enforceable agreement at the time the agreement is made to the extent that it ancillary to or part of an otherwise enforceable agreement at the time the agreement is made to the extent that it contains limitations as to time, geographical area, and scope of activity to be restrained that are reasonable; and,contains limitations as to time, geographical area, and scope of activity to be restrained that are reasonable; and,

2.2. does not impose a greater restraint than is necessary to protect the goodwill or other business interest of the does not impose a greater restraint than is necessary to protect the goodwill or other business interest of the promisee”promisee”

7

TEXAS BUSINESS & COMMERCE CODETEXAS BUSINESS & COMMERCE CODE

Two Step Inquiry:Two Step Inquiry:1.1. Is there an otherwise enforceable agreement; and,Is there an otherwise enforceable agreement; and,

2.2. Is the non-compete covenant part of or ancillary to that agreement.Is the non-compete covenant part of or ancillary to that agreement.

Marsh USA v. CookMarsh USA v. Cook, 354 S.W3d 764 (2011)., 354 S.W3d 764 (2011).

8

QUESTIONQUESTION

What type of agreement will satisfy the What type of agreement will satisfy the “otherwise enforceable agreement”“otherwise enforceable agreement”

requirement?requirement?

9

Otherwise Enforceable AgreementOtherwise Enforceable Agreement

The “otherwise enforceable agreement” requirement is satisfied when the covenant is “part of an agreement that contain[s] mutual non-illusory promises.”

Marsh USA v. Cook

10

EXAMPLESEXAMPLESConfidentiality/Non-Disclosure AgreementConfidentiality/Non-Disclosure Agreement

• Employer promises to provide or provides confidential Employer promises to provide or provides confidential information in exchange for employee’s promise not to information in exchange for employee’s promise not to disclose such information.disclose such information.

Employment Agreement for a Guaranteed Employment Agreement for a Guaranteed Term Term

Employment Agreement in which Employment Agreement in which Termination can only be “For Cause” Termination can only be “For Cause”

11

EXAMPLESEXAMPLES

At-Will Employment AgreementAt-Will Employment Agreement• Employer promises to provide specialized training, 14 Employer promises to provide specialized training, 14

days notice, and inventory upon terminationdays notice, and inventory upon termination

•Evan’s World Travel, Inc. v. AdamsEvan’s World Travel, Inc. v. Adams

Stock Options In Return For Promise Not Stock Options In Return For Promise Not To Disclose or Solicit.To Disclose or Solicit.

12

Marsh USA Inc. v. CookMarsh USA Inc. v. Cook

In order for a covenant not to compete to be In order for a covenant not to compete to be “ancillary to or part of an otherwise enforceable “ancillary to or part of an otherwise enforceable agreement”agreement” between an employer and an between an employer and an employee…employee…

• the the consideration given consideration given by the employer in the by the employer in the otherwise enforceable agreement must be reasonably otherwise enforceable agreement must be reasonably related to an interest worthy of protectionrelated to an interest worthy of protection

13

QUESTIONQUESTION

Is a company required to provide an Is a company required to provide an employee with the confidential employee with the confidential information, trade secrets or information, trade secrets or

specialized training specialized training at the time the at the time the agreement is entered into?agreement is entered into?

14

ALEX SHESHUNOFF MGMT. SERVS. V. ALEX SHESHUNOFF MGMT. SERVS. V. JOHNSONJOHNSON

The Supreme Court of Texas Held:The Supreme Court of Texas Held:

• NO,NO, employers are only required to employers are only required to promisepromise to to give an employee confidential information, trade give an employee confidential information, trade secrets or specialized training at the time the secrets or specialized training at the time the agreement is made; and,agreement is made; and,

• the employer must actually provide the the employer must actually provide the consideration during the employee’s employmentconsideration during the employee’s employment209 S.W.3d 644 (Tex. 2006)

15

QUESTIONQUESTION

Is a company required to Is a company required to expressly promiseexpressly promise to to provide an employee with confidential provide an employee with confidential

information, trade secrets or specialized information, trade secrets or specialized training in the future or can it be training in the future or can it be impliedimplied??

16

MANN FRANKFORT STEIN MANN FRANKFORT STEIN & LIPP ADVISORS, INC. V. FIELDINGS& LIPP ADVISORS, INC. V. FIELDINGS

The Supreme Court of Texas Held:The Supreme Court of Texas Held:

• No need for an express promise by an employer to No need for an express promise by an employer to provide an employee with confidential information so provide an employee with confidential information so long as the long as the “nature of the work”“nature of the work” required it required it

• Courts may imply a return promiseCourts may imply a return promise

• Expands Expands SheshunoffSheshunoff

289 S.W.3d 844 (Tex. 2009)289 S.W.3d 844 (Tex. 2009)

17

QUESTIONQUESTION

What type of activities can a company What type of activities can a company lawfully restrictlawfully restrict an employee from an employee from

engaging in after employment?engaging in after employment?

18

RESTRICTIONSRESTRICTIONS• Common to preclude employee from soliciting or Common to preclude employee from soliciting or

doing business with clients he/she serviced during doing business with clients he/she serviced during employmentemployment

• Industry-wide exclusions may be unreasonableIndustry-wide exclusions may be unreasonable

• Restrictions that prohibit an employee from doing Restrictions that prohibit an employee from doing business with clients with whom they had no contact business with clients with whom they had no contact may be unreasonablemay be unreasonable

19

QUESTIONQUESTION

What is a reasonable time period for a What is a reasonable time period for a covenant not to complete?covenant not to complete?

20

REASONABLE TIMEREASONABLE TIME

• Fact-specific inquiry (depending on industry, type of Fact-specific inquiry (depending on industry, type of information involved, etc.)information involved, etc.)

• Generally, 6 months to 1 year is well within rangeGenerally, 6 months to 1 year is well within range

• Anything over two years will be highly-scrutinizedAnything over two years will be highly-scrutinized

• Unlimited restriction on time is unenforceableUnlimited restriction on time is unenforceable

• May depend on the speed with which technology or other May depend on the speed with which technology or other confidential information evolves in particular industry; confidential information evolves in particular industry; What is “shelf life” of confidential information?What is “shelf life” of confidential information?

21

QUESTIONQUESTION

What is a reasonable geographic area in What is a reasonable geographic area in which to restrain an employee from which to restrain an employee from

competing?competing?

22

GEOGRAPHIC AREAGEOGRAPHIC AREA• Typically found reasonable if limited Typically found reasonable if limited

to the to the region within which the region within which the employee worked during employmentemployee worked during employment

• This issue may not be relevant due to This issue may not be relevant due to today’s global business landscape; today’s global business landscape; better practice is to restrict non-better practice is to restrict non-compete to compete to customers employee customers employee servicedserviced

23

Non-Solicitation AgreementNon-Solicitation Agreement

Are Non-Solicits considered to be Non-Competes? Are Non-Solicits considered to be Non-Competes?

Yes – Subject to same analysis under Texas law.Yes – Subject to same analysis under Texas law.

How do you include a geographic restriction on a How do you include a geographic restriction on a non-solicitation agreement where the customers non-solicitation agreement where the customers are not limited to one area?are not limited to one area?

Texas law allows a description of customers, or a Texas law allows a description of customers, or a customer list, to substitute for a geographic customer list, to substitute for a geographic restriction.restriction.

24

Enforcement IssuesEnforcement Issues What happens if the Judge modifies the What happens if the Judge modifies the

scope of the agreement? scope of the agreement?

The employer can only recover damages for a The employer can only recover damages for a breach breach afterafter modification. modification.

If the agreement is found unenforceable, does If the agreement is found unenforceable, does the employee get fees?the employee get fees?

Texas law allows for the employee to recover Texas law allows for the employee to recover fees if the employer knew at time of drafting fees if the employer knew at time of drafting that the restrictions were overly broad, and that the restrictions were overly broad, and sought to enforce a greater restraint than sought to enforce a greater restraint than necessary. necessary.

25

PART 3:PART 3: “I Don’t Have A Non- “I Don’t Have A Non-

Compete, Now What?”Compete, Now What?”

Related Common Law Claims or Related Common Law Claims or TheoriesTheories

Tortious Interference with Contract/Business Relationship or Expectancy

– New employer induced employee to breach employment or non-disclosure agreement

Breach of Fiduciary Duty/Duty of Loyalty

– employee is removing or transferring documents or actively competing while still employed

“Inevitable Disclosure”

– Employee will be employed in similar position requiring him or her to use information

Texas Uniform Trade Texas Uniform Trade Secrets ActSecrets Act

Definition of Trade Secret

Includes a formula, drawing, pattern, compilation including a customer list, program, device, method, technique or process that:

(1) Derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable by proper means by, other persons who can obtain economic value from its disclosure or use.

(2) Is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.

Texas Uniform Trade Texas Uniform Trade Secrets ActSecrets Act

Misappropriation

(1) Acquisition knowing or having reason to know trade secret was acquired by improper means.

(2) Disclosure or use (actual or threatened) of trade secret without express or implied consent.

(3) “Improper means” includes theft, bribery misrepresentation, breach of a duty to maintain secrecy, to limit use, or to prohibit discovery, espionage through electronic of other means.

Texas Uniform Trade Texas Uniform Trade Secrets ActSecrets Act

Damages

(1) Actual loss

(2) Unjust Enrichment

(3) Reasonable Royalty

Examples of Trade SecretsExamples of Trade Secrets

– Financial goals and marketing strategies;

– Computer software, hardware, and databases;

– Cost and pricing information;

– Customer lists and preferences;

– Employee compensation information

PART 4:PART 4:Protecting Trade Secrets Protecting Trade Secrets

Protect Trade Secrets through Protect Trade Secrets through ContractContract

You can require any employee (even at-will) to execute a non disclosure agreement including a confidentiality provision:

– List materials identified as trade secrets or confidential information and acknowledge that they are confidential.

– Acknowledge that the information belongs to the employer and was developed through the employer’s lengthy and expensive efforts.

Protect Trade Secrets through Protect Trade Secrets through Employment ContractEmployment Contract

– Establish guidelines regarding access and handling of the information.

– The provision should be effective both during and after the employment relationship.

– Do not include a time frame. Consider – would it ever be okay for an ex-Coke employee to divulge the secret formula?

Protect Trade Secrets Protect Trade Secrets Through Additional Through Additional

MeasuresMeasures

• Include confidentiality provisions in the employee handbook.

• Periodically distribute memoranda to employees to remind them of their obligations to maintain confidentiality

Protect Trade Secrets Protect Trade Secrets Through Internal ControlsThrough Internal Controls

• Include confidentiality provisions in contracts with third parties.

• Use passwords to protect company information.

• Monitor software that logs database access.

• Mark confidential documents with a warning that indicates the documents’ proprietary and confidential status.

– Segregate confidential documents in locked storage cabinets or designate custodian to track the information.

– Do not indiscriminately mark documents “confidential,” as that will undermine the validity of the designation.

• Maintain customer contacts in employer-owned media.

Take Action When Suspect Take Action When Suspect Departing Employee of Departing Employee of

WrongdoingWrongdoingIf an employer suspects that one of its employees is using confidential information to set up business in competition with the employer’s business, it should move quickly to ensure it has effective IT and other relevant systems in place to track and record the employee’s actions.

InvestigationsInvestigations

• Get/seal computers

– Chain of custody

• Save/copy all back-up tapes

• Get employer’s records

– Cell phone bills, expense reimbursements, agreements,

handbooks

InvestigationsInvestigations

• Determine what confidential information the employee

had access to.

• Check the employee’s office.

– Lock down

– Missing files/documents

– Shredder

Computer ForensicsComputer Forensics

• Look for the smoking gun

• Removable media

– Flash drives

– CD burning

– Portable hard-drives/zip drives

Computer ForensicsComputer Forensics

• Use of email to send documents to home computer

• Lockbox or cloud storage

• Deletion – the black hole theory

Computer ForensicsComputer Forensics

• If feasible – do not search for anything on our own; it ruins chain of custody.

• Get an experienced expert.

Handling Resignations of Handling Resignations of Departing EmployeesDeparting Employees

In most cases, employees should be immediately relieved of any duties that would expose them to company information or customers.

– This may necessitate immediate termination—but beware, because if a restrictive covenant is in place, the employee may be able to argue that the early termination should preclude its enforcement.

Handling Resignations Handling Resignations cont’dcont’d

• Another option is to keep employees on the payroll while serving out the notice period, but relieve them of any meaningful job duties.

• Employers may want to consider offering severance packages in exchange for contractual nondisclosure provisions.

Conduct an Exit InterviewConduct an Exit Interview

• Question the employee about his or her future plans Lying = Misrepresentation

• Remind exiting employees of their obligations with respect to the company’s confidential information.

– Review terms of the employee’s non-compete agreements during the interview.

• Ask employee to sign acknowledgement that he or she is aware of his or her obligations.

Conduct an Exit InterviewConduct an Exit Interview

• Encourage employees to ask questions they may have about their obligations concerning confidential information.

• Record employees’ questions and responses as part of the minutes of the meeting.

• Ask employee to verify that he or she is not keeping any company property or documents that contain confidential or proprietary business information.

Prevent Further Access to Prevent Further Access to Company InformationCompany Information

• Disable former employees’ passwords and e-mail accounts.

• Require the return of keys or building pass-cards and notify security that the individual is not allowed on the premises.

• Require the return of any company-owned equipment; i.e., laptop, PDA, that may contain business information.

PART 5:PART 5:Issues in Litigation Issues in Litigation

RemediesRemedies

• Injunction

• Actual Damages

• Disgorgement for Unjust Enrichment

• Exemplary Damages

• Punitive Damages

• Attorneys’ Fees, Costs and Expenses

Injunctive ReliefInjunctive Relief

Helpful Tips

1. Computer Analysis

2. Expedited Discovery

3. Move Swiftly

50

Expedited DiscoveryExpedited Discovery

• Request simultaneously with filing the lawsuit

• Demonstrate to the Court

– Some connection between the expedited discovery and the avoidance of irreparable injury; and

– Some evidence that the injury that will result without expedited discovery is greater than the defendant will suffer if the expedited relief is granted.

Expedited DiscoveryExpedited Discovery

• Request from ex-employee

– Expedited depositions

– Expedited document requests

– Entry onto new employer’s premises

– Access to computers and email

– Court order prohibiting deletions/destruction

• Stop the bleeding theory

DamagesDamages

• Defendant’s Profits

• Plaintiff’s Lost Profits

• Economies of Scale

• Royalty

Preparing to Compete Preparing to Compete

• In Texas, employees can prepare to compete.

• Employees can generally set-up a business, but can’t tell customers or take affirmative steps to compete.

• Right to Compete vs. Breach of Fiduciary Duty – gray line.

Federal LiabilityFederal Liability

• The Computer Fraud and Abuse Act

– Hacking into employer computer systems

– Deleting data to “cover tracks”

• The Electronic Communications Privacy Act

– Criminal Penalties

PART 5:PART 5:ConclusionConclusion

Steps for Protecting Steps for Protecting CompanyCompany

1. Agreements

Non-Compete and Non-Solicitation

Confidentiality and Non Disclosure

2. Policies

Confidentiality

Security of Trade Secrets

IT Security

3. Systems and Processes

Restrictions on Flash Drives and Other Copying

Protocol for Resigning Employees

Exit Interviews

Charles H. WilsonOffice Managing Partner, Vice Chaircwilson@cozen.com(713) 750-3117

Contact Contact InformationInformation