On September 19, 2018, the New York Attorney General (“NYAG”) released a Frequently Asked Questions document (“FAQ”) regarding non-compete agreements in New York. The FAQ posits and answers the following basic questions about non-competes:

  • What is a non-compete agreement?
  • Are non-competes legal?
  • Do I have to sign a non-compete?
  • How could a non-compete affect me?
  • How do employers enforce non-competes?

In addition, the FAQ advises employees on specific steps to take before signing a non-compete, as well as actions employees can take if they signed a non-compete and are contemplating leaving their job. The FAQ concludes by emphasizing the NYAG’s efforts to end overly broad non-competes for rank-and-file employees who do not have access to trade secrets or confidential information, noting several recent settlements in this space and legislation introduced by the NYAG that would prohibit non-competes for workers earning below $75,000 per year (which is still pending).

The publication of the FAQ is not only a useful resource to employers and employees alike, but also another notable development in the close scrutiny that state attorneys general, nationwide, are applying to non-compete agreements.

gavel and scale_246212914 1280x720

On April 13, 2015 we blogged about the decision of the Ninth Circuit in Golden v. California Emergency Physicians Medical Group, 782 F.3d 1083 (9th Cir. 2015). There, the Ninth Circuit considered whether, under California law, an employee could be ordered to sign a settlement agreement that included language that restricted him, inter alia, from future employment with his former employer.

Dr. Golden is an emergency-room doctor who sued California Emergency Physicians Medical Group (“CEP”), among others, regarding his loss of staff membership at a medical facility.  His lawsuit was based on various state and federal causes of action, including racial discrimination.  The parties orally agreed in open court to settle the case and the settlement terms included “a substantial monetary amount,”  dismissal of the action, a release of CEP and a waiver of any and all rights to employment with CEP or at any facility that CEP may own or with which it may contract in the future (the “no-employment provision”).  Dr. Golden refused to sign the written agreement and attempted to have it set aside.  His attorney moved the court to withdraw as counsel, moved the court to intervene and further moved the court to enforce the settlement agreement so he could collect his contingency fee. In further proceedings, a magistrate judge recommended that Dr. Golden be ordered to sign an amended agreement, and that recommendation was adopted by the district court judge who concluded the settlement agreement was not within the ambit of Business and Professions Code § 16600, which makes unlawful in California (with limited exceptions) any contract to the extent it restrains someone from engaging in a lawful trade, business or profession.  Dr. Golden refused to sign the agreement and filed a notice of appeal.

On appeal, the Ninth Circuit Court of Appeals reversed the district court’s enforcement of the settlement agreement and remanded the case to the district court to determine whether a no employment provision in the agreement is a “restraint of substantial character” to the Plaintiff’s medical practice.

On remand, the district court again ordered Dr. Golden to sign the settlement agreement, concluding that the no-employment provision was not a restraint of substantial character. Dr. Golden again appealed.

In its July 24, 2018 decision, the Ninth Circuit surveyed California law and noted first that a contractual provision imposes a restraint of substantial character if it significantly or materially impedes a person’s lawful profession, trade, or business.  The Ninth Circuit noted that a provision need not completely prohibit the business or professional activity at issue, nor need it be sufficient to dissuade a reasonable person from engaging in that activity.  Rather, the “restraining effect must be significant enough that its enforcement would implicate the policies of open competition and employee mobility that animate Section 16600.”  The Court noted that it “will be the rare contractual restraint whose effect is so insubstantial that it escapes scrutiny under Section 16600.”

Looking to the provision in the settlement agreement at issue, the Ninth Circuit noted that it impeded Dr. Golden’s ability to practice medicine in three ways.

First, the settlement agreement prohibited Dr. Golden from working or being reinstated at any facility owned or managed by CEP.

Second, the settlement agreement prohibited Dr. Golden from working at any CEP-contracted facility.

Third, the settlement agreement provided that if CEP contracts to provide services to, or acquires rights in a facility where Dr. Golden is currently working as an emergency room physician or hospitalist, CEP has the right to terminate his employment with no liability.

The Ninth Circuit held that the first provision, which barred Dr. Golden from future employment at facilities owned or managed by CEP did not impose a substantial restraint on his medical practice. The Ninth Circuit further held, however that the second and third provisions did substantially restrain Dr. Golden’s practice of medicine and were therefore barred by Section 16600.  These two provisions limited employment with third parties based merely on whether CEP contracted with them. As a result, if Dr. Golden was employed by a hospital that later contracted with CEP to provide, for example, anesthesiology services, Dr. Golden would be ineligible for employment with the hospital.

Given the size of CEP’s business in California—it staffs 160 facilities in the state and handles between 25% and 30% of the state’s emergency room admissions, these provisions were a substantial restraint on Dr. Golden’s trade.

The Ninth Circuit’s ruling may leave open whether a provision in a settlement agreement that permits an employer to terminate the employment of an employee where it acquires the employee’s new employer will pass muster under Section 16600.  The provisions at issue in Golden were extremely broad: Plaintiff was prohibited from employment with entities with which CEP contracts to provide services to, or “acquires rights” in.  A different, more limited provision that prohibited employment at entities as to which the employer acquires outright may be held not to impose a substantial restraint on trade.  Further, the Ninth Circuit relied in part on CEP’s broad reach in the state of California.  This leaves open that smaller employers may be able to impose restrictions that larger employers with more market share may not.

Effective as of October 1, 2018, Massachusetts will become the 49th state to adopt a version of the Uniform Trade Secrets Act (leaving New York as the only holdout). Massachusetts did so as part of a large budget bill recently signed into law, which also resulted in the adoption of the Massachusetts Noncompetition Agreement Act. (The text of the Massachusetts version of the Uniform Trade Secrets Act is set out on pages 47-52 of the bill, H. 4868, while the effective date is set out on page 117. Here is a link to the entire budget bill.)

While there are differences from existing Massachusetts law regarding trade secrets, the new law is similar in most respects to the federal Defend Trade Secrets Act (“DTSA”). Nevertheless, the remedy provisions of the two laws are not identical, and there will be situations where greater relief is available under one statute than the other. For example, ex parte seizure orders are only available under DTSA, and attorney’s fees and exemplary damages are only available under DTSA if certain required disclosures about whistleblower immunity were made in agreements containing confidentiality provisions. The new Massachusetts law allows attorneys’ fees in circumstances of willful and malicious misappropriation and/or where claims or defenses are pursued in bad faith.

Additionally, employers should be aware that the Massachusetts statute does not apply to “misappropriation occurring prior to” October 1, 2018 or to “continuing misappropriation that began prior to” that date but continued after it.

We just published an article with Thomson Reuters Practical Law discussing garden leave provisions in employment agreements as an alternative or a companion to traditional employee non-compete agreements. With Thomson Reuters Practical Law’s permission, we have attached it here.

On August 10, 2018, the Governor of Massachusetts signed “An Act relative to the judicial enforcement of noncompetition agreements,” otherwise known as The Massachusetts Noncompetition Agreement Act, §24L of Chapter 149 of the Massachusetts General Laws. (That bill was part of a large budget bill, H. 4868, available here; the text of the provisions relevant here at pages 56-62 of the bill as linked). The Act limited non-competition provisions in most employment contexts to one-year and required employers wishing to enforce such a one-year period to pay their ex-employees for the time that such employees are sidelined. The Act also precluded enforcing such provisions against employees laid-off or terminated without cause or against employees classified as non-exempt under the Fair Labor Standards Act. These and the other requirements noted below become effective and apply to employee noncompetition agreements entered into on or after October 1, 2018, and the Act curiously contains some significant exceptions as well. Below we will highlight material aspects of the new law, which was recently featured on Employment Law This Week.

Requirements for Enforcement Start Early

In connection with a non-compete agreement provided to an employee at the start of employment, an employer must provide it to the employee at the time of the offer of employment or ten business days prior to starting employment, whichever is earlier. Act, lines 1282-1291, at page 58-59. (The Act defines such agreements as “an agreement between an employer and employee, or otherwise arising out of an existing or anticipated employment relationship, under which the employee or expected employee agrees that he or she will not engage in certain specified activities competitive with his or her employer after the employment relationship has ended.” Act, lines 1264-1267, at page 57-58)

For a non-competition agreement presented to an employee during employment, the employer must provide it to the employee ten business days before it takes effect and such an agreement must be supported by “fair and reasonable consideration independent from the continuation of employment.” Act, lines 1287-1297, at page 58-59.

The Act also requires that a non-competition agreement “expressly state that the employee has the right to consult with counsel prior to signing.” Act, lines 1289, at page 59.

Further, the Act applies to all employees and independent contractors working in Massachusetts regardless of whether the agreement has a choice-of-law provision specifying the law of some other jurisdiction applies. Act, lines 1249-51, at page 57. (How it will apply to sales personnel with multi-jurisdiction territories remains to be seen, and its provision purporting to apply its requirements to those who are a “resident of” Massachusetts as opposed to those working there certainly appears one likely to be litigated as well. Act, lines 1346-1349, at page 61.)

The Death of Reasonable Pro-Employer Restrictions In Massachusetts?

The Act certainly requires employers to pay attention. But it preserves many tools for employers to use with employees, so it seems that reports of the death of such restrictions is greatly exaggerated. When employers understand a core of four concepts about the new law, they will be able to structure their approach accordingly.

First and foremost, the Act requires that most non-compete periods be limited to one-year during which the employee receives garden-leave pay or some “other mutually agreed-upon consideration.” Act, lines 1318-1330, at page 60. The Act defines garden-leave pay as payment of at least half of the employee’s highest base salary during the two years preceding the restricted period but it does not define in any way the phrase “other mutually agreed-upon consideration.” Id. The Act also allows the one-year period to be extended to two years and the obligation to pay compensation to vanish where the employee has breached fiduciary duties or has taken property belonging to the employer. Act, lines 1305-1313, at page 59-60. In the end, the Act states that such provisions “must be no broader than necessary to protect one or more . . . legitimate business interests of the employer” but also that “[a] noncompetition agreement may be presumed necessary where the legitimate business interest cannot be adequately protected through an alternative restrictive covenant, including but not limited to a non-solicitation agreement or a non-disclosure or confidentiality agreement.” Act, lines 1298-1304, at page 59.   But the Act also notes that courts may “reform or otherwise revise” such agreements to be consistent with the Act and Massachusetts public policy. Act, lines 1331, at page 60 and Act, lines 1343-1345, at page 61.

Second, the Act precludes enforcement of non-competition agreements against certain classes of employees. An employer may not enforce non-competes against employees who are (i) nonexempt under the Fair Labor Standards Act, (ii) undergraduate or graduate students who are in an internship program or other short-term employment relationship with an employer (whether paid or unpaid) while enrolled in a full-time or part-time undergraduate or graduate educational institution, (iii) under age 18, or (iv) terminated without cause, though “cause” and “without cause” are undefined. Act, lines 1332-1342, at page 61. Still, the Act expressly states that a number of traditional restrictions fall outside its requirements, and may continue to be used by Massachusetts’ employers, including the following as agreements unaffected by the Act:

  • those “not to solicit or hire employees of the employer”
  • those “not to solicit or transact business with customers, clients, or vendors of the employer”
  • those “made in connection with the sale of a business entity or substantially all of the operating assets of a business entity or partnership, or otherwise disposing of the ownership interest of a business entity or partnership, or division or subsidiary thereof, when the party restricted by the noncompetition agreement is a significant owner of, or member or partner in, the business entity who will receive significant consideration or benefit from the sale or disposal”
  • those “outside of an employment relationship”
  • “forfeiture agreements,” which are defined as “an agreement that imposes adverse financial consequences on a former employee as a result of the termination of an employment relationship, regardless of whether the employee engages in competitive activities following cessation of the employment”
  • nondisclosure or confidentiality agreements
  • invention assignment agreements.

[Act, lines 1268-1281, at page 58.]

Perhaps of greatest interest, employers may still extract longer non-competes “made in connection with the cessation of or separation from employment if the employee is expressly given seven business days to rescind,” which means that noncompetition agreement may be part of a severance agreement. Id. How that will play out where one enters into a severance agreement with one who would otherwise be terminated without cause will prove interesting.

Third, the Act also limits both geographic scope and precludable competitive activities. It does so by limiting scope to those geographic areas employee actually worked in and those services the employee actually provided—during employee’s last two years of employment. This is seen in the statutory language that says “[a] geographic reach that is limited to only the geographic areas in which the employee, during any time within the last two years of employment, provided services or had a material presence or influence is presumptively reasonable” and that “[a] restriction on activities that protects a legitimate business interest and is limited to only the specific types of services provided by the employee at any time during the last two years of employment is presumptively reasonable.” Act, lines 1310-1317, at page 60.

Fourth, the Act also seems to limit venue to certain specific courts. The Act states that “[a]ll civil actions relating to employee noncompetition agreements subject to this section shall be brought in the county where the employee resides or, if mutually agreed upon by the employer and employee, in Suffolk county; provided that, in any such action brought in Suffolk county, the superior court or the business litigation session of the superior court shall have exclusive jurisdiction.” Act, lines 1350-1354, at page 60-61. The notion of “exclusive jurisdiction” will also likely be the subject of contested claims brought in federal court under the Act.

All Things Considered, I’d Rather Be In ….

As noted at the outset, the Massachusetts Act is a set of significant, material changes for employers. But they are manageable when one understands the full panoply of options that remain open to employers in Massachusetts and takes the time to plan with counsel for the October 1st transition to a new non-compete regime that in fact will continue to include much of what is already in use for sophisticated employers. So, Massachusetts will remain manageable.

In E.J. Brooks Company v. Cambridge Security Seals, the Court of Appeals of New York narrowed the scope of permissible damage claims plaintiffs can assert in trade secret actions under New York law. The ruling denies plaintiffs the ability to recover costs that defendants avoided through misappropriating trade secrets (known as “avoided costs” theory), making New York law less attractive to certain types of trade secret actions due to the state’s conservative approach in calculating damages.

E.J. Brooks Company d/b/a TydenBrooks (“TydenBrooks”), the largest manufacturer of plastic indicative security seals in the United States, brought an action in federal district court against rival manufacturer Cambridge Security Seals (“CSS”), asserting causes of action that included common law misappropriation of trade secrets, unfair competition and unjust enrichment. TydenBrooks alleged that former TydenBrooks employees misappropriated trade secrets after defecting to CSS and sought damages based on an “avoided costs” theory.

Under an “avoided costs” calculation, the plaintiff estimates damages based on the amount the defendant saved in research and development costs by unlawfully acquiring the plaintiff’s trade secrets. At trial, the jury found CSS liable under all three claims and awarded TydenBrooks a $3.9 million judgment based solely on the TydenBrooks’ avoided cost theory.

On appeal, the Second Circuit requested guidance from the New York State Court of Appeals on the issue of whether, under New York law, a plaintiff asserting claims of misappropriation of a trade secret, unfair competition, and unjust enrichment can recover damages measured by the costs the defendant avoided due to its unlawful activity. Prior New York precedent had not conclusively addressed whether a plaintiff could recover damages based solely on the cost avoidance of a defendant’s unlawful misappropriation of trade secrets.

In a 4-3 decision, the Court of Appeals held that a plaintiff may not elect to measure its damages by the defendant’s avoided costs in lieu of the plaintiff’s own losses. The majority went on to explain that the calculation of damages must be narrowly focused on the economic injuries incurred by the plaintiff. The minority noted that the decision departs from the predominant rule accepted by most states and may even encourage unlawful theft of trade secrets in circumstances where the unlawful actor’s benefit far exceeds the likely cost of defending against a trade secret action. Other jurisdictions, such as the Fifth, Tenth and Eleventh Circuits, have either allowed actions based solely on an “avoided cost” theory, or allowed a calculation of reasonable royalty[1] in lieu of a calculation of the plaintiff’s own losses.

Companies should be aware of New York’s conservative approach to damage calculations when entering into litigation surrounding trade secrets. Plaintiffs should also pay special attention to choice of law and choice of forum provisions in their contractual dealings with employees and contractors, as these may have an impact on the type of calculations that can be used to assess damages.

It is also important to note that the federal government expanded protections for trade secrets in adopting the Defend Trade Secrets Act (“DTSA”) of 2016. DTSA claims were not at issue in this case, because it predated DTSA’s enactment, but are an important consideration given the current case law in New York.

_______________

[1] A reasonable royalty is similar to “avoided costs” because it allows a plaintiff to recover damages in lieu of showing actual loss.

This post was written with significant assistance from Eduardo J. Quiroga, a 2018 Summer Associate at Epstein Becker Green.

So far, the year 2018 has brought an increasing number of labor and employment rules and regulations. To help you stay up to date, we are pleased to invite you to join our Employment, Labor & Workforce Management Webinar Series. Each month, we will focus on a specific industry, topic, or practice area.

Our July webinar will be hosted by Epstein Becker Green’s Health Employment and Labor (HEAL) strategic service team and Trade Secrets and Employee Mobility service team. This webinar will provide an overview of the legal landscape of non-compete agreements in the health care industry, including state law requirements and restrictions, public policy considerations, recent developments, and expected trends. The webinar will also address key considerations when drafting and enforcing non-competes, engaging in the due diligence process, and integrating providers following a health care transaction.

Tuesday, July 24, 2018
12:00 p.m. – 1:00 p.m. ET

Register for this complimentary webinar today!

We published an article with NYSBA Labor and Employment Law Journal, titled “Employee Threats to Critical Technologies Are Best Addressed Through a Formalized Insider Threat Risk Assessment Process and Program.” With the New York State Bar Association’s permission, we have linked it here.

fast_food_burger_chicken_soda_shutterstock_285533255_1280x720

On Monday, attorneys general in eleven states, including New York, New Jersey, Massachusetts, California, and Illinois, revealed that they are investigating several prominent fast food franchisors for their potential use of no-poaching or non-compete agreements restricting the ability of low wage workers to obtain a better-paying job with another franchise. To that end, these attorneys general have propounded document and information requests to these restaurants, returnable August 6, 2018.

In the Illinois AG’s press release, Attorney General Madigan stated that “No-poach agreements trap workers in low-wage jobs and limit their ability to seek promotion into higher-paying positions within the same chain of restaurants.” Madigan claims that at least 58 percent of major franchisors have no-poach provisions in their franchise agreements. This is not the first time that the Illinois AG has taken aim at non-compete agreements. Over two years ago, Madigan’s office sued sandwich chain Jimmy John’s for employing what it deemed “highly restrictive non-compete agreements,” ultimately reaching a $100,000 settlement with the franchisor. Ten months after Illinois passed the Freedom to Work Act, which prohibits private sector employers from requiring non-compete covenants of low-wage employees, defined as the greater of the applicable federal, state, or local minimum wage (currently $7.25 under federal law and $8.25 under Illinois state law) or $13 per hour, Madigan sued a national payday lender for requiring its employees, including workers who earn less than $13 an hour, to sign a non-compete agreement as a condition of employment.

Illinois is not the only state to pursue non-compete reform. Several other states recently have enacted legislation curbing the use of non-competes with respect to certain categories of workers, such as certified nurse practitioners and midwives (New Mexico) and workers in the broadcasting industry earning under a certain salary (Utah). Other states have proposed similar legislation. For example, New Hampshire bill SB 423 would ban non-compete agreements with “low-wage employees.” On the other end of the spectrum, Vermont House Bill 556 and Pennsylvania House Bill 1938 would ban all non-competes other than those formed in connection with the sale of an ownership interest in a business entity or the dissolution of a partnership or limited liability company. Even if these bills ultimately fail, they signal a rising trend of state-level restrictive covenant reform, which will likely gain momentum as state attorneys general step up enforcement in this area.

Following what it described as a three year “one-man legal circus,” a Seventh Circuit panel recently affirmed a sanction award of over $440,000 in a trade secret misappropriation case, after finding that the defendant, Raj Shekar, “demonstrated nothing but disrespect, deceit, and flat-out hostility[.]” Teledyne Technologies Incorporated v. Raj Shekar, No. 17-2171, 2018 U.S. App. LEXIS 17153, at *13 (7th Cir. June 25, 2018).

Shekar worked at Teledyne Technologies as a marketing and sales manager from June 2013 until he was fired less than two years later. Following his termination, Teledyne sued him for allegedly stealing trade secrets, among other common law and statutory claims. The district court granted a temporary restraining order and a preliminary injunction, ordering Shekar to turn over all of his electronic devices for inspection. Shekar did not comply with any of the court’s orders, and even produced what the court found to be a “fake” hard drive that appeared “totally blank” and “fresh from the electronics store.” As a result, the district court found Shekar in civil contempt and, when Shekar failed to purge himself of contempt, the district court ultimately issued a default judgment and awarded attorneys’ fees and damages totaling more than $441,000.

The Seventh Circuit found the sanction award appropriate, and acknowledged that the large amount determined was “due solely to Shekar’s decision to drag opposing counsel (not to mention the court) through a disingenuous legal battle rather than comply with the court’s clear order.” The panel found no abuse of discretion in the district court’s calculation of attorney’s fees or in the amount of damages awarded.

In so ruling, the court sent a very strong message that attempting to abuse the judicial system in an effort to stall or prolong litigation may result in costly consequences. Parties who face obstructionist behavior during trade secret litigation may want to consider raising a motion for sanctions when appropriate.