Thomson Reuters Practical Law has released a new edition of “Preparing for Non-Compete Litigation,” a Practice Note co-authored by our colleague Peter A. Steinmeyer of Epstein Becker Green.

Following is an excerpt:

Non-compete litigation is typically fast-paced and expensive. An employer must act quickly when it suspects that an employee or former employee is violating a non-compete agreement (also referred to as a non-competition agreement or non-compete). It is critical to confirm that there is sufficient factual and legal support before initiating legal action. Filing a complaint for monetary damages or a request for an injunction can backfire if an employer is not prepared with sufficient evidence to support its request. This Note discusses the steps an employer can take to best position itself for successful enforcement of a non-compete and the strategic considerations involved with initiating non-compete litigation. In particular, it discusses:

  • Best practices for investigating a suspected violation and gathering relevant evidence.
  • Key steps for evaluating the likelihood a court will enforce a non-compete.
  • Factors to consider before initiating legal action.
  • The options for enforcing a non-compete through legal action and the key decisions relevant to each option.

Click here to download the full Note in PDF format.

In its 2008 landmark decision Edwards v. Arthur Andersen LLP (2008) 44 Cal. 4th 937, the California Supreme Court set forth a broad prohibition against non-compete provisions, but it left open whether or to what extent employee non-solicit provisions were enforceable. Since Edwards, no California appellate court has addressed that issue in a published opinion – until recently. On November 1, the California Court of Appeal in AMN Healthcare, Inc. v. Aya Healthcare Services, Inc., ruled that a broadly worded contractual clause that prohibited solicitation of employees for one year after employment was void under California Business and Professions Code section 16600, which provides “Except as provided in this chapter every contract by which anyone is restrained from engaging in a lawful profession, trade or business of any kind is to that extent void.” The decision calls into question the continuing viability of employee non-solicitation provisions in the employment context, and employers who regularly include such provisions in their agreements should reassess their use and enforcement of those provisions.

AMN and Aya are competing healthcare staffing companies that provide travel nurses, to medical care facilities throughout the country. The individual defendants were former travel nurse recruiters of AMN who left AMN and joined Aya, where they also worked as travel nurse recruiters.

The individual defendants each signed a confidentiality and nondisclosure agreement (CNDA) with AMN, which included a provision preventing them from soliciting any employee of AMN to leave AMN for a one-year period. Section 3.2 of the CDNA provided:

Employee covenants and agrees that during Employee’s employment with the Company and for a period of [one year or] eighteen months after the termination of the employment relationship with the Company, Employee shall not directly or indirectly solicit or induce, or cause others to solicit or induce, any employee of the Company or any Company Affiliate to leave the service of the Company or such Company Affiliate.

Because AMN’s travel nurses were employees of AMN, section 3.2 of the CNDA applied to prevent a former AMN employee from recruiting a travel nurse on a temporary assignment for AMN.

After the individual defendants resigned, AMN sued them, asserting various causes of action, including breach of the non-solicitation provision in the CNDA. Defendants filed a cross-complaint, requesting the court declare the non-solicitation provision in the CNDA void and enjoining AMN from enforcing the provision against other former AMN employees.

The defendants moved for summary judgment of AMN’s complaint and of their own cross-complaint. Defendants claimed that the non-solicitation provision in the CNDA was an improper restraint on individual defendants’ ability to engage in their profession – soliciting and recruiting travel nurses – in violation of Business and Professions Code section 16600. The trial court agreed, and granted defendants summary judgment on AMN’s complaint and granted summary adjudication of defendants’ declaratory relief cause of action. Then the court enjoined AMN from enforcing the employee non-solicitation provision in the CNDA as to any former California employee and awarded defendants attorney’s fees.

The Fourth District Court of Appeal affirmed the trial court’s grant of summary judgment. In doing so, the court concluded that the non-solicitation provision in the CNDA was void under section 16600. “Indeed, the broadly worded provision prevents individual defendants, for a period of at least one year after termination of employment with AMN, from either ‘directly or indirectly’ soliciting or recruiting, or causing others to solicit or induce, any employee of AMN. This provision clearly restrained individual defendants from practicing with Aya their chosen profession—recruiting travel nurses on 13-week assignments with AMN.” The court further found that a one-year, post-termination restriction preventing a former AMN recruiter from contacting and recruiting a travel nurse on a 13-week assignment with AMN “at a minimum equates to a period of four such assignments for a given nurse. The undisputed evidence thus shows section 3.2 of the CNDA restricted individual defendants’ ability to engage in their ‘profession, trade, or business.'”

In granting summary adjudication, the court rejected AMN’s reliance on Loral Corp. v. Moyes (1985) 174 Cal. App. 3d 268 for the argument that the CNDA was valid because it only prevented non-solicitation of employees (here, travel nurses). Moyes involved the validity of a contractual clause restricting a former executive officer from “raiding” the plaintiffs’ employees. In determining the provision was more like a permissible non-solicitation or nondisclosure agreement and not an invalid non-competition agreement, the court observed that the agreement “restrained [defendant] from disrupting, damaging, impairing or interfering with his former employer by raiding [the plaintiffs’] employees …. This does not appear to be any more of a significant restraint on his engaging in his profession, trade or business than a restraint on solicitation of customers or on disclosure of confidential information.”

 The court concluded that Moyes‘s use of a reasonableness standard in analyzing the non-solicitation clause conflicted with Edwards – decided over twenty years later – where the California Supreme Court interpreted Section 16600 to be a “settled public policy in favor of open competition,” and rejected the common law “rule of reasonableness.” Because the Edwards court found section 16600 “unambiguous,” and noted that “if the Legislature intended the statute to apply only to restraints that were unreasonable or overbroad, it could have included language to that effect,” the court expressed “doubt [as to] the continuing viability of Moyes post-Edwards.”

The court also affirmed the injunction, which prevented AMN and its employees and agents “from using, enforcing, or attempting to enforce any contract or employment agreement in the State of California which purports to restrain its former employees from directly or indirectly soliciting or inducing, or causing others to solicit or induce, any employee of AMN to leave the service of AMN.” In connection with the injunction, the court approved an award of attorney’s fees to defendants under Code of Civil Procedure section 1021.5, which permits fees to be awarded “in any action which has resulted in the enforcement of an important right affecting the public interest if: (a) a significant benefit … has been conferred on the general public or a large class of persons, (b) the necessity and financial burden of private enforcement … are such as to make the award appropriate, and (c) such fees should not in the interest of justice be paid out of the recovery, if any.”

In affirming the award of attorney’s fees, the court concluded that “Defendants clearly were successful parties within the meaning of the statute … the instant action involved an important issue affecting the public interest, namely the enforceability of section 3.2 [of the CNDA, which], if enforced, prevented former AMN employees from recruiting travel nurses and similar professionals who were on temporary assignment with AMN, even if those same travel nurses had applied to, were known by, and/or had previously been placed by, a competitor of AMN, as the instant case aptly shows.” The court further concluded that “instant action conferred a significant benefit on the public … [and] a large class of persons … namely, all current and former AMN California employees who had signed a CNDA containing a non-solicitation of employee provision similar to section 3.2 of the CNDA.”

The AMN Healthcare decision is significant for several reasons. The court’s expressed doubt as to the viability of Loral Corp. v. Moyes should give pause to both employers who regularly include such provisions in employment agreements and practitioners who advise employers as to the inclusion or enforceability of such provisions. While it could be argued the appellate court’s ruling should be limited to its facts because an employee non-solicitation clause easily restrains a recruiter from engaging in their “profession, trade, or business,” the AMN Healthcare court’s reasoning could be extended to other situations. Further, the court’s award of attorney’s fees under Code of Civil Procedure section 1021.5 provides a cautionary tale for employers attempting to enforce contractual provisions that run afoul of Business & Professions Code section 16600. Well-informed defendants will bring a cross-complaint seeking injunctive relief, and, if they prevail, could be entitled their attorney’s fees in doing so.

States across the country have been using enforcement actions, legislation, and interpretive guidance to limit employers’ ability to enforce restrictive covenants against low wage workers. The recent decision in Butler v. Jimmy John’s Franchise, LLC et. al., 18-cv-0133 (S.D. Ill. 2018) suggests this trend may extend to federal antitrust law.

The Butler case relates to the legality of certain restrictive covenants in Jimmy John’s franchise agreements.[1] The Complaint alleges that Jimmy John’s required franchisees to agree not to hire any job applicants who worked for a different Jimmy John’s franchise in the previous year. Franchisees also agreed not to solicit one another’s employees. The franchise agreements also named all other Jimmy John’s franchisees as third party beneficiaries of the agreement. This meant that if Franchise B hired a Franchise A employee, Franchise A could sue to enforce the agreement between Franchise B and Jimmy John’s Franchise LLC (the franchisor).

In determining claims of antitrust violations, the distinction between “horizontal” and “vertical” agreements is highly significant. Challenges to vertical agreements are analyzed under the “rule of reason” under which plaintiffs must prove market power and that the challenged practices actually harm competition. This generally requires sophisticated economic analysis. Horizontal agreements not to compete, in contrast, are generally deemed “per se” unreasonable and do not require any proof regarding market context.

In Butler, the Court characterized the franchise agreements as horizontal agreements. Such a characterization permitted the plaintiffs to state a claim without alleging that a particular franchisor has sufficient market power to effect the market for employees in an entire geographic region. In other words, the plaintiffs did not have to prove that Jimmy John’s on its own had enough market power to depress the wages of delivery drivers in a particular city.

To keep things in perspective, Butler is an isolated district court decision which may remain an outlier. However, it serves as another example of how subjecting low wage workers to restrictive covenants can impose heightened litigation risk. Butler provides another reason (on top of the joint FTC/DOJ Antitrust Guidance for Human Resources Professionals and DOJ enforcement actions following through on that guidance) for employers to ensure their restrictive covenants are not only enforceable but compliant with antitrust law.

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[1] Jimmy John’s has since agreed to remove the challenged provisions from their franchise agreements.

Join Epstein Becker Green attorneys, Brian G. Cesaratto and Brian E. Spang, for a discussion of how employers can best protect their critical technologies and trade secrets from employee and other insider threats. Topics to be discussed include:

  • Determining your biggest threat by using available data
  • What keeps you up at night?
  • Foreseeing the escalation in risk, from insider and cyber threats to critical technologies
  • New protections and remedies under the Trade Secret Protection Act of 2014
  • Where are your trade secrets located, and what existing protections are in place?
  • What types of administrative and technical controls should your firm consider implementing for the key material on your network to protect against an insider threat?
  • What legal requirements may apply under applicable data protection laws?
  • How do you best protect trade secrets and other critical technologies as information increasingly moves into the cloud?
  • Using workforce management and personnel techniques to gain protection
  • The importance of an incident response plan
  • Developing and implementing an effective litigation response strategy to employee theft

Wednesday, October 3, 2018.
12:30 p.m. – 2:00 p.m. ET
Register for this complimentary webinar today!

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.

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.

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[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.