Editor: What are some of the general principles governing non-compete clauses?
Epstein: Non-compete clauses are governed by state law, and courts generally scrutinize non-compete provisions strictly and take a rigorous view when being asked to enforce these types of provisions.
There are certain general principles that can be stated because for a majority of states there are common elements that govern the enforceability of a non-compete provision. A non-compete provision should protect a legitimate interest of the employer and be reasonable as to its geographic scope, duration, and scope of activity that the non-compete prohibits.
Regarding protecting legitimate interests of the employer, courts generally recognize three types of legitimate interests that can serve as the basis for justifying a non-compete provision. First would be to protect the employer’s trade secrets. Second would be to protect the employer’s customer relationships. This prong could form the basis for justifying a non-compete provision when the employee has direct contact or is the alter-ego of the employer with the employer’s customers. Third, and this prong is seen less frequently, would be when the employee has what the court deems to be a “special, unique or extraordinary” job position. A number of states recognize a fourth legitimate employer interest that could justify a non-compete provision. This fourth prong would be when the employer provides extraordinary or special training to the employee.
As mentioned, another common feature of non-compete provisions is that to be enforceable, the provision must be reasonable in at least three ways: the geographic scope, the duration, and the scope of the proscribed activity all must be reasonable. Reasonableness is typically assessed by looking at the interest of the employer to be protected and assessing whether the restriction is reasonable in light of that interest. For example, if an employee only had relations with customers located in New York State, a non-compete provision having a nationwide geographic scope may well be unreasonable. If the reason for the non-compete is to protect trade secrets and the average life-span of those secrets is six months, a non-compete lasting three years may well be unreasonable.
Lastly, a non-compete provision cannot violate the public policy of a state whose courts are being asked to enforce the provision. For example, courts in California will apply California public policy and will generally refuse to enforce a non-compete between an employer and former employee even when the choice of law provision governing the non-compete stipulates that another state’s law applies to the contract. California courts will generally enforce employer-employee non-competes only in connection with the sale of a business or dissolution of a partnership.
Editor: What should be done to assure that the intended geographic area is covered?
Epstein: The main step to take to make sure the intended geographical area is covered is to be very careful in drafting the non-compete provision to make sure that the language of the non-compete clearly defines the restricted geographical area and delineates the activities that are restricted within the defined geographical area. Heiderich v. Florida Equine Veterinary Services, Inc., 86 So. 3d 527 (Fla. Dist. Ct. App. 2012) is instructive. In this case, the employee, a veterinarian, executed a non-compete provision in which she agreed for a two-year period not to perform veterinary services from any business located within a 30-mile radius of her former employer’s address. After leaving her employer, the veterinarian opened up a practice just outside the 30-mile limit and continued to treat animals within the 30-mile limit. In interpreting the geographic scope covered, the court held that the veterinarian’s actions were not prohibited by the language of the non-compete because the “clear” language of the provision only prohibited performing services from a business located within the 30-mile range but was silent on the location of where the services themselves could be performed. As long as the veterinarian practiced from a business located outside the 30-mile range, under the non-compete it was irrelevant where her services were performed.
Based on the teachings of this and other cases, it is best to be specific concerning the scope of the geographic restriction. Vague, ambiguous terms should not be used. Do not rely on the court implying a particular meaning or intent. State clearly the relevant geographic area, and enumerate the precise activities that are restricted within that area.
Editor: As to confidentiality agreements, what should be done to assure they achieve the results intended?
Epstein: Because of the ubiquitous nature of confidentiality agreements, one sometimes gets the impression that they are not given the time, care and attention that they deserve. Confidentiality agreements can be extremely important, need to be taken seriously, and should not treated as an afterthought. Don’t automatically assume that the last form of confidentiality agreement can be used in the next transaction.
Care and attention must be given to defining the term “confidential information.” This term is critical because it typically defines the scope of the entire confidentiality agreement and the information to which the restrictions apply. This term should be fulsome as it puts the recipient of the information on notice as to the subject matter of the restrictions.
The term “confidential information” will usually contain several exclusions negotiated at the behest of the information recipient. Those exclusions need to be stated very carefully. For example, typically a confidentiality agreement will not apply to information that is “independently developed” by the receiving party. Consideration should be given as to whether the words “independently developed” should be further defined. Another typical exclusion is when the recipient “legitimately reverse engineers” the confidential information. Thought should be given as to whether the terms “legitimate” and “reverse engineers” should be defined further.
The parties should be very precise in stating the permissible uses of the confidential information and to whom, if anyone, the initial recipient of the confidential information may make further disclosures. Finally, the provision should state those situations under which the disclosing party could require the return of the confidential information.
Giving sufficient thought and attention to the language being drafted is critical, and taking extra time to get the details correct is important to protect properly the sensitive information that is being disclosed pursuant to the confidentiality agreement.
Editor: As a recipient of confidential information, why is it important to protect “residuals”?
Epstein: As a recipient of confidential information, it makes sense to try to obtain a residuals provision in a confidentiality agreement. Of course, the entity disclosing the confidential information may be hesitant to agree to a residuals clause.
A residuals clause is contained within a confidentiality agreement and provides that, notwithstanding any other provision in the agreement, the recipient is free to use information in non-tangible form that may be retained in the unaided memory of the recipient even though the recipient had access to this information from the disclosing party and the information is otherwise covered by the agreement.
The clause reduces the potential liability of the recipient under a confidentiality agreement by making express that the recipient is free to carry on its activities after tangible versions of the confidential information have been returned to the disclosing party or tangible versions of the confidential information have not been used or referred to in the recipient’s current work. The clause provides the recipient a defense to an allegation of misuse or misappropriation of confidential information by specifying the situation under which that information may be used without incurring liability to the disclosing party.
Editor: What are the teachings of the Martin Marietta and RAA Management cases?
Epstein: The Martin Marietta and the RAA cases are fundamentally important decisions of the Delaware courts. They teach that parties should not ignore the potential impact that confidentiality provisions could have, and that the impact could be far-reaching. Parties should not take confidentiality agreements for granted.
In Martin Marietta, the company executed what by all accounts was a standard confidentiality agreement. Yet that agreement subsequently prevented Martin Marietta from moving forward with a hostile takeover. In essence, the confidentiality provision in question restricted the use of information only to a friendly transaction. The court found that a hostile takeover did not fit within this use restriction and issued an injunction blocking Martin Marietta from moving forward with its proposed hostile takeover. This meant that every other company in the world was free to go after the target via a hostile takeover except for the one company, Martin Marietta, that agreed that it would use the information the target provided only to engage in a friendly transaction.
This case demonstrates vividly that confidentiality agreements can have far-reaching effects on their signatories. Care and consideration needs to be given to potential unintended ramifications of agreeing to certain restrictions that may be contained in a confidentiality agreement.
Editor: Did you want to mention the RAA Management case?
Epstein: RAA Management teaches a similar lesson as the Martin Marietta case. In RAA Management, the confidentiality agreement provided the defendant in a lawsuit with a defense to claims of fraud and misrepresentation. When the parties executed the confidentiality agreement, it was under circumstances where the parties were considering a friendly transaction. The transaction did not go forward, and one party sued the other for fraud and misrepresentation. The defendant was able to avoid liability by citing provisions in the confidentiality agreement entered into by the parties that provided defenses to these types of claims. As with Martin Marietta, the case demonstrates the potentially far-reaching effect that provisions contained in confidentiality agreements can have.
Editor: Why is it important to carefully draft assignments and grants of licenses?
Epstein: It is important to carefully draft grants of assignments and licenses because in a recent case the Supreme Court interpreted an assignment grant in a manner that one of the parties - a very sophisticated party, Stanford University - did not intend and did not expect. There are two ways to draft language granting an assignment or granting a license. One way is to use present tense language. For example, present tense language states that a party “hereby grants” to the counterparty an assignment or a license. Using present tense language such as this effectuates the grant of the license or the grant of the assignment when the agreement is executed by the parties.
The second way to draft a grant of a license or assignment is to use future tense language. For example, future tense language states that a party “agrees to grant” or “will grant” to the counterparty an assignment or a license.
The Supreme Court made clear in Stanford Univ. v. Roche Molecular Systems that future tense language is not an effective grant of an assignment or a license. The inventor signed both Stanford’s agreement and Roche’s predecessor’s agreement. Stanford University used an agreement that contained future tense language in the grant of assignment. Roche’s predecessor used present tense language in its assignment grant. The Court ruled in favor of Roche explaining that Stanford’s language is merely a promise by the counterparty to take an action – grant an assignment -- in the future. Since the Roche agreement contained an actual present assignment, Roche was awarded the invention in question.
Editor: What precautions should be taken with respect to arriving employees with possible obligations to former employers?
Epstein: Care must be taken with respect to hiring employees. This is particularly true if the employee is reasonably senior or if the employee works in a technical or scientific area. Before a company hires such an employee, it needs to undertake diligence. The company should ascertain whether the employee has entered into any contractual obligations that may inhibit his or her future activities. For example, a potential new employer would want to know if the potential new employee had signed a non-compete agreement, a confidentiality agreement, or any other restriction that could impact on the new employee’s work.
The new employer should ensure that the employee has not taken anything from the former employer. This includes obvious items such as trade secrets and confidential information but extends to virtually any tangible item that could become the subject of a misappropriation claim by the former employer.
The new employer should have some sensitivity as to the new employee’s position. What tasks will the new employee be required to do? Will those tasks overlap with and be very similar to the tasks that the employee performed at his or her former job? Will the tasks allow the former employer to argue that use of its trade secrets will be inevitable in the course of the new employment because of the similarity of the work? If so, are there any precautions that the new employer should consider implementing to reduce the risk of liability? For example, should the new employer make special efforts to document that its new employee is not referring to any information learned at his or her prior employment? Should there be a period of time when the new employee does not engage in any similar tasks?
The new employer needs to educate its new employee as to the new employer’s policy regarding trade secrets. This education is at least twofold. First, it must be made clear that the new employer forbids its new employee from using or disclosing any trade secrets of the former employer. Second, the new employer should explain that it has certain procedures that the new employee must follow with respect to protecting the new employer’s own trade secrets.
Finally, the new employer should monitor the situation for a reasonable period of time to make sure that its new hire is not doing anything suspicious or that no red flags arise. An example of a red flag would be if the new employee is able to accomplish certain very difficult, very technical or time-consuming tasks in an unreasonably short period of time.
Editor: What should be done when an employee leaves?
Epstein: When an employee departs, the employer needs to conduct an exit interview with the employee. An exit interview is usually conducted by two individuals from the employer. At a minimum, they should remind the departing employee that he or she has continuing obligations to the company to maintain the confidentiality of trade secrets; they should obtain from the employee any items in the employee’s possession belonging to the company, such as laptops, smart phones and other types of devices; and they should have the departing employee sign an acknowledgement that the exit interview took place, that the employee understands his or her continuing obligations of confidentiality, and that the employee has returned all items constituting company property. The individuals conducting the exit interview for the employer should make clear that if the employee has any questions at any time, the employee should contact a specifically designated individual at the employer.
Editor: What lessons are to be learned from the recent STR litigation?
Epstein: STR refers to a litigation that took place in Massachusetts concerning the misappropriation of solar cell technology and provides a textbook example of the lessons that can be learned from trade secret litigation. For a company that is claiming misappropriation, it is important to detail how the trade secrets were developed and how they are protected. The trade secret owner should pursue misappropriators promptly and diligently. If only one misappropriator discloses the trade secret publicly, the trade secret can cease to exist and its owner loses valuable property.
When misappropriation is threatened, it is important for a trade secret owner to put its former employee’s new employer on notice that the individual has knowledge of trade secrets and has an obligation to keep them confidential. From a litigation strategy perspective, it is important to consider the consequences of not seeking a preliminary injunction, because failure to do so may convey to the court a sense that the trade secrets are not important.
As the STR case demonstrates, when a trade secret owner takes proper action, trade secret litigation can be very rewarding. In the STR case, the trial result for the our client, STR, which was upheld on appeal, included damages, punitive damages, attorneys’ fees, and a permanent injunction preventing the defendant from selling a competing product – regardless of how it was developed – for a significant period of time.
Editor: What is one of the biggest risks faced by trade secret owners?
Epstein: Cybercrime is a major risk. Unscrupulous companies and governments try to obtain confidential business information and other trade secrets by unlawfully penetrating the owner’s computer systems. This unlawful activity creates several significant risks for a trade secret owner. First, there is the economic and competitive risk of losing one’s trade secrets. This exposure to cybercrime has been estimated currently to be in the billions of dollars. Second is the litigation risk. Companies that are victims of cybercrime have found themselves embroiled in both securities and consumer class action litigation. Third is the risk of corrupted computer systems that have to be replaced or updated. Fourth is the monetary risk of having to pay for remediation of computer systems, and for fines or penalties assessed by government regulators who make a determination that the systems were insufficiently secure or the cybercrime victim did not act with the appropriate level of diligence. Finally, there is the reputational risk that arises from being a victim of cybercrime.
Published May 23, 2013.
