Category: Litigation

Are Restrictive Covenants Enforceable in California? It Depends.

Recently posted in the National Law Review an article by attorneys Alice Y. Chu and Kurt A. Kappes of Greenberg Traurig, LLP regarding the enforeceability of non-competes in California:

 

GT Law

 

In California, it is well established that non-compete provisions are unenforceable, subject to certain statutory exceptions. Nevertheless, some courts have also recognized that non-compete provisions are enforceable if necessary to protect confidential information or trade secrets.

But what about non-compete provisions that are ambiguous as to their protection of confidential information or trade secrets? Recently, when faced with such a provision, one California federal court narrowly construed the provision to find it enforceable.

The Facts in Richmond

In Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158 (N.D. Cal. July 1, 2011), a California federal district court evaluated the following provisions included in the parties’ Confidentiality and Non-Disclosure Agreement (“NDA”):1

Non–Solicitation. During the Term of this Employment (a[s] hereinafter defined), and for a period of one year thereafter, [defendant] [shall not] directly or indirectly, initiate any contact or communication with, solicit or attempt to solicit the employee of, or enter into any agreement with any employee, consultant, sales representative, or account manager of [plaintiff] unless such person has ceased its relationship with [plaintiff] for a period of not less than six months. Similarly [plaintiff] shall not solicit the employment of, or enter into any agreement with any employee, consultant or representative of [defendant].

Non–Interference. During the Term of this Employment, and for a period of one year thereafter, [defendant] will not initiate any contact or communication with, solicit or attempt to solicit, or enter into any agreement with, any account, acquiring bank, merchant, customer, client, or vendor of [plaintiff] in the products created and serviced by [plaintiff], unless (a) such person has ceased its relationship with [plaintiff] for a period of not less than six months, or (b) [defendant]’s relationship and association with such person both (i) pre-existed the date of this Agreement and (ii) does not directly or indirectly conflict with any of the current or reasonably anticipated future business of [plaintiff].

Non Compete and Non Circumvent. [Defendant] will not compete with [plaintiff] with similar product and or Service using its technology for a period of one year thereafter. [Defendant] will not use any of the [plaintiff]’s technical knowhow or Source Code for the personal benefit other than the employment and to meet the customer needs defined by [plaintiff].2

The NDA also contained a provision that barred the defendant from disclosing or using confidential information used in plaintiff’s business.3 Confidential information was defined to include “Proprietary Data,” such as “know-how,” contract terms and conditions with merchants, technical data, and source code; “Business and Financial Data;” “Marketing and Developing Operations;” and “Customers, Vendors, Contractors, and Employees,” including their names and identities, data provided by customers, and information on the products and services purchased by customers.4

The Richmond Court’s Analysis

In evaluating plaintiff’s motion for a temporary restraining order, the court assessed plaintiff’s claim that, by teaming up with plaintiff’s former employee to form a competing venture, the defendant had breached the non-compete provisions of the NDA.5 Defendants argued that the plaintiff was not likely to prevail on its contract claims because the non-compete provisions in the NDA are unenforceable under California Business and Professions Code § 16600.6

Within this context, the court first noted that the California Supreme Court had recently confirmed that “‘[t]oday in California, covenants not to compete are void, subject to several exceptions,” and that the California Supreme Court “‘generally condemns noncompetition agreements.’”7

Second, the court also observed that the California Supreme Court had rejected the “narrow-restraints” exception to Section 16600 applied in several Ninth Circuit cases, finding that “‘California courts have been clear in their expression that section 16600 represents a strong public policy of the state which should not be diluted by judicial fiat.’”8 As the court stated, “Section 16600 stands as a broad prohibition on ‘every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind.’”9

Third, the court rejected plaintiff’s argument that Section 16600 applies only to restrictions on employees, concluding that Section 16600 did apply to the facts of the case.10

Fourth, the court acknowledged that, even though Section 16600 applied, a number of California courts have also held that former employees may not misappropriate a former employer’s trade secrets to compete unfairly with the former employer.11

Applying these principles, the court held that the non-solicitation and non-interference provisions of the NDA were likely unenforceable under California law because the provisions were more broadly drafted than necessary to protect plaintiff’s trade secrets and “would have the effect of restraining Defendants from pursuing their chosen business and professions if enforced.”12

In regards to the non-compete provision, the court reasoned that “the scope of the prohibitions on ‘compet[ing] with [plaintiff] with similar product and or Service using its technology” and using ‘technical knowhow’ is not entirely clear.”13 However, the court then concluded that “if the clause is construed to bar only the use of confidential source code, software, or techniques developed for [plaintiff’s] products or clients, it is likely enforceable as necessary to protect [plaintiff]’s trade secrets.”14

To support this construction, the court specifically cited the California Uniform Trade Secrets Act (“UTSA”)’s definition of a “trade secret,” even though plaintiff had not alleged a UTSA claim against the defendants and the UTSA was not briefed.15 The court also found that the provision prohibiting use of confidential information was likely enforceable to the extent that the claimed confidential information is protectable as a trade secret.16

Based on these conclusions regarding the enforceability of the provisions, and facts showing that plaintiff had established at least serious questions going to the merits of its claims, the court issued a narrow temporary restraining order.17

IMPLICATIONS

Richmond demonstrates that at least one California federal court may be willing to narrowly construe an ambiguous non-compete provision and find it enforceable to the extent necessary to protect a party’s trade secrets. In so doing, however, the court invites comparisons to California cases where courts have refused to narrowly construe broad non-compete provisions to be protections of trade secrets.18 For example, in D’sa v. Playhut, Inc., 85 Cal. App. 4th 927 (2000), a Court of Appeals refused to reform a non-compete provision that broadly prohibited employees from working in connection with a competing product.19 But D’sa was strictly in the employment context, where courts are more likely to look for over-reaching. Arguably, moreover, the provision at issue in D’Sa was broader than the provision considered inRichmond, which expressly referenced “technology,” “technical knowhow,” and “Source Code” in its language. Nevertheless, even with these references, the Richmond court conceded that the scope of the provision was “not entirely clear,” yet was willing to reform it to find it enforceable.

Furthermore, in enforcing the non-compete provision, the Richmond court also relied on the so-called “trade secret exception” to Section 1660020 — an exception that the California Supreme Court noted but declined to address in Edwards v. Arthur Andersen LLP, 44 Cal. 4th 937, 946 n.4 (2008). This is an exception that other courts, particularly state courts, have questioned.21 This reliance suggests that, in the absence of conclusive guidance from the California Supreme Court on the viability of this exception, federal courts may remain willing to apply this exception to non-compete provisions perhaps as a way to harmonize the two statutes. In doing so, it is possible that the same collision between federal jurisprudence and state jurisprudence that gave rise to the Edwards decision may lie ahead. The California Supreme Court will then have an opportunity to address a key issue that the Supreme Court left unaddressed in a footnote in Edwards.

Finally, even with the uncertainty over the viability of the “trade secret exception” and whether courts will narrowly construe a non-compete provision to find it enforceable, companies should ensure non-compete provisions are drafted to clearly and specifically protect trade secrets, thereby increasing the likelihood that such a provision will be enforced.

1Plaintiff is a company that provides enterprise resource planning software for financial service companies that provide credit card terminals to merchants. Id. at *1. One of the defendants developed and maintained enterprise resource planning software for the plaintiff and, pursuant to this relationship, entered into this NDA with plaintiff’s predecessor-in-interest. Id. at *1-2.

2Id. at *16.
3Id. at *16.
4Id. at *16.
5Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158, at *15-22 (N.D. Cal. July 1, 2011).
6Id. at *16.
7Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158, at *16 (N.D. Cal. July 1, 2011)(quoting Edwards v. Arthur Andersen LLP, 44 Cal. 4th 937, 945-46 (2008)).
8Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158, at *17 (N.D. Cal. July 1, 2011)(quoting Edwards v. Arthur Andersen LLP, 44 Cal. 4th 937, 949 (2008)).
9Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158, at *17 (N.D. Cal. July 1, 2011)(quoting Cal. Bus. & Profs. Code § 16600).
10Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158, at *17 (N.D. Cal. July 1, 2011).
11Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158 at *18 (N.D. Cal. July 1, 2011)(quoting Retirement Group v. Galante, 176 Cal. App. 4th 1226, 1237 (2009)(citing Morlife Inc. v. Perry, 56 Cal. App. 4th 1514, 1519-20 (1997); American Credit Indemnity Co. v. Sacks, 213 Cal. App. 3d 622, 634 (1989); Southern Cal. Disinfecting Co. v. Lomkin, 183 Cal. App. 2d 431, 442–448 (1960); Hollingsworth Solderless Terminal Co. v. Turley, 622 F.2d 1324, 1338 (9th Cir. 1980); Gordon v. Landau, 49 Cal. 2d 690 (1958); Gordon v. Schwartz, 147 Cal. App. 2d 213 (1956); Gordon v. Wasserman, 153 Cal. App. 2d 328 (1957)).
12Id. at *18.
13Id. at *19.
14Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158, at *19 (N.D. Cal. July 1, 2011)(citing Whyte v. Schlage Lock Co., 101 Cal. App. 4th 1443, 1456 (2002)). Interestingly, there is theoretically no temporal limit to a trade secret, so the one year limit of the non-compete provision actually undercut the plaintiff’s protection!
15See Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158, at *19 (N.D. Cal. July 1, 2011)(citing Cal. Civ.Code § 3426.1(defining “trade secret” to include programs, methods, and techniques that derive independent economic value from not being generally known to the public, provided they are subject to reasonable efforts to maintain their secrecy)).
16Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158, at *19 (N.D. Cal. July 1, 2011)
17Id. at *23.
18Perhaps this decision also signals a willingness among California federal courts to protect employer’s interests by reforming or severing provisions that may not comply with Section 16600. See also Thomas Weisel Partners LLC v. BNP Paribas, No. C 07–6198 MHP, 2010 WL 1267744 (N.D. Cal. Feb. 10, 2010)(holding that a former employee’s non-solicitation provision was void to the extent it restricted the former employee’s ability to hire the employer’s employees after the former employee transitioned to another company, but upholding the rest of the employment agreement). These decisions may renew forum shopping, the ill that the California Supreme Court’s decision in Edwards v. Arthur Andersen LLP, 44 Cal. 4th 937 (2008) was implicitly designed to address.
19The provision stated: “Employee will not render services, directly or indirectly, for a period of one year after separation of employment with Playhut, Inc. to any person or entity in connection with any Competing Product. A ‘Competing Product’ shall mean any products, processes or services of any person or entity other than Playhut, Inc. in existence or under development, which are substantially the same, may be substituted for, or applied to substantially that same end use as the products, processes or services with which I work during the time of my employment with Playhut, Inc. or about which I work during the time of my employment with Playhut Inc. or about which I acquire Confidential Information through my work with Playhut, Inc. Employee agrees that, upon accepting employment with any organization in competition with the Company or its affiliates during a period of five year(s) following employment separation, Employee shall notify the Company in writing within thirty days of the name and address of such new employer.” D’sa v. Playhut, Inc., 85 Cal. App. 4th 927, 930 -31(2000).
20Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158 at *18 (N.D. Cal. July 1, 2011).
21As an example of the trend, see, e.g., Dowell v. Biosense Webster, Inc., 179 Cal. App. 4th 564, 577 (2009)(“Although we doubt the continued viability of the common law trade secret exception to covenants not to compete, we need not resolve the issue here.”); Robinson v. U-Haul Co. of California, Nos. A124070, A124097, A124096, 2010 WL 4113578, at *10 (Cal. Ct. App. Oct. 20, 2010)(“the so-called ‘trade secrets’ exception to Business and Professions Code section 16600 . . .rests on shaky legal grounds”)(citing Edwards v. Arthur Andersen LLP, 44 Cal. 4th 937, 946 n.4 (2008); Dowell v. Biosense Webster, Inc., 179 Cal. App. 4th 564, 578 (2009);Retirement Group v. Galante, 176 Cal. App. 4th 1226, 1238 (2009)). When the apparent conflict in this area is addressed, perhaps the California Supreme Court will defuse it entirely, by agreeing with the way the court in Retirement Group v. Galante, 176 Cal. App. 4th 1226 (2009) reconciled it: “the conduct is enjoinable not because it falls within a judicially-created ‘exception’ to section 16600’s ban on contractual nonsolicitation clauses, but is instead enjoinable because it is wrongful independent of any contractual undertaking.” Retirement Group v. Galante, 176 Cal. App. 4th at 1238.

©2011 Greenberg Traurig, LLP. All rights reserved.

Intervening Rights Can Apply to an Original Claim Based on Arguments Made During Reexamination

Recently posted in the National Law Review an article by Cynthia Chen, Ph.D. of McDermott Will & Emery  regarding the U.S. Court of Appeals for the Federal Circuit’s decision to grant injunction and reasonable royalty damages for patent infringement:

 

In reversing and vacating a district court’s decision to grant injunction and reasonable royalty damages for patent infringement, the U.S. Court of Appeals for the Federal Circuit held that intervening rights can apply to an original claim based on arguments made by the patentee during reexamination.   Marine Polymer Technologies, Inc. v. HemCon, Inc., Case No. 10-1548 (Fed. Cir., Sept. 26, 2011) (Dyk, J.) (Lourie, J., dissenting).  Intervening rights typically occur where the scope of coverage of a patent changes during reexamination.

Marine Polymer sued HemCon for infringing its patent claiming a biocompatible polymer.   In the ensuing litigation, the district court construed the term “biocompatible” as meaning polymers “with no detectable biological reactivity as determined by biocompatibility tests.”  Meanwhile, in the parallel reexamination proceeding, the examiner construed the term “biocompatible” as meaning polymers with “little or no detectable reactivity” reasoning that certain dependent claims recited a biocompatibility test score that is greater than zero.  Marine Polymer urged the examiner to adopt the district court’s claim construction and canceled all dependent claims reciting a biocompatibility test score greater than zero.  In view of the cancellation of those dependent claims, the examiner adopted the district court’s claim construction, and the remaining claims were issued.

In this appeal from the district court (where HemCon was subjected to a $29 million dollar damages award against it), HemCon argued that it was entitled to intervening rights because Marine Polymer changed the scope of the claims of the asserted patent during reexamination.  Marine Polymer, contended that intervening rights cannot apply because the actual language of the asserted claims was not amended during reexamination.

The Federal Circuit agreed with HemCon and held that Marine Polymer indeed narrowed the scope of the claims by “argument rather than changing the language of the claims to preserve otherwise invalid claims.”   Noting that intervening rights are available if the original claims have been “substantively changed,” the Court emphasized that “in determining whether substantive changes have been made, we must discern whether the scope of the claims [has changed], not merely whether different words are used.”  In particular, those dependent claims that were canceled during reexamination indicated that “the term ‘biocompatible’ must include slight or mild biological reactivity.”  As such, the district court’s claim construction, which required that the polymer show “no detectable biological reactivity,” imposed a new claim limitation that narrowed the scope of the claims. Therefore, intervening rights did apply in this case, as “argument to PTO on reexamination constituted disavowal of claim scope even though ‘no amendments were made.’”

Judge Lourie dissented and argued that the majority went beyond the statutory rules for intervening rights under 35 U.S.C. §§ 307(b) and 316(b).   Judge Lourie believes that, according to the language of the statute, intervening rights should only apply to “amended or new claims.”

Practice Note:   Post-grant proceedings could be a pitfall for patentees seeking to enforce their patents.  A patentee should consider whether it would be better off filing a continuing application before grant of the original patent to leave a vehicle to present new or amended claims.

© 2011 McDermott Will & Emery

Under The Radar–The Supreme Court, Commercial Speech and the First Amendment

Recently posted in the National Law Review an article by attorney  Charles M. English of Ober | Kaler regarding U.S. Supreme Court’s  view of the First Amendment as applied especially to political speech:

Ober

Over the past several years, a great deal has been written about the .  In both the 2010 and 2011 terms the Court in dramatic and well-publicized cases struck down federal (Citizens United) and state (Arizona Free Enterprise Club’s Freedom PAC) campaign finance restrictions as applied to corporate political donations and laws supporting public financing of candidates who forgo private donations.  These are of course significant, far-reaching decisions with major impacts on political discourse in the United States.  But even more may be going on in First Amendment jurisprudence when one looks beyond the headline-grabbing cases to less well publicized commercial speech cases.

More often than not the Court moves not dramatically, but in incremental steps as both the law and the Justices evolve and the Court personnel change.   Such an incremental step appears to have been taken by the Court this year with respect to commercial speech regulation – speech intended not for political discourse, but by commercial entities seeking to buy, sell, advertise, market or provide information to each other and consumers.

On June 23, 2011, the Court, in a 6-3 majority, issued Sorrell v. IMS Health, Inc.,No. 10-779, striking down on First Amendment grounds Vermont’s law that prohibited the sale and use of physician prescription data for commercial purposes especially by pharmaceutical companies wishing to use that data to advertise and otherwise reach out to physicians in order to market their drugs.  Having monitored the case closely and attended the Court’s oral argument, I don’t think that the result itself was much of a surprise.  The Court concluded that the regulated activity interfered with the exchange of ideas and was thus speech and then concluded that the protected speech could not be regulated by Vermont in the fashion proposed.

What to many observers was less predictable was the breadth of the decision and the language employed in the majority opinion written by Justice Anthony Kennedy and joined both by the four justices normally considered “conservative”, but also joined by Justice Sonia Sotomayor.  The majority appears to have applied a stricter standard to the “content and speaker-based” commercial speech restrictions than it has applied in the past.  So the question arises: Is the Court moving, however incrementally, towards a change in how it treats commercial speech under the First Amendment – one that would increase the level of scrutiny applied to restraints on such speech?

While Sorrell received far less coverage than many of other cases decided by the Court in the 2011 Term, commercial speech proponents have been quick to embrace the decision and to assert broader commercial speech rights.  After the Food and Drug Administration adopted new cigarette warning label requirements in the summer of 2011, R.J. Reynolds, together with other tobacco companies and supported by national advertising organizations, were quick to seek court intervention against the new warning label requirements. They relied in no small part on the expansive language found in Sorrell.  That suit, filed in mid-August, is set for a decision on motions for a preliminary injunction and summary judgment after a hearing before Judge Richard Leon in the U.S. District Court for the District of Columbia on September 21, 2011.

To understand where the Court may be heading, it is important first to know where we have been.  While the First Amendment, which is also applicable to the States, might appear to the casual reader to be absolute  – “Congress shall make no law . . . abridging the freedom of speech. . .”, it in fact has not been so regarded historically by the Court.  In 1942, the Court declared that commercial speech was not protected by the First Amendment at all.  The Court reversed course in 1976, declaring that some form of intermediate protection did exist for commercial speech, and established in 1980 a multi-part test (Central Hudson) for evaluating the constitutionality of commercial speech restrictions:  In order to regulated non-misleading commercial speech regarding otherwise legal activity, the government must establish that there is a substantial state interest, that the regulation directly advances that state interest, and that the regulation is narrowly tailored to advance that substantial interest.

It doesn’t take a lawyer to conclude that this test is confusing, and not surprisingly, most observers from a wide array of the political spectrum have concluded that the results of the cases decided under Central Hudson are unpredictable and that the test is simply unworkable.  Importantly, Justice Clarence Thomas has repeatedly criticized the Court’s commercial speech jurisprudence directly, with some indirect support from others from the Court’s so-called conservative wing.

The majority in Sorrell certainly did not overrule (at least not expressly or entirely)Central Hudson.  However, the majority opinion , however subtly, appears to provide a measurable shift in the First Amendment analysis by the Court by carving out in commercial speech cases types of restrictions to which the majority appears to provide some form of scrutiny greater than the protections found in theCentral Hudson test.   Indeed and perhaps most tellingly the minority opinion written by Justice Stephen Breyer accuses the majority of having created a new test, stricter than Central Hudson, for content-based or speaker-based speech that undermines the differentiation of commercial speech from what is often called core First Amendment speech.  If so, the court may have indirectly moved towards Justice Thomas’ assertion that commercial speech should not be treated differently from core speech.

In the short run, we should expect the decision in Sorrell to actually add to the confusion that surrounds Central Hudson.  Will lower courts such as the one now presented with the cigarette warning dispute conclude that there is a new, higher standard?  If so, in which cases will this new standard apply, and how will those cases be decided?  This is not an academic or legalistic point.  Both business and government thrive on certainty in results, and legal uncertainty is simply very expensive for everyone:  When states lose these First Amendment cases, they normally must pay the attorneys’ fees to the prevailing party; meanwhile, businesses subject to regulation of uncertain legality incur costs in complying and challenging such regulation.  Nobody benefits from this kind of uncertainty – well, except for the lawyers of course.

Of course, we may not have long to wait after all.  The case of the FDA regulation of cigarette packaging,  or possible other cases involving other governmental regulation of health-care claims or of health insurance, or new food safety regulation – any one of these could give rise to litigation that provides new guidance, clarity or even another incremental step.  However, when one goes back to the text of the First Amendment and its absolute prohibition on abridging the freedom of speech, examines the Court’s recent dramatic political speech cases in the past two terms, considers the muscular conservative majority, and carefully reads between the lines of Sorrell (decided with six votes in the majority), one must conclude that we are in for interesting times, and that advocates of commercial speech restrictions, including anti-smoking advocates, may now face a greater uphill battle in defending and maintaining what have come to be accepted restrictions in marketing and advertising in the United States.

© 2011 Ober | Kaler

 

 

Second Circuit's Citigroup Decision Endorses Presumption of Prudence, Upholds Dismissal of Disclosure Claims

Posted this week at the National Law Review by Morgan, Lewis & Bockius LLP regarding the decision that employer stock in a 401(k) plan is subject to a “presumption of prudence” that a plaintiff alleging fiduciary breach:

 

 

 

In a much-anticipated decision, the U.S. Court of Appeals for the Second Circuit joined five other circuits in ruling that employer stock in a 401(k) plan is subject to a “presumption of prudence” that a plaintiff alleging fiduciary breach can overcome only upon a showing that the employer was facing a “dire situation” that was objectively unforeseeable by the plan sponsor. In re Citigroup ERISA Litigation, No. 09-3804, 2011 WL 4950368 (2d Cir. Oct. 19, 2011). The appellate court found the plaintiffs had not rebutted the presumption of prudence and so upheld the dismissal of their “stock drop” claims.

BACKGROUND

The Citigroup plaintiffs were participants in two 401(k) plans that specifically required the offering of Citigroup stock as an investment option. The plaintiffs alleged that Citigroup’s large subprime mortgage exposure caused the share price of Citigroup stock to decline sharply between January 2007 and January 2008, and that plan fiduciaries breached their duties of prudence and loyalty by not divesting the plans of the stock in the face of the declines. The plaintiffs further alleged that the defendants breached their duty of disclosure by not providing complete and accurate information to plan participants regarding the risks associated with investing in Citigroup stock in light of the company’s exposure to the subprime market. On a motion to dismiss, the district court found no fiduciary breach because the defendants had “no discretion whatsoever” to eliminate Citigroup stock as an investment option (sometimes referred to as “hardwiring”). Alternatively, the lower court ruled that Citigroup stock was a presumptively prudent investment and the plaintiffs had not alleged sufficient facts to overcome the presumption.

SECOND CIRCUIT DECISION

Oral argument in the Citigroup case occurred nearly a year ago, and legal observers have been anxiously awaiting the court’s ruling. In a 2-1 decision, with Judge Chester J. Straub issuing a lengthy dissent, the Second Circuit rejected the “hardwiring” rationale but confirmed the application of the presumption of prudence, which was first articulated by the Third Circuit in Moench v. Robertson, 62 F.3d 553 (3d Cir. 1995). The court also rejected claims that the defendants violated ERISA’s disclosure obligations by failing to provide plan participants with information about the expected future performance of Citigroup stock.

Prudence

Joining the Third, Fifth, Sixth, Seventh, and Ninth Circuits,[1] the court adopted the presumption of prudence as the “best accommodation between the competing ERISA values of protecting retirement assets and encouraging investment in employer stock.” Under the presumption of prudence, a fiduciary’s decision to continue to offer participants the opportunity to invest in employer stock is reviewed under an abuse of discretion standard of review, which provides that a fiduciary’s conduct will not be second-guessed so long as it is reasonable. The court also ruled that the presumption of prudence applies at the earliest stages of the litigation and is relevant to all defined contribution plans that offer employer stock (not just ESOPs, which are designed to invest primarily in employer securities).

Having announced the relevant legal standard, the court of appeals dispatched the plaintiffs’ prudence claim in relatively short order. The plaintiffs alleged that Citigroup made ill-advised investments in the subprime market and hid the extent of its exposure from plan participants and the public; consequently, Citigroup’s stock price was artificially inflated. These facts alone, the court held, were not enough to plead a breach of fiduciary duty: “[T]hat Citigroup made a bad business decision is insufficient to show that the company was in a ‘dire situation,’ much less that the Investment Committee or the Administrative Committee knew or should have known that the situation was dire.” Nor could the plaintiffs carry their burden by alleging in conclusory fashion that individual fiduciaries “knew or should have known” about Citigroup’s subprime exposure but failed to act. Relying on the Supreme Court’s decision in Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007), the court of appeals held these bald assertions were insufficient at the pleadings stage to suggest knowledge of imprudence or to support the inference that the fiduciaries could have foreseen Citigroup’s subprime losses.

Disclosure

The court’s treatment of the disclosure claims was equally instructive. Plaintiffs’ allegations rested on two theories of liability under ERISA: (1) failing to provide complete and accurate information to participants (the “nondisclosure” theory), and (2) conveying materially inaccurate information about Citigroup stock to participants (the “misrepresentation” theory).

As to the nondisclosure theory, the court found that Citigroup adequately disclosed in plan documents made available to participants the risks of investing in Citigroup stock, including the undiversified nature of the investment, its volatility, and the importance of diversification. The court also emphasized that ERISA does not impose an obligation on employers to disclose nonpublic information to participants regarding a specific plan investment option.

Turning to the misrepresentation theory, the court found plaintiffs’ allegations that the fiduciaries “knew or should have known” about Citigroup’s subprime losses, or that they failed to investigate the prudence of the stock, were too threadbare to support a claim for relief. Though plaintiffs claimed that false statements in SEC filings were incorporated by reference into summary plan descriptions (SPDs), the court found no basis to infer that the individual defendants knew the statements were false. It also concluded there were no facts which, if proved, would show (without the benefit of hindsight) that an investigation of Citigroup’s financial condition would have revealed the stock was no longer a prudent investment.

IMPLICATIONS

Coming from the influential Second Circuit, the Citigroup decision represents something of a tipping point in stock-drop jurisprudence, especially with respect to the dozens of companies (including many financial services companies) that have been sued in stock-drop cases based on events surrounding the 2007-08 global financial crisis. The Second Circuit opinion gives the presumption of prudence critical mass among appellate courts and signals a potential shift in how stock-drop claims will be evaluated, including at the motion to dismiss stage.[2]

Under the Citigroup analysis, fiduciaries should not override the plan terms regarding employer stock unless maintaining the stock investment would frustrate the purpose of the plan, such as when the company is facing imminent collapse or some other “dire situation” that threatens its viability. Like other circuits that have adopted the prudence presumption, the Citigroup court emphasized the long-term nature of retirement investing and the need to refrain from acting in response to “mere stock fluctuations, even those that trend downhill significantly.” It also sided with other courts in holding that the presumption of prudence should be applied at the motion to dismiss stage (i.e., not allowing plaintiffs to gather evidence through discovery to show the imprudence of the stock). Taken together, these rulings may make it harder for plaintiffs to survive a motion to dismiss, especially where their allegations of imprudence are based on relatively short-lived declines in stock price.

Some had predicted the Second Circuit would endorse the “hardwiring” argument and allow employers to remove fiduciary discretion by designating stock as a mandatory investment in the plan document. The Citigroup court was unwilling to go that far, but it did adopt a “sliding scale” under which judicial scrutiny will increase with the degree of discretion a plan gives its fiduciaries to offer company stock as an investment. This is similar to the approach taken by the Ninth Circuit inQuan and consistent with the heightened deference that courts generally give to fiduciaries when employer stock is hardwired into the plan. Thus, through careful plan drafting, employers should be able to secure the desired standard of review. Language in the plan document and trust agreement (as well as other documents) confirming that employer stock is a required investment option should result in the most deferential standard and provide fiduciaries the greatest protection.

Also noteworthy was the court’s treatment of the disclosure claims. Many stock-drop complaints piggyback on allegations of securities fraud, creating an inevitable tension between disclosure obligations under the federal securities laws and disclosure obligations under ERISA. The Second Circuit did not resolve this tension, but it construed ERISA fiduciary disclosure requirements narrowly and rejected the notion that fiduciaries have a general duty to tell participants about adverse corporate developments. The court made this ruling in the context of SPD disclosures under the 401(k) plan that identified specific risks of investing in Citigroup stock. Plan sponsors should review their SPDs and other participant communications to make sure company stock descriptions are sufficiently explicit about issues such as the volatility of a single-stock investment and the importance of diversification. These disclosures may go beyond what is already required under Department of Labor regulations.

[1]. See Howell v. Motorola, Inc., 633 F.3d 552, 568 (7th Cir.), cert.denied, ­­­2011 WL 4530151 (2011); Quan v. Computer Sciences Corp., 623 F.3d 870, 881 (9th Cir. 2010); Kirschbaum v. Reliant Energy, Inc., 526 F.3d 243, 254 (5th Cir. 2008); Kuper v. Iovenko, 66 F.3d 1447, 1459-60 (6th Cir. 1995).

[2]. That said, plan sponsors and fiduciaries should continue to monitor future developments in Citigroup in light of Judge Straub’s dissenting opinion and the likelihood of a petition for rehearing (or rehearing en banc), which the Citigroup plaintiffs have indicated they intend to seek. In his dissent, Judge Straub rejected the Moench presumption in favor of plenary review of fiduciary decisions regarding employer stock. He also disagreed with the majority’s interpretation of ERISA disclosure duties.

Copyright © 2011 by Morgan, Lewis & Bockius LLP. All Rights Reserved.

"The Sins of the Father": Third Party Retaliation Claims Allowed to Proceed

Recently posted in the National Law Review an article written by Ralph A. Morris of Schiff Hardin LLP about third-party retaliation claims :

A recent Texas federal court decision has further expanded the bases for Title VII retaliation claims against employers. In Zamora v. City of Houston, Christopher Zamora, a Houston police officer, alleged that the Houston Police Department demoted him in retaliation for the filing of a charge with the U.S. EqualEmployment Opportunity Commission (“EEOC”). In this case, however, the charge was not filed by Christopher Zamora, but by his father, Manuel Zamora, alleging that he, Manuel Zamora, had been discriminated against by the Department.

Earlier this year, in Thompson v. North American Stainless, LP, the United States Supreme Court permitted an employee’s Title VII retaliation claim to proceed where the employee’s fiancee had earlier filed an EEOC charge. The Court held that a Title VII retaliation claim could stand where the employee is subject to an adverse employment action because a co-worker to whom the employee is “closely related” engaged in protected activity.

The Supreme Court decided Thompson while the Zamora case was pending in the U.S. District Court for the Southern District of Texas. After the Thompson decision was issued, the Zamora court reversed its prior determination that dismissed Christopher Zamora’s claim. The court concluded that under Thompson, Mr. Zamora’s retaliation claim could proceed based on his father’s filing of an EEOC charge. Thus, under Zamora, in addition to a fiancee, a parent-child relationship satisfies the “closely related” test enunciated by the Supreme Court in Thompson.

Retaliation charges and lawsuits typically are more challenging to defend because the employee’s burden of proof is not as difficult to meet, as compared with a charge of discrimination. Thompson and Zamora now place an additional burden on employers by holding that employees themselves do not necessarily need to engage in the protected activity to have standing to sue for retaliation. These decisions may have a greater impact on employers that make it a practice to hire family members and friends of existing employees than on those with anti-nepotism policies.

The Supreme Court refrained from identifying a fixed class of relationships for which third-party retaliation claims are viable. Future cases will have to decide how far retaliation claims will be expanded: whether, for example, partners involved in a romantic relationship but who are not engaged, or familial relationships more distant than parent and child, are sufficiently close so as to fall within the zone of protection. Employers can help reduce the risk for these types of claims by reviewing their EEOC and anti-retaliation policies and ensuring that managers are trained and educated on compliance.

© 2011 Schiff Hardin LLP

Hooters Sues Competitor over Alleged Trade Secrets Theft after Top Executives Fly Away

Recently posted in the National Law Review an article by Eric H. Rumbaugh, Luis I. Arroyo and Steven A. Nigh of Michael Best & Friedrich  LLP regarding  misappropriating its trade secrets and other confidential business information following the departure of several Hooters executives:

 

Hooters of America LLC has sued a competitor in Georgia Federal Court for allegedly misappropriating its trade secrets and other confidential business information following the departure of several Hooters executives to Twin Peaks Restaurants.

Hooters’ complaint alleges that former vice president of operations and purchasing, Joseph Hummel, gained unauthorized access to Hooters’ computers and took trade secrets and other confidential information. Specifically, Hooters claims that around the time of his departure, Hummel downloaded and transferred confidential sales figures, employee training and retention strategies and purchasing information to his personal e-mail account. The suit also accuses Hummel of additional unauthorized access of private business information following the termination of his employment.

Hummel, as well as Hooters’ former Chief Executive Officer and its general counsel, left the beach-themed restaurant franchise to join up with Twin Peaks, which operates a mountain lodge-themed restaurant chain featuring an all-female wait staff. Hooters contends that Hummel’s alleged theft has allowed Twin Peaks to hit the ground running in its efforts to open 35 restaurants in the next decade, several of which are planned for markets with Hooters restaurants.

The case illustrates the potential damage that departing employees, particularly those with access to sensitive information, can wreak on an employer. Hooters has already taken one step towards protecting itself; before Hummel left, he signed a confidentiality agreement requiring him to return all confidential and proprietary information to Hooters. In addition to confidentiality agreements, employers should consider having their top executives or other employees with access to sensitive information sign non-competition agreements. Moreover, most states’ trade secret statutes require businesses to take steps that are reasonable under the circumstances to protect their confidential information in order to preserve the trade secret status of that information. Accordingly, employers should consider implementing electronic security measures beyond just login credentials; limiting the number of employees who are authorized to access confidential information; and regulating employees’ ability to take information off company premises.

Next, when key employees depart, and especially when they depart for a competitor, businesses should consult with counsel immediately, and before examining (and arguably damaging) electronic evidence. Departing employees who take information often leave a shockingly obvious electronic trail; but that trail can be lost quickly if not preserved, or inadvertently destroyed if improperly accessed.

Lastly, businesses engaging talent, and especially talent that comes from a competitor, cannot be too careful or too forceful in making sure that the incoming talent does not make, retain or transfer any copies of information from their previous employer. Businesses engaging talent that acted improperly on the way out can quickly embroil their new employers in costly and risky litigation.

© MICHAEL BEST & FRIEDRICH LLP

ZIPped Back Up: Williams-Sonoma Gains Federal Dismissal Of New Jersey Consumer Privacy Claim in Feder

Recently published in the National Law Review an article by Theodore C. Max of Sheppard, Mullin, Richter & Hampton LLP regarding the United States District Court for the District of New Jersey joined the New Jersey Superior Court in weighing in on the issue of whether a retailer violates consumer privacy state law by requesting a customer’s zip code at the point of purchase.

In Feder v. Williams-Sonoma Stores, Inc., the United States District Court for the District of New Jersey joined the New Jersey Superior Court in weighing in on the issue of whether a retailer violates consumer privacy state law by requesting a customer’s zip code at the point of purchase.  Feder was brought by the same plaintiff’s lawyers and with claims similar to those in the state court case Imbert v. Harmon Stores, Inc.(Bed, Bath & Beyond). Imbert was decided last month, but without any written decision, and permitted that case to proceed past the pleading stage. The District Court in Feder, however, issued the first written opinion under the New Jersey statutes, finding that allegations that a zip code was verbally requested could not support a claim under New Jersey law.

Both Feder and Imbert involved plaintiffs suing under New Jersey’s Truth-in-Consumer Contract, Warranty and Notice Act (“TCCWNA”), alleging that a store’s requirement that customers provide their zip codes during a credit card transaction violates their rights under the TCCWNA. The TCCNWA prohibits a seller from “offering, entering into, giving or displaying a written consumer contract or notice that violates a clearly established right of the consumer.” N.J. Stat. Ann. 56: 12-15.  As a predicate for the TCCNWA claim, both Feder and Imbert relied on the Restrictions on Information Required to Complete Credit Card Transactions (“Restriction Statute“). The Restriction Statute prohibits a retailer from requiring a customer to provide “personal identification information” to complete a credit card transaction, thus providing the basis for violation of a “clearly established consumer right.”

Senior District Judge Walls in Feder granted Williams-Sonoma’s Motion to Dismiss, finding that the plaintiff failed to sufficiently allege conduct that violated the TCCWNA because she failed to identify a particular provision of a written consumer contract that violated her rights. Feder pled that the credit card transaction form constituted the written consumer contract.  Judge Walls, skeptical of this assertion, reasoned that even if the form qualified as a contract, plaintiff’s recorded zip code and verbal request for the same did not constitute a contract provision. Consequently, Judge Wales found that plaintiff failed to satisfy the elements of TCCNWA because “[t]he alleged requirement that plaintiff provide her zip code would only violate the TCCWNA if it was a provision of a written contract.”  Plaintiff also alleged that her rights were violated under the Restriction Statute — not by the recording of her zip code — but by the requirement that she provide her zip code. However, the Restriction Statute does not provide for a private right of action, and, as discussed above, a claim under Plaintiff’s proposed private vehicle for enforcement, the TCCNWA, failed.

Williams-Sonoma also argued that if the credit card transaction was considered a written consumer contract, the court must consider all terms of that “contract” including the point of sale signage at Williams-Sonoma stores expressly stating that when a zip code is requested it is used for marketing purposes, and that providing it is voluntary and is not a condition of processing the transaction. The Restriction Statute differs critically from California’s Song-Beverly in that New Jersey’s Restriction Statute only applies to information being “required,” whereas Song-Beverly also applies to a “request.” This issue was not presented inImbert. However, since the District Court ruled on the TWNCCA, it did not need to reach this issue.

One additional anomaly between the Feder and Imbert cases is that in Imbert the state court permitted the plaintiff to proceed with an invasion of privacy claim. However, when presented with Williams-Sonoma’s Motion to Dismiss, Feder abandoned her invasion of privacy claim in her Opposition because the Motion revealed she had previously provided her contact information to Williams-Sonoma. Feder also filed a cross-motion for leave to file an Amended Complaint, which the District Court denied as futile.

Sheppard Mullin Richter & Hampton LLP

Second Circuit Finds that Employers May be Obligated to Accommodate a Disabled Employee's Commute

Posted in the National Law Review an article by attorneys James R. Hays, Jonathan Sokolowski and James R. Hays of Sheppard Mullin Richter & Hampton LLP regarding disabled employees and employers requirements to assist them:

 

The Second Circuit Court of Appeals has held that under the Americans with Disabilities Act (“ADA”) and the Rehabilitation Act, employers may be required to assist disabled employees with their commute.

In Nixon-Tinkelman v. N.Y. City Dep’t of Health & Mental Hygiene, No. 10-3317-cv, 2011 U.S. App. LEXIS 16569 (2d Cir. N.Y. Aug. 10, 2011), plaintiff Barbara Nixon-Tinkelman (“Plaintiff”), who has cancer, heart problems, asthma, and is hearing impaired, brought suit under the ADA and the Rehabilitation Act alleging that the New York City Department of Health & Mental Hygiene (“Defendant” or “DOHMH”) failed to reasonably accommodate her disability. Specifically, following her transfer from Queens to Manhattan, Plaintiff requested that DOHMH accommodate her commute by transferring her back to an office location closer to her home in Queens. DOHMH ultimately denied Plaintiff’s request.

The Southern District of New York dismissed Plaintiff’s complaint on Defendant’s motion for summary judgment, finding that activities which “fall outside the scope of the job, like commuting to and from the workplace, are not within the province of an employer’s obligations under the ADA and the Rehabilitation Act.” However, on appeal, the Second Circuit faulted the district court’s holding, explaining that certain circumstances may require an employer to provide commuting assistance to a disabled employee, and furthermore, that providing such assistance is not “inherently unreasonable.” Accordingly, the Second Circuit remanded the case to the district court, and tasked it with engaging in the “fact-specific inquiry” necessary to determine whether it would have been reasonable to provide Plaintiff with a commuting accommodation. On remand, the Second Circuit directed the district court to consider the following factors: (a) Defendant’s total number of employees; (b) the number and location of Defendant’s offices; (c) whether other positions exist for which Plaintiff was qualified; (d) whether Plaintiff could have been transferred to a more convenient office without unduly burdening Defendant’s operations; and (e) the reasonableness of allowing Plaintiff to work from home without on-site supervision.

In addition to the above-listed factors, the Second Circuit also noted that the district court should have contemplated whether transferring Plaintiff “back to Queens or another closer location, allowing her to work from home, or providing a car or parking permit” would have accommodated her needs.

Nixon-Tinkelman serves as a reminder to employers that they must carefully assess all requests for reasonable accommodations from disabled employees. Although employers are not required to provide the specific accommodations employees may request, they must nevertheless work with employees to determine what reasonable accommodations, if any, can be made.

Copyright © 2011, Sheppard Mullin Richter & Hampton LLP.

Medical Marijuana User Not Protected from Termination

Recently posted in the National Law Review an article by Darren A. Feider  of Williams Kastner regarding medical marijuana and employment:

A developing exception to Washington law of employment at will is the tort of wrongful termination in violation of public policy. This narrow exception was recently tested in Roe v. TeleTech Customer Care, 171 Wn.2d 736 (2011), when a new hire employee asserted that her employer had violated Washington public policy for terminating her for a positive drug test for marijuana.

In Roe, the new hire claimed to suffer from migraine headaches, causing chronic pain, nausea, blurred vision and sensitivity to light. Her physician prescribed medical marijuana and she smoked it four times a day, but ingested it only at home. She was offered a position as a customer service representative contingent on a background check and a drug screening. After failing the drug screening, the new hire informed her supervisor she had been prescribed medical marijuana. Her supervisor informed her that use of medical marijuana violated the company drug policy and terminated her employment during the training phase. She sued the company for wrongful termination in violation of public policy. The trial court dismissed the claim, finding that medical marijuana merely provided an affirmative defense to criminal prosecution under Washington state drug laws but did not imply a civil cause of action in employment. She appealed.

On appeal, the Roe court recognized that the voters of Washington had provided a defense to caregivers and physicians who prescribed marijuana to those with certain illnesses such as the new hire. That statute, however, did not provide protection for employment and specifically noted that the law did not require any accommodation of on-site use of medical marijuana.

The Roe court had focused on the language of the medical marijuana statute which only discussed protecting health care providers. The court also emphasized that there was no evidence that the statute provided employment protection or prohibited an employer from discharging an employee for medical marijuana use. The court found that the statute did not support a broad public policy that would remove all impediments to authorized medical marijuana use or forbid an employer from discharging an employee because she used medical marijuana.

The Roe court also recognized that Washington patients have no legal right to marijuana under federal law, which has the effect of establishing that there is not a broad public policy that would require an employer to allow an employee to engage in illegal activity.

The take-aways from the Roe decision are that Washington courts will move cautiously in expanding the scope of legal protections for employees. Washington courts will not attempt to graft on an expansion of the public policy tort claims. The Roe decision also emphasizes that employment in Washington is at will and that any public policy exceptions are narrowly construed.

© 2002-2011 by Williams Kastner ALL RIGHTS RESERVED

Administrative Law Judge Finds Employer Unlawfully Discharged Employees Based on Facebook Posts

Recently posted  in the National Law Review an article by Stephen D. Erf, Heather Egan Sussman and Sabrina E. Dunlap  of McDermott Will & Emery regarding the NLRB found that an employer unlawfully terminated five employees because they posted comments on Facebook:

In a first of its kind ruling, a National Labor Relations Board (NLRB) Administrative Law Judge (ALJ) found that an employer unlawfully terminated five employees because they posted comments on Facebook related to working conditions.  This is a landmark decision because, up to this point, employers have only been able to rely on the prosecution trends of the General Counsel’s office, including a recently issued report on the topic, and not actual decisions by the adjudicative body of the NLRB.

This landmark case involved an employee of Hispanics United of Buffalo (HUB) (a nonunionized organization), who posted a message on Facebook sharing critical comments made by a coworker concerning employees’ poor job performance and asking for the employees’ reactions.  Five employees commented on the post, defending their job performance and criticizing the critical employee and their working conditions, including work load and staffing problems.  HUB later discharged the Facebook poster and the employees who responded to the post, stating that their comments constituted harassment of the critical coworker.

Based on an unfair labor practice charge filed by one of the employees, the NLRB’s Buffalo Regional Director issued a complaint in May 2011. The ALJ heard the case in July and, on September 2, issued a written decision finding that the employees’ Facebook posts were protected concerted activity under Section 7 of the National Labor Relations Act (NLRA) because they concerned a conversation among coworkers about the terms and conditions of employment and the employees’ conduct was not sufficiently inappropriate as to lose the protection of the NLRA.  The ALJ awarded the employees back pay and ordered HUB to reinstate the five employees.  The ALJ also ordered HUB to post a notice at its Buffalo facility explaining to employees their rights under the NLRA and committing not to violate those rights in the future.

While NLRB complaints related to social media have been on the rise, this is the first ALJ decision specifically addressing employees’ use of Facebook.  As a result, employers are wise to consider the ALJ’s decision when disciplining employees based on social media activity.

© 2011 McDermott Will & Emery