Tag: Litigation

Chief Litigation Officer Summit – September 13-15, 2012

The National Law Review is pleased to bring you information about the upcoming Chief Litigation Officer Summit:

The Chief Litigation Officer Summit will highlight the current challenges and opportunities through visionary conference sessions and keynote presentations delivered by your most esteemed peers and thought leaders from America’s leading corporations. The one-on-one meetings with leading service providers will offer vast expertise in the area of litigation. All this, seamlessly integrated with informal networking opportunities over three days, will provide a unique interactive forum. Do not miss this opportunity to network, establish new connections, exchange ideas and gain knowledge.

New Facebook Cases – No Protected Concerted Activity, But Is It Surveillance??

Posted in the National Law Review an article by Adam L. Bartrom and Gerald F. Lutkus of Barnes & Thornburg LLP regarding Facebook cases continue to be examined by the NLRB

Facebook cases continue to be examined by the NLRB as a new technology cloaked in traditional case law.  The NLRB’s General Counsel has recently decided to dismiss three complaints brought by terminated employees who were fired for their Facebook posts.  In all three cases, the GC found the conduct not to be protected concerted activity under Section 7 of the NLRA.  That approach is consistent with the GC’s memo earlier this year which emphasized that content and context were key in analyzing whether disciplinary action brought as a result of social media chatter violated the NLRA.  A recent blog post on the topic appears here. To access the GC’s office memoranda on these cases, click here.  All three continue to show the NLRB’s focus on whether the Facebook chatter is merely an expression of individual gripes or is the chatter an effort to initiate group dialogue or group action.  Employers must continue to evaluate decisions to discipline for social media postings within that context.

 However, buried in one of the opinions, Intermountain Specialized Abuse Treatment Center, is a provocative and concerning analysis by the GC’s office regarding union surveillance.  The Advice Memorandum concludes that it agrees with the Regional Director that the Employer did not unlawfully create the impression that it was engaged in surveillance of protected union activity by having knowledge of the Facebook post.  What??  The memorandum states that employer surveillance or creation of an impression of surveillance constitutes unlawful interference with Section 7 rights.  Here, there was no such impression of surveillance because the employer received the Facebook information from another employee and the conduct at issue turned out not to be protected activity.  However, the memorandum certainly raises the question of whether an employer practice to examine Facebook posts on a regular or even on an as needed basis would violate Section 7 rights.  The jury is still out on that issue.  Stay tuned.

© 2011 BARNES & THORNBURG LLP

Washington Supreme Court Affirms Class Certification and Post-Accident Diminution in Value Award to Automobile Insureds

Recently posted in the National Law Review an article by Dana Ferestien of Williams Kastner regarding Moeller v. Farmers Ins. Co, of Washington wherein the Washington Supreme Court affirmed lower court rulings in favor of a plaintiff class of automobile insureds:

On December 22, 2011, in Moeller v. Farmers Ins. Co, of Washington, a 5-3 majority of the Washington Supreme Court affirmed lower court rulings in favor of a plaintiff class of automobile insureds seeking breach of contract damages against their insurer for failure to compensate them for the diminished value of a postaccident, repaired car.

The Supreme Court acknowledged that a majority of other jurisdictions have previously denied coverage for diminished value because an automobile policy’s reference to “repair or replace” unambiguously encompasses only a concept of tangible, physical value. But the Court disagreed with this view, emphasizing that Washington law imposes “presumptions in favor of the insurance consumer that are inherent in the rules of construction regarding insurance contracts.” The Court explained that, it “must read an insurance contract as an average person would read it” and that, from the point of view of the consumer, “the reasonable expectation is that, following repairs, the insured will be in the same position he or she enjoyed before teh accidenten enjoyed before the accident.”
© 2002-2011 by Williams Kastner ALL RIGHTS RESERVED

 

Illinois Supreme Court Establishes A New Test To Determine Whether Non-Compete Agreements Are Enforceable

Posted in the National Law Review on December 17, 2011 an article by Eric H. Rumbaugh, Brian P. Paul and  Sarah E. Flotte of Michael Best & Friedrich  LLP regarding  Illinois Supreme Court’s clarification whether a non-compete agreement or other restrictive c ovenant is enforceable:

In a case with favorable implications for employers, in Reliable Fire Equip. Co. v. Arredondo, 2011 IL 111871 (Ill. Dec. 1, 2011), the Illinois Supreme Court clarified the “legitimate business interest test” that Illinois courts must use to determine whether a non-compete agreement or other restrictive covenant is enforceable. BeforeArredondo, appellate courts in Illinois were divided on how to apply this test, which resulted in uncertainty and legal expense for businesses and employees. The Arredondo decision provides clarity and a reasonable rule, both of which should help employers reduce risk and uncertainty.

This dispute began in late 2009, when the Fourth District of the Illinois Appellate Court took the position that an enforceable non-compete agreement only had to be reasonable as to time and geography. In doing so, the Fourth District rejected the legitimate business interest test that required that a former employer establish either that confidential information or near-permanent customer relationships were at risk if the non-compete agreement was not enforced. The legitimate business interest test had been used consistently by Illinois Appellate courts since 1975. However, after the Fourth District’s decision, almost every Illinois appellate court district struggled with the Fourth District’s opinion and, as a result, each district developed its own standards. Thus, employers and employees had to evaluate which district their lawsuit would proceed in before either could figure out whether the non-compete agreement was enforceable.

Thus, the Illinois Supreme Court agreed to hear Reliable Fire Equip., a very typical non-compete case where Arnold Arredondo (“Arredondo”) and Rene Garcia (“Garcia”) were employed as salespersons for Reliable Fire Equipment Company (“Reliable”). Reliable sells installs and services portable fire extinguishers and related equipment. Both Arredondo and Garcia signed a non-compete agreement prohibiting them from competing with Reliable in Illinois, Indiana and Wisconsin for one year after their termination. When Arredondo and Garcia went to work for a newly formed competitor, Reliable sued to enforce the non-compete agreements.

The Trial Court ruled that the covenant was unenforceable, finding that Reliable had failed to identify a legitimate business interest that needed to be protected by the non-compete agreements. A divided panel of the Appellate Court upheld the Circuit Court’s order, but questioned whether it was applying the appropriate test for non-compete agreements.

The Illinois Supreme Court reversed and remanded the case for further proceedings. In doing so, the Court held that a valid and enforceable non-compete agreement must meet three basic components of reasonableness:

A restrictive covenant, assuming it is ancillary to a valid employment relationship, is reasonable only if the covenant: (1) is no greater than is required for the protection of a legitimate business interest of the employer-promisee; (2) does not impose undue hardship on the employee-promisor, and (3) is not injurious to the public.

However, the Supreme Court then went one step further. Over the last 36 years, the Appellate Court decisions that applied the legitimate business interest test had held that there were only two legitimate business interests that would justify enforcing a non-compete agreement: (1) protecting confidential information; and (2) protecting near-permanent customer relationships.  The Illinois Supreme Court rejected the rigidity of this standard, holding that the Illinois Appellate Court decisions of the last 36 years are “are only nonconclusive aids in determining the promisee’s legitimate business interest.”

Under Reliable, the new standard for determining whether a legitimate business interest exists is:

[B]ased on the totality of the facts and circumstances of the individual case. Factors to be considered in this analysis include, but are not limited to, the near-permanence of customer relationships, the employee’s acquisition of confidential information through his employment, and time and place restrictions. No factor carries any more weight than any other, but rather its importance will depend on the specific facts and circumstances of the individual case.

Most carefully drafted non-compete agreements for use in Illinois proactively identify confidential information and near-permanent customer relationships as the business interests the employer is trying to protect. Given this ruling, the door is open for employers to enforce restrictive covenants in a broader range of circumstances and even perhaps for the purpose of protecting customer goodwill. Employers should reevaluate their non-compete agreements in light of the decision in Reliable Fire Equip. Co. v. Arredondo to determine whether additional business interests should be identified as protectable business interests and whether additional job positions now warrant non-compete agreements.

© MICHAEL BEST & FRIEDRICH LLP

Cherchez les Catalogues Raisonné

Posted in the National Law Review an article by Art Law Practice of  Sheppard Mullin Richter & Hampton LLP regarding Art and the legal system:

The success of the art market depends largely on confidence in the authenticity of artists’ works. Traditionally, a work in an artist’s “catalogue raisonné” has been key to confirming the authenticity, and thus value. To that point, a recent lawsuit filed in the U.S. District Court for the Southern District of New York (“S.D.N.Y.”) regarding a purported Jackson Pollock work underscores the importance of the catalogue raisonné in pre-purchase due diligence, and shows that omission from the catalogue could be potentially disastrous to the value of a work. See Lagrange v. Knoedler Gallery, LLC, 11-cv-8757 (S.D.N.Y.) (filed Dec. 1, 2011).

A catalogue raisonné is designed to be a comprehensive compilation of artist works, describing the works in a way that may be reliably identified by third parties.  As scholarly compilations of an artist’s body of work,catalogues raisonnés are critical tools for researching the attribution and provenance of artwork. In a catalogue raisonné, the works are arranged in chronological order, and each entry describes the individual work’s dimensions, materials, exhibition history, citation history and ownership information.  Typically, a catalogue raisonné is written by the leading experts on an artist over the course of many years’ research.  In evaluating a work, such experts examine the work’s overall visual appearance, technical execution, historical context, and even resort to forensics in the quest to confirm or deny whether a work is by the artist’s hand. While historically catalogues raisonnés have been published as books, there has been a recent movement toward digital versions of such catalogs, such as the online catalogue raisonné of artist Isamu Noguchi, recently launched by the Noguchi Museum.

In the recently filed New York lawsuit, Pierre Lagrange, a London hedge-fund executive, and the trust of which he is principal beneficiary, sued the Knoedler Gallery and its former director and president, Ann Freedman, over the sale of a painting advertised as Untitled, 1950 by Jackson Pollock. The complaint for breach of warranties, fraud, and unjust enrichment alleges that the plaintiffs relied on the defendants’ representations in purchasing the purported Pollock painting for $17 million. The plaintiffs add that an unnamed consulting company hired by Lagrange concluded in a report last month that the painting was a fake. The plaintiffs contend that the defendants’ misrepresentations included verbal assurances (supported by allegedly false printed materials) on the authenticity of the work, although the painting was not included in the Jackson Pollock catalogue raisonné. The plaintiffs claim that auction houses Christie’s and Sotheby’s refused to sell the work principally because it is omitted from the Pollock catalogue raisonné, and therefore questions surrounding authenticity, because of that omission, would have doomed any future resale of the work. Additionally, the plaintiffs allege that because the defendants were aware that this omission from the catalogue raisonné would effectively render the work unsalable, the defendants falsely represented that the Pollock catalogue raisonné was in the process of being updated and that the revised version would include the work.

Authors of catalogue raisonné operate under threat of lawsuits because excluding a work from a work from an artist’s catalogue raisonné can so greatly affect its market value. Owners of questionable works may be under great pressure to have those works included in the catalogue, and have turned to the courts on various theories, including antitrust, disparagement and the like. Similarly, as we noted in our last posting, the Andy Warhol Art Authentication Board will dissolve in early 2012, citing substantial legal fees incurred in defense of its authentication activities. And it should be noted that Knoedler reacted to the suit by shuttering its doors after 165 years in business.

Whatever the eventual findings of fact and outcome of the case may be, this lawsuit highlights the critical importance of the catalogue raisonné on the value of a work. Omission from an artist’s catalogue raisonné indeed can prove fatal to any potential resale of a work, notwithstanding any proof the owner may offer to support authenticity. Thus, potential art buyers should exercise due diligence in investigating the authenticity of a work, and should likely seek the advice of impartial third parties in evaluating the genuineness and potential value of a work not included in an artist’s catalogue raisonné.

Copyright © 2011, Sheppard Mullin Richter & Hampton LLP.

Non-Compete Agreements: A Brave New World in Illinois

Posted on December 8th in the National Law Review an article by attorney Anthony C. Valiulis of  Much Shelist Denenberg Ament & Rubenstein P.C. regarding Illinois Supreme Court’s recent changes regarding non-compete & non-solicitation agreements:

 

 

On Thursday, December 1, 2011, the Illinois Supreme Court dramatically changed state law regarding non-compete and non-solicitation agreements. In Reliable Fire Equipment Company v. Arredondo, the court adopted a new test for determining the enforceability of an employee restrictive covenant.

For the last 30 or so years, Illinois courts have generally held that there were essentially only two “legitimate business interests” that could support a restrictive covenant in the employment context: (1) a company’s confidential information or (2) near-permanent relationships with customers. As we have discussed in previous articles, the Fourth District rejected this test in Sunbelt Rentals, Inc. v. Ehlers, holding that a restrictive covenant could be upheld regardless of the existence of a legitimate business interest—provided that the scope of the covenant was reasonable. The Second District rejected Sunbelt in the Reliablecase but held open the possibility that there could be more than the two traditional legitimate business interests. In the Second District Court’s decision, the concurring opinion felt that the test should be based on the totality of the circumstances involved in each particular case. It was this position that the Illinois Supreme Court adopted in its December 1 opinion.

According to the Illinois Supreme Court, for an employee restrictive covenant to be enforceable, its restrictions must be “(1) no greater than is required for the protection of a legitimate business interest of the employer-promisee; (2) does not impose undue hardship on the employee-promisor; and (3) is not injurious to the public.” That has been pretty much the law for the last 30 years. But the important portion of the Reliable decision relates to the test for determining whether a legitimate business interest exists. It is here that the Illinois Supreme Court has created a brave new world.

According to the Reliable court, “[W]hether a legitimate business interest exists is based on the totality of the facts and circumstances of the individual case.” In reviewing that totality, a court is to consider various factors, including but not limited to “the near-permanence of customer relationships, the employee’s acquisition of confidential information through his [or her] employment, and time and place restrictions.” But the Illinois Supreme Court made it clear that these factors are not exclusive. Moreover, “[N]o factor carries any more weight than any other, but rather its importance will depend on the specific facts and circumstances of the individual case.”

So what does all this mean? Well, we now have a clear statement, articulated by the state’s highest court, of the test for enforceability. But what we do not have is certainty. Under this “totality of the circumstances” test, it will be very difficult to determine whether a particular restrictive covenant will be enforceable or not. As these cases are litigated over time, more certainty will undoubtedly arise. As of now, however, we can only speculate about what additional factors will be important. Goodwill is likely to be one. So might an employee’s unique value.

What is a business to do in the wake of the Reliable decision? First and foremost, all existing restrictive covenants should be reviewed to determine, under the particular set of facts applicable to your business, what might be enforceable. Although there is no certainty, there are drafting measures that can and should be taken to help make your agreements fit into this brave new world.

© 2011 Much Shelist Denenberg Ament & Rubenstein, P.C.

Surprise! You Just Starred In Our Movie

Recently posted in the National Law Review an article by Matthew J. Kreutzer of Armstrong Teasdale regarding a lawsuit by actor Jesse Eisenberg’s small role in a movie although the DVD cover has his face prominently featured:

One of my all-time favorite comedies is the movie Bowfinger, in which a down-and-out movie producer named Bobby Bowfinger (played by Steve Martin) makes a movie starring a well-known A-list actor named Kit Ramsey (played by Eddie Murphy) without Ramsey’s knowing participation.  Some of the best scenes in the movie occur when Bowfinger and his “crew” create situations around the increasingly-unhinged Ramsey, secretly filming his hilarious reactions to the ridiculous set-ups.  Apparently, life has (sort of) imitated art: in a recently-filed $3 million lawsuit, actor Jesse Eisenberg (star of The Social Network and Zombieland) claims that he was exploited in a similar manner by the producers of the direct-to-DVD movie, Camp Hell.

According to the lawsuit, in 2007 Eisenberg agreed to appear in Camp Hell as a favor to his friends.  He was on set for only one day of filming, and logged only a few minutes of total screen time.  Because he was only minimally involved in the movie, he was surprised to see that his face was prominently featured on the cover of the DVD, implying that he starred in the film.  His lawsuit asserts various California law causes of action, including claims for unfair business practices and publicity rights.  But, according to Hollywood law blogger Eriq Gardner, the lawsuit reads more like “a consumer class action, saying that the producers are ‘continuing to perpetrate a fraud on the public.’”

Camp-Hell-Poster
Overselling a famous actor’s involvement in a film is a common practice in the industry, although the Camp Hell example may be one of the worst offenders.  But, while there are agreements and rules among various creative unions in Hollywood relating to attribution and credit, there apparently aren’t any that specifically state the number of minutes of screen time that are necessary in a movie before an actor can be marketed as a film’s “star.”

Fortunately, the franchising world has more explicit rules regarding how a franchise can be marketed and sold to potential franchisees.  Generally, the FTC Franchise Rule and a number of state laws require a franchise company to provide to a prospect certain types of disclosures regarding the business being marketed.  Through a legally compliant Franchise Disclosure Document, a possible franchise buyer will obtain a great deal of information about the franchise being sold, which information should support the marketing claims the franchisor makes generally.  Further, several states have specific restrictions on the types of statements that franchisors can make in advertising pieces, which restrictions are further designed to protect against misinformation to franchise buyers.  These laws work together to attempt to ensure that members of the public are not lured into buying a franchise based on puffery or overblown claims of success.

It will be interesting to see how the Court handles Mr. Eisenberg’s lawsuit.  I wonder if the movie industry will, in the face of the Camp Hell situation, consider adopting more stringent rules about marketing actors?

I would love to hear from you — have you ever watched a movie based on the claim that a movie was “starring” a certain actor, only to find out that the actor’s involvement was minimal?

© Copyright 2011 Armstrong Teasdale LLP. All rights reserved

In Ninth Circuit, Whistleblowers Not Exempt From Confidentiality Agreements

Posted in the National Law Review an article by attorney Anthony Navid Moshirnia of Sheppard, Mullin, Richter & Hampton LLP about blowing the whistle on alleged fraud against the Government does not entitle an employee to loot:

 

Blowing the whistle on alleged fraud against the Government does not entitle an employee to loot and disclose her employer’s records in violation of a confidentiality agreement – at least not in the Ninth Circuit. In an opinion handed down in March of this year, the Ninth Circuit refused to adopt a so-called “public policy exception to confidentiality agreements to protect [qui tam plaintiffs]” who misappropriate documents from their employers ostensibly to buttress claims brought under the federal False Claims Act (“FCA”). U.S. ex rel. Cafasso v. Gen. Dynamics C4 Sys., Inc., 637 F.3d 1047, 1061-62 (9th Cir. 2011). Though this opinion has been on the books since Spring, it remains relevant, and worth keeping an eye on, as it provides powerful ammunition against FCA plaintiffs that continue to tout the “public policy” exception as though it were unassailable.

After learning that her job at General Dynamics C4 Systems, Inc. (“General Dynamics”) was going to be terminated, but before leaving her employment, Mary Cafasso “copied almost eleven gigabytes of data from [her employer’s] computers in anticipation of bringing a qui tam action” under the FCA.  When it discovered what Ms. Cafasso had done, General Dynamics filed suit in Arizona state court, seeking return of its purloined documents through a temporary restraining order (“TRO”). Apparently to avoid complying with the TRO, which the state court granted, Ms. Cafasso filed “a conclusory six page complaint . . . alleg[ing] FCA violations and retaliation.” She then used the FCA action to persuade the Arizona court to vacate the TRO and stay General Dynamics’ lawsuit.

When Ms. Cafasso’s FCA complaint was unsealed, General Dynamics counterclaimed alleging, inter alia, breach of contract arising from Ms. Cafasso’s misappropriation of documents in violation of a confidentiality agreement. In opposition to General Dynamics’ motion for summary judgment, Ms. Cafasso argued that General Dynamics had failed to prove contract damages and that, even if it had, her conduct was permissible because “[p]ublic policy grants [a] Relator a privilege in gathering copies of documents as part of an investigation under the FCA and gives [a] Relator immunity from civil liability based on claims against her for so doing.” U.S. ex rel. Cafasso v. Gen. Dynamics C4 Sys., Inc., 2009 WL 1457036, *13 (D. Ariz. May 21, 2009).

The trial court dismissed both of Ms. Cafasso’s arguments. It found that damages were established by the stipulated damages clause in the General Dynamics confidentiality agreement. After reviewing the parties’ competing legal arguments, the trial court also found that “public policy does not immunize Cafasso, [who] confuses protecting whistleblowers from retaliation for lawfully reporting fraud with immunizing whistleblowers for wrongful acts made in the course of looking for evidence of fraud.” The court concluded that “[s]tatutory incentives encouraging investigation of possible fraud under the FCA do not establish a public policy in favor of violating an employer’s contractual confidentiality and nondisclosure rights.”

On appeal, Ms. Cafasso did not dispute that her actions violated her confidentiality agreement with General Dynamics, but nonetheless urged the Court to “adopt a public policy exception to enforcement of such contracts that would allow relators to disclose confidential information in furtherance of an FCA action.”  While noting that Ms. Cafasso’s position was not frivolous, and might apply “in particular instances for particular documents,” the Ninth Circuit found that Ms. Cafasso’s data removal was not privileged.

The Ninth Circuit appears to have relied on two factors to reach this conclusion: the scope and volume of the documents Ms. Cafasso took. With respect to scope, the Ninth Circuit faulted Ms. Cafasso’s “indiscriminate appropriation of documents,” referring to it as an “unselective taking [that included] attorney client privileged communications, trade secrets belonging to [General Dynamics] and other contractors, internal research and development information, sensitive government information, and at least one patent application that the Patent Office had placed under a secrecy order.”  The Court was also troubled by the fact that Ms. Cafasso had taken over 11 gigabytes of data, noting that “the need to facilitate valid claims does not justify the wholesale stripping of a company’s confidential documents.” In sum, the Ninth Circuit found that an “exception broad enough to protect the scope of Cafasso’s massive document gather in this case would make all confidentiality agreements unenforceable as long as the employee later files a qui tam action” – an unacceptable result.

While Cafasso stopped short of rejecting the public policy defense to data theft as a matter of law, it certainly provides a new avenue to FCA defendants attempting to prevent qui tam relators from benefitting from extrajudicial discovery.

Copyright © 2011, Sheppard Mullin Richter & Hampton LLP.

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.

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.