Some time ago (March 27, 2009), we wrote a post describing the applicability of the federal Computer Crimes and Abuse Act, 18 U. S. C. § 1030, (the “CFAA” or the “Act”) to unfair business practices cases. The Act provides a federal remedy for anyone who intentionally accesses a protected computer without authorization, or exceeds authorized access, and obtains information or who knowingly and with intent to defraud and in furtherance of the fraud, obtains something of value, unless the only thing obtained is the use of the computer and that use is not valued at more than $5000 in a one year period. An employer owned computer is “protected” under the statute.
It is becoming increasingly common for plaintiffs to use this Act as a vehicle for obtaining access to federal courts where diversity jurisdiction does not exist. As might be expected, a split of authority exists as to whether this statute may be so used, or whether it is intended only to address actions by computer hackers. At the present time, three federal Circuit Courts of Appeals (1st, 5th and 7th), as well as a number of District courts, have adopted a broad view of the statute and allow claims where an employee permissively accesses an employer’s computer system for an improper purpose. A common example is where an employee, who has accepted a job with a competitor or who intends to start a competitive company, copies proprietary electronic data from his employer’s system for use in his new job with the competitive company.
Those courts adopting the broader view reason that once an employee decides to join a competing company or has made arrangements to form one, his loyalty is divided between his existing employer and the new one. In that circumstance, by accessing the employer’s network and copying files, the employee violates his fiduciary duty of loyalty to his employer. Such conduct satisfies the CFAA requirement that the defendant “exceeds authorized access” to the computer system.
In a recent case, the federal district court for the Southern District of New York, Starwood Hotels & Resorts Worldwide, Inc. v. Hilton Hotels Corporation et al., 09-cv-3862 (June 16, 2010) joined those courts adopting the broader view. Click here for the opinion. The facts of the case, as alleged, are extreme. But they should serve as a cautionary tale to employees who are considering joining a competitive firm and as a roadmap for employers who have been victimized by departing employees.
In this case, two of Starwood’s executive officers who worked on its luxury hotel brands were recruited to join Hilton and accepted offers of employment. Both had access to Starwood’s most confidential data and both were subject to confidentiality agreements requiring that they safeguard Starwood’s confidential information and, once their employment ended, return all such information to Starwood and not disclose it to anyone.
After signing an employment agreement with Hilton but before notifying Starwood of his intent to resign, one of the executives asked his staff to compile a significant amount of confidential information for him that he then forwarded to his personal email account. This included digital images of thousands of documents that Starwood used in designing and branding its luxury hotels. As alleged, he forwarded this information to Hilton. He also copied electronic documents to his personal laptop computer and used that information to benefit Hilton. In addition, once he joined Hilton he solicited additional confidential information from other Starwood employees who used their personal email accounts to convey Starwood’s proprietary information to their former superior.
The other executive, while still at Starwood and after engaging in discussions with Hilton representatives, allegedly acted as a corporate spy for Hilton and collected and forwarded to Hilton confidential information related to Starwood’s business and development opportunities.
Starwood knew nothing of the extent of this piracy until, in discovery, Hilton produced eight large boxes of computer hard drives, thumb and zip drives and paper records containing large quantities of Starwood documents. Indeed, the computer drives contained over 100,000 downloaded files.
At issue in the recent opinion was Hilton’s motion to dismiss the count for a violation of the CFAA because the Act was not intended to cover such conduct. The court noted at the outset that this case did not involve an employee who accessed his employer’s computer in the ordinary course of his duties and then, at some later time, used some of that information to benefit a competitor. Rather, here the information was obtained with the specific intent to use it against the employer through “trickery and deceit.” The court concluded that once the executives accepted employment with Hilton, they “no longer had Starwood’s authorization to access this information. Thus, even construing the statute narrowly to prohibit only accessing computer information without permission, Starwood’s complaint adequately alleges a claim under the CFAA.”
The court also held that Hilton could potentially be liable under the Act because, as alleged, it used one of the executives, as well as others, as corporate spies to steal Starwood’s confidential information. Finally, the court found that Starwood’s expenditure of sums to investigate the damage sustained as a result of the former employees’ actions, which exceeded $5000, met the damages requirement of the statute. Thus, Hilton’s motion to dismiss the claim was denied.
Unquestionably, these actions were extreme. But apart from the volume of electronic documents that were pilfered, the story line is not that unusual. Departing employees often take confidential information belonging to their employer for use in their new employment, thinking that it will make them more valuable to the new employer. And it is not unusual for them to contact former colleagues, once at the new employer, and ask for information they “forgot” to take with them. This case adds to the growing line of authorities that recognize that, under such circumstances, the CFAA provides a potential remedy to the former employer. Moreover, unlike in Starwood, where confidentiality agreements existed, such agreements are not an essential predicate to applicability of the statute. The common law duty of loyalty prohibits employees from using confidential information to benefit a new employer.
Tuesday, September 7, 2010
Monday, July 12, 2010
A Virginia Court Redefines a LLC's Unanimous Consent Requirement to Permit the LLC to Sue One of Its Members
A circuit court in Virginia was faced with the question of whether a Limited Liability Company can sue one of its three Members when, under the LLC’s Operating Agreement, the decision to file a law suit required that all three Members agree, including the Member being sued. For obvious reasons, no Member would vote to be sued. The case is Infinite Design Electric Assoc. LLC, et al. v. Donald R. Hague, 2010 Va. Cir. LEXIS 27 (Fairfax Cir. Ct. 2010).
The question presented the court with a classic legal dilemma by arguably pitting a just outcome against a technical legal interpretation that would deprive the aggrieved party of a remedy.
The LLC member being sued in the Infinite Design case allegedly engaged in the unfair business practices of forming a competing company, courting the existing LLC's clients using that LLC's "client lists, estimate strategies, and proposal forms to out maneuver [the existing LLC] and steal its clients."
In reaching its decision, the court could have framed the legal question in a number of different ways, but chose to ask: "Should a manager of an LLC be able to hold the entity hostage when it is the bad acts of that manager that the LLC seeks to redress?" The problem for the court in answering that question is that it found "no Virginia statutory or case law directly on point with this situation . . . ." Thus, the court looked to “analogous authority from Virginia and other states."
But the court looked to more than just analogous statutes, relying instead on other states' statutes that have no parallel in the Virginia Code; finding that "Pennsylvania does not allow interested managers to vote to sue if that manager has 'an interest in the outcome of the suit that is adverse to the interest of the company.' 15 Pa.C.S. § 8992(2) (2009). New York's LLC act precludes managers of LLCs from transacting with the LLC when that manager has a 'substantial financial interest' in the transaction. NY CLS LLC § 411 (2010)." The decisions of the Pennsylvania and New York legislative bodies, however, may have no bearing on how Virginia's General Assembly might address that issue in the future.
The court also relied upon a 1937 Virginia Supreme Court case that "suggests that the vote of a director of a corporation who has a personal interest in a matter is not to be counted in relation to that matter," citing Crump v. Bronson, 168 Va. 527, 537, 191 S.E. 663 (1937). The court's use of the word "suggests" is apt because the Court in Crump faced the question of whether an interested director could be used to constitute a quorum under the old Code requirement that every corporation have at least three directors. Now, however, there are many single member LLCs where the member is necessarily an interested director for any vote pertaining to the member’s compensation and rights.
The third leg supporting the Court's decision was the LLC's incorporation of Virginia Code § 13.1-1024.1 that "requires managers to carry out their duties with 'good faith business judgment [that is in] the best interest of the [LLC].'" The incorporation of this section, according to the court, was a clear reflection of the LLC’s "intention to hold managers' actions to a certain standard. A manager would never vote to authorize a suit against himself, but bringing suit is the only course of action an LLC ca[n] take in the case of manager misconduct."
For those reasons, the court held that the LLC "did not need unanimous approval of the managers to bring suit when the suit was intended to be brought against one of its managers. Such a reading of the Operating Agreement would amount to a situation of 'suicide by operating agreement', and would paralyze the LLC from remedying any suspected malfeasance by one of its managers."
The court, however, did not address several countervailing Virginia Code sections and legal principles. First, Virginia Code § 13.1-1002 defines an "Operating agreement" as “an agreement of the members as to the affairs of a limited liability company and the conduct of its business . . . ." Second, § 13.1-1001.1.C. provides that the Virginia Code sections governing LLCs "shall be construed in furtherance of the policies of giving maximum effect to the principle of freedom of contract and of enforcing operating agreements." (Emphasis added.) Third, § 13.1021.A.1. states that "A limited liability company is bound by its operating agreement whether or not the limited liability company executes the operating agreement. An operating agreement may contain any provisions regarding the affairs of a limited liability company and the conduct of its business to the extent that such provisions are not inconsistent with the laws of the Commonwealth or the articles of organization."
In addition, a significant body of Virginia case law arguably dictates a different result. In a decirion also coming out of Fairfax County Circuit Court, Coker v. State Farm Fire & Cas. Co., 45 Va. Cir. 510 (Fairfax Cir. Ct. 1998), the court explained that it was "precluded from rewriting a contract between two parties, quoting a series of Virginia Supreme Court cases that state: "It is not the province of this Court to rewrite contractual language. Rather, it is incumbent upon courts to construe the language drafted by the parties."; "It is the function of the court to construe the contract made by the parties, not to make a contract for them."; "Courts will not rewrite contracts; parties to a contract will be held to the terms upon which they agreed."; "A court is not at liberty to rewrite a contract simply because the contract may appear to reach an unfair result." (Citations omitted.)
Finally, there are economic consequences to the LLC and the member being sued. Both the LLC and the member hired their respective attorneys. The member being sued, however, has to pay his pro rata share for both the LLC’s lawyer and his own lawyer, even if the member prevails at trial.
The Infinite Design court's decision to rewrite the operating agreement, if followed, presents future courts with the question of which circumstances justify rewriting operating agreements or other corporate documents. Although courts will invariably try to limit those circumstances, those attempts will be more difficult if courts frame the question like the Infinite Design court and ask: "Should a manager of an LLC be able to hold the entity hostage when it is the bad acts of that manager that the LLC seeks to redress?" For instance, the member being sued might vote against the LLC entering into profitable contracts to starve the LLC, thereby making it impossible for the LLC to pay for its attorneys. Would the court then waive the unanimous consent requirement and contractually bind the LLC against one member’s interests?
It will be interesting to track whether the Infinite Design decision gets appealed to the Virginia Supreme Court, or whether other Virginia Circuit Courts follow or extend it.
The question presented the court with a classic legal dilemma by arguably pitting a just outcome against a technical legal interpretation that would deprive the aggrieved party of a remedy.
The LLC member being sued in the Infinite Design case allegedly engaged in the unfair business practices of forming a competing company, courting the existing LLC's clients using that LLC's "client lists, estimate strategies, and proposal forms to out maneuver [the existing LLC] and steal its clients."
In reaching its decision, the court could have framed the legal question in a number of different ways, but chose to ask: "Should a manager of an LLC be able to hold the entity hostage when it is the bad acts of that manager that the LLC seeks to redress?" The problem for the court in answering that question is that it found "no Virginia statutory or case law directly on point with this situation . . . ." Thus, the court looked to “analogous authority from Virginia and other states."
But the court looked to more than just analogous statutes, relying instead on other states' statutes that have no parallel in the Virginia Code; finding that "Pennsylvania does not allow interested managers to vote to sue if that manager has 'an interest in the outcome of the suit that is adverse to the interest of the company.' 15 Pa.C.S. § 8992(2) (2009). New York's LLC act precludes managers of LLCs from transacting with the LLC when that manager has a 'substantial financial interest' in the transaction. NY CLS LLC § 411 (2010)." The decisions of the Pennsylvania and New York legislative bodies, however, may have no bearing on how Virginia's General Assembly might address that issue in the future.
The court also relied upon a 1937 Virginia Supreme Court case that "suggests that the vote of a director of a corporation who has a personal interest in a matter is not to be counted in relation to that matter," citing Crump v. Bronson, 168 Va. 527, 537, 191 S.E. 663 (1937). The court's use of the word "suggests" is apt because the Court in Crump faced the question of whether an interested director could be used to constitute a quorum under the old Code requirement that every corporation have at least three directors. Now, however, there are many single member LLCs where the member is necessarily an interested director for any vote pertaining to the member’s compensation and rights.
The third leg supporting the Court's decision was the LLC's incorporation of Virginia Code § 13.1-1024.1 that "requires managers to carry out their duties with 'good faith business judgment [that is in] the best interest of the [LLC].'" The incorporation of this section, according to the court, was a clear reflection of the LLC’s "intention to hold managers' actions to a certain standard. A manager would never vote to authorize a suit against himself, but bringing suit is the only course of action an LLC ca[n] take in the case of manager misconduct."
For those reasons, the court held that the LLC "did not need unanimous approval of the managers to bring suit when the suit was intended to be brought against one of its managers. Such a reading of the Operating Agreement would amount to a situation of 'suicide by operating agreement', and would paralyze the LLC from remedying any suspected malfeasance by one of its managers."
The court, however, did not address several countervailing Virginia Code sections and legal principles. First, Virginia Code § 13.1-1002 defines an "Operating agreement" as “an agreement of the members as to the affairs of a limited liability company and the conduct of its business . . . ." Second, § 13.1-1001.1.C. provides that the Virginia Code sections governing LLCs "shall be construed in furtherance of the policies of giving maximum effect to the principle of freedom of contract and of enforcing operating agreements." (Emphasis added.) Third, § 13.1021.A.1. states that "A limited liability company is bound by its operating agreement whether or not the limited liability company executes the operating agreement. An operating agreement may contain any provisions regarding the affairs of a limited liability company and the conduct of its business to the extent that such provisions are not inconsistent with the laws of the Commonwealth or the articles of organization."
In addition, a significant body of Virginia case law arguably dictates a different result. In a decirion also coming out of Fairfax County Circuit Court, Coker v. State Farm Fire & Cas. Co., 45 Va. Cir. 510 (Fairfax Cir. Ct. 1998), the court explained that it was "precluded from rewriting a contract between two parties, quoting a series of Virginia Supreme Court cases that state: "It is not the province of this Court to rewrite contractual language. Rather, it is incumbent upon courts to construe the language drafted by the parties."; "It is the function of the court to construe the contract made by the parties, not to make a contract for them."; "Courts will not rewrite contracts; parties to a contract will be held to the terms upon which they agreed."; "A court is not at liberty to rewrite a contract simply because the contract may appear to reach an unfair result." (Citations omitted.)
Finally, there are economic consequences to the LLC and the member being sued. Both the LLC and the member hired their respective attorneys. The member being sued, however, has to pay his pro rata share for both the LLC’s lawyer and his own lawyer, even if the member prevails at trial.
The Infinite Design court's decision to rewrite the operating agreement, if followed, presents future courts with the question of which circumstances justify rewriting operating agreements or other corporate documents. Although courts will invariably try to limit those circumstances, those attempts will be more difficult if courts frame the question like the Infinite Design court and ask: "Should a manager of an LLC be able to hold the entity hostage when it is the bad acts of that manager that the LLC seeks to redress?" For instance, the member being sued might vote against the LLC entering into profitable contracts to starve the LLC, thereby making it impossible for the LLC to pay for its attorneys. Would the court then waive the unanimous consent requirement and contractually bind the LLC against one member’s interests?
It will be interesting to track whether the Infinite Design decision gets appealed to the Virginia Supreme Court, or whether other Virginia Circuit Courts follow or extend it.
Tuesday, July 6, 2010
Eastern District of Virginia Holds that Minimum Contacts Must be Demonstrated for Each Count in Complaint
Your Virginia company has been damaged by unfair business activities of another individual or business that is located outside of Virginia. You file a multi-count suit in federal court alleging both breach of contract and tort causes of action based upon diversity of citizenship. The defendant moves to dismiss the suit on the basis that the court lacks personal jurisdiction over the nonresident defendant for some, if not all of the counts. What test does the court employ in resolving that motion?
Under the Constitution, a court may exercise personal jurisdiction over an out of state defendant in two situations: (1) where the defandant has "systematic and continuous" contacts with the forum state; or (2) where the contacts with the forum state "give rise to the liabilities sued on." International Shoe v. State of Washington , 326 U.S. 310,317,320 (1945). The first situation is referred to as "general jurisdiction," It is a hard test to meet and generally requires significant contacts over a period of several years. Most cases proceed based upon the second situation that is referred to as "specific jurisdiction."
A threshold question where "specific jurisdiction" is alleged, is whether, once a plaintiff proves minimum contacts with the forum state related to one cause of action, he may add other claims to the suit that do not arise out of those contacts? For example, assume that the parties negotiated and executed a contract in Virginia and the plaintiff sues in Virginia for breach of that contract. But in addition to that count, the plaintiff adds tort counts that are based upon actions that took place in the state where the defendant is located. The plaintiff asserts that the effects of those actions were felt in Virginia. Can all of the claims constitutionally proceed in Virginia where the action was filed? The Fourth Circuit Court of Appeals has never directly addressed these issues. Recently, a district court in the Eastern District of Virginia did.
In Gatekeper. Inc. v. Stratech Systems, Ltd., 2010 U.S. Dist. LEXIS 56625 (June 9, 2010), click here, the district court found that "specific jurisdiction" requires proof that the defendant's contacts with the forum state give rise to each claim alleged in the complaint. Thus, using the example above, it is the plaintiff's burden to demonstrate that each tort claim is supported by the requisite minimum contacts with Virginia. That there werd sufficient contacts to support the breach of contract claim is not enough to save the tort claims. According to the court, if the plaintiff cannot meet that requirement, the unsupported claims must be dismissed for lack of personal jurisdiction. Moreover, that the effects of the bad acts were felt in Virginia, while relevant, is not dispositive.
This is an important decision, not only in the Eastern District of Virginia, but throughout the Fourth Circuit, given that it is a matter of first impression in this Circuit.
Under the Constitution, a court may exercise personal jurisdiction over an out of state defendant in two situations: (1) where the defandant has "systematic and continuous" contacts with the forum state; or (2) where the contacts with the forum state "give rise to the liabilities sued on." International Shoe v. State of Washington , 326 U.S. 310,317,320 (1945). The first situation is referred to as "general jurisdiction," It is a hard test to meet and generally requires significant contacts over a period of several years. Most cases proceed based upon the second situation that is referred to as "specific jurisdiction."
A threshold question where "specific jurisdiction" is alleged, is whether, once a plaintiff proves minimum contacts with the forum state related to one cause of action, he may add other claims to the suit that do not arise out of those contacts? For example, assume that the parties negotiated and executed a contract in Virginia and the plaintiff sues in Virginia for breach of that contract. But in addition to that count, the plaintiff adds tort counts that are based upon actions that took place in the state where the defendant is located. The plaintiff asserts that the effects of those actions were felt in Virginia. Can all of the claims constitutionally proceed in Virginia where the action was filed? The Fourth Circuit Court of Appeals has never directly addressed these issues. Recently, a district court in the Eastern District of Virginia did.
In Gatekeper. Inc. v. Stratech Systems, Ltd., 2010 U.S. Dist. LEXIS 56625 (June 9, 2010), click here, the district court found that "specific jurisdiction" requires proof that the defendant's contacts with the forum state give rise to each claim alleged in the complaint. Thus, using the example above, it is the plaintiff's burden to demonstrate that each tort claim is supported by the requisite minimum contacts with Virginia. That there werd sufficient contacts to support the breach of contract claim is not enough to save the tort claims. According to the court, if the plaintiff cannot meet that requirement, the unsupported claims must be dismissed for lack of personal jurisdiction. Moreover, that the effects of the bad acts were felt in Virginia, while relevant, is not dispositive.
This is an important decision, not only in the Eastern District of Virginia, but throughout the Fourth Circuit, given that it is a matter of first impression in this Circuit.
Thursday, June 17, 2010
Breach of Contract Will Not Support Statutory Business Conspiracy Claim in Virginia
In an important new case, the Supreme Court of Virginia has clearly held that breach of contract will not support a claim of statutory business conspiracy under Sections 18.2-499 and 500 of the Code of Virginia. The case, Station #2, LLC v. Lynch, (Virginia, June 10, 2010), click here, involved a claim that Lynch and others had conspired to deny Station #2 the ability to soundproof a portion of leased space above a restaurant it operated in Norfolk, Virginia. As a result of the dispute, the City of Norfolk ordered the restaurant to cease all live musical performances, and ultimately the restaurant failed.
In its Complaint, Station #2 argued that the breach of Lynch's agreement to allow the soundproofing satisfied the unlawful act or unlawful purpose requirement of Sections 18.2-499 and 500. The Supreme Court disagreed.
The Court held that: "[W]e presently are of opinion that a conspiracy merely to breach a contract that does not involve an independent duty arising outside the contract is insufficient to establish a civil claim under Code Section 18.2-500." It added: "To permit a mere breach of contract to constitute an 'unlawful act' for the purposes of the conspiracy statute would be inconsistent with the diligence we have exercised to prevent 'turning every breach of contract into an actionable claim for fraud,'" quoting Dunn Constr. Co. v. Cloney, 682 S.E.2d 943, 946 (Va. 2009); Augusta Mut. Ins. Co. v. Mason , 645 S.E.2d 290, 295 (Va. 2007); Richmond Metro Auth. v. McDevitt Street Bovis, Inc., 507 S.E.2d 344, 348 (Va. 1998). According to the Court, to support a statutory conspiracy claim, the duty must arise from a statute or independently by common law.
In its Complaint, Station #2 argued that the breach of Lynch's agreement to allow the soundproofing satisfied the unlawful act or unlawful purpose requirement of Sections 18.2-499 and 500. The Supreme Court disagreed.
The Court held that: "[W]e presently are of opinion that a conspiracy merely to breach a contract that does not involve an independent duty arising outside the contract is insufficient to establish a civil claim under Code Section 18.2-500." It added: "To permit a mere breach of contract to constitute an 'unlawful act' for the purposes of the conspiracy statute would be inconsistent with the diligence we have exercised to prevent 'turning every breach of contract into an actionable claim for fraud,'" quoting Dunn Constr. Co. v. Cloney, 682 S.E.2d 943, 946 (Va. 2009); Augusta Mut. Ins. Co. v. Mason , 645 S.E.2d 290, 295 (Va. 2007); Richmond Metro Auth. v. McDevitt Street Bovis, Inc., 507 S.E.2d 344, 348 (Va. 1998). According to the Court, to support a statutory conspiracy claim, the duty must arise from a statute or independently by common law.
Monday, May 3, 2010
The Protocol: The Financial Services Industry Potentially Changes the Common Law By Contract
This blog has discussed the concepts of employee fiduciary duties, proprietary and trade secret information and corporate raids in many contexts. But what if an entire industry or major players within that industry negotiate a method for handling: (1) how employees leave their employers; (2) what types of information they can take with them; and (3) whether “corporate raids” are acceptable? Are such agreements enforceable between the parties to such an agreement? And what about companies in that industry that are not parties to the agreement?
That scenario presented itself to my firm several weeks ago in a litigation matter when a large financial services company filed a law suit, claiming that our clients, two of the plaintiff’s former financial advisors and their newly formed company, misappropriated the plaintiff company’s trade secrets. The plaintiff also asserted that the former employees violated their fiduciary duties owed to the plaintiff company. What is important is not the result of this particular case—we as blog authors do not talk about our specific cases anyway—but the financial services industry’s attempt to shift the common and statutory law by contract.
The shift is designed by the over thirty financial services companies that are signatories to the “Protocol for Broker Recruiting”. The Protocol provides that: “If departing [brokers] and the new firm follow this Protocol, neither the departing [advisor] nor the firm that he or she joins would have any monetary or other liability to the firm that the [advisor] left by reason of the [advisor] taking the information identified below or the solicitation of the clients serviced by the [advisor] at his or her prior firm, provided, however, that this Protocol does not bar or otherwise affect the ability of the prior firm to bring an action against the new firm for “raiding.” The signatories to this Protocol agree to implement and adhere to it in good faith.”
The Protocol then describes what a departing advisor may copy when the advisor changes jobs: “[w]hen [advisors] move from one firm to another and both firms are signatories to this Protocol they may take only the following account information, client name, address, phone number, email address, and account title of the clients that they serviced while at the firm (“the Client Information”) and are prohibited from taking any of her documents or shall include a copy of the Client Information that the [advisor] is taking with him or her.”
The Protocol does not demand perfection from departing advisors. Rather, it offers advisors a safe harbor, provided that they operated in good faith and “substantially complied with the requirement that only Client Information related to clients he or she serviced while at the firm be taken by him or her.”
The Protocol’s impact upon trade secret law is potentially significant because companies will often claim that client account information constitutes trade secrets. But many courts consider the “crucial characteristic of a trade secret [to be] secrecy . . . .” Microstrategy Inc. v. Li, 268 Va. 249, 262 (Va. 2004) (internal citations omitted). Thus, if companies agree that the certain account information may be copied by a departing advisor—provided that the Protocol is followed and the departing advisor goes to another Protocol signatory firm—it becomes difficult to later contend that the account information constitutes a trade secret if either of the prerequisites are not followed.
Similar questions may be raised regarding how the Protocol may affect an advisor’s common law fiduciary duties to the advisors employer or other unfair business practices tort claims.
There is also the question of how much impact being a signatory of the Protocol should have on a court’s decision. The Protocol only requires a party to be a signatory to receive the benefits when recruiting an advisor. Of course, it also subjects itself to the added risk of allowing departing advisors to take more information than might otherwise be allowed. But, a small company might elect to become a signatory immediately before recruiting advisors to shield their efforts from liability, without facing a practical threat of losing its own advisers. And there is no restriction limiting when a company can sign the Protocol or how long a company must remain a signatory. This is the system that the signatories elected, however, so a court might not have much sympathy to a complaining signatory company in that circumstance.
Some courts have used the Protocol as a reason not to grant an injunction, holding that when a financial services company “permits its financial advisors to leave for 38 other financial institutions and solicit their former clients with Client Information they took from [the company], it cannot credibly contend that the harm that will result if . . . [defendants are] allowed to do the same at a 39th firm is so substantial and so irreparable. . .” as to require an injunction. Smith Barney Div. of Citigroup Global Markets, Inc. v. Griffin, 23 Mass. L. Rep. 457; 2008 WL 325269 at *5 (Mass. Super. 2008). The court further held that “[b]y setting up such a procedure for departing brokers to take client lists, [the financial services firm] tacitly accepts that such an occurrence does not cause irreparable harm.’” Id.; quoting Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Brennan, et al., 2007 U.S. Dist. LEXIS 34501 at *7 (N.D. Ohio 2007) (finding that in the case where client contact information is transferred to non-Protocol firms, mere agreement to the Protocol constitutes tacit acceptance that transfers of client contact information do not cause irreparable harm).
It will be interesting to see whether and how courts in the Washington DC area treat the Protocol when faced with one of the myriad issues associated with competing companies, departing employees and the removal of otherwise confidential information.
That scenario presented itself to my firm several weeks ago in a litigation matter when a large financial services company filed a law suit, claiming that our clients, two of the plaintiff’s former financial advisors and their newly formed company, misappropriated the plaintiff company’s trade secrets. The plaintiff also asserted that the former employees violated their fiduciary duties owed to the plaintiff company. What is important is not the result of this particular case—we as blog authors do not talk about our specific cases anyway—but the financial services industry’s attempt to shift the common and statutory law by contract.
The shift is designed by the over thirty financial services companies that are signatories to the “Protocol for Broker Recruiting”. The Protocol provides that: “If departing [brokers] and the new firm follow this Protocol, neither the departing [advisor] nor the firm that he or she joins would have any monetary or other liability to the firm that the [advisor] left by reason of the [advisor] taking the information identified below or the solicitation of the clients serviced by the [advisor] at his or her prior firm, provided, however, that this Protocol does not bar or otherwise affect the ability of the prior firm to bring an action against the new firm for “raiding.” The signatories to this Protocol agree to implement and adhere to it in good faith.”
The Protocol then describes what a departing advisor may copy when the advisor changes jobs: “[w]hen [advisors] move from one firm to another and both firms are signatories to this Protocol they may take only the following account information, client name, address, phone number, email address, and account title of the clients that they serviced while at the firm (“the Client Information”) and are prohibited from taking any of her documents or shall include a copy of the Client Information that the [advisor] is taking with him or her.”
The Protocol does not demand perfection from departing advisors. Rather, it offers advisors a safe harbor, provided that they operated in good faith and “substantially complied with the requirement that only Client Information related to clients he or she serviced while at the firm be taken by him or her.”
The Protocol’s impact upon trade secret law is potentially significant because companies will often claim that client account information constitutes trade secrets. But many courts consider the “crucial characteristic of a trade secret [to be] secrecy . . . .” Microstrategy Inc. v. Li, 268 Va. 249, 262 (Va. 2004) (internal citations omitted). Thus, if companies agree that the certain account information may be copied by a departing advisor—provided that the Protocol is followed and the departing advisor goes to another Protocol signatory firm—it becomes difficult to later contend that the account information constitutes a trade secret if either of the prerequisites are not followed.
Similar questions may be raised regarding how the Protocol may affect an advisor’s common law fiduciary duties to the advisors employer or other unfair business practices tort claims.
There is also the question of how much impact being a signatory of the Protocol should have on a court’s decision. The Protocol only requires a party to be a signatory to receive the benefits when recruiting an advisor. Of course, it also subjects itself to the added risk of allowing departing advisors to take more information than might otherwise be allowed. But, a small company might elect to become a signatory immediately before recruiting advisors to shield their efforts from liability, without facing a practical threat of losing its own advisers. And there is no restriction limiting when a company can sign the Protocol or how long a company must remain a signatory. This is the system that the signatories elected, however, so a court might not have much sympathy to a complaining signatory company in that circumstance.
Some courts have used the Protocol as a reason not to grant an injunction, holding that when a financial services company “permits its financial advisors to leave for 38 other financial institutions and solicit their former clients with Client Information they took from [the company], it cannot credibly contend that the harm that will result if . . . [defendants are] allowed to do the same at a 39th firm is so substantial and so irreparable. . .” as to require an injunction. Smith Barney Div. of Citigroup Global Markets, Inc. v. Griffin, 23 Mass. L. Rep. 457; 2008 WL 325269 at *5 (Mass. Super. 2008). The court further held that “[b]y setting up such a procedure for departing brokers to take client lists, [the financial services firm] tacitly accepts that such an occurrence does not cause irreparable harm.’” Id.; quoting Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Brennan, et al., 2007 U.S. Dist. LEXIS 34501 at *7 (N.D. Ohio 2007) (finding that in the case where client contact information is transferred to non-Protocol firms, mere agreement to the Protocol constitutes tacit acceptance that transfers of client contact information do not cause irreparable harm).
It will be interesting to see whether and how courts in the Washington DC area treat the Protocol when faced with one of the myriad issues associated with competing companies, departing employees and the removal of otherwise confidential information.
Thursday, March 11, 2010
Maryland Court Upholds Non-compete Covenant and Enters Prospective Permanent Injunction
The United States District Court for Maryland recently granted summary judgment in a case upholding a covenant not to compete involving a former Director of Strategic Accounts for TEKsystems, Inc. In doing so, it signaled a willingness on the part of Maryland courts to enforce such covenants even where there was no evidence of lost profits by the employer. TEKsystems, Inc. v. Bolton, 2010 U.S. Dist. LEXIS 9651 (February 4, 2010). Click here.
TEKsystems is a technical staffing and services company. Jonathan Bolton worked in the New York City region. At the time he was hired he entered into an employment agreement containing a restrictive covenant that barred him from "engaging in the business of recruiting or providing on a temporary or permanent basis technical service personnel ... industrial personnel ... or office support personnel ... within a radius of fifty (50) miles of the office in which EMPLOYEE worked at the time his/her employment ended ..." The covenant effectively barred him from competing in the New York City area.
After resigning from TEKsystems, Bolton became employed by another IT-staffing company and operated from his home in New Jersey that was within the 50 mile radius of his former office. He was given the title "Managing Director of New York City." The evidence established that during his first year in the new position Bolton made nine placements, none of which were to companies that had been TEKsystems' clients. TEKsystems sued to enforce the covenant not to compete and sought both injunctive relief and damages.
The employment agreement provided that any dispute arising under the contract would be governed by the law of Maryland. In its opinion, the district court provides a thorough discussion of Maryland's law relating to the enforcement of covenants not to compete. Bolton challenged the covenant on the basis that it was overbroad, failed to protect a legitimate business interest, imposed an undue hardship on him and violated the public's interest.
Under Maryland law, covenants will be enforced "if the restraint is confined within limits which are no wider as to area and duration than are reasonable for the protection of the business of the employer and do not impose undue hardship on the employee or disregard the interests of the public." Id. at *12, quoting Ruhl v. F.A. Bartlett Tree Expert Co., 225 A.2d 288 (Md. 1967). Where the scope is reasonable, courts may also consider other factors, such as: "whether the person sought to be enjoined is an unskilled worker whose services are not unique; whether the covenant is necessary to prevent the solicitation of customers or the use of trade secrets, assigned routes, or private customer lists; whether there is any exploitation of the personal contacts between the employee and customer; and, whether enforcement of the clause would impose an undue hardship on the employee or disregard the interests of the public." Bolton, at *12-13, quoting Budget Rent A Car of Wash., Inc. v. Raab, 302 A.2d 11 (Md. 1973).
The court first upheld the 50 mile radius geographic scope of the covenant, noting that Maryland courts had upheld covenants that had unlimited geographic limitations. It found significant that, while TEKsystems operated nationally and internationally, the covenant only applied to the New York City area. The court also found the 18 month period to be reasonable, as Maryland courts have routinely upheld covenants that spanned two years.
Bolton also charged that the covenant was overbroad in that it barred him from engaging "in any activity which may affect adversely the interests of the Company." The court rejected the argument, noting that Maryland courts have "sanctioned restrictive covenants that prohibit former employees from securing employment with competitors." Bolton at *15.
It also noted that employers have a protective interest in preventing an employee from using customer contacts post employment, especially where the "personal contacts between the employee and the customer are an important element determining the business's success." Id. at 16-17, quoting Intelus Corp. v. Barton, 7 F. Supp.2d 635, 639 (D. Md. 1998). Here, the court found that TEKsystem's business depended overwhelmingly on the personal connections between its employees and its clients, and Bolton was one of TEKsystem's most important employees in the New York City area. In Maryland "[c]ourts are more willing to enforce restrictive covenants when the employee at issue possesses unique or specialized skills." Bolton at *18.
Bolton also claimed that enforcing the covenant would create an undue hardship on him because it barred him from bompeting in the New York City area. Again the court rejected the argument, holding that, while such a claim might be inconvenient, it did not rise to a level of undue hardship.
Finally, the court considered the public interest at stake and noted that "the public benefits from the enforcement of reasonable restrictive covenants. ... Such measures facilitate and protect business growth, especially in technology-related and information-based fields." Id. at *20. And it quoted approvingly from Intelus, supra, regarding Maryland's policy as to such covenants: "As long as employers do not restrict employees from earning a living and do not limit fair competition, they must be given the opportunity to provide a service to their customers without risking a substantial loss of business and good will every time an employee decides to switch employment." Id. quoting Intelus , 7 F. Supp.2d at 642.
Turning to remedies, the court denied compensatory damages finding that there was no proof that any of TEKsystem's customers had paid any fees to Bolton for work with his new employer. It reserved, however, on the issue of whether the parties had a desire to litigate further on the damages issue.
And as for equitable relief, the court awarded a permanent injunction, barring Bolton from operating in the New York City area. It noted, however, that the original 18 month period had expired in December 2009. Given prior Maryland precedent that "if the non-compete period is not enforced through equitable extension, it could 'reward the breach of contract, encourage protracted litigation, and provide an incentive to dilatory tactics,'" Bolton at *28, quoting PADCO Advisors, Inc. v. Omdahl, 179 F. Supp.2d 600, 613 (D. Md. 2002)(quoting Roanoke Engineering Sales Co. v. Rosenbaum, 290 S.E.2d 882 (Va. 1982)) the court prospectively enjoined Bolton from violating the terms of his restrictive covenant for 18 months from the date of the court's order.
This case should be viewed as a cautionary tale to employees who are dismissive of the legal import of covenants not to compete that are governed by Maryland law.
TEKsystems is a technical staffing and services company. Jonathan Bolton worked in the New York City region. At the time he was hired he entered into an employment agreement containing a restrictive covenant that barred him from "engaging in the business of recruiting or providing on a temporary or permanent basis technical service personnel ... industrial personnel ... or office support personnel ... within a radius of fifty (50) miles of the office in which EMPLOYEE worked at the time his/her employment ended ..." The covenant effectively barred him from competing in the New York City area.
After resigning from TEKsystems, Bolton became employed by another IT-staffing company and operated from his home in New Jersey that was within the 50 mile radius of his former office. He was given the title "Managing Director of New York City." The evidence established that during his first year in the new position Bolton made nine placements, none of which were to companies that had been TEKsystems' clients. TEKsystems sued to enforce the covenant not to compete and sought both injunctive relief and damages.
The employment agreement provided that any dispute arising under the contract would be governed by the law of Maryland. In its opinion, the district court provides a thorough discussion of Maryland's law relating to the enforcement of covenants not to compete. Bolton challenged the covenant on the basis that it was overbroad, failed to protect a legitimate business interest, imposed an undue hardship on him and violated the public's interest.
Under Maryland law, covenants will be enforced "if the restraint is confined within limits which are no wider as to area and duration than are reasonable for the protection of the business of the employer and do not impose undue hardship on the employee or disregard the interests of the public." Id. at *12, quoting Ruhl v. F.A. Bartlett Tree Expert Co., 225 A.2d 288 (Md. 1967). Where the scope is reasonable, courts may also consider other factors, such as: "whether the person sought to be enjoined is an unskilled worker whose services are not unique; whether the covenant is necessary to prevent the solicitation of customers or the use of trade secrets, assigned routes, or private customer lists; whether there is any exploitation of the personal contacts between the employee and customer; and, whether enforcement of the clause would impose an undue hardship on the employee or disregard the interests of the public." Bolton, at *12-13, quoting Budget Rent A Car of Wash., Inc. v. Raab, 302 A.2d 11 (Md. 1973).
The court first upheld the 50 mile radius geographic scope of the covenant, noting that Maryland courts had upheld covenants that had unlimited geographic limitations. It found significant that, while TEKsystems operated nationally and internationally, the covenant only applied to the New York City area. The court also found the 18 month period to be reasonable, as Maryland courts have routinely upheld covenants that spanned two years.
Bolton also charged that the covenant was overbroad in that it barred him from engaging "in any activity which may affect adversely the interests of the Company." The court rejected the argument, noting that Maryland courts have "sanctioned restrictive covenants that prohibit former employees from securing employment with competitors." Bolton at *15.
It also noted that employers have a protective interest in preventing an employee from using customer contacts post employment, especially where the "personal contacts between the employee and the customer are an important element determining the business's success." Id. at 16-17, quoting Intelus Corp. v. Barton, 7 F. Supp.2d 635, 639 (D. Md. 1998). Here, the court found that TEKsystem's business depended overwhelmingly on the personal connections between its employees and its clients, and Bolton was one of TEKsystem's most important employees in the New York City area. In Maryland "[c]ourts are more willing to enforce restrictive covenants when the employee at issue possesses unique or specialized skills." Bolton at *18.
Bolton also claimed that enforcing the covenant would create an undue hardship on him because it barred him from bompeting in the New York City area. Again the court rejected the argument, holding that, while such a claim might be inconvenient, it did not rise to a level of undue hardship.
Finally, the court considered the public interest at stake and noted that "the public benefits from the enforcement of reasonable restrictive covenants. ... Such measures facilitate and protect business growth, especially in technology-related and information-based fields." Id. at *20. And it quoted approvingly from Intelus, supra, regarding Maryland's policy as to such covenants: "As long as employers do not restrict employees from earning a living and do not limit fair competition, they must be given the opportunity to provide a service to their customers without risking a substantial loss of business and good will every time an employee decides to switch employment." Id. quoting Intelus , 7 F. Supp.2d at 642.
Turning to remedies, the court denied compensatory damages finding that there was no proof that any of TEKsystem's customers had paid any fees to Bolton for work with his new employer. It reserved, however, on the issue of whether the parties had a desire to litigate further on the damages issue.
And as for equitable relief, the court awarded a permanent injunction, barring Bolton from operating in the New York City area. It noted, however, that the original 18 month period had expired in December 2009. Given prior Maryland precedent that "if the non-compete period is not enforced through equitable extension, it could 'reward the breach of contract, encourage protracted litigation, and provide an incentive to dilatory tactics,'" Bolton at *28, quoting PADCO Advisors, Inc. v. Omdahl, 179 F. Supp.2d 600, 613 (D. Md. 2002)(quoting Roanoke Engineering Sales Co. v. Rosenbaum, 290 S.E.2d 882 (Va. 1982)) the court prospectively enjoined Bolton from violating the terms of his restrictive covenant for 18 months from the date of the court's order.
This case should be viewed as a cautionary tale to employees who are dismissive of the legal import of covenants not to compete that are governed by Maryland law.
Thursday, January 28, 2010
Failure to Produce Knowledgeable Corporate Designee for Depositions Results in Sanctions
In unfair business practices cases, as with most civil cases involving companies, partnerships or other organizations, a party frequently wants to take a deposition of someone designated by the organization to speak for it as to certain issues. Unfortunately, it is not unusual for counsel to depose one or more designated individuals only to find that they have not been adequately prepared to testify and possess little useful knowledge. Two recent opinions from the Eastern District of Virginia and the District of Maryland suggest that such gamesmanship violates the requirements of the Rule and is sanctionable.
In the federal system these depositions are authorized by Rule 30(b)(6) of the Federal Rules of Civil Procedure. Under that Rule a party may serve notice on an organization that it will depose a corporate designee and provide a list of topics to be covered in the deposition. The organization is obligated to produce an officer, director, managing agent or some other representative who consents to testify on its behalf regarding the enumerated topics. The term "organization" includes corporations, partnerships, LLCs, associations and governmental agencies or other entities.
In Humanscale Corp. v. Compx International, Inc., 2009 U.S. Dist. LEXIS 120197 (E.D.Va. December 24, 2009), click here, the district court examined the clear requirements of the Rule. "The corporation must make a good-faith effort to designate people with knowledge of the matter sought by the opposing party and to adequately prepare its representatives so that they may give complete, knowledgable, and nonevasive answers in deposition." Given that the individual speaks for the corporation, the duty to prepare goes beyond the actual knowledge of the individual to the knowledge of the company. Therefore, the Rule requires the company to prepare the designee to testify as to all matters known by or reasonably available to the company. That this may be burdensome and time consuming to the company does not excuse its failure to adequately prepare its designee. As the court noted, "... sanctions may be properly imposed against a corporation when its 30(b)(6) designee is unknowledgable of relevant facts and it fails to designate an available, knowledgable, and readily identifiable witness because such an 'appearance is, for all practical purposes, no appearance at all,'" quoting Resolution Trust Co. v. Southern Union Co. , 985 F.2d 196, 197 (5th Cir. 1993).
In Humanscale Corp., the court ordered the defandant to designate properly prepared witnesses to testify as to both financial and non-financial topics. It also directed the plaintiff to submit statements of attorneys' fees and costs incurred so that sanctions could be awarded.
Just last week, the District of Maryland in Weintraub v. Mental Health Authority of St. Mary's, Inc., 2010 U.S. Dist. LEXIS 5131 (D. Md. January 22, 2010), addressed the Rule in the context of a defunct corporation. There the plaintiff had served a Rule 30(b)(6) notice on the defendant who sought a protective order given that the company was no longer in business and had no employees or authorized representatives. Counsel for the defendant conceded that he might be able to find a former director who could be deposed, but noted it was likely the individual would have no information related to the designated topics of interest. Nevertheless, the court ordered that the defendant designate an individual who could testify and cautioned that the company could not "throw up its hands" and designate an individual who was inadequately prepared.
Unfortunately for the defendant, counsel did not produce a fully informed deponent. In fairness, however, in his letter designating the individual, counsel informed opposing counsel that he was designating her "having been left essentially no alternative by the court," but acknowledged that he could not compel her to come to Maryland to be deposed. At her deposition, the designee could not testify meaningfully as to at least ten topics and repeatedly testified that no efforts to obtain such information had been undertaken.
The plaintiff filed a motion for sanctions which the court granted. Finding that the defendant had violated its prior order to produce a knowledgable deponent, the court held that the defendant's actions constituted bad faith. The court refused to give credence to the defendant's lack of control over the witness, finding that under the circumstances "Ms. Zoss was a poor choice to serve as the Rule 30(b)(6) designee." Fortunately for the defendant, the plaintiff also deposed the President of defendant's Board of Directors who was more knowledgable and defense counsel asked to treat his testimony as that of a corporate representative. Thus, the plaintiff was able to obtain much of the desired testimony. Because two depositions were required to obtain the information that should have been forthcoming in one, however, the court imposed modest sanctions. Given the tenor of the opinion, had the Board member not testified, it is proabable that the sanctions would have been more severe.
These cases should be cautionary tales to a litigant. The courts have been clear that an organization must produce knowledgable individuals to testify in response to a Rule 30(b)(6) notice even if the designee has no personal, first-hand knowledge. The law requires that they be well prepared to testify as to all topics for which they have been designated. Difficulties arising out of the organization's status or availability of knowledgable employees according to these cases will not excuse that obligation.
In the federal system these depositions are authorized by Rule 30(b)(6) of the Federal Rules of Civil Procedure. Under that Rule a party may serve notice on an organization that it will depose a corporate designee and provide a list of topics to be covered in the deposition. The organization is obligated to produce an officer, director, managing agent or some other representative who consents to testify on its behalf regarding the enumerated topics. The term "organization" includes corporations, partnerships, LLCs, associations and governmental agencies or other entities.
In Humanscale Corp. v. Compx International, Inc., 2009 U.S. Dist. LEXIS 120197 (E.D.Va. December 24, 2009), click here, the district court examined the clear requirements of the Rule. "The corporation must make a good-faith effort to designate people with knowledge of the matter sought by the opposing party and to adequately prepare its representatives so that they may give complete, knowledgable, and nonevasive answers in deposition." Given that the individual speaks for the corporation, the duty to prepare goes beyond the actual knowledge of the individual to the knowledge of the company. Therefore, the Rule requires the company to prepare the designee to testify as to all matters known by or reasonably available to the company. That this may be burdensome and time consuming to the company does not excuse its failure to adequately prepare its designee. As the court noted, "... sanctions may be properly imposed against a corporation when its 30(b)(6) designee is unknowledgable of relevant facts and it fails to designate an available, knowledgable, and readily identifiable witness because such an 'appearance is, for all practical purposes, no appearance at all,'" quoting Resolution Trust Co. v. Southern Union Co. , 985 F.2d 196, 197 (5th Cir. 1993).
In Humanscale Corp., the court ordered the defandant to designate properly prepared witnesses to testify as to both financial and non-financial topics. It also directed the plaintiff to submit statements of attorneys' fees and costs incurred so that sanctions could be awarded.
Just last week, the District of Maryland in Weintraub v. Mental Health Authority of St. Mary's, Inc., 2010 U.S. Dist. LEXIS 5131 (D. Md. January 22, 2010), addressed the Rule in the context of a defunct corporation. There the plaintiff had served a Rule 30(b)(6) notice on the defendant who sought a protective order given that the company was no longer in business and had no employees or authorized representatives. Counsel for the defendant conceded that he might be able to find a former director who could be deposed, but noted it was likely the individual would have no information related to the designated topics of interest. Nevertheless, the court ordered that the defendant designate an individual who could testify and cautioned that the company could not "throw up its hands" and designate an individual who was inadequately prepared.
Unfortunately for the defendant, counsel did not produce a fully informed deponent. In fairness, however, in his letter designating the individual, counsel informed opposing counsel that he was designating her "having been left essentially no alternative by the court," but acknowledged that he could not compel her to come to Maryland to be deposed. At her deposition, the designee could not testify meaningfully as to at least ten topics and repeatedly testified that no efforts to obtain such information had been undertaken.
The plaintiff filed a motion for sanctions which the court granted. Finding that the defendant had violated its prior order to produce a knowledgable deponent, the court held that the defendant's actions constituted bad faith. The court refused to give credence to the defendant's lack of control over the witness, finding that under the circumstances "Ms. Zoss was a poor choice to serve as the Rule 30(b)(6) designee." Fortunately for the defendant, the plaintiff also deposed the President of defendant's Board of Directors who was more knowledgable and defense counsel asked to treat his testimony as that of a corporate representative. Thus, the plaintiff was able to obtain much of the desired testimony. Because two depositions were required to obtain the information that should have been forthcoming in one, however, the court imposed modest sanctions. Given the tenor of the opinion, had the Board member not testified, it is proabable that the sanctions would have been more severe.
These cases should be cautionary tales to a litigant. The courts have been clear that an organization must produce knowledgable individuals to testify in response to a Rule 30(b)(6) notice even if the designee has no personal, first-hand knowledge. The law requires that they be well prepared to testify as to all topics for which they have been designated. Difficulties arising out of the organization's status or availability of knowledgable employees according to these cases will not excuse that obligation.
Subscribe to:
Posts (Atom)
