Earn-outs are an often used and potentially effective mechanism to help bridge the price gap between buyers and sellers. However, there are a number of key considerations regarding earn-outs that, if not properly considered, can lead to suboptimal outcomes.
Problem
Oftentimes, although both buyer and seller are highly motivated, their respective expectations of future financial performance of the target can be meaningfully different, creating a substantial bid-ask spread in the acquisition price.
With both parties highly motivated to finalize the deal, they are eager for ways to bridge that gap. One useful tool in this regard is the “earn-out.” However, for the dealmakers to craft an effective earn-out, they need to understand certain mechanisms of the earn-out. These mechanisms can be:
structuring considerations;
dispute resolution;
valuation considerations; and
tax considerations, to name a few.
Without grasping these key considerations, the buyer or seller may wind up disadvantaged at the time of the deal or later, when it comes time to realize the earn-out.
Therefore, it is critically important for attorneys and their clients to think through these issues fully.
Solution
Houlihan Lokey, a leading valuation and investment banking firm, has built a wealth of experience in understanding and identifying some of these considerations.
We have prepared highlights of some of the key nuts and bolts of earn-outs. We hope this information will be useful in helping you and your clients think through the various issues that can accompany an earn-out structure.
Overview of Earn-Outs: An Abbreviated Summary
This section briefly summarizes the more in-depth information that follows. For more detailed discussion of these topics, see the next section, “Understanding Earn-Outs in Detail.”
An earn-out is a provision in an acquisition agreement that makes a portion of the purchase price payable to the seller if/when certain post-closing performance targets are achieved.
Bridges the Gap Between Buyer and Seller
Situations where the seller’s optimism contrasts with the buyer’s skepticism can often be found in businesses with:
limited operating history,
financial distress,
a historical pattern of not meeting budgets/forecasts,
an uncertain business environment with unusually high volatility (e.g., COVID-19), or
an unproven product or new market for an existing product.
Commonly Used
Earn-outs are found in nearly 30 percent of M&A deals, but are more typical in private deals with deal values under $250 million. An earn-out can mitigate risk for the buyer, while giving the seller an opportunity to enhance the aggregate consideration. A poorly structured earn-out can result in mismanagement of the newly acquired business and lead to post-deal disputes.
“[A]n earn-out…typically reflects [a] disagreement over the value of the business that is bridged when the seller trades the certainty of less cash at closing for the prospect of more cash over time…But since value is frequently debatable and the causes of underperformance equally so, an earn-out often converts today’s disagreement over price into tomorrow’s litigation over the outcome.”[1]
The challenge in crafting an earn-out is to reconcile the parties’ competing priorities and their desire to shift as much post-closing risk as possible to the other party.
Buyer Considerations
Could result in a higher purchase price if the acquired business proves successful
May result in restrictions in operating the newly acquired business
The chosen measure for the achievement of earn-out may be poorly defined and not ultimately as meaningful or relevant
Seller Considerations
Underperformance can lead to reduced purchase price
Postponing payment increases the risks of external impact adversely impacting the aggregate purchase price paid
Seller may surrender control to the buyer and/or be adversely impacted by the buyer’s business, making it more difficult to achieve the earn-out
Structuring Earn-Outs
Each earn-out is unique, but several provisions are usually addressed—and if not, post-deal disputes may ensue.
Key Provisions to Be Addressed
Defining the Business
Relevant Performance Metrics
Financial metrics (e.g., revenue, EBITDA, net income, etc.)
Thresholds
The required level of the financial metric
Milestones
Non-financial (e.g., FDA approval of a drug)
Measurement Standards
GAAP and/or exceptions to GAAP
Form of Consideration
Securities law issues
Earn-Out Period
Buyer/seller considerations with respect to the period
Sufficient to assess performance of the business
1–3 years is common
Operational Control
Critical Issue: buyer flexibility to run the business versus the seller’s desire to maximize the earn-out
Payout Formula
Binary
All or nothing; more common with milestones
Graduated (e.g., [x]% of adjusted EBITDA)
Multiple (e.g., milestone plus a revenue threshold)
Caps/floors
Maximum/minimum payouts under the earn-out
Payout schedules
One or several payouts
Indemnification
Offsets against amounts due to the buyer
Dispute Resolution
A large body of Delaware case law suggests that earn-outs tend to only postpone disputes because cases typically involve a business’s failure to meet earn-out criteria. Key considerations concerning earn-out-related disputes include payout calculation, arbitration vs. litigation, and breach of contract or breach of the implied covenant of good faith and fair dealing.
Delaware courts interpret earn-out provisions literally, and intent of the parties is paramount. Resorting to good-faith provisions can be problematic. Sellers may claim, among other things, that the payout calculation was incorrect or there were certain breaches by the buyer.
Payout Calculation Disputes
If the buyer and seller disagree initially on the payout calculation, the agreements typically would call for an expert or arbitrator (a “neutral”) to make a final determination. (An expert or arbitrator is an important distinction with significant consequences.)
Note, Delaware courts will not lightly intervene in payout calculation disputes, which may lead to pursuit of other legal actions. Therefore, it is important for the agreement to distinguish payout calculation and other causes of action, which would be resolved in a different manner.
Payout Calculation Considerations
Relevant concerns that should be addressed in the provisions regarding the payout provisions include:
how the neutral will be selected
the scope of review and whether the neutral will be an expert or arbitrator
who pays
whether the neutral will be bound by methodologies provided for in the agreement or can raise issues beyond those identified by the parties
the timetable
the basis for dispute of the neutral’s conclusion
Agreements sometimes include mandatory arbitration as the primary means of dispute resolution. However, litigation may arise over whether a court or an arbitrator has jurisdiction to make certain determinations.
Arbitration vs. Litigation
Some advantages of arbitration include speed, cost-effectiveness, and enhanced confidentiality. However, some advantages of litigation may include discovery, definitive resolution, availability of appeal, and alleviation of concerns over arbitrator competency or seeking a compromise value.
Breach of Contract
Losing sellers sometimes recast claims in a subsequent lawsuit alleging breach or express or implied obligations. This is a high bar. Delaware recognizes an implied covenant of good faith and fair dealing, which serves as a gap-filling role. Sellers will argue that the buyer may not undermine the business and that the implied covenant might obligate the buyer to take reasonable measures to achieve the earn-out. Buyers argue that there are no gaps to fill and that the implied covenant does not provide protections not secured at the time of the original agreement.
Valuation of Earn-Outs
There are a number of considerations for how an earn-out is treated for accounting purposes, and there are multiple ways to value the earn-out.
Accounting Treatment
An earn-out is treated as a liability if payment involves cash or variable number of shares. The liability must be remeasured to fair value at each reporting period until contingency is extinguished and associated change is recorded as a gain or loss on the income statement. If opening liability is greater than the payout, a loss is recorded, or vice versa. If payment involves a fixed number of shares, it is treated as equity.
How an earn-out is treated can impact the buyer’s income statement (e.g., EBITDA) and, thereby, may have an impact on certain other aspects of its business (e.g., bank financial covenant measurements).
Earn-OutMethodologies
There are two different valuation methodologies: the scenario-based method (SBM) and the option pricing method (OPM). In the SBM, multiple scenarios are identified. A payout is calculated for and a probability assigned to each, and an averaged payout is discounted at a risk-adjusted discount rate.
The OPM is better suited for non-linear payout structures or when multiple metrics involved. It treats earn-outs like a call option and employs option pricing models (e.g., Black-Scholes).
Tax Issues
The parties may have adverse tax interests in the characterization of payouts, so the treatment of the earn-out should be addressed as early as possible.
Tax Considerations for Parties
Compensation or purchase consideration
Compensation taxed as ordinary income to the seller, with a deduction for the buyer
Consideration taxed as capital gain to the seller, and the cost is capitalized for the buyer
Magnitude of payout
Should any tax sharing agreements be factored in as part of achieving thresholds?
IRS Considerations
Is the seller required to provide services to be eligible for payout?
Is the seller otherwise adequately compensated for services?
Are payouts proportionate to seller’s equity?
Do total payouts represent a reasonable price paid to seller?
What is the compensation of non-selling carryover employees?
How is the earn-out treated for tax and financial reporting purposes?
Contingent Value Rights
Contingent Value Rights (CVRs) represent a version of the earn-out in transactions involving publicly traded companies, and they are particularly common in the pharma-life sciences sector.
Tax Considerations for Parties
Typically, shorter in duration than traditional earn-outs and tied to an objectively verifiable outcome (e.g., FDA approval of a new drug).
Can be considered a security, subjecting it to registration requirements of the Securities Act
Five Factors
The SEC sets out five essential factors for CVRs not to be considered a security:
Integral part of transaction
Not represented by any form of certificate or instrument
No rights common to stockholders (e.g., voting) and does not bear a stated interest rate
Does not represent an equity or ownership interest
Not transferable
Understanding Earn-Outs in Detail
What Is an Earn-Out?
An earn-out is a provision in an acquisition agreement (the agreement) that makes a portion of the purchase price for a target company or business (the business) payable to the seller of the business (the seller) based on the post-closing performance of the business.
Earn-outs most often are found in private company acquisitions with a value of under $250 million.[2]The size of an earn-out relative to the total consideration in the transaction will typically reflect the magnitude of the disagreement between the parties with respect to the value of the business. An earn-out representing less than 15 percent of the purchase price may not be worth the time and effort to negotiate the earn-out provisions and/or the risk of future litigation.[3]
Payments of deferred purchase price and post-closing purchase price adjustments are not earn-outs.
A purchase price deferral is effectively a loan by the seller of a portion of the purchase price to the buyer of the business (the buyer).
Purchase price adjustments reflect changes in the working capital of the business between the signing of the agreement and closing and can increase or decrease the purchase price for the business, whereas earn-outs will only increase the purchase price in the future.
An earn-out in the context of a public company acquisition is known as a “contingent value right.” See the “Contingent Value Rights” section later in this article for more information.
When to Use an Earn-Out
Earn-outs can potentially bridge a gap between parties with differing views as to the business’s prospects and/or value.
An ex post “true-up” allows the parties to agree to disagree and complete the acquisition of the business (the acquisition).
Among other things, earn-outs may be particularly useful in situations involving a(n):
Business with a limited operating history but with significant growth potential,
Uncertain economic environment or a highly volatile industry,
Business with a historical inability to achieve its projections,
Unproven product or a new market for an existing product,
Business having recently undergone a financial or operational restructuring,
Company that has experienced a recent drop in earnings that may be temporary (e.g., due to COVID-19),
Business that is dependent on relatively few customers, or
Buyer with limited access to debt financing.
Properly structured, an earn-out can produce a win-win situation for both seller and buyer.
Advantages of an Earn-Out to the Buyer
Earn-out payments can be used to secure the seller’s indemnification obligations under an agreement. They provide the potential for greater aggregate consideration than in a fixed price structure (especially for the seller of a financially distressed business). And earn-out payments may allow the seller to benefit from synergies achieved by integrating the business with the buyer, allow for deferral of taxes (see the “Tax Issues” section for further discussion), and may allow the seller to control its own destiny if the incumbent management manages the business post closing.
Considerations Regarding Earn-Outs
A poorly crafted earn-out can result in mismanagement of the business and can create contentious post-deal disputes. As Vice Chancellor Laster of the Delaware Chancery Court (the Court) observed in Airborne Health:[4]
“[A]n earn-out…typically reflects [a] disagreement over the value of the business that is bridged when the seller trades the certainty of less cash at closing for the prospect of more cash over time…But since value is frequently debatable and the causes of underperformance equally so, an earn-out often converts today’s disagreement over price into tomorrow’s litigation over the outcome.”
The challenge in crafting an earn-out is to reconcile the parties’ competing priorities and their desire to shift as much post-closing risk as possible to the other party.
Buyers will want to (i) control the post-closing activities of the business and (ii) minimize the future earn-out payments. Sellers will want the buyer to (i) actively pursue the growth of the business and (ii) maximize the future earn-out payments. Structuring an earn-out usually involves complex accounting, valuation, and tax issues that require the involvement of expert advisors. Because it is impossible to anticipate and address every scenario that could impact the earn-out, there is usually a “trust-me” aspect to the negotiation.
Buyer Considerations
If the acquisition is successful, the buyer may pay more for the business than if it had paid a higher price up front.
An earn-out may impose restrictions and covenants on the buyer, including restrictions on integrating the business.
The seller may benefit from enhancements to the business contributed by the buyer after closing.
Due to unexpected changes, the chosen measure of success at closing may not be a relevant metric in the future.
If incumbent management continues to operate the business, short-term, earn-out targets may undermine the buyer’s long-term goals.
Seller Considerations
If the business underperforms, the seller will receive less consideration than anticipated.
The seller may lose the ability to influence decisions that affect the achievement of the full earn-out.
The business may be affected by exogenous post-closing factors that were not anticipated when the agreement was signed.
The buyer may not be motivated to improve the performance of the business during the pendency of the earn-out period.
Financial support from the buyer may be critical to achieving the business’s projections.
The seller is likely to lose custody of the books and records of the business (see Windy City).
The seller is vulnerable to the credit risk of the buyer.
Structuring Earn-Outs
Earn-outs are bespoke provisions; however, several key areas are typically addressed:
definition of the business on which the earn-out will be based,
relevant performance metric(s),
appropriate target(s) for achieving the earn-out,
amount to be paid if the earn-out target(s) are achieved (the payout),
appropriate standard for measuring the performance of the business (the performance metric),
formula that will quantify the payout,
appropriate time period for achieving the earn-out (the earn-out period),
allocation of post-closing control of the business, and
mechanisms for dispute resolution.
Defining the Business
If operated ex post as a subsidiary or segregated division, measuring the business’s performance should be relatively straightforward. Integration of the business with the buyer can make a pre- and post-comparison of performance of the business difficult.
The following matters, among others, should be considered in defining the business:
the specific line(s) of business to be included (by business line, customer type, price point, or region, etc.) (See Windy City);
whether expansion of the business by the buyer will count toward the earn-out (see Glidepath and Western Standard); and
the treatment of revenue from pre-closing customers common to the business and the buyer.
Performance Metrics
The performance metrics can be (i) financial, (ii) non-financial, or (iii) a combination of both.
Financial Performance Metrics
Financial performance metrics include income statement line items (for example, net revenues, EBITDA, net income), balance sheet items (e.g., net equity), or other performance metrics (such as buyer’s stock price).
Sellers prefer revenue-based performance metrics, which are less impacted by expenses and buyer post-closing accounting practices.
Buyers, on the other hand, prefer income performance metrics, as they can be better indicators of the success of the business. Buyers are more likely to insist on net income if incumbent management will operate the business post closing (to incent cost control).
Earnings before interest, taxes, and depreciation and amortization (EBITDA) is a commonly used financial performance metric. Because the aggregate purchase price is often calculated as a multiple of EBITDA, it is logical to use the same measure for the earn-out.[5] EBITDA is not defined under generally accepted accounting principles (GAAP) and may not be presented in the historical financials of the business. Accordingly, the items to be included/excluded in calculating EBITDA need to be clearly specified in the agreement.
Thresholds
The earn-out threshold (the threshold) is the financial performance metric level that the business must achieve for the seller to receive a payout. Thresholds are typically based on the seller’s projections for the business (the projections). Thresholds should be objective and measurable, plainly defined, and consistent with the character of the business.
Milestones
Non-financial performance metrics commonly include regulatory approval or the launch of a new product (a milestone and, together with a threshold, a target). Milestones obviate many of the complexities associated with structuring financial thresholds. However, an issue can arise as to whether a milestone can be achieved in part, but not in whole, (e.g., if only some of the claims of a patent are granted (see Gilead Sciences and Allergan)).
Milestones are especially useful in the context of emerging companies, where setting financial thresholds may be challenging due to the high growth trajectory of the business and/or the lack of historical information to use as a baseline. Milestones are most frequently observed in life sciences (FDA approval of a drug) and in technology (receipt of a patent).
A milestone structure requires the parties to agree on:
the specific milestone (see Gilead Sciences),
the specified degree of buyer efforts to cause, or to cooperate in causing, the milestone event to occur (see Allergan), and
any deadline by which the milestone must occur (see Shire).
The most successful milestone is either an event over which neither the buyer nor the seller has any control or an event that is so important, the buyer remains motivated to see that event occur, despite the obligation to make the milestone payout.
The parties should be very specific as to what types of approval satisfies a milestone. The use of industry and colloquial terms in defining the milestone (on the assumption everyone knows what is meant) can lead to subsequent disputes (see Valeant). Examples should be included in the agreement of what will, and what will not, satisfy the milestone (see Shire and Tutor Perini II). Parties should also ensure that documents outside the agreement, such as term sheets and board presentations, clearly and consistently describe any milestones.
Measurement Standards
Earn-outs based on financial performance metrics require that the post-closing financial statements allow the performance of the business to be accurately compared to the relevant threshold.
The seller’s goal will be to ensure that the earn-out calculation provides an “apples-to-apples” comparison between the pre-closing and post-closing performance of the business. The baseline methodology is usually GAAP, applied consistently with the seller’s pre-closing practices.
Reference to GAAP alone, however, is insufficient, as GAAP permits a wide range of accounting policies (see Chambers).
Some of the accounting issues that are commonly prone to dispute include, among others:
inventory valuation: excess and obsolescence reserves (see Winshall I);
collectability of accounts receivable and bad debt allowances (see Tutor Perini II);
current expense versus capitalization (see Chambers);
reserves for warranty and product returns and for pension and post-retirement benefits;
contingencies such as litigation and environmental clean-up; and
changes to conform to newly promulgated GAAP.
The parties and their advisors need to identify and agree on line items that will be a supplement (or an exception) to GAAP. Adjustments specified in the agreement take precedence over GAAP (see Chambers and LaPoint). The agreement should set forth in detail how the financial performance metric should be calculated, including how specific line items would impact the calculation. Illustrative calculations can be helpful in resolving later disputes (see Tutor Perini I). In particular, matters commonly addressed in determining a financial performance metric include, among others:
costs and expenses incurred in connection with the acquisition (see Chambers and Comet Systems);
allocation of intercompany overhead for home office services;
determination of appropriate transfer pricing in intercompany transactions;
treatment of extraordinary or non-recurring items of gain or loss (see Comet Systems);
revenues and expenses from new lines of business not contemplated by the agreement;
capital expenditures and R&D costs, the benefit of which accrue after the earn-out;
management or other fees charged to the business;
the treatment of discontinued operations; and
the treatment of synergies arising from the acquisition.
Payout Formula
Once the performance metric(s), threshold(s), and measurement standards are established, the parties need to agree on whether the payout will be structured as a fixed percentage of an underlying performance metric or as a complex, nonlinear function of the underlying performance metric, which can feature floors, caps, and catch-up or make-whole provisions (the payout formula).
Binary Payout Formulas
Under a binary or an “all-or-nothing” payout formula, a lump sum is payable only upon the achievement of a stated target (e.g., $10 million upon the launch of Product X). Binary payout formulas are more commonly found in earn-outs with non-financial milestones, such as regulatory approvals. A binary payout formula can incentivize the buyer or an incumbent management to take actions to miss or achieve the threshold, as the case may be. A binary payout formula can demotivate an incumbent management when it becomes apparent that the business will not be able to achieve a required target.
Graduated Payout Formulas
Given the negative incentives of a binary payout formula, sellers will try to negotiate a payout formula that is a percentage of the performance threshold (e.g., “the annual payout shall equal 5 percent of adjusted EBITDA” or a graduated payout formula). Graduated payout formulas are relatively uncommon, as buyers resist paying for performance that does not achieve the relevant target.
The compromise is to set a minimum threshold (e.g., “the payout shall be 15 percent of the excess of 2021 EBITDA over $5 million”).
Multiple Payout Formulas
Payout formulas can include more than one performance metric (e.g., satisfaction of two of the following: (i) a revenue threshold, (ii) an EBITDA threshold, and/or (iii) retention of X% of the business’s customers).
Multiple performance metrics reduce the opportunity for a buyer or an incumbent management to manipulate the earn-out.
Caps and Floors
The payout in an earn-out can become substantial if the achieved performance metric exceeds the threshold by a significant amount. Buyers will want to cap the amount of each payout or the aggregate of all payouts (see Tutor Perini and Windy City). Sellers will try to resist any caps and will try to negotiate for a minimum floor payout (see Windy City).
Including floors and caps narrows the range of potential discrepancy that can be subject to subsequent dispute.
Payout Schedule
Payouts may be in one payment at the end of a short earn-out period or in periodic installments over a longer earn-out period. Multiple installment payouts raise a number of complicated issues:
The buyer may want to set near-term payouts at a lower percentage than later ones to protect against future shortfalls but, conversely, may want to decrease the payout over time to reflect any synergies from integrating the business with the buyer.
If the business fails to achieve the threshold in one period but exceeds it in the following period, the buyer may require that the seller make up the prior deficiency before becoming entitled to receive the current year payout.
Similarly, if the business achieves the threshold in an earlier period but fails to achieve it in later periods, the buyer may seek to “claw back” all or a portion of the prior year payout.
Conversely, the seller will want to be able to make up any deficiencies in performance in one period with any excess in a prior or later period to achieve the target for the deficient period (see Tutor Perini).
Such complexities can be avoided through the use of a cumulative approach, which depends on the extent to which the average results during the earn-out period exceed a specified cumulative threshold.
Interaction with Indemnification
The agreement should specify any interaction between the seller’s indemnification obligations and the earn-out provisions. Buyers will want the right to offset payouts against amounts due pursuant to the seller’s indemnity under the agreement.[6]Buyers will resist having the earn-out be the sole source of indemnity payment inasmuch as the earn-out may never be earned. Sellers will want to ensure that a given event does not give rise to both an earn-out offset and a separate indemnity claim.
Form of Consideration
Payouts may take the form of cash or non-cash consideration, such as a buyer note or stock, or both. If the consideration is cash or a buyer note, the seller will assume the buyer’s credit risk and will want assurances that the buyer will be able to make required payouts when due, and they may request security in the form of an escrow.
Sellers will want to ensure that the buyer’s credit facilities (existing and, if possible, future) will not impact the buyer’s ability to make the required payouts when due. The seller may ask for interest to begin accruing at a punitive rate if the buyer does not make a required payout when due.
If payouts are to be made in buyer stock, the agreement will need to address a number of issues pertaining to:
the date as of which the value of the buyer stock will be measured (e.g., the closing or issue date),
the seller’s registration rights, if any,
any voting restrictions/requirements,
tag-along/drag-along rights,
repurchase right by the buyer,
restrictions on transferability, and
anti-dilution protection.
If the buyer is a private company, the parties will need to specify a valuation methodology (e.g., formula or third-party valuation). The seller will want to ensure that the maximum number of potentially issuable shares of buyer stock are reserved at closing and any required stockholder approvals are secured.
Securities Law Issues
The Securities Exchange Commission (SEC) has issued numerous no-action letters on the subject of whether an earn-out is a security and considers many factors when making this determination, including whether:
the earn-out is an integral part of the consideration to be received in the acquisition;
the earn-out right is represented by any form of certificate or instrument;
the holders of the earn-out have rights in common with stockholders (for example, voting and dividend rights);
the earn-out represents an equity or ownership interest in the buyer; and
the earn-out is transferable.
The Earn-Out Period
Once the appropriate performance metrics, targets, and payout formulas have been agreed upon, the parties will need to consider the length of the earn-out period, the end of which may be triggered by the passage of time or the occurrence of an agreed-upon event. The earn-out period should be sufficient to adequately assess the performance of the business. An earn-out period that is too short carries the risk that performance of the business may be distorted by temporary short-term factors, such as COVID-19 or a drop in the price of oil. An earn-out period of one to three years after closing is common.[7]
Buyer Considerations
Buyers prefer shorter earn-out periods to minimize the duration of any restrictions on their management of the business. The buyer may want an early buyout option in the event the earn-out hinders the buyer’s ability to operate the business. Ideally, the price of any buyout should be a fixed dollar amount to avoid interim payout calculation disputes. However, if incumbent management is to manage the business, an earn-out period that is too short might provide an incentive to sacrifice the buyer’s long-term interests for short-term profits. If financing is an issue, the buyer may prefer a longer earn-out period to have more time to actually make the required payout.
Seller Considerations
A shorter earn-out period can result in an earlier potential payout.
If incumbent management is running the business post closing, a longer earn-out period will provide more time to achieve the relevant target; however, a longer earn-out period reduces the present value of the consideration ultimately received. Sellers will want to include a provision that accelerates the payout upon the occurrence of certain events that might negatively impact the ability of the business to achieve its target, including, among other things:
a sale of all or a substantial portion of the business,
a default under any of the buyer’s credit facilities or other material contracts, and
termination of incumbent management for any reason.
Operating Control Issues
Two of the most difficult, albeit most important, aspects of structuring an earn-out are determining:
the degree of control (if any) that the seller will have over the business post closing, and
the level of support (if any) that the buyer will be obligated to provide to the business.
Balancing the buyer’s desire to run the business as it sees fit and the seller’s desire to protect the business’s ability to achieve its target(s) can be difficult and often leads to disputes.
Buyer Considerations
The buyer will want to negotiate for:
the right to operate the business in its sole discretion[9] (see LaPoint) and
a disclaimer of fiduciary duty to the seller regarding the earn-out.[10]
If the business is to be run by an incumbent management, the buyer will want covenants and restrictions in the agreement to ensure the business is not operated solely to maximize the payout through risk-taking or failure to invest. An incumbent management may face potential fiduciary duty conflicts. As employees of the buyer, incumbent management will have an obligation to do what is best for the parent corporation, even if that means taking actions that could adversely affect the business and reduce the likelihood of receiving a payout.
Seller Considerations
Sellers will seek to impose certain restrictions on a buyer’s operation of the business, including obligations for the buyer to:
operate the business consistent with past practice,[12]
use “commercially reasonable” efforts to achieve a target (see Allergan),
not take any action with the intent of decreasing the amount of any payouts,
provide the business with appropriate levels of working capital and capital expenditures,
maintain the existing research and development programs, and
not divert business to other entities controlled by the buyer.
The seller will also try to reserve some authority regarding major decisions by the buyer, including restrictions on:
disposing of all or a significant portion of the business,
hiring or firing of incumbent management,
restrictions on dividends from the business,
incurrence of additional debt, and
combining all or a significant part of the businesses with another company or business.
Dispute Resolution
Unfortunately, as observed by Vice Chancellor Laster in Airborne Health, earn-outs often merely postpone disputes, as is evidenced by the large body of Delaware case law respecting earn-outs. Though fact-specific, the cases usually involve a failure of the business to meet its target, followed by the seller’s claim the:
payout calculation was incorrect,
buyer breached the agreement, and/or
buyer breached the implied covenant of good faith and fair dealing (the implied covenant).
As with other contract provisions, when Delaware courts interpret earn-out provisions, the intent of the parties is paramount. An agreement’s plain language will be enforced notwithstanding a windfall to one of the parties (see Chambers and LaPoint). If the agreement is unambiguous, extrinsic evidence as to the intent of the parties will not be admissible (see Exelon Generation).
Ambiguous provisions are likely to result in a trial (see Stora Enso, Western Standard, and Windy City). The Court is unlikely to aid a sophisticated party that could have, but failed to, negotiate contractual protections (see Airborne Health). Recognizing the futility of trying to provide for every contingency, parties often resort to good-faith provisions in the agreement (usually at the seller’s request). The Court has criticized such provisions as “gossamer definitions” and “aspirational statements” that are “too fragile to prevent the parties from devolving into…dispute” (see LaPoint).
Payout Calculation Disputes
In the typical scenario, the buyer’s accountants prepare the post-closing financial statements and calculate the payout amount. The seller then has a period of time either to submit a notice of disagreement or to accept the calculation as final and binding. The buyer will often try to limit the seller’s scope of objections to factual or numerical mistakes, or inconsistencies with the agreement.
Failing a negotiated resolution of any disputes, the agreement frequently provides for the parties to jointly select an accountant from a third independent accounting firm (a neutral accountant), whose determination will be final. Whether a chosen neutral accountant is denominated as an expert or as an arbitrator can have serious ramifications. See Chicago Bridge & Iron Co. N.V. v. Westinghouse Elec. Co. LLC, 166 A.3rd 912 (Del. 2017) (Chicago Bridge). An expert determination is merely a determination of a specific factual issue that the agreement requires to be determined by an expert.
In contrast, an arbitrator’s powers are analogous to those of a judge and include, among other things, the power to interpret contracts, resolve factual disputes, determine liability, and award damages. An arbitrator’s award is enforceable by a court, with limited right to appeal or review under the Federal Arbitration Act (FAA).
Delaware courts will not lightly intervene in disputes over payout calculations when the agreement provides for arbitration and is likely to treat a neutral accountant’s resolution as final. The Delaware Supreme Court (DSC) has held that the courts have no role in considering disputes where the “plain language of the…agreement” made arbitration by [a neutral accountant]…the “mandatory path” for resolving disputes over a post-closing adjustment. (See Chicago Bridge. See also MarkDutchCo.)
There are important differences between a payout calculation (addressed by the neutral accountant) and potential causes of action, such as fraud or a breach of the agreement, which are not suitable for expert determination. The agreement should carefully distinguish and separate payout calculation disputes from such other potential issues. Relevant concerns in drafting a payout calculation dispute provision will include:
how the neutral accountant will be selected,
the scope of review by the neutral accountant (solely the payout calculation as an expert or “any and all disputes” as an arbitrator),
who will pay for the neutral accountant (the loser, or shared equally or proportionally) (see MarkDutchCo),
whether the neutral accountant is bound by the methodologies provided in the agreement,
whether the neutral accountant can raise issues beyond those identified by the parties (see Chicago Bridge),
what work papers will be provided in support of the neutral accountant’s calculation,
whether the neutral accountant is free to perform a de novo calculation to derive its own result,
a timetable for the process, and
the basis on which, if any, a party can bring a claim to dispute the neutral accountant’s determination.
The neutral accountant’s engagement letter is important because the scope of its mandate can be opened up beyond what was contemplated in the agreement if the parties agree to a wider scope in the engagement letter.
General Arbitration vs. Litigation
Agreements sometimes include mandatory arbitration as the primary means of dispute resolution. Factors favoring arbitration over litigation include speed, reduced expense, and enhanced confidentiality. On the other hand, factors favoring litigation include more expansive discovery, definitive resolution of legal issues, the availability of plenary appeal, concern over the competence of the arbitrator pool, and concern that an arbitrator will gravitate toward compromise outcomes.
Litigation can arise over whether a court or an arbitrator has jurisdiction to make certain determinations. The DSC has stated that:
“Issues of substantive arbitrability are gateway questions relating to the scope of an arbitration provision and its applicability to a given dispute, and are presumptively decided by the [C]ourt. Procedural arbitrability issues concern whether the parties have complied with the terms of an arbitration provision and are presumptively handled by arbitrators. These issues include whether prerequisites such as time limits, notice, laches, estoppel, and other conditions precedent to an obligation to arbitrate have been met, as well as allegations of waiver, delay, or a like defense to arbitrability.” (See Winshall I)
Once jurisdiction has been resolved, a Delaware court will likely take an expansive view of the competence of an arbitrator to decide a broad range of matters, including procedural questions as well as interpretation of the agreement and applicable law. Many of the same considerations apply to the appointment of a general arbitrator as pertain to the retention of a neutral accountant. If the agreement allows recourse to litigation, jurisdiction and venue should be clearly specified.
Breach of Contract
Losing sellers in payout calculation disputes often try to recast their claims in a subsequent lawsuit alleging that the failure of the business to achieve a target was due to the buyer’s breach of an express or implied obligation under the agreement.
Sellers (as the usual plaintiff in these cases) face an uphill battle in proving not only the buyer’s misconduct but also that such misconduct caused the business to miss its target. (See LPL Holdings and En Pointe.) The high bar results in many earn-out cases being dismissed at the motion to dismiss or summary judgment stage.
Delaware courts often hold that the buyer’s conduct reflected the exercise of legitimate business judgment and that the seller’s complaint is merely a dispute over business strategy. (See Lazard Technology, Boston Scientific, and Glidepath.) However, a claim based on the manner in which the business was operated post closing may involve factual determinations that will preclude a successful motion to dismiss. (See Edinburgh Holdings and Cephalon.)
Proving whether the seller has been damaged—and in what amount—requires expert testimony, especially when the business is a startup or has a limited track record, which makes it difficult to quantify how the buyer’s actions or inactions harmed the business. It can be difficult to prove that targets would have been reached but for breaches by the buyer, and the Court may be reluctant to speculate what the payout would have been in the absence of the breach. (See LaPoint and LPL Holdings.) The seller might consider seeking to specify remedies for breaches of any of the obligations or restrictions regarding the post-closing operation of the business—such as liquidated damages or payment of the maximum payout.
Breach of the Implied Covenant
Delaware recognizes an implied covenant that “requires a party in a contractual relationship to refrain from arbitrary or unreasonable conduct which has the effect of preventing the other party to the contract from receiving the fruits of the bargain.” (See Winshall II.) The implied covenant serves a gap-filling function where the parties to the agreement did not anticipate some contingency, and had they thought of it, the parties would have agreed at the time of contracting to address that contingency. (See LPL Holdings.)
Sellers will argue that a buyer may not undermine the business and thereby deprive the seller of its “fruits of the bargain,” i.e., a payout. Sellers often further argue that the implied covenant obligates the buyer to take “reasonable” or even “best efforts” to reach a target.
The Court has held that the implied covenant does not impose a duty on a buyer to maximize an earn-out and does not “give the plaintiffs contractual protections that ‘they failed to secure for themselves at the bargaining table.’” (See En Pointe and Winshall II.) On the other hand, the Court is not tolerant of actions by a buyer that demonstrate an attempt to divert resources, opportunities, or revenue away from the business to avoid paying an earn-out. (See LPL Holdings and Haney.) Buyers defend against implied covenant attacks by emphasizing that the implied covenant is inapplicable when “the subject at issue is expressly covered by the contract.” (See Airborne Health, Lazard Technology, and Dialog Semiconductor.)
However, the Court has sometimes recognized claims for breach of the implied covenant where “the contracting parties would have agreed to proscribe the act later complained of…had they thought to negotiate with respect to that matter.” (See Winshall I.) The Court will not countenance a claim for breach of the implied covenant if such claim is duplicative of a related breach of contract claim. (See Edinburgh Holdings.)
Valuation of Earn-Outs
Accounting Standards
Under FASB ASC Topic 805 (Topic 805), the fair value of an earn-out is required to be recorded as a liability (the opening liability) on the buyer’s balance sheet if the payout involves the payment of cash or the issuance of a variable number of shares of buyer common stock. If the payout is in a fixed number of shares, it is classified as equity.
An earn-out recognized as a liability must be remeasured to fair value at each reporting period until the contingency is extinguished. To the extent there is a change in fair value, the change must be recognized as gain or loss on the buyer’s income statement. Contingent consideration recorded in equity is not required to be remeasured.
The accounting treatment for an earn-out is somewhat counterintuitive. If the opening liability is less than the payout, a loss is recorded (though the business is actually performing better than expected). On the other hand, if the opening liability is higher than the payout, a gain is recorded (though the business is not performing up to expectations).
The accounting for earn-outs can distort or skew a buyer’s EBITDA. If the business performs better than expected, the buyer may be required to book a loss, thereby reducing its EBITDA. The parties will also need to determine if and how such gains and losses figure into the payout calculation. A buyer also needs to address whether these types of gains and losses should be excluded in calculating leverage ratios in its credit and other material agreements.
Valuation Methods
In an effort to standardize the methodologies being used to value contingent consideration, in February 2019, the Appraisal Institute issued its “Valuation Advisory #4: Valuation of Contingent Consideration” (the Advisory), which suggested two primary methodologies for valuing earn-outs: the scenario-based method and the option pricing method.
Scenario-Based Method (SBM)
Under the SBM, multiple possible scenarios are identified for the underlying performance metric. A payout, if any, is calculated for each scenario and is weighted with an estimated probability factor. The weighted average payout calculated from the scenarios is then discounted to present value using a risk-adjusted discount rate. The choice of discount rate for the SBM should reflect the riskiness of the underlying performance metric.
Although the industry-weighted average cost of capital (WACC) is a reasonable starting point, other factors to consider include, among other things, the risk of buyer default on the payout and whether the earn-out is more or less risky than typical industry cash flows. Another alternative is to use the WACC that was used to calculate the enterprise value of the business in the acquisition, adjusted for any risks arising after the agreement was signed.
Milestone-based earn-outs are not exposed to market risk and are valued using a risk-free rate to discount probability-weighted payouts.
A standard discounted cash flow analysis (a DCF) is a form of SBM with only a single scenario representing an expected case. When valuing an earn-out using a DCF, the performance metric for the business is forecasted over the earn-out period and is compared to the relevant target to determine any payouts, which are then discounted to present value as of the acquisition date.
Generally, a DCF analysis is appropriate only when valuing an earn-out with a linear percentage payout formula. For example, an earn-out with a payout equal to 30 percent of the next fiscal year’s EBITDA is linear because it has a constant relationship to the underlying performance metric (i.e., a payout is due whether EBITDA is $1 million or $100 million).
Option Pricing Method (OPM)
The SBM approach is not well suited to capture the economics of more complex nonlinear structures, which feature, e.g., thresholds or caps, or where there are multiple performance metrics at play. The valuation of such complex payout formulas requires more sophisticated probabilistic methodologies, such as OPM, which incorporate assumptions about the full range of future outcomes rather than just a sampling of possible scenarios. Payout formulas that have a nonlinear structure are similar to options in that they are triggered when certain thresholds are reached.
The OPM treats earn-outs like call options on the future payouts and uses option models such as Black-Scholes. Option models work for simpler payout formulas, under which a payout is earned only if the business hits a target, or for linear graduated payout formulas with caps or floors.
For complex payout formulas that are path-dependent (e.g., where there are catch-ups, claw-backs, or multi-year features), a Monte Carlo simulation may be required.
Tax Issues
The parties may have adverse tax interests in the characterization of payouts, so the treatment should be addressed as early as possible. If treated as compensation for services, the payout will be treated as ordinary income to the seller (i.e., a negative implication) but will provide a compensation deduction to the buyer (i.e., a positive implication).
Alternatively, if the payout is treated as purchase price, the seller will be taxed at the lower capital gain rate (i.e., a positive implication), but the buyer will have to capitalize the cost (i.e., a negative implication).
The Internal Revenue Service will consider the facts and circumstances surrounding the payouts and has historically focused on the following factors:
whether the seller is required to provide services in order to be eligible for the payout;
whether the seller is otherwise adequately compensated for the performance of any required services;
whether the Payouts are proportionate to the seller’s equity in the business;
whether the total payouts made to the seller when viewed together with any upfront cash payments represent a reasonable price to be paid for the business;
the manner in which non-selling carryover employees are compensated for post-closing service; and
how the parties report the payouts for both tax and financial reporting purposes.
When a payout is properly considered compensation for services, it will be treated as taxable income when received by the service provider. The timing of the related deduction will depend upon the accounting method of the buyer. If the payout is treated as purchase price, special rules related to installment sales may apply. Additionally, an imputed interest component may apply to the deemed installment sale.
Other considerations with respect to earn-out payments:
The size of any cash payouts should not be of a magnitude to threaten a tax-free reorganization.
The size of any payout can also impact whether a Section 338(h)(10) election can be made.
If the business is to become part of a consolidated tax group, the seller should determine if any applicable tax sharing agreement will have an adverse effect on achieving any threshold.
Contingent Value Rights
Contingent value rights (CVRs) represent a version of an earn-out in transactions involving publicly traded companies. CVRs are particularly common in the pharmaceutical industry. As compared to traditional earn-outs, CVRs are usually of shorter duration and tied to the objectively verifiable outcome of a specific event, e.g., FDA approval of a drug.
A CVR can be deemed a security under applicable U.S. securities laws, subjecting the CVR to the registration requirements of the Securities Act at the time of closing. SEC no-action letters set out five essential factors that are needed for a CVR not to be considered a security:
the CVR is an integral part of the consideration to be received in a transaction,
the CVR is not represented by any form of certificate or instrument (usually not satisfied),
the holder has no rights common to stockholders (e.g., voting and dividend rights) and the earn-out does not bear a stated interest rate,
the CVR does not represent an equity or ownership interest in the buyer or the business, and
the CVR is not assignable or transferable, except by operation of law.
Conclusions
Earn-outs:
can be an effective negotiating tool when there are differing perspectives on value and/or outlook for the business;
have benefits and risks to both parties that should be considered prior to inclusion as an element of the purchase price;
are difficult because they can be manipulated by whoever is running the business;
must be carefully drafted to minimize the potential for litigation;
recognize and address potential conflicting incentives in the agreement;
require specificity regarding thresholds and milestones and measurement methods; use examples whenever possible; and
require definition of a clear set of responsibilities and contractual protections.
Post-closing adjustment arbitration provisions can be enforceable, but they may not preclude litigation of all causes of action arising from the acquisition.
Appendix: Representative Delaware Cases
Chambers v. Genesee & Wyoming Inc., 2005 WL 2000765 (Del. Ch. Aug. 11, 2005) (Chambers)
The earn-out in connection with the acquisition of the business by the Buyer (Genesee & Wyoming, Inc.) provided for a payout if the business achieved $9 million of EBITDA (as defined in the agreement) in any of the five years 1999–2003. Following the acquisition, the Buyer’s publicly reported EBITDA exceeded the threshold in four of the five years. The Buyer, however, claimed that EBITDA (as defined in the agreement) had not exceeded $9 million in any year and that the earn-out had not been earned.
The discrepancy arose because the Buyer adjusted its publicly reported EBITDA to reflect vested options, and those adjustments lowered the EBITDA of the business. Noting that “EBITDA…can be a slippery concept,” the Court focused on “the plain language of the contract itself” and noted that while the adjustments might have been appropriate under GAAP, the agreement specifically excluded them for the purposes of the earn-out. Moreover, the agreement did not permit the Buyer to expense certain labor costs (for purposes of the earn-out) that it had capitalized for its public financial statements. The Court therefore concluded that the Buyer’s calculation of EBITDA was flawed
William J. LaPoint v. AmerisourceBergen Corp., 2007 WL 2565709 (Del. Ch. Sept. 4, 2007), aff’d, 956 A.2d 642 (Del 2008) (LaPoint).
Under the agreement, up to $55 million was contingent upon the business meeting certain EBITA targets in 2003 and 2004. The agreement provided that the Buyer (AmerisourceBergen Corp.) would “exclusively and actively promote the [business],” would act “in good faith” during the earn-out period and would not do anything to impede the ability of the Seller (William J. LaPoint, as stockholder representative) to receive the payout. The Court called such terms “aspirational statements…and gossamer definitions…too fragile to prevent the parties from devolving into the present dispute.”
In his suit, the Seller alleged that the Buyer had not “exclusively and actively” promoted the business’s products and that the Buyer had turned down a proposal for a marketing relationship that would have been very favorable to the Seller under the earn-out.
Despite accepting the Seller’s allegation that the Buyer had failed to promote the business, the Court held that there was no evidence that the Buyer’s failure had made a difference insofar as the market was moving away from the type of product made by the Business. Thus, damages were awarded in the amount of six cents. The Court also held that the buyer was not obliged to enter into the marketing agreement.
The Seller fared better on the claim the earn-out calculation was in error. Among other things, the Court held that the Buyer could not adjust EBITA downward to account for incumbent management’s failure to invest in research and development as was required by the agreement. The Court noted the Buyer would have “done well to have included in the…agreement” an appropriate EBITA adjustment, but it declined to draft “any such clause into the agreement ex post.”
Under the agreement, sales to certain customers were to be discounted by an average discount (based on the last five contracts entered into before the execution of the agreement) in determining an adjustment to EBITA for earn-out purposes. The Buyer argued that the determination of average discount should be based on a weighted (by transaction size) average, which would have the effect of lowering EBITA. The Court rejected the argument because “the most straightforward usage of the term ‘average’ is an arithmetic mean.”
Overall, the Court characterized the Buyer’s arguments as “invok[ing] the agreement that it wishes it had signed, rather than the agreement that it drafted.” The cumulative changes resulted in an upward adjustment to the business’s EBITA of $6.2 million and a payout of $21 million, 44 percent of the total transaction price.
Airborne Health, Inc. v. Squid Soap, LP, 984 A.2d 126 (Del. Ch. 2009) (Airborne Health)
Because the Buyer (Airborne Health, Inc.) and the seller (Squid Soap, LP) were unable to agree on the value of the business, the agreement provided for a cash payment of $1 million at closing, “plus the potential for…[payouts] of up to $26.5 million if certain targets were achieved.” Although the agreement provided that the Buyer would return the business to the Seller if the Buyer did not meet certain targets, such as advertising spend and sales volume, the agreement did not contain “any specific commitments by [the Buyer] regarding the level of efforts or resources that it would devote” to the marketing and sale of the business’s products.
Owing, in part, to significant litigation filed against the Buyer prior to the closing of the agreement that had not been disclosed to the Seller, the targets were not met and the Seller sued the Buyer for fraud and breach of the implied covenant. Owing to the specific wording of the Buyer’s representations in the agreement, the Court dismissed the claims for fraud.
The Court did agree with the Seller that “[w]hen a contract confers discretion on one party, the implied covenant requires that the discretion be used reasonably and in good faith” and that “[the Buyer] could not arbitrarily refuse to expend resources and thereby deprive [the Seller] of the prospects for the earn-out.” However, the Court recognized that the Buyer had suffered a “corporate crisis” and “was [u]ndoubtedly restrained by…legal and financial burdens” and that such a scenario did not support a claim that the buyer exercised its contractual discretion in bad faith.
Comet Systems, Inc. v. Miva, Inc., 980 A.2d 1024 (Del. Ch. 2008) (Comet Systems)
In calculating the earn-out, the Buyer (Miva, Inc.) treated bonus payments as an operating expense rather than a “one-time, non-recurring expense,” which was to be excluded from the calculation of “profit per user.” As a result, the profit per user target under the earn-out was not met and the payout was reduced significantly. The agreement did not specifically define the intended meaning of “one-time, non-recurring expense.” The Court concluded that the bonus payments qualified as a “one-time, non-recurring expense” pursuant to the “plain, unambiguous meaning of the agreement.” The Court observed that “charges and costs which occur as a result of the [acquisition] and are not expected to be representative of future costs in the business are reasonably excluded. The natural reading of ‘one-time, non-recurring expenses’ is to exclude exactly such charges.”
Winshall v. Viacom International Inc., 55 A.3D (del. Ch. Nov. 10, 2011), aff’d 72 A.3d 78 (Del. 2013) (Winshall I)
In 2006, the Buyer (Viacom International, Inc.) acquired the business (Harmonix Music Systems, Inc.) for $175 million in cash and contingent uncapped earn-out payments based on the financial performance of the business in 2007 and 2008.
Winshall (as Seller’s representative) challenged the Buyer’s earn-out calculation, and the dispute was put to a designated neutral accountant. Although it was not identified in its original calculation, the Buyer argued to the neutral accountant it should be allowed to deduct, or, in the alternative, take a write-down for, the cost of the business’s unsold inventory (the “inventory issue”). In its decision, the neutral accountant rejected the inventory issue because the Buyer had not identified it, as required by the agreement, in its initial calculation and the Seller did not agree to have it resolved by the neutral accountant.
The Buyer filed a complaint with the Court, seeking a declaration vacating the neutral accountant’s determination on the grounds that it constituted “manifest error.” The Court disagreed and granted Winshall’s motion for summary judgment.
On appeal, the Buyer argued, among other things, that (i) the neutral accountant’s refusal to consider evidence of the inventory issue amounted to misconduct and (ii) the inventory issue was one of substantive arbitrability, which should have been decided by a court. The DSC disagreed and concluded that (a) the neutral accountant’s refusal to consider the inventory issue without the consent of the Seller was appropriate and (b) the Inventory Issue was one of procedural arbitrability, properly decided by the neutral accountant.
Winshall v. Viacom International Inc., 2012 WL 3249620 (Del. Ch. Aug. 9, 2012), aff’d 76 A.3d 808 (Del. 2013) (Winshall II)
The representative of the Sellers (Winshall) claimed that the Buyer deliberately failed to renegotiate certain distribution fees in order to reduce the Seller’s payout. Given that the agreement did not obligate the Buyer to renegotiate the fees, the Court rejected the Seller’s argument that the implied covenant implicitly obligated the Buyer to avoid manipulating the cost structure of the business to lower the payout.
The DSC upheld, among other things, the Court’s rejection of the Seller’s claim, noting that “the implied covenant is not a license to rewrite contractual language just because the plaintiff failed to negotiate for protections that, in hindsight, would have made the contract a better deal.”
American Capital Acquisition Partners v. LPL Holdings, 2014 WL 354496 (Del. Ch. Feb. 3, 2014) (LPL Holdings)
The agreement provided for a payout based on the achievement of certain “gross margin” thresholds. The agreement, however, did not include any provision requiring the Buyer (LPL Holdings) to make, or to use any efforts to make, certain technical adaptations to its computer systems necessary to allow the business to expand and eventually meet those thresholds.
The Seller (American Capital Acquisition Partners) argued that the existence of contingent price provisions obligated the Buyer to make those adaptations under the implied covenant. The Court pointed out in its opinion that although the parties anticipated that the Buyer’s systems would require some changes, they did not include any provision in the agreement obligating the Buyer to make any technical adaptations necessary to allow the further development of the Business. The Court reiterated that the implied covenant serves only a gap-filling function that is only relevant when an issue arises ex post that was not anticipated when the contract was negotiated. Here, the Seller “anticipated, but failed to bargain for, a requirement that [the Buyer] adapt [its] software and data-handling capabilities.”
At the same time, the Court did find that the Buyer breached the implied covenant by allegedly diverting the Seller’s clients and employees to another subsidiary of the Buyer and discouraging clients and prospective clients from using the Seller’s resources.
Lazard Technology Partners, LLC v. Qinetiq North America Operations LLC, 114 A.3d 193 (Del. 2015) (Lazard Technology)
The Buyer (Qinetiq North America Operations LLC) paid the Seller (Lazard Technology Partners, LLC, as stockholder representative) $40 million for the business, plus a potential earn-out of $40 million if the business reached certain revenue levels. The agreement prohibited the Buyer from taking “any action to divert or defer [revenue] with the intent of reducing or limiting the…[Payout].” When the business did not reach the requisite target, the Seller sued the Buyer for violating the contractual prohibition and the implied covenant.
After trial, the Court held that the Seller failed to prove that the Buyer acted with the requisite intent to violate the agreement. Owing to the existence of the express covenant not to take action “with the intent of reducing or limiting the…[payout],” there was not an implied covenant inconsistent with that express covenant.
The DSC upheld the lower court’s bench ruling. According to the DSC, the plaintiff had the burden to establish that the Buyer’s action was “specifically motivated by a desire to avoid the earn-out.” In that regard, the plain language of the agreement limited the Buyer’s actions only if they were done with the motivation to avoid the earn-out. Furthermore, because the agreement specifically set forth the standard for the Buyer’s behavior, the Seller’s argument was without merit.
The Buyer (Dialog Semiconductor PLC) was required to “use commercially reasonable best efforts” in managing the business to achieve the earn-out. The agreement also included specific obligations and prohibitions on the Buyer’s operation of the business.
When the business failed to achieve the earn-out threshold, the Seller (through Fortis Advisors) brought suit alleging, among other things, breach of contract and, in the alternative, breach of the implied covenant.
As the agreement expressly obligated the Buyer to use commercially reasonable best efforts and explicitly restricted the Buyer from taking certain actions, the Court rejected the assertion that the implied covenant could be used as an alternative theory to contractual breach with respect to the earn-out provision in dispute.
The Seller (Haney) sued for, among other things, breach of the implied covenant when the business failed to reach an earn-out target. The Seller alleged that the Buyer (Blackhawk Network Holdings Inc.) deliberately prevented the business from achieving the Target by failing to devote required resources to the business.
The Seller argued that the agreement’s requirement that the Buyer’s “key personnel…dedicate a commercially reasonable” amount of time and resources to the generation of revenue did not specifically provide a standard for evaluating the conduct of the Buyer’s personnel. (The argument was intended to distinguish from Dialog Semiconductor where the Court held that an agreement’s “best efforts” standard and specified Buyer obligations barred applying the implied covenant.)
The Court disagreed, finding that the express terms of the agreement controlled, and dismissed the Seller’s claim. The Court, however, did find that the Seller’s allegation that the Buyer failed to disclose an exclusivity provision in a key contract (which precluded the achievement of the relevant target) stated a claim for unjust enrichment based on fraud.
Zhu v. Boston Scientific Corp., 2016 WL 1039487 (D. Del. Mar. 15, 2016) (Boston Scientific)
A federal court applying Delaware law concluded that the failure to develop a medical technology in a manner that would have allowed the Seller (Zhu) to receive a payout did not constitute a breach of the implied covenant. The Court concluded that the Sellers “simply disagree with how [the Buyer (Boston Scientific Corp.)] chose to develop the [t]echnology” and that commercially reasonable conduct does not rise to the level of a breach of good faith.
Sharma v. TriZetto Corp., 2016 WL 1238709 (D. Del. March 29, 2016) (TriZetto)
The Seller (Sharma) sold the business to the Buyer (TriZetto Corp.) for $13.5 million in cash plus additional consideration in an earn-out if the Business achieved gross revenues of $47.2 million in the 2013 calendar year.
The parties anticipated that the Buyer would engage in subsequent acquisitions, and the agreement provided that the parties would negotiate in good faith to determine whether revenue from such acquisitions would apply toward the earn-out revenue goal. As a default, until the parties agreed otherwise, the revenue from those acquisitions would not be applied against the goal.
After objecting to the payout calculation, the Seller sued claiming that the Buyer breached the agreement by operating the business to avoid owing the payout, by failing to include post-closing acquisitions in the payout calculation, by failing to engage in good-faith negotiations or provide reasonable details concerning the earn-out calculations, by failing to appoint a neutral accountant to resolve the dispute between the parties, and by failing to maintain and promote the business.
The District Court (applying Delaware law) dismissed the claim for breach of contract, holding that the Seller had failed to allege facts that suggested that the Buyer made its decisions to avoid the earn-out payment. Because the agreement did not require the Buyer to make any specific disclosures in connection with the earn-out calculation statement, and because the parties had over ten months of discussions concerning the earn-out calculation, the Court held the plaintiffs had not alleged sufficient facts to support a claim that they failed to engage in good faith negotiations or to supply reasonable detail regarding its calculation. Because the dispute concerned which of the acquired businesses were part of the business, the issue was deemed outside the purview of the neutral accountant. Lastly, the Court held that the alleged facts did not fall into a “gap” in the agreement that would require the operation of the implied covenant.
Shareholder Representative Services LLC v. Gilead Sciences Inc. et al., 2017 WL 101561 (Del. Ch. Mar. 15, 2017), aff’d 177 A.3d 610 (Del. 2017) (Gilead Sciences)
The Buyer (Gilead Sciences Inc.) purchased the business for $375 million plus a series of three milestone payments if the business’s principal cancer drug obtained certain regulatory approvals, two of which were obtained.
The third $50 million payout was due upon regulatory approval of the drug in the United States or European Union as a “first-line drug treatment…for a Hematologic Cancer Indication.” When the drug was approved by the European Union as a first-line treatment for patients with chronic lymphocytic leukemia, but only those with a specified genetic mutation, the parties disputed whether the final milestone had been met.
Finding that the use of the word “indication” to describe the milestone was ambiguous, the Court reviewed the extrinsic evidence to determine that when the parties entered into the agreement, they mutually understood that the term “indication” meant “a disease.” Because the drug had been approved only for a specific subset of patients having leukemia, rather than having been approved as a first-line treatment of the disease called leukemia, the Court determined that the requisite milestone had not been achieved.
The Seller (Sprout Pharmaceuticals), which had developed a “female Viagra” drug (Addyi), entered into an agreement that required the Buyer (Valeant Pharmaceuticals) to use “diligent efforts” to pursue the development and “commercialization” of Addyi.
The agreement had explicit definitions of the required post-closing “diligent efforts” required of the Buyer, specifying both general standards plus four specific requirements on matters like minimum spending and staffing.
The Seller’s representative alleged that the Buyer’s high pricing of Addyi, while not contrary to any of the requirements of the agreement, violated the implied covenant by being unreasonable and therefore causing sales to be lower than anticipated.
Notwithstanding that the agreement covered “commercialization” of Addyi, the Court held that it could not dismiss an argument that “pricing” was separate from “commercialization,” and, therefore, there was a gap that could be filled by the implied covenant. The Court made a similar finding about the Buyer’s decision to sell Addyi through a pharmacy channel that was under criminal investigation.
Fortis Advisors LLC v. Shire US Holdings, Inc., 2017 WL 3420751 (Del. Ch. Aug. 9, 2017) (Shire)
The Seller’s representative (Fortis Advisors LLC) sought the payment of two milestone payouts totaling $425 million. The first milestone required the occurrence of an “achievement date,” which was defined in the agreement as satisfaction of certain efficacy endpoints in a study of a drug for dry eye disease (the “Study”). The second milestone was payable upon receipt of regulatory approval for the drug, contingent on the prior occurrence of the achievement date milestone.
The drug did not meet the required Study endpoints by the achievement date. However, the Buyer (Shire US Holdings, Inc.) continued development of the drug, which ultimately gained regulatory approval using the results of the Study as well as clinical data from other studies conducted prior to the Study (the “Prior Studies”).
The Sellers argued that the agreement should be interpreted as allowing consideration of the Prior Studies, not just the Study, in determining whether the endpoints had been achieved for purposes of determining whether the achievement date had occurred.
The Court held that since the “achievement date” was defined by reference to the outcome of a specific Study, the first milestone was not met because the endpoints of that Study were not met.
The Court rejected the Sellers’ argument that the first milestone did not expressly exclude consideration of other studies, and, therefore, the results of the Prior Studies could be included, noting that the agreement specifically referenced the Study and did not reference the results of other clinical studies.
The Court also found that since the second regulatory approval milestone was contingent on the occurrence of the achievement date, which was not met, the regulatory approval milestone was also not met.
GreenStar IH Rep., LLC v. Tutor Perini Corp., 2017 WL 5035567 (Del. Ch. Oct. 31, 2017) (Tutor Perini)
The agreement pursuant to which the Buyer (Tutor Perini Corp.) bought the business provided for the Seller (GreenStar Services Corp.) to receive payouts over five one-year terms. For each term, the Seller was entitled to a payout equal to 25 percent of the business’s pre-tax profit in excess of $17.5 million, up to a cap of $8 million. Any excess amounts (a surplus) that would have been paid but for the cap were to be applied to any ensuing payouts falling short of the cap.
The agreement required the Buyer to calculate pre-tax profit and provide the calculation to the Seller’s shareholder representative. If the representative accepted the calculation or did not object to it within 30 days, the Buyer was obligated to pay the payout it had calculated. If there was an objection to the calculation, the parties were required to try to resolve the dispute and, failing a resolution, to submit the matter to arbitration by a neutral accountant.
After making the first two annual payouts (capped in each case at $8 million, with $9.2 million surplus available to use in future years), the Buyer claimed that it had come to suspect that incumbent management had supplied false information to raise the reported profits of the business. Although the Buyer calculated pre-tax profits for the third and fourth years (which were materially lower than the first two years and were not objected to by the Seller’s representative), it did not make the required payout to the Seller (despite the $9.2 million Surplus from the first two years). In the fifth year, the Buyer neither calculated the pre-tax profit nor made a Payout.
As a counterclaim to the Seller’s suit for the unpaid payouts, the Buyer asked the Court to rule, among other things, that it was not obligated to make the payouts for the third, fourth, and fifth year due to the fraudulently inflated pre-tax profit numbers.
The Court rejected the counterclaim, holding that the agreement did not permit the Buyer to withhold payouts if it doubted the accuracy of the information that was used to calculate pre-tax profit. The agreement only provided a dispute resolution mechanism under which if the Seller objected to the Buyer’s earn-out calculation, there would be binding arbitration. As the Seller had not objected to the calculations, the Court ordered the Buyer to make $20 million in payouts for the third, fourth, and fifth years. The Court noted that the Buyer could have negotiated for the right to withhold a payout if it doubted the accuracy of the information on which it was calculating the pre-tax profit of the Business.
In a subsequent proceeding (GreenStar IH rep, LLC, et al. v. Tutor Perini Corp., C.A. No. 12885-VCS, memo op. (Del. Ch. Dec. 4, 2019), or Tutor Perini II), the Court addressed an escrow release agreement that the parties had entered into that provided for payouts to the Seller only if certain accounts receivable were collected. In adjudicating whether the condition had been satisfied, the Court found that the agreement, though not a model of clarity, was unambiguous when read together with an incorporated exhibit illustrating its operation and when “read in full and situated in the commercial context between the parties.”
The Buyer (Exelon Generation) agreed to make payouts to the Seller (Deere & Co.) if certain milestones were reached in the development of three wind farm projects that were underway at the time of sale. One of the projects became impossible to develop due to local ordinances that were passed. An issue arose as to whether the development by the Buyer of another wind farm 100 miles away, that was not referenced in the agreement, could satisfy one of the milestones that would trigger the payout.
The DSC reversed the Delaware Superior Court and rejected the earn-out claim based on the application of contract interpretation principles. Specifically, the DSC noted that if a contract is unambiguous, extrinsic evidence may not be used to interpret the intent of the parties, to vary the terms of the contract, or to create an ambiguity. In addition, in interpreting an earn-out provision, the parties’ post-closing conduct may be used to determine whether there is a breach, but post-closing evidence cannot be used as an aid to interpreting the meaning of the contract when the contract is unambiguous.
Edinburgh Holdings, Inc. v. Education Affiliates, Inc., 2018 WL 2727542 (Del. Ch. June 6, 2018) (Edinburgh Holdings)
The agreement pursuant to which the business was sold provided for four annual contingent payouts based upon the revenue of the business, which was to be managed by the incumbent management “in a reasonable manner and consistent with the past practices of the Seller (Edinburgh Holdings, Inc.).”
After making three payouts, the Buyer refused to make the fourth and the Seller sued to obtain the payout. The Buyer sought dismissal on the basis that the business had not been operated by the incumbent management “consistent with past practices.”
The Court refused to grant the Buyer’s motion to dismiss because the issue of whether the business was operated consistent with past practices was fact-intensive and therefore could not be decided at the pleading stage.
The Court also ruled that the Seller’s implied covenant claim was inapplicable because the agreement expressly set forth a standard for operation of the business during the earn-out period. The Court further noted that a claim for breach of the implied covenant can be maintained only if the factual allegations underlying the claim differ from those underlying an accompanying breach of contract claim.
Fortis Advisors LLC v. Stora Enso AB, 2018 WL 3814929 (Del. Ch. Aug. 10, 2018) (Stora Enso)
The Seller’s representative (Fortis Advisors LLC) alleged that two payouts were owed to it based on the achievement of two milestones, the first of which required the construction of a plant and the completion of the production of certain other products, and the second of which required the construction of a separate plant and the production of certain products at a specific price by a specific deadline. The claim for breach of contract alleged that the Buyer (Stora Enso AB) did not comply with the business plan that was part of the agreement and failed to take the actions required to be taken for the payouts to be due.
The Court observed that in a motion to dismiss, the movant can only prevail if its proffered interpretation of the agreement is the only reasonable interpretation. Here, the interpretations of the agreement by each of the parties were both reasonable, and, therefore, as a procedural matter, the Court found that granting the Buyer’s motion to dismiss was inappropriate.
Four hundred million dollars in payouts were contingent on the continued development and commercialization by the Buyer (Cephalon, Inc.) of a particular antibody, with $200 million being payable upon regulatory approval of the antibody for each of two medical conditions.
The agreement required the Buyer to use “commercially reasonable efforts” to develop the antibody and achieve the milestones, with “commercially reasonable efforts” defined as “the exercise of such efforts and commitment of such resources by a company with substantially the same resources and expertise as [the Buyer], with due regard to the nature of efforts and cost required for the undertaking at stake.”
The Buyer received relevant regulatory approval for one of the identified conditions and paid the Seller $200 million. The Buyer, however, abandoned development and commercialization of the antibody for the second identified condition, foreclosing the possibility of the second $200 million payout and prompting a lawsuit by the Seller (Himawan) for breach of contract.
In denying a motion to dismiss, the Court focused on the requirement that the Buyer expend efforts that companies with substantially the same resources and expertise would expend in the circumstances at hand and noted that it was unclear what additional obligations, if any, were imposed upon the Buyer by such language. Because the Sellers alleged that the Buyer abandoned efforts toward the second milestone while companies with similar resources and expertise continued to pursue them, the Court found dismissal inappropriate.
The Buyer (Beumer Corp.) acquired 60 percent of Seller (Glidepath Ltd.) upfront, with the remaining 40 percent to be acquired three years later at a price dependent upon the future performance of the business.
The agreement stated that the earn-out period covered “fiscal years 2014, 2015 and 2016.” Although the parties expected to sign the agreement shortly before the commencement of the Seller’s fiscal 2014 year, the signing and closing did not take place until several months later. Notwithstanding the change in signing date, the specified earn-out period remained unchanged.
During the period of the Seller’s minority ownership, the Buyer (which had primary control over the venture) reoriented the business towards longer-term projects and invested in training personnel, which depressed the short-term profits of the business.
When it became apparent that the Seller would not be entitled to much, if any, of the earn-out, the Seller sued for, among other things, breach of fiduciary duty, contending that the Buyer “disloyally engag[ed] in a scheme to depress revenues, increase expenses and divert business opportunities for their own benefit.”
Though finding that the Buyer owed fiduciary duties as a manager and controlling shareholder, the Court held that, because Delaware LLCs exist perpetually, the default duty must be to “maximize the value of the LLC over a long-term horizon,” rather than maximizing the value of a beneficiary’s contractual claim against the Buyer.
Although there was no breach of fiduciary duty, the deal structure did create a conflict of interest that was subject to entire fairness review. However, the Court found that focusing on large-scale projects was a valid business strategy and promoted the value of the LLC. According, the Buyer’s conduct was found to be entirely fair even though it did not maximize the Seller’s contingent consideration.
Western Standard, LLC v. SourceHOV Holdings, Inc., 2019 WL 3322406 (Del. Ch. July 24, 2019) (Western Standard)
Pursuant to the agreement by which the Buyer (SourceHOV Holdings, Inc.) acquired the business, the Sellers (represented by Western Standard LLC) were entitled to a payout if a “realization event” occurred within seven years of closing. During the earn-out period, the Buyer undertook several merger transactions, which resulted in a demand from the Sellers to receive the payout, as they interpreted the transactions to all be within the scope of the definition of a realization event. The Buyer moved to dismiss, arguing that the agreement stated that mergers of the type undertaken by the Buyer would not be considered a realization event.
The Court confessed that it was “unable to divine any meaning from the contract” and found that neither party provided an interpretation of realization event that made sense; therefore, the Court denied the motion to dismiss to allow the parties to present extrinsic evidence that would allow the Court to discern the meaning of the relevant provisions of the agreement.
Windy City Investments Holdings, LLC v. Teachers’ Insurance and Annuity Assoc. of America, C.A. No. 2018-0419-MTZ (Del. Ch. July 26, 2019) (WindyCity)
The Buyer (Teachers’ Insurance) acquired the business (Nuveen, Inc.) from the Seller (Windy City Investments) for $6.25 billion, plus an earn-out based on the profitability of the business of between $45 million (if the specified floor targets were met) and $278 million (if the specified target caps were met). The earn-out was based on the “cumulative advisory revenues” and net flows of the business during the four-year earn-out period. The floor and cap targets were to be adjusted (upward or downward, respectively) “in the event of acquisitions or dispositions” of investment accounts from non-[Buyer] affiliated parties. The agreement also provided that the Seller would receive the maximum payout if the business was sold.
Cumulative advisory revenues included 50 percent of revenues derived from investment accounts advised by the Buyer and excluded advisory revenues derived from the Buyer’s general investment accounts. Net flows were to be based on increases in assets under management by the business less withdrawals, and they included 50 percent of third-party accounts advised by the Buyer and excluded general assets of the Buyer.
Among other things, the agreement provided that the Buyer would not take “any action the intent of which is to reduce the [payout]” and that the Seller would have “reasonable access to relevant personnel (including accountants), work papers, and books and records related to the [Business]”. Disputes with respect to the earn-out were to be submitted to a neutral accountant for resolution; however, the parties were obligated to seek judicial interpretation of any disputed contract terms, with the neutral accountant being bound by such interpretation in making its calculations.
A dispute arose as to how revenues and flows from investment products advised or managed solely by the Buyer, but distributed through the business, were to be treated. The Seller believed it was entitled to 50 percent credit for any gains from such products, whereas the Buyer believed the Seller was only entitled to credit for gains from investment products with respect to which the business was the advisor.
In a subsequent suit, the Court rejected the Buyer’s motion to dismiss, finding that “[n]either party provide[d] the only reasonable interpretation” of the disputed language and that the parties’ respective interpretations “require[d] the Court to minimize deliberately placed language or, in some cases, import extra-contractual concepts to reconcile that language.”
The Court also refused to dismiss the Seller’s claims (i) that the Buyer breached the agreement in connection with the sale of certain businesses in a manner intended to depress the Seller’s payout and (ii) for access to the books and records of the business.
Collab9, LLC v. En Pointe Technologies Sales, LLC, C.A. No. N16C-12-032 MMJ CCLD (Del. Super. Sept. 17, 2019) (En Pointe)
The Buyer (En Pointe Technologies) acquired substantially all of the assets of the business from the Seller (Collab9 LLC) pursuant to an agreement which provided for payout calculated as a percentage of the business’s adjusted gross profit over several years.
The agreement provided that the Buyer would have “sole discretion with regard to all matters relating to the operation of the business” and would have no obligation, express or implied, to take any action, or omit to take any action, to maximize the payout.
The Seller brought suit for breach of contract, for breach of the implied covenant, and for fraud based upon alleged inaccuracies in the Buyer’s quarterly earn-out certifications.
The Court dismissed the claims for breach of the implied covenant and for fraud. Given the agreement’s “comprehensive and explicit” language controlling the obligations of the parties with respect to operating the business post closing, there was no place for the gap-filling role of the implied covenant under the circumstances. The Court found that the Seller’s fraud claim, based upon the Buyer’s alleged failure to respect duties under the agreement, amounted to a deficient “repackaging” or “bootstrapping” to its breach of contract claim.
The Buyer (Allergan) paid $125 million at closing and contracted for payments of up to $300 million upon certain milestones for a device for the treatment of dry-eye disease (the Device). The first milestone was achieved, and the Buyer paid $100 million to the Seller.
The second $100 milestone required FDA authorization of the Device’s use for “the treatment of at least one Dry Eye Disease Symptom (the “Labeling Milestone”).” The agreement required the Buyer to use “commercially reasonable efforts” to achieve the Labeling Milestone. “Commercially reasonable” was further defined to include “expending resources that [the] Buyer would typically devote to…products of similar market potential at a similar stage of development.”
The FDA approved a label for the Device that indicated that the product “provides a temporary increase in tear production…to improve dry eye symptoms in adult patients with severe dry eye symptoms.” In turn, the Buyer claimed the Labeling Milestone was not achieved because the FDA approval did not include “treatment” or “disease” and because the increase in tear production was “temporary.”
The Seller (Fortis Advisors, as representative) brought suit alleging breach of the agreement due to the Buyer’s refusal to make the second milestone payment and for its failure to use “commercially reasonable efforts” to achieve the Labeling Milestone.
The Court rejected the Buyer’s motion to dismiss, concluding that the FDA approval of an indication for use of the product “to improve dry eye symptoms” satisfied the Labeling Milestone requirement of “treatment of dry eye symptoms.” The Court also concluded that the indication of “temporary” did not preclude satisfaction of the Labeling Milestone. Moreover, the indication for “severe” dry eye symptoms did not matter because the Labeling Milestone did not specify a specific patient population to be addressed by the device.
The Court also credited the Seller’s allegation that the Buyer waited two years before applying to the FDA for a label for the Device and then waited four months to reapply when the FDA rejected the Buyer’s first labeling application. The Court determined that the allegations supported a reasonable inference that the Buyer’s efforts “fell short of its comparable efforts for other similar products,” as required by the agreement.
MarkDutchCo 1 B.V. v. Zeta Interactive Corp., C.A. No. 17-1420-CFC (D. Del. Nov. 12, 2019) (MarkDutchCo)
The Seller (MarkDutchCo) sold its interest in the business (customer relation management) to the Buyer (Zeta Interactive Corp.) for $23 million in cash, shares of Zeta common stock, and several earn-out payments, the first of which required a payout of $4 million if the business’s EBITDA was at least $10 million during the 12-month earn-out period following closing. The agreement required the Buyer to deliver to the Seller a statement detailing the Buyer’s determination of EBITDA for the relevant period and its calculation of the associated payout. The agreement gave the Seller the right to “review all [the] materials and information” the Buyer used to prepare the calculation. The Seller could dispute the Buyer’s calculation by providing a written objection notice within ten business days, setting forth “in reasonable detail [its] alternative calculations (if any), together with reasonable supporting details.”
The Seller sent an objection notice disputing the entirety of the Buyer’s calculation but did not include an alternative EBITDA calculation because it lacked sufficient information. The Buyer claimed the notice was therefore invalid and its calculation was final and binding. After receiving more information, the Seller sent a supplement to its objection and calculated an EBITDA for the business that was significantly higher than the $10 million target. The Seller also submitted the dispute to a neutral accountant, who was to be “the sole arbiter of all matters, procedural and/or substantive, as to such Disputed Payment Amount.” The neutral accountant’s determination was to be final and binding absent “fraud, bad faith or manifest error.” Ultimately, the neutral accountant found the EBITDA to be in excess of the target, and the Seller sued for confirmation of the $4 million payout under the FAA.
In its counterclaim, the Buyer alleged that the Seller misrepresented the validity of certain patents and that such misrepresentations were fraudulent and constituted a breach of the representations in the agreement, entitling the Buyer to without the payout. The Buyer also alleged, among other things, that the neutral accountant exceeded his scope of powers by considering the Seller’s supplement. The District Court (applying Delaware law) disagreed, finding that because the Seller was only required to provide an alternative calculation “to the extent possible based on the information available to [it],” the neutral accountant was within the scope of his powers in accepting the supplement following receipt of the required information from the Buyer.
In affirming the neutral accountant’s award, the Court also rejected the Buyer’s counterclaims and indemnity offsets as being outside the ambit of the arbitration confirmation proceeding or as being time barred.
The Buyer (Mitchell International, Inc.) bought a business from the Seller (Quaram) that developed review and approval processes from reimbursement and insurance claims. The Buyer and the Seller entered into an earn-out agreement that allowed the Seller to earn additional compensation for two years after the sale. Pursuant to the agreement, the Buyer had “the power to direct the management, strategy and decisions” of the business post closing. However, the Buyer also agreed that it would “act in good faith and in a commercially reasonable manner to avoid taking actions that would reasonably be expected to materially reduce the earnout.” The Buyer also agreed to “act in good faith and use commercially reasonable efforts to present and promote” the acquired company’s products “to customers that could reasonably be expected to utilize them.” Lastly, the Buyer agreed to upgrade or build a bridge between the Buyer’s existing systems and those of the acquired business within six months of closing so as to allow the Buyer to sell the acquired company’s products to its existing customers and to assist in calculating the earn-out.
The Seller entered into a two-year employment agreement with the Buyer to assist with the post-closing marketing and business. After the Seller was terminated by the Buyer, the Seller brought suit alleging breach of the earn-out covenants. The Superior Court denied the Buyer’s motion to dismiss certain of the Seller’s allegations.
The Court viewed the first earn-out covenant as one requiring the Buyer to refrain from positive actions that reasonably could be expected to reduce the earnout or impede calculating the earnout. In that regard, the Court indicated that the covenant’s obligation did not extend to “avoiding inaction,” inasmuch as to do so would give the Seller the “power to manage the company.” Examples of such inaction related to “decisions and strategies [the Buyer] could have pursued but did not,” such as consulting with the Seller on marketing.
The claims that survived the motion to dismiss focused on positive actions, such as “routinely cancel[ing] regularly scheduled calls to prevent [the Seller] from promoting and selling” the products, making improper accounting decisions concerning minimum thresholds for bills, and diverting revenue to different products to avoid paying the earn-out.
With respect to the third provision of the earn-out agreement, the Buyer argued that the Seller could not plead damages resulting from the Buyer’s decision to build an alternative bridge between the parties’ systems. The Court, however, found that it was reasonable to infer from the agreement that a specific solution was necessary to provide services to customers and calculate the earn-out amount and that failing to build that solution could constitute damages.
Shareholder Representative Services LLC v. Albertsons Companies, Inc., 2021 WL 2311455 (Del. Ch. June 7, 2021)
The Sellers were the former stockholders in DineInFresh, Inc. (d/b/a Plated), an e-commerce subscription meal-kit delivery company (Plated) whose business model involved consumers subscribing to its services in exchange for ingredients and recipes for home-cooked meals being delivered to their homes. In September 2017, the Sellers and the Buyer entered into a merger agreement pursuant to which the Buyer acquired the Sellers for $175 million in cash and an earn-out of $125 million, payable over three years.
The merger agreement gave the Buyer the right to make all post-closing business and operational decisions “in its sole and absolute discretion” and expressly stated that it would have “no obligation to operate [Plated] in a manner to maximize achievement of the [earn-out].” However, that right was subject to a provision obligating the Buyer not to “take any action (or omit to take any actions) with the intent of decreasing or avoiding” payment of the earn-out.
In the litigation, the plaintiff, on behalf of the Sellers, contended that the earn-out was premised on Plated’s historical and projected performance and that the Buyer had repeatedly provided assurances throughout the merger negotiation that it would allow Plated to operate independently post acquisition and would support Plated’s efforts to increase meal-kit market share while gradually phasing in brick-and-mortar initiatives. Instead, immediately upon closing of the merger, the Buyer directed Plated to reallocate its resources to get a retail version of its product into 1,000 of the Buyer’s stores in the space of one week. In addition, the plaintiff alleged that the Buyer interfered with employment decisions and generally mismanaged the business, including by failing to take advantage of preferred pricing and financing opportunities. Thereafter, Plated missed its earn-out milestones and the Buyer did not make the earn-out payment to the Sellers.
The plaintiff alleged that Plated would have succeeded and at least a portion of the earn-out would have been paid but for Albertsons’s active interference with Plated’s business. The plaintiff asserted three causes of action: (i) breach of contract by acting with the intent of avoiding the earn-out, (ii) breach of the implied covenant, and (iii) fraudulent inducement.
The Court held that the plaintiff’s allegations were sufficient to support a reasonable inference that the Buyer breached the earn-out agreement inasmuch as those well-pleaded allegations suggested that the Buyer knew that changing Plated’s business model would cause the company to miss the earn-out milestones and that the Buyer’s actions were motivated at least in part by a desire to avoid the earn-out. The Court reasoned that even if the Buyer took its actions only in part with the purpose of causing Plated to miss the earn-out milestones, this was enough at the pleading stage to support the plaintiff’s breach of contract claim.
The Court dismissed the plaintiff’s implied covenant claim, finding that the merger agreement gave the Buyer the absolute discretion to run the business in good faith. Accordingly, there was no contractual gap to fill. The Court also rejected the plaintiff’s fraudulent inducement claim based on the Buyer’s alleged misrepresentations during the merger agreement negotiation. The Court found that such misrepresentations were future promises and statements of intent with respect to post closing operations and that the Sellers were not justified in relying on such misrepresentations.
Appendix: Disclaimer
A version of this article originally appeared as a Houlihan Lokey presentation in November 2021. This version is published with permission.
Houlihan Lokey is a trade name for Houlihan Lokey, Inc., and its subsidiaries and affiliates, which include those in (i) the United States: Houlihan Lokey Capital, Inc., an SEC-registered broker-dealer and member of FINRA (www.finra.org) and SIPC (www.sipc.org) (investment banking services); Houlihan Lokey Financial Advisors, Inc. (financial advisory services); HL Finance, LLC (syndicated leveraged finance platform); and Houlihan Lokey Real Estate Group, Inc. (real estate advisory services); (ii) Europe: Houlihan Lokey EMEA, LLP, and Houlihan Lokey (Corporate Finance) Limited, authorized and regulated by the U.K. Financial Conduct Authority; Houlihan Lokey (Europe) GmbH, authorized and regulated by the German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht); Houlihan Lokey GmbH; Houlihan Lokey S.p.A.; Houlihan Lokey (Netherlands) B.V.; Houlihan Lokey (España), S.A.; and Houlihan Lokey (Corporate Finance), S.A.; (iii) the United Arab Emirates, Dubai International Financial Centre (Dubai): Houlihan Lokey (MEA Financial Advisory) Limited, regulated by the Dubai Financial Services Authority for the provision of advising on financial products, arranging deals in investments, and arranging credit and advising on credit to professional clients only; (iv) Singapore: Houlihan Lokey (Singapore) Private Limited, an “exempt corporate finance adviser” able to provide exempt corporate finance advisory services to accredited investors only; (v) Hong Kong SAR: Houlihan Lokey (China) Limited, licensed in Hong Kong by the Securities and Futures Commission to conduct Type 1, 4, and 6 regulated activities to professional investors only; (vi) China: Houlihan Lokey Howard & Zukin Investment Consulting (Beijing) Co., Limited (financial advisory services); (vii) Japan: Houlihan Lokey K.K. (financial advisory services); and (viii) Australia: Houlihan Lokey (Australia) Pty Limited (ABN 74 601 825 227), a company incorporated in Australia and licensed by the Australian Securities and Investments Commission (AFSL number 474953) in respect of financial services provided to wholesale clients only. In the European Economic Area (EEA), Dubai, Singapore, Hong Kong, and Australia, this communication is directed to intended recipients, including actual or potential professional clients (EEA and Dubai), accredited investors (Singapore), professional investors (Hong Kong), and wholesale clients (Australia), respectively. Other persons, such as retail clients, are NOT the intended recipients of our communications or services and should not act upon this communication.
Houlihan Lokey gathers its data from sources it considers reliable; however, it does not guarantee the accuracy or completeness of the information provided within this presentation. The material presented reflects information known to the authors at the time this presentation was written, and this information is subject to change. Houlihan Lokey makes no representations or warranties, expressed or implied, regarding the accuracy of this material. The views expressed in this material accurately reflect the personal views of the authors regarding the subject securities and issuers and do not necessarily coincide with those of Houlihan Lokey. Officers, directors, and partners in the Houlihan Lokey group of companies may have positions in the securities of the companies discussed. This presentation does not constitute advice or a recommendation, offer, or solicitation with respect to the securities of any company discussed herein, is not intended to provide information upon which to base an investment decision, and should not be construed as such. Houlihan Lokey or its affiliates may from time to time provide investment banking or related services to these companies. Like all Houlihan Lokey employees, the author of this presentation receives compensation that is affected by overall firm profitability.
Airborne Health, Inc. vs. Squid Soap LP, 984 A.2d 126 (Del. Ch. 2009). ↑
The average transaction value of the 151 target companies in the ABA Study was $207.8 million. ↑
Earn-outs made up 27 percent of the consideration in the (non-life sciences) transactions between the 2014–2018 review in SRS Acquiom’s 2019 M&A Deal Terms Study (the SRS Study). ↑
Unless otherwise specified, case citations and summaries are found in the appendix. ↑
Approximately 31 percent of the earn-out provisions in the ABA Study used EBITDA as the principal performance metric; 29 percent used revenue. ↑
In the ABA Study, 66 percent of the agreements contained such a provision, whereas 76 percent of the agreements in the SRS Study contained such a provision. ↑
Eighty percent of the agreements in the SRS Study had earn-out periods of 1–3 years. However, longer earn-out periods were present in Chambers (five years), Tutor Perini (five years), Edinburgh (four years), Western Standard (seven years), and Windy City (four years). ↑
Twenty-two percent of the agreements in the ABA Study and 21 percent of the agreements in the SRS Study contained such a provision. ↑
Found in 33 percent of the agreements in the ABA Study. ↑
Found in 15 percent of the agreements in the ABA Study. ↑
Found in 17 percent of agreements in the ABA Study and 14 percent of the agreements in the SRS Study. ↑
Found in ten percent of the agreements in the ABA Study and three percent of the agreements in the SRS Study. ↑
The Seventh Circuit issued a resounding message: Delaware forum selection clauses in corporate bylaws cannot lawfully prevent a plaintiff from bringing claims under the Securities Exchange Act of 1934 (the Exchange Act or the Act) in federal court. The Court, in its decision in Seafarers Pension Plan v. Bradway,[1] chose not to follow other federal courts that have enforced Delaware forum selection clauses in corporate bylaws to effectively bar shareholders from bringing Exchange Act claims.[2]
Although Section 115 of the General Corporation Law of the State of Delaware (Section 115) authorizes the adoption of forum selection bylaw (and charter) provisions that “require, consistent with applicable jurisdictional requirements, that any or all internal corporate claims shall be brought solely and exclusively in any or all courts in this State,” the Seventh Circuit’s decision is not inconsistent with the statute. Notably, while the Court did not look to the legislative history of Section 115, the synopsis for Senate Bill No. 75, the legislation that enacted the 2015 amendments to the General Corporation Law of the State of Delaware (the DGCL), including Section 115, states in pertinent part: “Section 115 also is not intended to authorize a provision that purports to foreclose suit in a federal court based on federal jurisdiction.”[3]
Overview of the Decision
The Seafarers dispute arose from the temporary grounding of all 737 MAX airliners following two airplane crashes in 2018 and 2019 that killed 346 people. Seafarers Pension Plan brought a derivative action in the Northern District of Illinois on behalf of Boeing under Section 14(a) of the Exchange Act of 1934,[4] alleging that officers and directors of Boeing made materially false and misleading public statements in proxy materials related to the development and operation of the 737 MAX airliner. The defendants moved to dismiss the action based on a forum selection clause in the Boeing bylaws, which provided that “the Court of Chancery of the State of Delaware shall be the sole and exclusive forum . . . for any derivative action . . . .” The district court agreed with the defendants and dismissed the case.
The Seventh Circuit reversed the district court in a 2–1 decision. The Court began by recognizing that the Exchange Act gives federal courts exclusive jurisdiction over claims brought under the Exchange Act.[5] Furthermore, the Exchange Act contains an anti-waiver provision that prohibits contractual waivers of compliance with the requirements of the Act.[6] Against this backdrop, the Court considered whether Boeing’s forum selection clause, as applied to the plaintiff’s §14(a) claim, complied with Delaware statutory law and concluded that it did not.
The Court first turned to Section 115, which provides that a corporation’s bylaws, “consistent with applicable jurisdictional requirements,” may require that internal corporate claims be brought “in any or all of the courts in this State.”[7] The Court focused on two aspects of Section 115: the requirement that a forum selection clause be “consistent with applicable jurisdictional requirements” and the reference to “the courts in this State” (emphasis supplied). The Court determined that Boeing’s forum selection clause was inconsistent with exclusive federal jurisdiction for claims brought under the Exchange Act. As the Court explained, by requiring that such actions must be brought in the Court of Chancery of the State of Delaware, the Boeing forum selection clause effectively barred plaintiffs from bringing a derivative claim under Section 14(a). Additionally, the Court emphasized that Section 115 refers to “the courts in this State,” rather than “the courts of this State,” which indicates that Section 115 contemplates forum selection clauses encompassing both federal and state courts located in Delaware.
While the Court did not look to the legislative history of Section 115, the synopsis for Senate Bill No. 75, the legislation which enacted the 2015 amendments to the DGCL, including Section 115, states in pertinent part: “Section 115 also is not intended to authorize a provision that purports to foreclose suit in a federal court based on federal jurisdiction.”[8]
In a dissenting opinion, Judge Easterbrook questioned whether a federal right to pursue a derivative claim under §14(a) exists, noting that the U.S. Supreme Court “has never held or even intimated” that there is such a right.[9] Judge Easterbrook also questioned the notion of exclusive federal jurisdiction in the context of a derivative action, since state law defines how and when such actions can be brought.
Impact of Decision
Given the Court’s reliance on Delaware law to provide a rationale for its holding, the most obvious question arising from this decision is whether Delaware courts will agree with the Seventh Circuit’s interpretation of Section 115. Considering the legislative history of Section 115, which neither the majority—nor Judge Easterbrook’s dissent—mentioned, it is likely that the Delaware courts will conclude that Section 115 cannot be used to deprive shareholders of the ability to bring claims arising under federal law in Delaware federal courts. The Delaware Chancery Court will have an opportunity to address this very question in a class action brought by Seafarers in Delaware under the same facts. In the Chancery Court action, stayed pending the outcome of the Seventh Circuit appeal, Seafarers challenges the legality of the forum-selection clause under Sections 115 and 109(b) of the Delaware General Corporation Law.
The Ninth Circuit also will have a chance to weigh in on this issue, where a decision of the district court for the Northern District of California in Lee v. Fisher is currently under appeal. The forum-selection clause in Fisher is identical to the one at issue in Seafarers: it requires that actions be brought in the Delaware Chancery Court. Similar to the district court in Seafarers, the Fisher Court enforced the forum-selection clause and dismissed the action. Notably, the Fisher Court explained that, under Ninth Circuit precedent, strong federal policy favors enforcing forum-selection clauses over anti-waiver provisions in state or federal statutes.[10] If the Ninth Circuit agrees, a Circuit split would exist, ripe for resolution by the U.S. Supreme Court.
Seafarers Pension Plan v. Bradway, 23 F.4th 714 (7th Cir. 2022) ↑
See, e.g., Ocegueda on behalf of Facebook v. Zuckerberg, 526 F. Supp. 3d 637 (N.D. Cal. 2021); Lee v. Fisher, No. 20-cv-06163-SK, 2021 WL 1659842 (N.D. Cal. Apr. 27, 2021), appeal filed, No. 21-15923 (May 27, 2021). ↑
Staffing trends look a bit different for law firms and legal departments in 2022, as the tumult of the past two years settles into more of a business-as-usual mode. It’s a new brand of “usual” for sure—one in which remote and hybrid work models are the norm, and attorneys have made their expectations of better work-life balance clear. As leaders navigate talent wars and heavy workloads (often with limited budgets), more agile staffing solutions are complementing permanent hiring. Alternative legal service providers (ALSPs) are playing a central role in connecting these leaders to contract talent to help round out their teams, bolster productivity, and keep costs in line.
The growing need for specialized lawyers. The circumstances of the past two years—an unprecedented surge in adoption of digital communication tools and automated workflows, changes in workplace/HR policies, commercial contract disputes, etc.—have brought new issues to the fore. Attorneys specializing in data privacy, contract law, M&A, regulatory compliance, employment law, digital technologies, real estate, finance, and other areas of expertise are in demand. In fact, there are layers within many of these areas that require even greater specialization.
Fortunately, supply is keeping up with demand: As more lawyers left their permanent positions to join the contract talent pool in 2020 and 2021, ALSPs have been able to focus their recruitment efforts more tightly to pinpoint ideal candidates. Due to the exceptional value these candidates bring to legal teams, matches often begin as temporary assignments but then grow into lengthier stints or even permanent positions. A corporation that frequently launches new products, for example, isn’t likely to let go of a brilliant regulatory attorney regardless of how, and under what type of arrangement, that attorney came to them.
Renewed focus on how associates’ time is being spent. As legal leaders take a fresh look at how efficiently their operations are running, they are scrutinizing who is doing the work. They understand that paying an associate to carry out routine tasks that could be delegated to a contract attorney with no compromise to quality is a waste of both dollars and the associate’s time. By strategically assigning work to contract attorneys, their organizations are becoming more productive for less money.
For years, law firms and corporations have leveraged this formula for managed document review, due diligence, and other routine tasks. Today, they’re bringing in more outside help to work on NDAs, MSAs, SOWs, digital agreements, licensing agreements, and other contracts. In addition, a growing number of law firms have begun turning to their ALSPs for junior-level contract attorneys they can train to fulfill a particular client’s needs. They can then bill these lawyers out to that client at a much more reasonable rate than they could an on-staff associate.
Increasing reliance on ALSPs. Close to four out of five U.S. law firms (79%) and nearly three out of four U.S. corporations (71%) used an ALSP in 2020, says the Alternative Legal Service Providers 2021 report. The report findings indicate that working with ALSPs has grown to become a mainstream—rather than alternative—staffing strategy, according to Thomson Reuters, which published the report in partnership with The Center on Ethics and the Legal Profession at Georgetown Law and the Saïd Business School at the University of Oxford.
What’s more, law firms and corporations that may have used temporary staffing solutions sparingly in the past, or that tried them for the first time during the pandemic, are now turning to them repeatedly. They’ve discovered that meshing the talents of their internal team with contract attorneys can help them improve their processes and workflows, lower costs, and achieve consistently outstanding results. As these organizations move forward, their perception of contract staffing will continue to evolve as they discover more varied opportunities to put it to use.
One of those opportunities is filling the void left when an attorney goes on leave. Increasingly, law firms and corporations are planning for these contract staffing needs several months in advance. Perhaps this is because so many legal teams were abruptly caught short-handed at moments during the past two years, and they never want to be in that situation again—or it may simply reflect growing confidence in temporary staffing. Leaders are also more likely to recognize that they shouldn’t rely on old protocols of divvying up work among peers when an attorney is out. We’ve all seen the fallout from attorney burnout, and no one wants to further fuel that fire.
Happier, less stressed talent. Speaking of attorney burnout, 2022 is seeing a new cohort of contract lawyers who are definitely not suffering from that particular affliction. These highly qualified pros are raring to go, as they have chosen to infuse their careers with balance while continuing to make a good living. Think about it: If a contractor is making $125 an hour, and they’re working 2,000 hours a year (40 hours a week x 50 weeks), that’s a run rate of $250,000—not a bad income, particularly when it comes with flexible terms. (They can often achieve that steady influx of work by working through an ALSP, which may also offer benefits and other perks.)
Even if they are making less than they were before, many contract attorneys are willing to make the trade-off: less money for more time to travel, write a book, start a business, or pursue other interests. And just like law firms and corporate counsel, many contractors are seeking “try before you buy” relationships that enable them to work with different teams to see where they might find an ideal fit for a permanent position.
The power of relationships. An important lesson many legal organizations learned in the chaotic environment of 2020–2021 was that incorporating contract attorneys into an overall staffing strategy requires an engaged staffing partner. Identifying and hiring talent to fill a particular need should never be a one-off transaction, but rather part of an ongoing strategy to have a strong, collaborative team in place. In 2022, these organizations are looking to solidify their relationships with their ALSPs to achieve long-term staffing success.
Good ALSPs are doing their part by getting to know their clients’ people, culture, and organizational structure well, so that they recognize a good fit when they see it, regardless of whether it’s to fill a particular role at a particular time or in anticipation of future needs. When a great résumé comes across their desk, they should know exactly where that candidate belongs and reach out proactively to let their client know about that talent before anyone else has a chance to swoop them up. This type of close relationship is essential to staffing success.
Overall, the outlook for legal staffing through 2022 and beyond is positive. While there are still issues to navigate—heavy workloads, attorney burnout, talent wars, and the prioritization of work-life balance—agile, cost-effective solutions are at hand. Corporate legal departments and law firms that strategically dovetail in-house and contract talent will be poised to win the day.
An examination of the Biden Administration’s proposed changes to the taxation of multinational corporations.
Biden Administration’s Proposed Changes to the Tax Code
On May 28, 2021, the Department of the Treasury released its General Explanations of the Biden Administration’s Fiscal Year 2022 Revenue Proposals, commonly referred to as the Green Book. The Green Book provides additional details on President Biden’s proposed changes to the tax code which are intended to fund his policy agenda; including the American Jobs Plan, the Made in America Tax Plan, and the American Families Plan. Many of the proposals date back to President Biden’s campaign, in which he made the case for policy changes involving infrastructure, manufacturing, and caregiving, and proposed paying for these changes by reversing some of the tax measures in the Tax Cuts and Jobs Act (“TCJA”) enacted under the previous administration.
Although there is debate over the U.S. international tax regime, there is an increased focus by the current administration on the issue in order to pay for President Biden’s Build Back Better (“BBB”) policy agenda. The following are some of the major changes to the international tax regime proposed by the Biden Administration in the BBB.
The GILTI Regime
The Biden Administration’s plan includes raising the minimum Global Intangible Low-Taxed Income (“GILTI”) tax rate from an effective 10.5% to 21% and calculating it on a jurisdiction-by-jurisdiction basis. The 21% effective tax rate will be achieved by increasing the corporate tax rate from 20% to 28% and reducing the GILTI deduction from 50% to 25%. By moving to a jurisdictional basis, a controlled foreign corporation (“CFC”) in a high-taxed jurisdiction would not be able to utilize its excess foreign tax credits against a CFC in a lower-taxed jurisdiction.
Additionally, the Biden Administration intends to eliminate the Qualified Business Asset Investment (“QBAI”) deduction from the GILTI calculation, as well as to repeal the Subpart F and GILTI high-tax exceptions. The net effect of these proposed changes results in the introduction of 21% global minimum tax. Currently, these proposed changes are stalled in Congress. However, the Biden Administration is confident it can enact a 15% international minimum tax under a scaled back version of BBB.
Repeal of the FDII Deduction
President Biden’s plan is considering repeal of the Foreign Derived Intangible Income (“FDII”) deduction to discourage domestic corporations generating profits from foreign revenue and from servicing foreign customers.
The Biden Administration’s proposed changes to the GILTI and FDII are meant to encourage domestic research and development investments and increase manufacturing operations (onshoring) and to deincentivize corporations from shifting manufacturing operations abroad (offshoring), thereby benefiting from both regimes and paying only a bare minimum tax in the U.S. The goals of these changes are to encourage R&D investments in the U.S. and to increase manufacturing operations.
Replacement of the BEAT with the SHIELD Proposal
President Biden also intends to replace the Base Erosion Anti-Abuse Tax (“BEAT”) and replace it with the Stopping Harmful Inversions and Ending Low-Tax Developments (“SHIELD”) proposal, the latter of which is meant to more effectively target corporations that shift their profits to low-taxed jurisdictions.
The SHIELD regime would apply to financial reporting groups with greater than $500 million USD in global annual revenues, determined based on a group’s consolidated financial statements. SHIELD looks to deny multinational corporations a U.S. tax deduction by referencing payments made to foreign related parties subject to a low effective rate of tax. SHIELD’s targets are financial reporting groups: groups of entities that prepare consolidated financial statements and include at least one domestic corporation, partnership or foreign entity with a U.S. trade or business, and have revenues of approximately $500 million. SHIELD would apply for tax years beginning after December 31, 2022.
Repeal of Parts of Section 245A Dividend Received Deduction
Currently, IRC Section 245A provides 100% dividends received deduction for the foreign source portions of any dividends received from a specified 10% owned foreign corporation, even in cases where the foreign corporation is not a controlled foreign corporation (“CFC”). The Biden Administration’s proposal would amend IRC Section 245A so the dividends received deduction applies to the foreign-source portions of dividends received only from CFCs.
Increased Funding for IRS Enforcement for Tax Evasion Among Corporations
The Biden Administration intends to provide $8 billion in additional annual funding to the IRS in order to improve tax enforcement, ensuring that wealthy individuals and corporations pay their fair share under current law.
Despite the BBB being stalled in Congress, the White House remains confident increased funding will be enacted in a scaled back version.
A prospective client calls you to represent the client as a defendant in a bankruptcy lawsuit where the client is also the debtor. The client offers to pay your usual retainer. What could go wrong?
Lawyers in private practice generally have some idea of what retainers are, but that understanding varies regionally. A lawyer’s general understanding of retainers, and the legal and ethical implications of retainers, may be wrong in the context of bankruptcy cases. Bankruptcy courts have taken positions on retainer issues that should be understood by counsel in order to avoid surprise and economic pain, and this is particularly true for lawyers representing clients in bankruptcy. The right way for debtor’s counsel to handle a retainer is not always clear. A recent South Carolina case offers one strategy for balancing the lawyer’s need for financial security against the implications of bankruptcy and helps bring the threads together.
Retainer Basics. In this article, a retainer means a payment received by a lawyer before the work is performed in connection with legal services to be provided, with a primary focus on security retainers. Attorneys and judges often refer to retainer agreements, which in this article will be called engagement agreements. This article is not meant to address earned upon receipt retainers, which include “classic retainers,” where a payment ensures the lawyer is available in the case, and “advance payment retainers,” [1] where the lawyer is paid an advance fee as a flat fee for work to be performed. [2]
Excluding such earned upon receipt retainers, the usual understanding of a retainer is a payment as security for payment of bills for future legal services. Unlike either a classic retainer to obtain the lawyer’s services, or an advance payment retainer, a security retainer remains client property,[3] and should be deposited in the attorney’s client trust account.[4] The funds held as a security retainer may be paid to the lawyer only after services are rendered and provided the fee is reasonable. Conversely, if an attorney is discharged, or the reasonable bill is less than the retainer, the unused balance of the security retainer is refundable.[5]
Prepetition Retainers for Post-petition Services. In a Chapter 7 context, the debtor may not retain counsel at estate expense. A pre-petition payment by the debtor as a security retainer for post-petition service may be at risk of disgorgement because the estate may not receive reasonably equivalent value via prospective service to the debtor[6] and property of the estate may not be used to represent the individual debtor.[7] If the security retainer is viewed as property of the estate, it is refundable to the trustee.[8] Conversely, courts usually approve reasonable pre-petition advance fee retainers for ordinary bankruptcy services, such as a flat fee to handle a “routine” Chapter 7 case,[9] and occasionally for agreed provision of post-petition services, such as defense of non-dischargeability proceedings.[10] The debtor needing post-petition legal service must find a source of payment not the debtor’s property, or use post-petition or exempt assets to pay counsel. An agreement concerning debtor representation, including the terms, and amount and source of compensation, must be disclosed.[11]
In Chapter 11, the trustee or debtor in possession may retain counsel at estate expense to provide post-petition services with disclosure and court approval. It is not unusual for debtor’s counsel or other professionals to receive pre-petition retainers as security for fees anticipated to be charged for post-petition services not yet performed.[12] Such security retainers must be disclosed as part of the employment process, and may be charged after the bankruptcy filing only in accordance with the Code and Rules and usually with a court order. The security retainer usually is estate property subject to the lawyer’s claim.[13]
In a Northern District of Illinois case, In re Caesars Ent. Operating Co., Inc., junior noteholders argued that proposed DIP counsel (Kirkland) received payments on and improperly drew on retainers the day after involuntary petitions were filed against Caesars entities, and a day or two before Caesars’ own voluntary filing. Kirkland treated its pre-petition retainers as Kirkland property under either an earned upon receipt agreement or classic retainer theory (but after bankruptcy, treated the retainer balance as debtor property subject to a security retainer). The bankruptcy court approved Kirkland’s employment, finding the retainers were not debtor property until Kirkland’s pre-petition bills were paid from the retainers and the balance converted into a security retainer.[14]
Post-Petition Retainers. Counsel occasionally seek post-petition retainers. In a Kentucky case, In re A Top New Casting, Inc., counsel unsuccessfully sought a payment arrangement in the nature of an escrow, which is more lawyer-friendly than a security retainer.[15] Less frequently, a post-petition retainer is paid with bankruptcy court approval, with payments from the retainer subject to court approval.[16]
Refunding Retainers. If an attorney is not entitled to charge the client, and thus be paid from the security retainer, the unused balance must be refunded. A line of cases in Chapter 15 matters hold that the presence of such an unused retainer is property of the debtor located in the United States to establish eligibility for bankruptcy relief.[17]
In the context of payment from estate property, no payment to counsel may be authorized absent compliance with Bankruptcy Code §§ 329, 330, 331 and applicable Bankruptcy Rules. Among other requirements, the court must approve employment of counsel, disclosure of compensation terms, and ultimately the fees and expenses sought. Failure to comply with the requirements of the Code and Rules can result in denial of compensation and disgorgement of a retainer.[18] Where counsel has received a retainer that is property of the estate, any refund of the retainer is refunded to the estate.
Even a properly disclosed retainer may be at risk if the Chapter 11 case is converted. After conversion, the debtor may not hire counsel at estate expense, so the lawyer may no longer use estate property to pay for legal services. And because chapter 11 administrative expenses, like fees of debtor in possession counsel, are subordinated in chapter 7 to chapter 7 bankruptcy expenses of administration, like fees of a trustee and counsel, if the trustee seeks subordination of Chapter 11 claims for legal services to Chapter 7 administrative expenses under § 726(b), the trustee may seek disgorgement of the retainer for reallocation under bankruptcy priorities.[19]
Non-Debtor Retainer. A South Carolina case, In re Parast, addressed the scenario where a debtor sought post-petition authority to retain counsel, and the attorneys required a retainer as a condition of the representation. Absent authority to make an out of the ordinary course of business transfer under § 363(b)(1), the debtor may not use estate property to pay the retainer, nor is counsel protected against the risk of disgorgement if retention of counsel is not approved. And counsel is not protected with respect to fees incurred before court approval of retention of counsel. However, the rules are less clear when the retainer is paid by a third party.[20]
In Parast, proposed counsel received and disclosed a $25,000 retainer paid by the debtor’s brother as part of the firm’s employment application. The retainer was fashioned as a conditional gift from the brother to the debtor, conditioned upon court approval of counsel’s retention. Due to objections, the firm eventually withdrew the employment application (after incurring over $40,000 in charges). The court held that the payment from the third party (brother) was not property of the estate, because the condition to the gift was not satisfied, and so the estate was not entitled to a refund.[21] Therefore, the dispute between the law firm and the brother over the retainer would have to be resolved in a non-bankruptcy forum.
Conclusion. Obtaining a retainer as a condition of representing a debtor in bankruptcy court litigation without understanding the legal environment for payment, including from a retainer, may create grave risks for the lawyer. Those risks include potential denial of compensation, refund of the retainer balance, and even disgorgement of sums paid from the retainer.
In re Caesars Ent. Operating Co., Inc., 561 B.R. 420, 436 (Bankr. N.D. Ill. 2015) (“An advance payment retainer is a payment in exchange for the commitment to provide future legal services. Like a classic retainer, ownership of an advance payment retainer ‘passes to the lawyer immediately upon payment’; unlike a classic retainer, the retainer is an ‘advance payment’ and so is applied to charges for legal services when rendered.”) (citations omitted). ↑
SeeIn re Ozcelebi, 631 B.R. 629 (Bankr. S.D. Tex. 2021); In re Dewey & Leboeuf LLP, 493 B.R. 421, 428 (Bankr. S.D.N.Y. 2013). ↑
SeeIn re Ozcelebi, 631 B.R. at 644; In re Caesars Ent. Operating Co., Inc., 561 B.R. at 436. ↑
In re Willis, 604 B.R. 206, 209, 212 (Bankr. W.D. Pa. 2019); see Model Rules of Professional Conduct (ER) 1.15(c); In re Riley, 577 B.R. 497, 512 (Bankr. W.D. La. 2017), aff’d sub nom.McBride v. Riley, No. CV 1:17-01302, 2018 WL 1768602 (W.D. La. Apr. 12, 2018), aff’d in part, vacated in part sub nom.Matter of Riley, 923 F.3d 433 (5th Cir. 2019). ↑
Law Offices of Charles B. Harris, S.C. v. United States Bank Nat’l Ass’n, N.D., 2009 WI App 158, 321 Wis.2d 748, 2009 WL 2929246 (2009) (unpublished disposition). ↑
In re Blackburn, 448 B.R. 28, 37 (Bankr. D. Idaho 2011). ↑
In re Glimcher, 469 B.R. 835, 842 (Bankr. D. Ariz. 2012), aff’d, No. CV-12-01692-PHX-FJM, 2012 WL 5868972 (D. Ariz. Nov. 19, 2012). ↑
In re Pawlak, 483 B.R. 169 (Bankr. W.D. Wis. 2012) ($50,000 flat fee retainer not property of the estate). ↑
In re Nunez, 598 B.R. 696, 705 (Bankr. E.D.N.Y. 2019); 11 U.S.C. § 329(a); Bankr. R. 2016(b). ↑
E.g., Armstrong Bank v. Shraiberg, Landau & Page, P.A. (In re Tuscany Energy, LLC), 581 B.R. 681, 686 (Bankr. S.D. Fla. 2018). ↑
In re IPS Sys., 205 B.R. 88, 89 (Bankr. S.D. Tex. 1997); In re Shafer Bros. Constr. Inc., 525 B.R. 607, 618 (Bankr. N.D.W. Va. 2015). ↑
In re Caesars Ent. Operating Co., Inc., 561 B.R. 420, 437 (Bankr. N.D. Ill. 2015). ↑
In re USHC, LLC, 456 B.R. 304, 307 (Bankr. W.D. Ky. 2011) (post-petition escrow for anticipated legal fees denied). ↑
In re A Top New Casting, Inc., 597 B.R. 746 (Bankr. W.D.N.Y. 2019). ↑
See, e.g., In re Foreign Econ. Indus. Bank Ltd., “Vneshprombank” Ltd., 607 B.R. 160, 172 (Bankr. S.D.N.Y. 2019). ↑
In re Woodcraft Studios, Inc., 464 B.R. 1, 9 (N.D. Cal. 2011), aff’d sub nom. Kun v. Mansdorf, 558 F. App’x 755 (9th Cir. 2014); In re Blackburn, 448 B.R. at 42-42.. ↑
In re King, 392 B.R. 62, 69 (Bankr. S.D.N.Y. 2008) (citing cases). ↑
SeeIn re Nunez, 598 B.R. 696, 709 (Bankr. E.D.N.Y. 2019) (retainer refunded to debtor’s girlfriend as the payment source). ↑
In re Parast, 612 B.R. 698 (Bankr. D.S.C. 2020). ↑
The sports-wagering landscape has evolved dramatically in the past 20 years. In 1992, Congress passed the Professional and Amateur Sports Protection Act (PASPA), 28 U.S.C. § 3702.[1] The Act prohibited any state from authorizing any entity within its borders to sponsor, operate, or promote any scheme involving betting on competitive sporting events.[2] Fifteen years later, the Supreme Court struck down PASPA as a violation of the Tenth Amendment’s anti-commandeering principle.[3] Since PASPA was struck down, states have rapidly moved to legalize sports wagering within their borders.[4] Before PASPA was struck down, only one state, Nevada, permitted full-scale sports wagering activities. In the three-and-a-half years since PASPA was struck down, as of January 2022, more than half of all U.S. states have passed legislation to authorize sports wagering.[5]
Enter the Wire Act, the federal law banning interstate sports-wagering activities over “wires,” including wired Internet connections. This law remains the most significant looming impediment to this burgeoning industry, in part because its terms leave significant ambiguity regarding how it extends to communications over the Internet. The Wire Act, 18 U.S.C. § 1084(a), prohibits use of interstate communication technology in the U.S. to place bets on sporting events. Notably, this law was written three decades before the invention of the Internet, and the Supreme Court has never weighed in on whether or how this law applies to communications over the Internet. However, among the lower courts that have faced the issue, the Act has been held applicable to communications over the Internet.[6]
So what exactly does the Wire Act prohibit? In one reading, the Wire Act prohibits wired Internet communications placing bets or wagers across state lines. Given that many states since 2018 have passed laws authorizing sports wagering within their borders over mobile devices, an important question for industry participants is whether the Wire Act prohibits communications that start and end in the same state, and only cross state lines temporarily along the way, known as intermediate routing.[7] To date, this issue has not been addressed through binding regulation or case law.
In the mid-2000s, when anti-wagering sentiment was at its peak, regulators repeatedly took the position that the Wire Act’s prohibitions do extend to intermediate routings. More recently, in 2018, the U.S. Department of Justice’s Office of Legal Counsel (OLC) issued an opinion rejecting the notion that a 2006 federal wagering law’s exclusion of intermediate routings should inform how the Wire Act is interpreted.[8] The unmistakable inference from this section of the 2018 OLC Opinion is a warning that DOJ prosecutors might interpret intermediate routings to fall within the reach of the Wire Act. While prosecutors have yet to bring a prosecution based on an Internet intermediate routing, the risk of prosecution arising from this sweeping interpretation chills innovation and deters risk-averse entities like large financial institutions from entering the industry. The legal question is thus an important one, and it is the subject of this article.
The question also matters because there is a non-trivial risk that Internet-based communications of licensed sports-wagering enterprises operating in a state where mobile sports wagering is allowed will be routed through other states.[9] Further, if licensed sports-wagering operators cannot safely use the Internet to receive bets and issue payouts within a single state, they must take a number of complicated and expensive steps to reduce the risk of intermediate routing. Moreover, the continuing legal uncertainty deters risk-averse market participants such as large financial institutions from entering the industry. In light of the recent dramatic state trend toward legalization of sports betting and the attendant shift in moral and social acceptance of such conduct, there is a growing tension between state laws permitting sports wagering within their borders and the legal uncertainty emanating from the Wire Act. This question accordingly must be addressed and regulatory clarity provided to allow the sports-wagering industry to innovate and grow.
In our view, as explained below, a careful textual analysis of the Act provides a clear answer—the Wire Act can and should be read to exclude intermediate routings.
The Better Reading of the Wire Act Is that It Does Not Extend to Intermediate Routings
The Wire Act’s provisions do not directly address the issue of intermediate routings. There is also no case law to date addressing whether intermediate routing of Internet communications falls within the scope of the Wire Act. If this question were to make its way before courts or regulators, its resolution would likely turn first and foremost on consideration of the statutory text.
The better reading of the Act’s text is that its prohibitions do not extend to intermediate routings of bets or information assisting in the placing of bets, even if those intermediate routings travel through states prohibiting sports wagering.
Specifically, the first subpart of this Act prohibits wagering entities from “knowingly” using wires “for the transmission in interstate or foreign commerce” to transmit (1) “bets or wagers” and also (2) “information assisting in the placing of bets or wagers” on sporting events.[10] The safe harbor, by its express terms, excludes intermediate routings falling within the second category.[11] The question, however, remains whether intermediate routings of intrastate bets and wagers placed over the Internet should also be excluded from the scope of Section 1084(a).
To answer that question, one must assess the meaning of the phrase “knowingly uses a wire communication facility for transmission in interstate or foreign commerce,” which modifies the first clause. The question is whether this phrase includes Internet communications originating in and destined for the same state, but which are intermediately routed through other states.
The textual analysis ultimately turns on the significance of the Act’s inclusion of the words “knowingly” and “for.” The term “knowingly” imports a “knowing” mens rea requirement into the statute. The question remains whether that knowledge requirement only modifies “uses a wire communication facility for the transmission . . . of bets or wagers” or also modifies the requirement that the “transmission [be] in interstate or foreign commerce.” The text makes clear that the knowledge requirement modifies the interstate transmission element for two primary reasons.
First, the grammatical structure of the clause suggests that the term “knowingly” modifies every element of this clause. The first clause of Section 1084(a) provides: “[w]hoever being engaged in the business of betting or wagering knowingly [a] uses a wire communication facility [b] for the transmission in interstate or foreign commerce [c] of bets or wagers” is guilty of an offense.[12] No one contests that the defendant must know that the wire communication is being used for the transmission of “bets or wagers,” which requires extending the term “knowingly” to the last element of the provision. There is no reason to think that Congress would have intended the term “knowingly” to modify the most immediate element (use of a wire) and the most remote element (to place a bet or wager) but not the intermediate element (for the transmission in interstate commerce). Such a construction would be arbitrary and should be rejected.
Second, this narrower reading is bolstered by Congress’s inclusion of the word “for” in the interstate transmission clause. As defined by the Merriam-Webster Dictionary, the word “for” is “a function word used to indicate purpose” or “to indicate an intended goal.”[13] It is also “used as a function word to indicate the object or recipient of a perception, desire, or activity.”[14] Thus, by including the word “for” to modify “transmission in interstate or foreign commerce,” the provision makes clear that only those transmissions intended to be transmitted in interstate or foreign commerce should fall within the scope of the prohibition. Thus, based on the inclusion of both “knowingly” and “for,” the text is clear that the knowledge requirement extends to the interstate transmission requirement. The analysis should end here.
However, even were it possible to read the text more broadly to include unintentional transmissions in interstate commerce, the rule of lenity would counsel against such a sweeping interpretation.[15] To understand why, it is important to stress that the broader interpretation would sweep in intrastate betting communications routed over the Internet that originate and ultimately arrive in the same state—including within states which permit sports wagering over the Internet. Thus, the broader reading would necessarily convert that entirely lawful conduct into unintentionallyunlawful conduct solely based on the inadvertent routing of a communication through a second state. Because sports betting is now legal in many states, the failure to extend the mens rea requirement to the interstate transmission clause would remove the mens rea requirement from the only remaining morally blameworthy aspect of the conduct. As such, it would convert this law into a strict liability crime.[16]
However, strict liability crimes are generally disfavored unless the provision expressly states that it operates without a mens rea requirement.[17] Indeed, the Supreme Court has repeatedly rejected the invitation to construe a statute as potentially imposing criminal sanctions on “a class of persons whose mental state . . . makes their actions entirely innocent.”[18] The Court has emphasized that “‘[t]he contention that an injury can amount to a crime only when inflicted by intention is no provincial or transient notion. It is as universal and persistent in mature systems of law as belief in freedom of the human will and a consequent ability and duty of the normal individual to choose between good and evil.’”[19] Accordingly, given that the Wire Act expressly includes a mens rea element, the rule of lenity would strongly counsel in favor of the narrower reading of this provision.
Conclusion
There remains immense untapped growth for the sports-wagering industry in America, but that potential is stifled by the significant legal uncertainty created by the Wire Act. Furthermore, OLC plays an important role in conveying which kinds of prosecutions are blessed (or not blessed) by DOJ. Thus, even though OLC’s opinions do not create binding law, they play a crucial role in providing legal clarity to the industry. Regulatory guidance is necessary to provide this much needed clarity to this nascent industry. Accordingly, DOJ’s OLC should reduce the persistent legal uncertainty surrounding the Wire Act by issuing a formal opinion holding that the Wire Act does not extend to intermediate routings. It looks like the ball is in your court, OLC.
[6]See, e.g., United States v. Lyons, 740 F.3d 702, 716 (1st Cir. 2014) (noting the “Wire Act’s evident applicability to the internet”); United States v. Corrar, 512 F. Supp. 2d 1280, 1289 (N.D. Ga. 2007) (holding the Wire Act applicable to sports gambling activity on the Internet); United States v. Cohen, 260 G.3d 68, 76 (2d. Cir. 2001) (affirming the conviction of the founder of an online sportsbook under the Wire Act for transmitting bets via the Internet).
[8] Steven A. Engel, Office of Legal Counsel, U.S. Dep’t of Justice Reconsidering Whether the Wire Act Applies to Non-Sports Gambling, 42 O.L.C. 1, 18 (Nov. 2, 2018), https://www.justice.gov/olc/file/1121531/download (“UIGEA defines ‘unlawful Internet gambling’ as follows . . . That term, however, ‘does not include’ certain enumerated activities. For instance, UIGEA excludes from coverage certain bets or wagers that are ‘initiated and received or otherwise made exclusively within a single State’ and done so in accordance with the laws of such State, even if the routing of those wire transmissions was done in a manner that involved interstate commerce. UIGEA’s definition of ‘unlawful Internet gambling’ simply does not affect what activities are lawful under the Wire Act.”) (internal citations omitted). Notably, this Opinion was recently invalidated by the First Circuit on other grounds. See N.H. Lottery Comm’n v. Rosen, 986 F.3d 38, 44-45 (1st Cir. 2021). However, prosecutors are not constrained by whether this Opinion remains in force. Accordingly, the risk remains that federal prosecutors could adopt an interpretation of the Wire Act that includes intermediate routings.
[11]Seeid. § 1804(b) (“[n]othing in this section shall be construed to prevent . . . the transmission of information assisting in the placing of bets or wagers on a sporting event or contest from a State or foreign country where betting on that sporting event or contest is legal into a State or foreign country in which such betting is legal”) (emphasis added).
[15]See Liparota v. United States, 471 U.S. 419, 427 (1985) (holding that “requiring mens rea is in keeping with our longstanding recognition of the principle that ‘ambiguity concerning the ambit of criminal statutes should be resolved in favor of lenity’” and noting that this rule “provides a time-honored interpretive guideline when the congressional purpose is unclear”).
[16] Because the interstate transmission is the only remaining morally blameworthy element of the crime, it does not just function as a jurisdictional element, but rather also as a substantive element of the crime. Accordingly, the exception to the presumption in favor of scienter for mere jurisdictional elements is necessarily inapplicable here. For a discussion of the presumption in favor of scienter and the jurisdictional exception, see Rehaif v. United States, 139 S. Ct. 2191, 2194 (2019). The Court’s discussion in Rehaif supports the application of the presumption in favor of scienter to the interstate transmission element of the Wire Act. As the Court explained in Rehaif, it is appropriate to extend the word “knowingly” to elements involving otherwise innocent conduct where doing so “helps to separate wrongful from innocent acts.” Id. at 2197. That is precisely the case here, as the interstate transmission element is the only wrongful act with respect to intermediate routings. This conclusion is further reinforced by the Act’s inclusion of the word “for” in the interstate transmission element of the Wire Act (not present in the statute at issue in Rehaif). Cf. 18 U.S.C. § 922(g). This additional language further clarifies Congress’s intent to extend the knowledge requirement to this element.
[17]Staples v. United States, 511 U.S. 600, 606 (1994) (“[O]ffenses that require no mens rea are generally disfavored, . . . [and] some indication of congressional intent, express or implied, is required to dispense with mens rea as an element of a crime.”); Liparota, 471 U.S. at 426; United States v. U.S. Gypsum Co., 438 U.S. 422, 437-38 (1978) (citations omitted) (noting that criminal offenses requiring no mens rea have a “generally disfavored status”).
[18]Staples, 511 U.S. at 614–15; see also Liparota, 471 U.S. at 426 (adopting narrower construction requiring proof of mens rea as “particularly appropriate where, as here, to interpret the statute otherwise would be to criminalize a broad range of apparently innocent conduct”).
[19]Liparota, 471 U.S. at 425 (internal citation omitted).
SPAC lawsuits are increasing in frequency. There was a big jump in the number of SPAC-related cases from 2020 to 2021. Five new securities class actions have already been filed against SPACs in 2022, just two months into the year. Several cases have gotten past a motion to dismiss.
One of the latest securities class actions, brought against the CEO and CFO of Fortress Value Acquisition Corp. (the SPAC) and the CEO and CFO of MP Materials Corp., a rare earth mining and processing company (the Target), was filed on February 22, 2022, in the District of Nevada.
The MP Materials lawsuit is similar to many others that came before it. It was filed after the merger was completed, followed a short seller report, involves officers of both the post-merger company and the SPAC, and alleges, among other things, that the defendants made materially false and misleading statements and that they did not do a good job with their due diligence of the target. This last allegation focusing on lack of proper diligence or willful ignorance of red flags is what is of interest.
It is of interest because although it might be too late for the defendants in this case, for the 600+ SPACs that are looking to find their targets right now, cases like this one should serve as a roadmap of how to avoid unnecessary litigation, how to find ways to refute similar allegations, and how to minimize losses.
Most SPAC teams are aware that well-structured D&O insurance policies at the time of the IPO and at the business combination could make a big difference for their balance sheet and the protection of their directors and officers. Many, however, are unaware that a representations and warranties insurance (RWI) policy could also go a long way towards refuting allegations of insufficient due diligence in addition to covering losses from a breach of representations in the merger agreement.
At its core, the RWI policy is designed to protect the buyer (in this case the SPAC) against two things: (i) the seller’s (in this case the Target’s) breaches of reps in the merger agreement and (ii) the Target’s fraud. However, a valuable side benefit of these policies, especially now that the number of SPAC cases alleging insufficient diligence is growing, is the insurer’s close examination of the SPAC team’s due diligence.
This second layer of diligence by a disinterested third party over the SPAC team’s diligence is important for at least two reasons. First, it either validates the SPAC team’s diligence process or points out potential problems that could be corrected and properly disclosed between the signing of the merger agreement and the close of the deal. Second, it is conducted by an experienced underwriting team and their top tier legal counsel, who are usually well versed in the industry of the target and very knowledgeable about the array of potential risks present in that industry.
An insurance broker that specializes in both RWI and SPACs can structure the process of obtaining a RWI policy to run along the timeline of the core transaction so that it can take approximately two weeks. The policy can be bound at the signing of the merger agreement, and coverage can run starting at signing. To ease the SPAC’s typical pre-merger cashflow problem, only 10% of the premium (along with a separate underwriting fee) would be payable at the time of signing, with the remaining 90% of the premium due at closing.
In a SPAC transaction the insurance underwriters would expect a standard level of due diligence like that conducted for any private company M&A deal. Many SPAC teams already run robust diligence processes and would not find this requirement a burden. Those teams who have not up until now been engaged in thorough due diligence practices should take note and consider adjusting their protocols. Regardless of whether they choose to avail themselves of the benefits of a RWI policy, to avoid allegations like those in MP Materials, they would be well advised to conduct as robust a diligence process as possible.
With ready availability of insurance carriers who are willing to offer coverage for most SPAC deals, not exploring the availability of this kind of policy ahead of the merger may raise questions of whether the SPAC team’s directors and officers explored all avenues of risk mitigation. Even if it does not, failing to obtain a RWI policy could lead the SPAC teams and their targets to the kind of elbow-biting and shin-kicking regrets that the MP Materials teams may be experiencing now and that most of us would rather avoid.
The legal industry has long relied on paper checks and manual processes to handle billing and invoicing. As technology has increasingly integrated itself into law firm processes, however, more firms are turning to automated payments, particularly with the rise of a remote and hybrid workforce.
From greater accuracy to getting paid faster, automated payments offer many benefits for law firms. If you seek the greatest efficiency in your billing processes, look for an all-in-one practice management platform that combines accounting features and automated payments as integrated steps in the same convenient system.
Making the switch is a win-win: clients receive better service, while you’ll be able to improve your financial visibility and gain the flexibility to offer alternative payment terms.
Reasons to Make the Move to Automated Payments
Automated payments offer a number of benefits for law firms. For starters, firms still mailing paper invoices and utilizing manual processes have surely experienced errors. These inaccuracies can have detrimental effects on your firm’s overall financial health. Automated payments significantly reduce errors, making it easier for you to receive payments for the amounts you’re owed.
Eliminating manual invoicing tasks also frees up staff and others to focus on higher-value work that better serves clients. Finally, and perhaps most importantly, automated payments naturally result in faster payment as they automate steps that often introduce delays, removing many of the obstacles to receiving payments that paper bills and manual processes present to clients and vendors. When it’s easier for them to pay using the same methods they use to pay utilities and shop online, you get paid quickly and spend far less time chasing down aging invoices.
The Drawbacks of Using Multiple Systems
Many firms use popular accounting systems like QuickBooks and may consider using them to handle their billing. While these systems are preferable to manual processes, relying on multiple systems or tools to handle practice management, accounting and billing does have drawbacks.
When automated payments are handled outside of the practice management workflow, staff will still be dogged by inefficiency—usually doubling the steps to bill, because they’ll continually have to jump back and forth between systems. This disconnect prevents firms from creating the seamless processes they need for peak efficiency and risk mitigation. Multiple systems also mean more vendors to work with, which in turn mean additional license fees, potentially higher costs and multiple channels of communication, further hindering efficiency.
Moreover, popular business accounting solutions are not necessarily tailored for law firms. For example, QuickBooks requires a number of complex workarounds and customizations to even start handling some common legal billing issues, including sensitive trust transaction management, practice management reporting, billing realization and other client-level fee arrangements such as flat fees, evergreen subscriptions, or contingency fees. While using a practice management solution that integrates with QuickBooks can help ease some of the effort demanded by these workarounds and reduce redundancies, it’s still not the ideal solution.
How, then, can firms best implement automated payments? By turning to an all-in-one practice management platform that also handles payments. Providers of legal practice management systems have long recognized that integrating business management workflows and information into an all-in-one system enhances client service and improves firm efficiency. Integrated payments are an important piece of a complete practice management system.
Why an Integrated Solution Is Better
The most successful approach for law firms looking to make the move to automated payments is to choose an all-in-one practice management platform that combines automated payments and all your firm’s other accounting needs into one system. The right end-to-end system will not only bring seamless workflows to your payment processes, it will support the unique features and compliance regulations that law firms require.
Ease of Use
All-in-one practice management platforms designed for law firms will ensure users do not have to constantly switch between disparate systems, and they also provide for unified training and support. The result is an integrated, efficient system that is easy to use.
Visibility
Another benefit is unified metrics and reporting. An integrated online payment system allows your team to review transactions, AR aging, and balance sheets anytime.
Fiduciary Compliance
Integration links between practice management, billing and payments do a better job of managing alternative fee arrangements and trust accounting, while also ensuring that they comply with attorneys’ fiduciary duties. General accounting tools are not designed to support the mandatory requirements for handling client funds held in trust accounts or deposited in operating accounts. Violating these requirements, even inadvertently, can jeopardize the ability to practice law.
Improved Firm Management
When practice management and payments work together, client and case files are clearly organized and up to date, and billing is a breeze, with payment processes built into overall case management workflows. This means that an entire matter is handled in one place, from intake to billing to reconciliation of your firm’s ledgers and financial reports.
Compliance with e-Billing (LEDES) Requirements
Business clients often adopt the LEDES standard—an acronym for the Legal Electronic Data Exchange Standard created in 1995 to systematize electronic exchange of billing and other information between corporations and law firms.
Complying with legal e-billing standards such as LEDES provides transparency for every line item that law firms bill with corresponding e-billing codes. LEDES-compliant billing, tailored to the firm and clients’ wishes, will speed through the client’s AP approval process and ensure timely payment.
Rapid Client Acceptance
Legal consumers, like the rest of us, prefer to pay via electronic means. Law firms that delay offering e-payment options to their clients are well behind the times, while firms that are not using proprietary, in-system payment tools are sacrificing efficiency.
Attorneys want to spend their time practicing law, not handling paperwork, preparing invoices and chasing down payments. An all-in-one system that combines practice management, accounting and automated payments allows them to do just that. You will be freed to focus on serving clients and remaining competitive, rather than toiling away to complete administrative tasks. Practice management that includes automated payments enables your firm to enhance client satisfaction, get paid faster, speed up cash flow and increase overall profitability.
Paul Hastings LLP 101 California Street Forty-Eighth Floor San Francisco, CA 94111 (415) 856-7002 phone (415) 856-7102 fax [email protected]
Assistant Editor
Amy Chau
Paul Hastings LLP 515 South Flower Street, Twenty-Fifth Floor Los Angeles, CA 90071 (213) 683-6121 phone (213) 996-3121 fax [email protected]
Contributors
Jessica Mendelson
Paul Hastings LLP 101 California Street Forty-Eighth Floor San Francisco, CA 94111 (415) 856-7006 phone (415)856-7106 fax [email protected]
Emily Stover
Paul Hastings LLP 101 California Street Forty-Eighth Floor San Francisco, CA 94111 (415) 856-7002 phone (415) 856-7102 fax [email protected]
Samantha Aceves
Sinclair Braun LLP 16501 Ventura Blvd., Suite 400 Encino, CA 91436 213.429.6116 phone 213.429.6101 fax [email protected]
Phillip Arencibia
Duane Morris LLP 201 S. Biscayne Boulevard, Suite 3400 Miami, FL 33131-4325 (305) 960-2339 phone (305) 675-0772 fax [email protected]
Cassidy Bolt
Paul Hastings LLP 4747 Executive Drive San Diego, Ca 92121 (858) 458-3037 phone (858) 458-3137 fax [email protected]
Barry Brown
Applied Materials, Inc. Global Employment Law P.O. Box 58039 Santa Clara, CA 95052 (408) 748-5329 [email protected]
Deisy Castro
Paul Hastings LLP 515 South Flower Street Twenty-Fifth Floor Los Angeles, CA 90071 (213) 683-6178 phone (213) 996-3178 fax [email protected]
Michael Costello-Caulkin
Paul Hastings LLP 1117 S. California Avenue Palo Alto, CA 94304 (650) 320-1888 phone (650)320-1988 fax [email protected]
Elliot Fink
Paul Hastings LLP 200 Park Ave New York, NY 10065 (212) 318-6710 phone [email protected]
Anuva Ganapathi
Paul Hastings LLP 1117 S. California Avenue Palo Alto, CA 94304 (650) 320-1886 phone (650)320-1986 fax [email protected]
Benjamin Gilberg
Paul Hastings LLP 200 Park Avenue New York, NY 10166 (212) 318-6721 phone (212) 230-7721 [email protected]
Jack Hibbard
Paul Hastings LLP 101 California Street, 48th Floor San Francisco, CA 94111
Brenna Hull
Paul Hastings LLP 101 California Street, 48th San Francisco, CA 94111 (415) 856-7094 phone (415) 856-7194 fax [email protected]
Julian A. Jackson-Fannin
Duane Morris LLP 201 S. Biscayne Boulevard, Suite 3400 Miami, FL 33131-4325 (305) 960-2253 phone (305) 402-0544 fax [email protected]
Nina John
Paul Hastings LLP 101 California Street, 48th Floor San Francisco, CA 94111
Elise Kang
Paul Hastings LLP 200 Park Avenue New York, NY 10166 (212) 318-6513 phone (213) 319-4090-fax [email protected]
Alex Kargher
Sinclair Braun LLP 16501 Ventura Blvd., Suite 400 Encino, CA 91436 213.429.6116 phone 213.429.6101 fax [email protected]
Syed Ali Khan
Paul Hastings LLP 515 South Flower Street Twenty-Fifth Floor Los Angeles, CA 90071 (213) 683-6186 phone (213) 996-3186 fax [email protected]
Jonathon Kosciewicz
Paul Hastings LLP 71 South Wacker Drive, Suite 4500 Chicago, IL 60606 (312) 499-6021 phone (312) 499-6121 [email protected]
Maryam Maleki
Duane Morris LLP Spear Tower One Market Plaza, Suite 2200 San Francisco, CA 94105 (415) 957-3080 phone (415) 354-3317 fax [email protected]
Meghan M. McBerry
Seyfarth Shaw LLP 2029 Century Park East, Suite 3500 Los Angeles, CA 90067 (310) 201-9349 phone (310) 201-5219 fax [email protected]
Robert Milligan
Seyfarth Shaw LLP 2029 Century Park East, Suite 3500 Los Angeles, CA 90067 (310) 201-1579 phone (310) 201-5219 fax [email protected]
Emily Monroe
Paul Hastings LLP 515 South Flower Street Twenty-Fifth Floor Los Angeles, CA 90071 (213) 683-6174 phone (213) 996-3174 fax [email protected]
Erik Oakley
Paul Hastings LLP 101 California Street, 48th Floor San Francisco, CA 94111
Lauren Rogers
Paul Hastings LLP 101 California Street, 48th Floor San Francisco, CA 94111
Catherine Rosoff
Paul Hastings LLP 695 Town Center Drive Costa Mesa, CA 92626 (714) 668-6218 phone (714) 668-6318 fax [email protected]
Claire Saba
Paul Hastings LLP 2050 M Street NW Washington, DC 20036 (202) 551-1827 phone (202) 551-0327 fax [email protected]
Joshua Salinas
Seyfarth Shaw LLP 2029 Century Park East, Suite 3500 Los Angeles, CA 90067 (310) 201-1514 phone (310) 201-5219 fax [email protected]
Olivia Wiebe
Paul Hastings LLP 515 South Flower Street Twenty-Fifth Floor Los Angeles, CA 90071 (213) 683-6151 phone (213) 996-3151 fax [email protected]
§ 1.1. Introduction
Non-compete laws and trade secret litigation continue to proliferate. Multiple states have enacted or amended statutes limiting use and enforcement of non-compete agreements. Over the past year, over sixty bills have been introduced that would affect non-compete laws. Limiting or banning the use of restrictive covenants is also a federal priority. In 2021, the Biden Administration issued an executive order directing multiple federal departments and agencies to take action against the unfair use of non-compete agreements and revise guidance on no-poach agreements. In addition to legislation, courts have continued to call into question the viability of non-compete and non-solicit agreements given the legislative policy disfavoring employee mobility restrictions,[1] and have readily held unenforceable such agreements as overbroad, vague, or otherwise invalid. Although non-competes are increasingly disfavored, trade secrets may be seen as a countervailing protectable interest.
This continued focus on non-compete laws and trade secrets occurs as the COVID-19 pandemic enters its third year and employees continue to work from home or return to offices in a hybrid work model. This sustained shift to remote work compounds the legal obstacles employers face when trying to protect trade secrets. This “new normal” will continue to evolve the legal standards for the protection of work secrets.
The use of choice-of-law provisions, which allow a party to select a particular state’s law to apply to a contract, has similarly come under attack. In recent years, several states have enacted statutes prohibiting the enforcement of forum-selection and choice-of-law clauses that designate another state’s forum or law against their citizens. Even in the absence of such statutes, courts have continued to find such provisions unenforceable where they might conflict with state public policy considerations.
Courts around the country have continued to see a sustained pace of new filings of employee mobility and trade secret cases over the past few years. This Chapter provides an overview of recent developments in case law, and will serve as a practical guide for business law practitioners navigating new changes in employee mobility issues and the protection of trade secrets.
§ 1.2. Employee Mobility: Breach of Duty of Loyalty; Breach of Fiduciary Duties
§ 1.2.2. First Circuit
Sebren v. Harrison, No. 1:18-cv-00667-MSM-PAS, 2021 U.S. Dist. LEXIS 146756 (D.R.I. 2021) (unpublished). The Rhode Island District Court granted in part and denied in part an employer’s motion for summary judgment against an employee for employer’s claims of breach of contract, usurpation of opportunity and breach of loyalty, tortious interference, theft, and extortion and abuse of process because there were no triable issues of fact. There, the employee worked for the employer as an attorney. Upon leaving employment, one of employee’s previous clients sought her representation. The employer filed the above-mentioned claims against the employee. As for the breach of contract claim, the employer alleged he and employee agreed to a 50/50 contingency fee split for the client’s case. The employee denied any fee agreement. Based on this evidence, the court held that whether any such agreement existed between the parties was an issue for the jury. As to the usurpation of opportunity and breach of loyalty claim, former employees are entitled, absent noncompete contracts to do business with clients of the former employer so long as the conduct occurs post departure. There, the court reasoned that because there was not a noncompete agreement between the parties and the employee’s independent representation of the client occurred after her departure from employment with the employer, the employee had no fiduciary obligation to the employer. As to the tortious interference claim, absent a noncompete agreement, a departing employee may continue to do business with a client who follows the employee so long as the employee did not actively abuse the trust of his employer in dealing with customers while employed. There, the court reasoned that because there was not a noncompete agreement between the parties, and no evidence to establish the employee acted wrongfully, the claim was unsupported. As to the theft claim, the court reasoned that because the employer offered no evidence to suggest the employee did not have permission to possess the file during her employment with the employer, and as soon as the employee was retained by the client, she was entitled to the file independently, there was no basis for his claim. As to the extortion and abuse of process claims, the court reasoned that the employee’s advice to the employer to speak with family and friends and consider all possible consequences in a communication to settle the case was insufficient to suggest extortion and abuse of process. Based on these findings, the court denied summary judgment as to employer’s breach of contract claim but granted summary judgment as to all other claims.
§ 1.2.4. Third Circuit
Sunbelt Rentals, Inc. v. Love, 2021 U.S. Dist. LEXIS 4587 (D. N.J 2021) (unpublished). Former high-level sales employee Love, assumed a national role with Sunbelt after they acquired his former employer, Interstate in 2018. The ‘national’ nature of Love’s role at Sunbelt was the product of initial negotiations between Love’s counsel and Sunbelt, which culminated in the signing of an employment agreement permitting Love to earn healthy compensation in consideration for a broad restrictive covenant. Later, after receiving approximately $300,000 in retention bonuses, Love emailed a host of proprietary Sunbelt customer, pricing, and project information to himself and his brother (a Sunbelt customer at the time) just weeks before resigning to join competitor EquipmentShare, where he planned to compete with Sunbelt nationally. Emphasizing Love’s lack of credibility when he testified that he did not know what was contained in the information he emailed himself and his brother, and when he averred that such information was deleted and never used, the court granted Sunbelt’s motion for an injunction on its breach of contract and trade secrets claims. Critically, without an injunction, “Sunbelt would have to trust the testimony of a disgruntled former employee who has demonstrated his animus towards his former employer,” which made the court uncomfortable. The court was much more comfortable holding Love to his bargain, given his voluntarily resignation and handsome compensation for the restrictive covenant. A large portion of the opinion contained interpretation about the geographic scope of the non-competition provision; the court ultimately found a national scope reasonable in light of Love’s national role and the handsome compensation that accompanied such a position. Because Love’s act of emailing information about Sunbelt’s unique nationwide strategies which he acknowledged was confidential to himself and his brother was such a clear breach of Love’s employment contract and misappropriation of Sunbelt’s trade secrets, the former employer had demonstrated success on the merits of both of its claims and that it would suffer “likely and imminent” harm absent the injunction.
Additional Cases of Note
Peoplestrategy, Inc. v. Hearthstone Advisors LLC, 2021 U.S. Dist. LEXIS 73529 (E.D.Pa 2021) (unpublished) (granting former CEO in purchase of consulting business scenario’s motion for summary judgment that he did not violate non-competition or customer non-solicitation provisions of poorly-written business purchase agreement (“BPA”); granting summary judgment to the purchasing entity on their claim that former CEO breached non-solicitation portion of BPA; and sending to jury the questions of whether the confidentiality portion of BPA was breached and whether the former CEO was acting as the alter-ego of the LLC in whose name he signed the BPA); EMC Outdoor, LLC v. Stuart, 2021 U.S. Dist. LEXIS 63438 (E.D.Pa 2021) (unpublished) (granting summary judgment to employee and new employer on breach of contract and fiduciary duty and misappropriation of trade secrets claims where all of the conduct occurred after former employer terminated employee because employment agreement’s restrictive covenants did not apply to a firing according to court’s interpretation of the contract; defendants prevailed on trade secrets claims because plaintiff could not show misappropriation where the employee acquired the customer information directly in the normal course of work for former employer).
§ 1.2.5. Fourth Circuit
Anderson v. Fluor Intercontinental, Inc., 2021 U.S. Dist. LEXIS 45526 (E.D. Va. 2021) (unpublished). Retired United States Army Brigadier General, Steve Anderson, participated in numerous business ventures after retiring, and prior to being hired by Fluor Intercontinental as its Country Manager in Afghanistan, including having served as Chief Marketing Officer of Relyant Global and owning a stake in Relyant’s holding company, as well as owner and CEO of consulting company Energistics Technologies through which he performed consulting working for several companies, including LEEP Expeditionary Buildings. As a result, during the hiring process, Fluor informed Anderson that they would need to address his potential conflicts of interests, specifically the risk that Relyant might improperly benefit from Anderson’s inside influence at Fluor. After he was hired by Fluor, Anderson entering into a consulting agreement with Relyant and a marketing agreement with LEEP, with whom he communicated his intent to use his position at Fluor for their benefit. Anderson did not report these business arrangements to Fluor when he completed its Code of Business Conduct and Ethics Certification. After Anderson’s interactions with subcontractors raised red flags and after Fluor awarded a contract to Relyant, Fluor investigated and terminated Anderson, in addition to recompeting the contract previously awarded to Relyant, who had been provided competitor pricing information that Anderson had obtained as a Fluor employee. Anderson filed this action against Fluor related to his termination and Fluor’s disclosure of his suspected conflict of interest violations; Fluor counterclaimed, resulting in the parties’ cross motions for summary judgment. Specifically, the court found Fluor’s claim for breach of duty of loyalty preempted by the Virginia Uniform Trade Secrets Act (VUTSA) to the extent it asserts a claim based on Anderson’s alleged misappropriation of the competitor pricing information in Fluor’s possession because VUTSA displaces conflicting Virginia laws providing civil remedies for misappropriation if a defendant misappropriates a trade secret under VUTSA. As such, the court held that, to recover for Anderson’s alleged breach of loyalty, Fluor must demonstrate that its theories of relief for this claim are supported by facts unrelated to Anderson’s alleged misappropriation of its trade secrets. Accordingly, the court denied Anderson’s motion for summary judgment as to this claim to the extent Fluor premises the claim on Anderson’s consulting arrangement with Relyant, which Anderson concealed from Fluor and which is unrelated to the misappropriation of trade secrets.[2]
Additional Cases of Note
ComRent Int’l, LLC v. Smidlein, 2021 U.S. Dist. LEXIS 13715 (D. Md. 2021) (applying Maryland law) (unpublished) (denying defendants’ motion to dismiss for failure to state claim and finding that plaintiff’s claims for breach of fiduciary duty and abetting a breach of fiduciary duty state plausible claims for relief for valid causes of action because, contrary to defendants’ argument, Maryland law recognized an independent action for breach of fiduciary duty)[3]; ComRent Int’l, LLC v. Thomson, 2021 U.S. Dist. LEXIS 84320 (D. Md. 2021) (unpublished) (denying defendants’ motions to dismiss for failure to state a claim and finding that plaintiff’s claim for breach of duty of loyalty, among other claims, are not preempted by the Maryland Uniform Trade Secrets Act, because they are based on the alleged wrongful acquisition and use of its confidential and proprietary non-trade secret information, and that plaintiff sufficiently pled a claim for breach of duty of loyalty through its allegations that Thomson accessed and used confidential information during and after his employment to the benefit of himself and/or his new employer)[4]; Gordon v. Blue Mountain Therapy, LLC, 2021 U.S. Dist. LEXIS 105432 (W.D. Va. 2021) (unpublished) (denying plaintiff’s motion to dismiss defendant’s counterclaim alleging that plaintiff violated his common law duty of loyalty to defendant when he secretly entered into contracts for his own benefit that should have gone to his employer and rejecting plaintiff’s argument that claims for breach of contract and breach of the duty of loyalty are mutually exclusive).[5]
§ 1.2.6. Fifth Circuit
Additional Cases of Note
Cyberx Grp., LLC v. Pearson, U.S. Lexis 92999, at *30 (N.D. Tex. May 17, 2021) (granting plaintiff’s request for a preliminary injunction against defendants due to breach of contract and breach of fiduciary duties, because “the evidence demonstrates that [defendants’] departure was not the result of unforeseen circumstances, but was rather a step in their plan to form a competing business, which they at least knew, if not intended, would leave [Cyberx] at a competitive disadvantage.”).
Mills v. Trustmark Nat’l Bank, No. 3:19-CV-941-CWR-FKB, 2021 U.S. Dist. LEXIS 37481, at *17 (S.D. Miss. Mar. 1, 2021) (recognizing an aiding and abetting breach of fiduciary duty claim under Mississippi Law even though the state courts had not ruled on the claim’s existence, reasoning that the Fifth Circuit requires its federal courts make an Erie guess as to how the Mississippi Supreme Court would decide a question in the absence of on-point caselaw and there is no evidence that Mississippi would not adopt the claim).
Mims v. Matrix Tr. Co. (In re Vantage Benefits Adm’rs), Nos. 18-31351-SGJ-7, 20-03055, 2021 Bankr. LEXIS 1195, at *59 (Bankr. N.D. Tex. May 5, 2021) (denying a motion to dismiss breach of fiduciary duty and aiding and abetting claims, reasoning that, given that the Texas Supreme Court had yet to decide whether aiding and abetting is a recognized cause of action, the court was unable to conclude as a matter of law that the Plaintiff was unable to bring a cause of action under Texas law).
People Source Staffing Prof’ls LLC v. Robertson, 2021 U.S. Dist. LEXIS 95665, at *24 (W.D. La. May 19, 2021) (granting defendant’s motion for summary judgment regarding plaintiff’s claim for breach of fiduciary duty because defendant “did not have a special duty as an agent or mandatory for [plaintiff]” in the role of account manager).[6]
People Source Staffing Prof’ls LLC v. Robertson, 2021 U.S. Dist. LEXIS 105712, at *20 (W.D. La. June 3, 2021) (granting defendant’s motion for summary judgment regarding the breach of fiduciary duty claim because plaintiff failed to meet its burden to demonstrate defendant was an agent or mandatory of plaintiff, as she was “not an officer, director, or owner of [plaintiff]”).[7]
Whitlock v. CSI Risk Mgmt., LLC, 2021 Tex. App. LEXIS 3345, at *13 (Tex. Ct. App., 5th Dist. Apr. 30, 2021) (determining a verdict in favor of a former employer in its suit against competitors, a former employee, and two others, was proper because “more than a scintilla of evidence supported the jury’s determination that Whitlock breached the confidentiality provision of the Temporary Agreement, and further conclude the jury’s verdict was not contrary to the overwhelming weight of the evidence”).[8]
§ 1.2.7. Sixth Circuit
Ingram v. Regano, 2021 U.S. Dist. LEXIS 61856 (N.D. Ohio 2021) (applying Ohio law) (unpublished). Plaintiff Meribethe R. Ingram sued defendants Joseph V. Regano and Fred E. Bolden, II for violations of her Procedural Due process and Equal Protection rights guaranteed by the United States Constitution, for sexual discrimination in violation of Title VII of the United States Code and Ohio law, and for breach of fiduciary duty in violation of Ohio law. Ingram was employed in various capacities at Lewis Elementary School, and alleged she was harassed by another teacher. She claimed she reported the behavior to the school’s administration, including Bolden and Regano, but that they did not act in response. Rather than investigating her complaint, the administration informed her she was no longer welcome on the Lewis Elementary premises. Ingram then filed a complaint for unlawful retaliation with the school district, who allowed Bolden and Regano to oversee the investigation even though both were the subject of such investigation. Her retaliation complaint was denied. One of Ingram’s claims was that both Bolden and Regano owed her a fiduciary duty to conduct the investigation into her complaint in a fair and unbiased manner. The Sixth Circuit found that Ingram failed to properly state a claim that a fiduciary relationship existed because the plain language of the District’s anti-harassment policy explained that the defendant’s obligations run to the “accused, the accuser, but primarily to the Board,” thus it was not clear that the defendants promised to act primarily for Ingram’s benefit. Thus, the defendants were entitled to judgment in their favor on the breach of fiduciary duty claim.
Ohio Nurses Ass’n v. Ashtabula Cty. Med. Ctr., 2020 U.S. Dist. LEXIS 136336 (N.D. Ohio 2020) (unpublished). The Defendant, Ashtabula County Medical Center (ACMC) is a non-profit hospital in Ohio and is governed by a Board of Trustees. It is the only hospital in Ashtabula County that provides labor and delivery services. The Board decided to close the Maternity Ward and Skilled Nursing Unit. The Plaintiffs, brought this case seeking a preliminary injunction to enjoin the Defendants from closing the Maternity Ward alleging among other things a breach of fiduciary duty of the Trustees of the ACMC Board of Trustees. The Plaintiffs allege that the Trustees, by acting against their organizational purpose to benefit members of the community, have breach their fiduciary duty. The Northern District of Ohio denied the Plaintiffs’ motion and stated that Plaintiffs failed to prove the Trustees did not act in good faith. Additionally, Plaintiffs failed to prove that they had standing to assert a breach of fiduciary claim because Ohio law only expressly allows for claims by members of the corporation not by intended beneficiaries, which Plaintiffs claimed to be.
United States ex rel. Felten v. William Beaumont Hosp., 933 F.3d 428 (6th Cir. (Mich.) 2021). Petitioner David Felten appealed the district court’s partial dismissal of his first amended complaint alleging William Beaumont Hospital (Beaumont) violated the anti-retaliation provision of the federal False Claims Act (FCA) (31 U.S.C. § 3730(h)). He alleged he was terminated after Beaumont falsely represented to him that an internal memorandum suggested he be replaced and that his position was subject to mandatory retirement. He also claimed Beaumont “intentionally maligned” him in retaliation for his reports of Beaumont’s unlawful conduct, which prevented him from getting a job anywhere else in academic medicine. His complaint was dismissed by the district court, after the court found the FCA’s anti-retaliation provision only applies to conduct occurring during a plaintiff’s employment. This was an issue of first impression for the Sixth Circuit, with the court holding that the provision does apply to actions taken after a plaintiff’s employment ends. Beaumont argued that the phrase “terms and conditions of employment” used in the FCA precludes the Act’s application to actions taken after a plaintiff’s employment ends. The court rejected that argument, finding that the phrase does not restrict misconduct to occurrences that take place only while the plaintiff is employed, and adding that “terms and conditions of employment” can continue long after a plaintiff leaves a job, such as non-compete and non-solicitation agreements. The court noted that the FCA does not define “employee” and instead relied on the dictionary definition’s requirement that there be the formation of an employment relationship, regardless of whether or not such a relationship still exists, in order for the Act to apply. Last, the court noted a considerable policy concern, that if the statute did not apply to actions taken after a plaintiff’s employment ends, there would be a perverse incentive for employers to fire employees who might bring FCA claims, and the anti-retaliation provision is meant to encourage the reporting of fraud, not stymie it.
Additional Cases of Note
Cheryl & Co. v. Krueger, 2021 U.S. Dist. LEXIS 80868 at *66 (S.D. Ohio 2021) (applying Ohio law) (unpublished) (explaining the “faithless servant doctrine” and granting summary judgment in favor of one defendant-employee on plaintiff-employer’s breach of duty of loyalty claim because the evidence was insufficient to show that disloyalty permeated the employee’s service under the standard); Henderson v. Skyview Satellite Networks, 474 F. Supp. 3d 893, at *902-908 (W.D. Ky. 2020) (finding that by being in negotiations for employment with a new employer, even though she had not accepted employment, the plaintiff was “engaging” and “entertaining” employment offers in violation of the terms of her employment agreement); Novolex Holdings v. Wurzburger, 2020 U.S. LEXIS 147891, at *23-28 (E.D. Ky. 2020) (holding that the defendant-employee breached his fiduciary duty by withholding information from plaintiff-employer in order to earn a bonus); PSC Indus. v. Johnson, 2021 U.S. Dist. LEXIS 81350, at *41-44 (M.D. Tenn. 2021) (applying Tennessee law) (unpublished) (explaining that plaintiff’s breach of fiduciary duty claim is to be construed by the court as a claim for a breach of the duty of loyalty, emphasizing that the two claims are “undeniably . . . different”); Radiant Global Logistics, Inc. v. BTX Air Express of Detroit LLC, 2021 U.S. Dist. LEXIS 68319, at *17-30 (E.D. Mich. 2021) (applying Michigan law) (unpublished) (explaining of the elements of fiduciary duty claims and breaches thereof in detail);[9]Vanderbilt Univ. v. Scholastic, Inc., 2021 U.S. Dist. LEXIS 99656 (M.D. Tenn. 2021) (applying Tennessee law) (unpublished) (finding a reasonable juror could conclude that defendant-employee acted adverse to plaintiff-employer’s interest by agreeing to several non-compete provisions and failing to inform plaintiff-employer about such agreements);
§ 1.2.8. Seventh Circuit
Hensiek v. Bd. of Dirs. of Casino Queen Holding Co., 514 F. Supp. 3d 1045 (S.D. Ill. 2021). Plaintiffs are former employees of the Casino Queen and participants in the Casino Queen ESOP that was created for the sole purpose of purchasing 100% of the outstanding common stock of CQ because the shareholders were unable to sell that asset elsewhere. To effectuate the sale of stock, the Board of Directors (Bidwell, Rand, Koman, Watson and Barrows) selected two of its members (Watson and Barrows) to be Co-Trustees of the ESOP and vested them with the authority to purchase from the selling shareholders (Bidwell, Rand, and Koman) all of the outstanding stock for the sum of $170 million. The Board retained the power to dismiss the Co-Trustees, which Plaintiffs asserted was functionally equivalent to having power and control over their decision making, thereby creating a fiduciary relationship between members of the Board and Plaintiffs. Plaintiffs went on to allege that two transactions served to benefit the selling shareholders who orchestrated the transactions and violated Defendants’s fiduciary duties to participants of the ESOP under the Employment Retirement Income Security Act (“ERISA”). Plaintiff contended that they were unaware of the events for several years until the shares of stock were reported to have suffered a significant loss in value and that defendants undertook acts to conceal and misrepresent their misconduct. Defendants moved to compel arbitration. The court noted that the Seventh Circuit has not directly addressed the issue of whether statutory ERISA claims are arbitrable but assumed that the “Circuit will at the appropriate time determine that statutory ERISA claims are arbitrable” based on rising trends in other circuits. Ultimately, however, the court held that arbitration was unenforceable in this case due to lack of consideration.
Additional Cases of Note
Hartford Steam Boiler Inspection & Ins. Co. v. Campbell, 2021 U.S. Dist. LEXIS 62332 (S.D. Ind. 2021) (unpublished) (applying Indiana law) (granting defendants’s motion to dismiss for failure to state a claim as to plaintiff’s allegation that defendants breached fiduciary duty of care by misappropriating trade secrets where Indiana trade secret law pre-empts any common law claim for misappropriation of trade secrets).[10]
NPF Racing Stables. LLC v. Aguirre, 2021 U.S. Dist. LEXIS 69912 (N.D. Ill. Apr. 12, 2021) (unpublished) (granting plaintiffs’s motion for summary judgment as to defendants’s counterclaims and third-party claims, explaining that fiduciary duty is not breached when the record indisputably shows that the alleged breacher’s actions were in the company’s best interest).
Switchboard Apparatus, Inc. v. Wolfram, 2021 U.S. Dist. LEXIS 105827, at *16 (N.D. Ill. June 7, 2021) (denying plaintiff’s motion to dismiss the claim as preempted by the Illinois Trade Secrets Act (ITSA) because even if the information plaintiff shared with his new employer was not a trade secret, plaintiff “breached his duty of loyalty by sharing the relevant information with E&I while employed by SAI.”).
Teague v. Healthcare Dev. Partners, LLC, 2021 U.S. Dist. LEXIS 37108, at *26 (N.D. Ill. Mar. 1, 2021) (denying defendant’s summary judgment motion because triable issues of material fact existed with respect to plaintiff’s potential breach of his duty of loyalty when he offered competing services to another company while still employed by his prior employer).[11]
Walgreens Co. v. Peters, 2021 U.S. Dist. LEXIS 140740, at *14 (N.D. Ill. July 28, 2021) (granting Walgreens’s motion for a preliminary injunction with respect to enjoining Peters’s use of the stolen Walgreens’s information and trade secrets because Peters “owed a fiduciary duty of loyalty to Walgreens, [] he breached that duty when he took Walgreens’s data, and [] Peters’s actions proximately caused injury to Walgreens” given that Peters “and his new employer used this information to target high performing Walgreens’s stores and purchased nearly $80,000,000 worth of Walgreens’s leased property” after Peters joined his new employer).
§ 1.2.9. Eighth Circuit
ATD Tools v. Fisher, 2021 U.S. Dist. LEXIS 27315 (E.D. Mo. 2021) (unpublished). ATD sells and distributes automotive tools for its own brand and other sellers. Fisher was employed by ATD as its category manager in charge of ATD’s branded products. As a condition of his employment, Fisher entered into ATD’s standard confidentiality and nonsolicit agreement. Fisher resigned, refused to identify his new employer, and claimed that he would live off his investments while contemplating his future. Fisher actually went to work for a direct competitor. Shortly after Fisher’s last day, ATD provided a written reminder of his confidentiality obligations. ATD investigated Fisher’s computer activity and found that he deleted almost all of the emails in his account for two years prior to his departure; accessed, copied, and utilized extensive data on ATD’s computer system; and transferred ATD personnel information, internal financial information, sales and products analytics, strategic marketing plans, and operational information to his own storage devices or accounts. Some of this information was outside of the scope of Fisher’s ATD job duties. ATD moved for a TRO on several claims against Fisher including breach of his duty of loyalty. The court found that ATD was likely to succeed on its claims because Fisher deleted data from ATD’s computer systems and took ATD’s confidential information with him when he left to go work for a competitor. The court also found that ATD was likely to succeed on its trade secret misappropriation and Missouri Computer Tampering Action claims, and entered an injunction prohibiting Fisher from using or disclosing ATD’s trade secrets. See Section 1.5.9 for a summary of the court’s analysis of the trade secret misappropriation claim.
Jim Hawk Truck-Trailers of Sioux Falls v. Crossroads Trailer Sales & Serv., 2021 U.S. Dist. LEXIS 50711 (D. S.D. 2021) (unpublished). Between December 2019 and March 2020, Crossroads Trailer hired nine employee mechanics from Jim Hawk, a direct competitor trucking company. Jim Hawk claimed that the mechanics breached their duty of loyalty by preparing to compete with Jim Hawk’s business while still employed, taking information belonging to Jim Hawk, diverting business from Jim Hawk, and attempting to determine if the customers with whom they worked at Jim Hawk would do business with them at Crossroads. Jim Hawk also alleged that three of the mechanics’ resignations with a period of six days without notice harmed Jim Hawk’s ability to serve its customers. The mechanics moved to dismiss for failure to state a claim. The court noted that the line between preparing to compete and actively competing or not preferring one’s employer is difficult to discern, but found that Jim Hawk alleged facts sufficient to state a claim for breach of duty of loyalty.
§ 1.2.10. Ninth Circuit
Bafford v. Northrop Grumman Corp., 994 F.3d 1020 (9th Cir. (Cal.) 2021). Northrop Grummon sponsored an employee pension plan (Plan) subject to the requirements of the Employee Retirement Income Security Act (ERISA). Northrop delegated administration of the Plan to a Committee which then delegated administration to an outside committee called Hewitt. One of Hewitt’s responsibilities was to generate monthly statements for Plan participants outlining what their monthly pension benefits would be when they retired. Plaintiffs Stephen Bafford and Evelyn Wilson requested these statements, but the statements they received grossly overestimated the benefits to which they were entitled. After plaintiffs retired, they began collecting benefits in the amounts predicted by the statements. Upon realizing the error, Northrop notified plaintiffs, informing them of the reduced amounts they were owed. Plaintiffs then sued, alleging, among other things, that Northrop, the Committee, and Hewitt violated their fiduciary duties to provide accurate benefit information. The district court dismissed plaintiffs’ claims for breach of fiduciary duty against Northrop and the Committee, and the appellate court agreed. The appellate court distinguished between a “named fiduciary,” a fiduciary designated in the plan instrument, and a “functional fiduciary,” a party that exercises discretionary control over management or administration of a plan. For a functional fiduciary, such as Hewitt, to be liable for breach of fiduciary duty, it must be performing a “fiduciary function” at the time of the purported violation. Here, the court found that Hewitt’s calculations of plaintiffs’ pension benefit estimates were not the type of communications with beneficiaries that were fiduciary in nature. Because a breach of fiduciary duty can only occur in connection with the performance of a fiduciary function, Northrop and the Committee could not be held liable for breach of fiduciary duty for delegating a task that did not serve a fiduciary function to Hewitt.
Richter v. Ausmus, No. 19-cv-08300-WHO, 2021 U.S. Dist. LEXIS 28673 (N.D. Cal. 2021) (unpublished). Plaintiff Julia Richter is a former employee of the Oakland Police Department, who alleged, among other things, that she was subjected to a wrongful investigation to prevent her from obtaining disability retirement benefits, which ultimately resulted in her termination. Plaintiff alleged that several parties breached their fiduciary duty to her related to their assessment of her disability benefits. While California courts have held that pension associations, their board members, and some other high-level administrators of pension funds owe a fiduciary duty to beneficiaries and employees applying for benefits, mere employees of the association or bureaucratic employees do not have a fiduciary relationship with the beneficiaries. Here, plaintiff alleged that the City of Oakland Retirement Commission was charged with the administration and management of the City of Oakland’s police retirement system. However, the evidence indicates that CalPERS is in fact the relevant pension association which accepted and rejected her application for disability benefits. Therefore, CalPERS and its board members are the relevant potential fiduciaries in this case. As a result, plaintiff’s claims against the City of Oakland, an Interim City Administrator for the City of Oakland, an attorney for the city of Oakland, a Finance Director assigned to Retirement Unit for the City of Oakland all fail, as none of these parties owe a fiduciary duty to plaintiff. In addition, plaintiff’s claims against an Associate Governmental Program Analyst at Disability Retirement, CalPERS; a member of Local Safety program at Disability Retirement, CalPERS; and an employee in the Special Programs Unit at Disability Retirement, CalPERS cannot stand, as the evidence suggests that these individuals are mere bureaucratic employees of CalPERS and do not owe a fiduciary duty to plaintiff.
Additional Cases of Note
Andreoli v. Youngevity Int’l, No. 3:16-cv-2922-BTM-JLB, 2021 U.S. Dist. LEXIS 207259 (S.D. Cal. 2021) (unpublished) (suggesting that all employees, regardless of whether they are managerial or lower-level, owe a duty of loyalty to their employers); Nat’l Union Fire Ins. Co. v. Lutge, No. 1:20-cv-01809 DAD JLT, 2021 U.S. Dist. LEXIS 99066 (E.D. Cal. 2021) (unpublished) (noting that an employer-employee relationship alone is not sufficient to create a fiduciary relationship between the parties); Tuomela v. Waldorf-Astoria Grand Wailea Hotel, No. 20-00117 JMS-RT, 2021 U.S. Dist. LEXIS 14862 (D. Haw. 2021) (unpublished) (acknowledging that there is no “general fiduciary relationship” between employers and their employees); Valmet Eng’g v. Subramanian, No. CV-19-00457-TUC-RCC (BGM), 2021 U.S. Dist. LEXIS 124760 (D. Ariz. 2021) (unpublished) (stating that an individual’s vague “association” with an entity that owes a fiduciary duty to a third party is not enough to create a fiduciary duty between the individual and that third party); Youngevity Int’l, Corp. v. Smith, No. 3:16-cv-704-BTM-JLB, 2021 U.S. Dist. LEXIS 53456 (S.D. Cal. 2021) (unpublished) (noting that the duty of loyalty that underlies California Business and Professions Code section 16600 applies to independent contractors and employees alike).
§ 1.2.11. Tenth Circuit
There were no qualifying decisions within the Tenth Circuit.
Additional Cases of Note
LS3 Inc. v. Cherokee Fed. Sols., L.L.C., 2021 U.S. Dist. LEXIS 186460 (D. Colo. 2021) (unpublished) (holding that there was no breach of the duty of loyalty since the duty only applied to active business opportunities, and the purported breach occurred after the business opportunity had ended)[12]; Smart Surgical, Inc. v. Utah Cord Bank, Inc., 2021 U.S. Dist. LEXIS 36563 (D. Utah 2021) (unpublished) (finding that a claim for aiding and abetting the breach of fiduciary duty cannot depend solely on the use of confidential customer information or it will be preempted by the UTSA).
§ 1.2.12. Eleventh Circuit
777 Partners LLC v. Pagnanelli, 2021 U.S. Dist. LEXIS 43976, at *7-9 (S.D. Fla. 2021): 777 Partners LLC sued its former CEO Pagnanelli for both breach of his employment contract and breach of fiduciary duty. The contract defined Pagnanelli’s fiduciary duties, and contained other restrictive covenants. Pagnanelli allegedly breached both the agreement and his fiduciary duties by engaging in self-dealing (through the solicitation of potential investors for a new startup) and sharing confidential information with individuals outside the company. Regarding the breach of fiduciary duty claim, the court found that 777 Partners LLC failed to state a claim because of the independent tort doctrine. The court relied on the fact that 777 Partners LLC’s complaint “incorporate[d] by reference the very same facts alleged in [the] breach of contract claim” to find that there was no independent conduct to support the breach of fiduciary duty claim. The court acknowledged that “there could be circumstances where the conduct forming a plaintiff’s breach of contract claim is different than the conduct that underlies a breach of fiduciary duty claim in the same complaint.” 777 Partners LLC’s claim, however, failed to show independent conduct demonstrating a breach of fiduciary duty. Consequently, it was barred by the independent tort doctrine.
§ 1.3. Restrictive Covenants: Covenants Not To Compete
§ 1.3.2. First Circuit
CVS Pharm. v. Brown, No. 21-070 WES, 2021 U.S. Dist. LEXIS 39688 (D.R.I. 2021)(unpublished). the Rhode Island District Court granted employee’s motion to transfer venue based on a lack of personal jurisdiction because employer failed to establish adequate “plus factors” to bolster a noncompete agreement’s choice of law provision.
Iorio v. Waste Connections of R.I., Inc., No. PC-2021-01558, 2021 R.I. Super. LEXIS 50 (Super. Ct. June 16, 2021)(unpublished). The Rhode Island Superior Court denied an employee’s application for a preliminary injunction to prohibit an employer from enforcing a noncompete agreement because the employee failed to establish that enforcement of the agreement would result in irreparable harm. There, the noncompete agreement required that, at the time of termination, the employee would be prohibited from working for a competing business within the geographical areas the employee had worked in the prior two years of employment for 18 months. In her application for injunctive relief, the employee argued that she had suffered irreparable harm through mental anguish she suffered during employment and her prolonged period of unemployment during the underlying action would also equate to irreparable harm. The court held that while evidence of mental anguish could be sufficient for a finding of harm, the mental anguish caused during her employment, which was not due to the enforcement of the noncompete, was not applicable for the purposes of injunctive relief. The court also held that the employee’s prolonged period of unemployment was not sufficient for a finding of irreparable harm when the purpose of a noncompete agreement is to restrict a former employee’s ability to work. Moreover, any loss of income would be a quantifiable claim for money damages, not injunctive relief.
Woodlands Senior Living LLC v. MAS Med. Staffing Corp., No. 1:19-cv-00230-JDL, 2021 U.S. Dist. LEXIS 96366 (D. Me. 2021) (unpublished) – the Maine District Court granted an employer’s motion for reconsideration and vacated a staffing corporation’s judgment on the pleadings because the order failed to address whether 1 M.R.S.A. § 302’s “non-application to pending proceedings” provision applied to the corporation’s underlying claim. There, the corporation sought relief under 26 M.R.S.A. § 599-B to bar the employer from enforcing a restrictive employment agreement. The question before the court was whether §599-B applied where an employer was attempting to enforce a restrictive employment agreement, but the enforcement action began prior to the statute’s enactment. 1 M.R.S.A. § 302 provides that actions and proceedings pending at the time of the passage of an Act are not affected thereby. Maine law has held that this rule is controlling absent clear and unequivocal language to the contrary. The court reasoned that because 26 M.R.S.A. § 599-B contained no explicit reference to section 302, or to “pending proceedings,” 1 M.R.S.A. § 302’s presumptive application was not overcome in this instance. Therefore, because there was no clear and unequivocal language indicating the Legislature sought to overcome §302, § 599-B did not bar the employer’s pending action to enforce the restrictive employment agreement against the staffing corporation.
§ 1.3.3. Second Circuit
IBM v. de Freitas Lima, 833 Fed. Appx. 911 (9th Cir. 2021). Rodrigo Kede de Freitas Lima signed a noncompete with IBM in December 2019. The noncompete, which was limited to a 12 month period, prohibited Lima from working for a competitor. In May 2020, Lima resigned from IBM and accepted an executive position at Microsoft. The district court enjoined Lima from taking the position at Microsoft, reasoning that the noncompete was reasonable under the circumstances. The court found that IBM successfully demonstrated that Lima would inevitably rely on IBM trade secrets when working in his new role at Microsoft. The Second Circuit affirmed this ruling. Because the Second Circuit has rarely reviewed injunctions enforcing such noncompetes under New York law, the case is of high precedential value. It is especially relevant for employers seeking to enjoin high-level executives from working for competitors, when the individual has been exposed to trade secrets.
§ 1.3.4. Third Circuit
Chromalox, Inc. v. Crombie, 2021 U.S. Dist. LEXIS 120745 (W.D.Pa 2021) (unpublished). Crombie was Chromalox’s former Vice President of heat trace for over two decades, which encompassed the “highest level of responsibility in the company for the entire heat trace segment on a global scale,” with heat trace comprising 25% of Chromalox’s sales and 35% of its profits. In 2017, upon Chromolox’s acquisition by new parent company Spirax, Crombie was induced by higher base pay and a new stock option program to sign Spirax’s employment agreement featuring confidentiality, non-competition, and non-solicitation provisions. In 2019 after indicating a pursuit of a career in music, Crombie resigned from Chromolox. The court found by a preponderance of the evidence that Crombie then first attempted to secure employment with Chromolox competitor Bartec, who did not advance an offer due to concerns about the restrictive covenants. Thereafter, Crombie successfully attained employment with Chromolox competitor Indeedco, and he was the architect of their new Heat Trace division, where 75% of new sales opportunities targeted were former Chromolox customers; proprietary technology that had not yet gone to market was stolen; and strategy and training presentations were plagiarized word for word from confidential Chromolox templates. The court granted an eight month preliminary injunction upholding the Spirax employment agreement’s restrictive covenants, which applied globally, as reasonable based on Crombie’s knowing breach thereof given the global nature of his role and of Chromolox and Indeedco’s business. Thus, in enjoining Crombie’s further employment at Indeedco, the court noted that the harm to Crombie was minimal, as he knew or should have known that he was violating the covenants based on the concerns expressed by Bartec.
Ethicon, Inc. v. Randall, 2021 U.S. Dist. LEXIS 102119 (D. N.J 2021) (unpublished). Randall worked for two entities wholly-owned by Johnson and Johnson’s medical device division – first DePuy Synthes, and then Ethicon – before resigning to join competitor Smith and Nephew. As part of assuming a senior leadership role at DePuy, Randall signed an employment agreement containing restrictive covenants preventing Randall from joining a competitor for 18 months. Critically, the agreement carved out the type of work that Randall could do, the terms by which Randall could work for a ‘competitor’ in a non-competitive position or other roles, and a requirement that Randall give 14 written days notice before undertaking such employment. In granting the preliminary injunction preventing Randall from working at Smith and Nephew for 18 months (on a global scale), the court held that Ethicon was properly viewed as a third party beneficiary to the employment agreement between Randall and DePuy based on the agreement’s express language; therefore, Ethicon could enforce the agreement against Randall. Moreover, the scope of the injunction was reasonable given the global nature of both Ethicon and Smith and Nephew’s business, the fact that not all employment was foreclosed to Randall, and the fact that Randall clearly acquired Ethicon’s confidential information as he admitted to forwarding certain information to his personal email before resigning. The court took stock further in Smith and Nephew’s offer to pay Randall’s base salary during the pendency of the injunction, which made the 18 month scope even less of a hardship on Randall. Lastly, although Randall technically failed to comply with the notice provision, the court gave weight to Ethicon’s attempts to place Randall in another position after he gave the deficient ‘notice’ (verbally and in an email noting he was joining the competitor); thus, the injunction would not impose undue harm upon Randall, especially given his voluntary resignation.
Additional Cases of Note
Jackson Hewitt Inc. v. Njoku, 2021 U.S. Dist. LEXIS 87407 (D.N.J 2021) (unpublished) (individual tax preparation franchising agreement gone sour where after franchising agreement was terminated, franchisee utilized his wife, who was really a nurse, to surreptitiously create a new ‘e-filing number’ whereby franchisee operated competitive tax business within 10-mile radius of former Queens, NY franchise location; questioning franchisee’s unauthorized retention of franchisor’s customer records and suspiciously-high, unexplained 60% customer retention rate; and concluding that high retention rate, along with alternative income sources, indicated that franchisee and relatives would not be harmed by enforcement of equitably-adjusted 18-month covenants not to compete and/or solicit franchisor’s customers).
§ 1.3.5. Fourth Circuit
Ihs Global Ltd. v. Trade Data Monitor, LLC, 2021 U.S. Dist. LEXIS 101952 (D.S.C. 2021) (applying New York law) (unpublished). IHS Global owns and operates Global Trade Atlas (GTA), a database providing comprehensive merchandise trade statistics. GTA was created by defendant Brasher and his brother through Global Trade Information Services (GTIS), which they sold, along with GTA, to IHS through a stock purchase agreement (SPA) that prohibited Brasher and his affiliates from using any confidential information or proprietary information related to GTIS, including GTA, for three years. Brasher also entered into a noncompetition agreement (NCA) with IHS in which he agreed that he and his affiliates would not “carry on a business that is competition to the Business” for the same three year period. After the sale of GTIS, Brasher worked as a consultant with IHS and entered into a consulting agreement that prohibited the use of IHS’s confidential and proprietary information. Defendants Stein and Stringfield also worked for GTIS, and then IHS after the acquisition, at which time they executed employment agreements with IHS that prohibited the use and disclosure of any of IHS’s proprietary information. Approximately 15 months after the acquisition of GTIS, Brasher began developing the Trade Data Monitor Production (TDM Product), which plaintiff alleges is a copycat version of the GTA, and then formed defendant Trade Data Monitor (TDM). Shortly thereafter, Stein and Stringfield terminated their employment with IHS and began working for Brasher. Also, still within the three year noncompete period, Brasher’s friend purchased a subscription to GTA through which Brasher and TDM frequently accessed GTA. During this time, Brasher also had access to his work laptop with GTIS’s customer relationship database, while Stein and Stringfield had access to a large volume of emails from their time at GTIS, although the parties dispute whether defendants actually relied upon any of this information in building and marketing the TMD Product, which they launched the day after the three year noncompete period ended. IHS alleges that defendants used IHS’s product, supplier, customer trade secrets and proprietary information to create the TDM Product and that they have been using IHS’s confidential customer information to create business for TDM. The parties filed competing motions for partial summary judgment. The court denied both motions as to IHS’s claim that Brasher breached the NCA because determination of whether Brasher’s conduct, which he describes as merely preparations to compete, is prohibited by the NCA requires interpretation of the NCA and the phrase “carry on a business that is a competitive to the Business” is ambiguous as to what it prohibits. The court also found that the raw trade data and customer contacts are protected under the relevant agreements and found that Brasher, Stein, and Stringfield breached the SPA and employment agreements because it was undisputed that Brasher and TDM employees used the confidential trade data output from the GTA in developing the TDM Product. The court disagreed with defendants’ argument that, although the evidence demonstrated that they obtained access to certain confidential and proprietary information, the evidence does not demonstrate that they ever used the information to build and market the TDM Product. The court noted that obtaining, accessing, utilizing and sending confidential and proprietary information are, in themselves, prohibited “uses” and “disclosures” of that information, which is sufficient for purposes of determining whether the relevant contracts were breached.[13]
Additional Cases of Note
ADESA, Inc. v. Lewis, 2021 U.S. Dist. LEXIS 10422 (W.D. Va. 2021) (applying Tennessee law) (unpublished) (denying request for a preliminary injunction due to a lack of clear showing that the action seeking to enforce a noncompete agreement against a former employee and his new employer is likely to succeed on the merits given questions of enforceability of the agreement under Tennessee law because the agreement was imposed after six years of employment and with only a few months of remaining employment leading to a level of financial uncertainty that likely outweighed plaintiff’s need for protection, among questions regarding the sufficiency the evidence presented regarding the training received by the employee and the justification for the restrictions); Chmura Econs. & Analytics, LLC v. Lombardo, 2021 U.S. Dist. LEXIS 143009 (E.D. Va. 2021) (unpublished) (finding, in response to cross motions for summary judgment, that the noncompetition and nonsolicitation provisions in defendant’s employment agreement with plaintiff are invalid, but severable, because the companies for whom he is restricted from working and the scope of prohibited activities are so broad that “Lombardo would seem to be forced to switch fields entirely,” which was compounded by a lack of meaningful geographic limitation); ComRent Int’l, LLC v. Smidlein, 2021 U.S. Dist. LEXIS 13715 (D. Md. 2021) (applying Maryland law) (unpublished) (denying defendants’ motion to dismiss for failure to state a claim and finding that plaintiff asserted a plausible claim that the restrictive covenants in its agreement with defendant were reasonably related to its legitimate interest given that it alleged that defendant was a highly compensated senior sales executive responsible for overseeing development of customer relationship and who was provided with confidential business records and noting that although the provisions were in some ways broad, such as a broad geographic scope, it was not obviously unreasonable)[14];. Gordon v. Blue Mountain Therapy, LLC, 2021 U.S. Dist. LEXIS 105432 (W.D. Va. 2021) (unpublished) (denying as premature plaintiff’s motion to dismiss defendant’s counterclaim alleging that plaintiff violated the restrictive covenant in his employment agreement because determining enforceability of the restrictive covenant may not be determined in a “factual vacuum” and discovery had not yet occurred)[15]; Richards Bldg. Servs., LLC v. Hegarty, 2021 U.S. Dist. LEXIS 143660 (E.D.N.C. 2021) (unpublished) (granting plaintiff’s unopposed motion for preliminary injunction and finding that plaintiff has a strong likelihood of success on the merits based on the court’s findings that the restrictive covenants in defendant’s employment agreement were in writing and based on valuable consideration in the amount of $2,000, apart from his wages, for signing the agreement, and that the restrictive covenants were designed to protect plaintiff’s legitimate business interests and the restrictions are reasonable as to time and territory because a two years and radius of 30 miles is reasonable based on North Carolina law, and plaintiff has made a showing that defendant breached the restrictive covenants, in addition to finding that plaintiff will suffer irreparable injury if defendant is not enjoined).
§ 1.3.6. Fifth Circuit
Additional Cases of Note
Chags Health Info. Tech. v. Rr Info. Techs., 2021 U.S. Dist. LEXIS 126855, at *9 (E.D. La. May 7, 2021) (denying plaintiff’s motion for entry of temporary restraining order against defendant due to breach of the noncompete agreement, because “the triple-layered hearsay offered” by plaintiff was inadequate, in light of defendant’s adamant denial, to establish that plaintiff was likely to prove that defendant was working with a competitor to compete with plaintiff).[16]
Champion Nat’l Sec., Inc. v. A&A Sec. Grp., LLC, U.S. Lexis 70918, at *18 (N.D. Tex. Apr. 13, 2021) (entering a limited temporary restraining order against defendants due to working for a competitor and breaching the restrictive covenants in their employment agreement, because the covenants were reasonable in time and scope and were reformed by the court so that the agreement was “limited to the geographic territory in which the employee worked and where the new company ha[d] an office”).
Delta Fuel Co. v. Abbott, 515 F. Supp. 3d 564, 571 (W.D. La. 2021) (granting plaintiff’s motion to dismiss or for summary judgment regarding the noncompetition agreement because its restrictive covenant impermissibly extended the agreement beyond the two-year period from termination stipulated by La. Rev. Stat. § 23:921).
EHO360, LLC v. Opalich, U.S. Lexis 137338, at *18 (N.D. Tex. July 23, 2021) (denying defendant’s motion to dismiss plaintiff’s claims for breach of contract on the ground they hinged on events that occurred after termination of the noncompete and nonsolicitation covenants, because “the court lack[ed] the evidence and briefing necessary to determine whether the covenants were tolled”).[17]
JTH Tax, LLC v. Johnson, No. 21-747, 2021 U.S. Dist. LEXIS 108769, at *10 (E.D. La. June 10, 2021) (applying Virginia law) (granting a preliminary injunction to enforce a non-competition covenant for a franchise agreement prospectively from the date of the injunction rather than the date the franchise agreement was terminated).
Morris-Shea Bridge Co. v. Cajun Indus., No. 3:20-cv-00342, 2021 U.S. Dist. LEXIS 173783, at *15 (S.D. Tex. Feb. 22, 2021) (denying plaintiff’s preliminary injunction to enforce non-compete agreement, finding that the agreement’s geographic restraint was too broad given that the multi-state restriction effectively prevented defendants from earning a livin wage in their profession).[18]
People Source Staffing Prof’ls LLC v. Robertson, 2021 U.S. Dist. LEXIS 95665, at *11-12 (W.D. La. May 19, 2021) (granting defendant’s motion for summ(ary judgment regarding the noncompetition agreement because “(1) it extends the provision to ’employees’ of competing businesses, and (2) it extends its provisions to [plaintiff]’s business on the date the agreement is signed, and to other businesses that [plaintiff] ‘from time to time’ enters into during the time [defendant] is an employee,” rendering the provision null and void and severed from the agreement).[19]
Providence Title Co. v. Truly Title, Inc., 2021 U.S. Dist. LEXIS 123502, at *22, 31 (E.D. Tex. July 1, 2021) (granting Providence’s request for a preliminary injunction against Defendant Tracie Fleming due to working for a competitor, breaching the noncompete provision in her shareholders’ agreement, because (1) as a departing shareholder, the process of repurchasing her shares has begun and (2) the noncompete is enforceable because “Providence is likely to establish that the activity, time, and geographical limitations of the noncompete are reasonable”).
Southeastrans, Inc. v. Landry, 2021 U.S. Dist. LEXIS 48318, at *16 (W.D. La. Mar. 15, 2021) (granting defendant’s motion for summary judgment regarding the nonspecific noncompetition agreement claim because La. Rev. Stat. § 23:921 “requires a specific listing of every parish in which an employer intends to restrict competition and in which that employer carries on a business for an agreement not to compete or to solicit customers to be valid and enforceable”).[20]
Volt Power, LLC v. Deville, 2021 U.S. Dist. LEXIS 76354, at *11-12 (W.D. La. Apr. 20, 2021) (denying defendant’s motion to dismiss plaintiff’s claims on the ground they hinge on invalid noncompetition and nonsolicitation agreements because (1) the “provisions do not, from the face of the pleadings, fail the ‘mechanical adherence’ standard required by § 23:921(C), notwithstanding their placement in an informed consent letter” and (2) plaintiff’s attorney complied with her obligations under Louisiana Rule of Professional Conduct 1.7 “by explaining the fundamentals of informed consent [letters], including the risks and consequences of waiving attorney-client privilege, and by obtaining [defendant’s] written consent to joint representation,” evidencing public policy supported the use of informed consent letters).
§ 1.3.7. Sixth Circuit
Additional Cases of Note
Abington Emerson Cap. v. Adkins, 2021 U.S. Dist. LEXIS 53083 (S.D. Ohio 2021) (rejecting defendants’ summary judgment motion which contended that only the subsidiary company could be vicariously liable for an employee’s negligence because the non-compete the employee signed with the parent company helped create a genuine dispute about how had the right to control the employee); Advance Wire Forming, Inc. v. Stein, 2020 US. Dist. LEXIS 153940 (N.D. Ohio 2020) (ruling that the defendant did violate the non-compete provision he had with the plaintiff by gaining proprietary information from plaintiff and sharing it with others.); AmeriSpec, L.L.C. v. Sutko Real Estate Servs., 2020 U.S. Dist. LEXIS 121040 (W.D. Tenn. 2020) (granting a motion for a preliminary injunction seeking to enforce a non-compete after determining the plaintiff would suffer irreparable harm to its reputation and customer goodwill if the defendants were allowed to continue competing in plaintiff’s market and using its name and clients to do business); Auto Konnect v. BMW of North America, 2021 U.S. Dist. LEXIS 105812 (E.D. Mich. 2021) (granting summary judgment to a plaintiff over the breach of a non-compete and holding that the defendant was required to obtain written consent to hire plaintiff’s employees); Cocentrix CVG Customer Mgmt. Grp. Inc. v. Daoust, 2021 U.S. Dist. LEXIS 83830, at *25 (applying Ohio law) (explaining the nine factors courts consider to determine the reasonableness of non-compete agreements); ComForCare Franchise Sys. v. ComForCare Hillsboro McMinnville Corp., 815 F. App’x 80 (6th Cir. (Mich.) 2020) (affirming a lower court decision to grant only partial injunctive relief to a plaintiff based on the defendant’s violation of a non-compete clause and holding that a court’s decision to grant injunctive relief is discretionary and bound by case law, no the parties’ contract); D.M. Rottermond, Inc. v. Shiklanian, 2021 U.S. Dist. LEXIS 53570 (E.D. Mich. 2021) (granting a temporary restraining order to a plaintiff in a non-compete case because the defendant was in direct competition with the plaintiff’s jewelry business and the geographic scope and the length of the restriction were reasonable); Dawson v. Assured Partners, NL, 2021 U.S. Dist. LEXIS 88555 (S.D. Ohio 2021) (holding that violation of an employment contract and non-compete clause is not per se severe enough behavior to establish the after-acquired evidence defense in a discrimination suit); I Love Juice Bar Franchising, LLC v. ILJB Charlotte Juice, LLC, 2020 U.S. Dist. LEXIS 146295 (M.D. Tenn. 2020) (granting a preliminary injunction after it found that the defendants violated these non-compete provisions by running a competing business with the plaintiff and using similar trademarks and trade names as plaintiff); Jannx Med. Sys. v. Agiliti, Inc., 2020 U.S. Dist. LEXIS 237184, 2020 U.S.P.Q.2D (BNA) 11506, 2020 WL 7398795 (explaining a restrictive covenant provision indefinitely prohibiting a former employee from contacting the former employer’s clients “is categorically unreasonable”); JTH Tax, Inc. v. Magnotte, 2020 U.S. Dist. LEXIS 131921 (E.D. Mich. 2020) (holding that the defendants had violated the non-compete provisions of the Franchise Agreement after terminating their franchise with the plaintiff by operating a tax business within 25 miles of plaintiff’s business and continuing to use the plaintiff’s confidential information to their business.); Konica Minolta Bus. Sols. U.S.A., Inc. v. Lowery Corp., 2020 U.S. Dist. LEXIS 120082 (E.D. Mich. 2020) (holding that a non-compete provision was valid because it was reasonable in time and geographic scope); LinTech Global, Inc. v. Can Softtech, Inc., 2021 U.S. Dist. LEXIS 49958 (E.D. Mich. 2021) (holding that a defendant’s motion to dismiss plaintiff’s tortious interference claim was not barred because, even if the underlying facts were indistinguishable from a breach of contract claim, the legal duties owed under each claim were different); Prudential Def. Solutions v. Graham, 2020 U.S. Dist. LEXIS 253437 (E.D. Mich. 2020) (denying injunctive relief because the plaintiff did not show sufficient factual support that it would suffer irreparable harm as the plaintiff only pled “information and belief” and not personal knowledge of the facts); RECO Equip., Inc. v. Wilson, 2020 U.S. Dist. LEXIS 218410, 2020 U.S.P.Q.2D (BNA) 11391, 2020 WL 6823119 (explaining a restrictive covenant provision prohibiting competition for 36 months is not per se unreasonable); Seaman Corp. v. Flaherty, 2020 U.S. Dist. LEXIS 161635 (N.D. Ohio 2020) (holding a 24-month, national non-compete provision as reasonable and finding that the defendant had violated the non-compete provision); Union Home Mortg. Corp. v. Jenkins, 2021 U.S. Dist. LEXIS 93872 (N.D. Ohio 2021) (unpublished) (emphasizing that even if a non-compete agreement is overbroad, the court will still enforce the agreement to the extent necessary to protect the employer’s interests).
§ 1.3.8. Seventh Circuit
HCC Cas. Ins. Servs. v. Day, 2021 U.S. Dist. LEXIS 57433 (N.D. Ill. 2021) (unpublished) (applying Illinois law). Plaintiff HCC Casualty Insurance Services, Inc. brought a breach of contract suit against Day, its former president, claiming that Day violated certain restrictive covenants in his employment agreement. Plaintiff sought monetary and injunctive relief. The dispute arose out of Day’s employment agreement with plaintiff, which was originally effective through April 30, 2019, but which was amended and extended through April 30, 2020. The agreement contained three restrictive covenants around confidentiality, noncompetition, and nonsolicitation. The confidentiality restrictive covenant included plaintiff’s “trade secrets” within the information that Day was supposed to keep confidential. On May 2, 2020, two days following the expiration of his employment agreement with plaintiff, Day resigned from his position as plaintiff’s president. Shortly thereafter, Day then joined another insurance underwriter as its president. Plaintiff claimed that Day violated his previous employment agreement by hiring nine employees from plaintiff, disclosing plaintiff’s trade secrets to his new company, and directly competing with plaintiff. Day filed a motion to dismiss plaintiff’s claims for failure to state a claim. As to the noncompete and nonsolicitation provisions, Day argued that he was not obligated to adhere to those provisions because the employment agreement expired on April 30, 2020, and therefore, when he resigned on May 2, 2020, he was an at-will employee not covered under the agreement. The court rejected this argument, holding that the covenants began to run upon the expiration of the agreement on April 30, 2020. The court said that although Day was not terminated during the “term of employment,” the agreement did not contemplate any employment past the employment agreement’s term. Therefore, Day’s employment was terminated upon the expiration of the employment agreement, and he was bound by the noncompete and nonsolicitation provisions.
Day also argued that the restrictive covenants were overbroad and unenforceable. As to the noncompete provision, Day argued that, if enforced, it would prevent him from working in any capacity at a competing business. The noncompete provision prohibited Day from “engag[ing] in or contribut[ing] [his] knowledge or Confidential Information to any work which is competitive with or similar to a product, process, apparatus, service, or development on which you worked or with respect to which you had reviewed Confidential Information.” The court disagreed that the clause was overbroad in scope, and using Day’s example, said that Day would not be prohibited from taking a job as a janitor at a competitor because that “work” is not “competitive with or similar to” the work he conducted with plaintiff. As to the geographic scope of the noncompete clause, the court held that although the scope was broad in that plaintiff did business in 180 countries, it would give plaintiff time to develop the record and establish why such breadth was needed.[21]
Additional Cases of Note
Conrad v. Jimmy John’s Franchise, LLC, 2021 U.S. Dist. LEXIS 142272 (S.D. Ill. July 23, 2021) (unpublished) (denying certification whereby class members claimed that a “No-Poach Provision” in Jimmy John’s Franchise Agreement that effectively prohibited employees from switching between rival locations stifled competition for labor in violation of the Sherman Act, finding that individualized inquiries regarding whether a given employee could have been injured by the Provision given the varied and dynamic labor markets across the country precluded satisfaction of the predominance requirement).
Fountain v. Zimmer Inc., 2021 U.S. Dist. LEXIS 96340 (N.D. Ind. 2021) (unpublished) (applying Indiana law) (granting defendants’ motion for summary judgement as to plaintiff’s allegation that defendants breached a confidentiality, noncompetition, and nonsolicitation agreement by failing to pay plaintiff his noncompetition period payments where court found that plaintiff did not meet the contractual requirements for those payments)[22]; Hartford Steam Boiler Inspection & Ins. Co. v. Campbell, 2021 U.S. Dist. LEXIS 62332 (S.D. Ind. 2021) (unpublished) (applying Connecticut law) (granting defendants’s motion to dismiss for failure to state a claim as to plaintiff’s allegation of breach of noncompete agreement where agreement imposed nationwide ban on defendants and where complaint did not provide sufficient facts to justify the breadth of that geographic scope)[23].
Shaw v. First Communs., LLC, 2021 U.S. Dist LEXIS 7451, at *19, 22-23, 44-45 (N.D. Ill. Jan. 14, 2021) (holding that (1) plaintiff’s claim for a declaratory judgment clearly fell within the noncompetition and confidentiality provisions in the Employment Agreement’s arbitration provision signed by plaintiff and was therefore subject to arbitration; (2) plaintiff’s claim for breach of contract under the Separation Agreement was subject to arbitration because the agreement effectively incorporated relevant portions of the Employment Agreement’s arbitration provisions; and (3) the arbitration provision was enforceable because it was not procedurally or substantively unconscionable due to the employer’s inability to bypass arbitration and seek judicial remedies in court).
§ 1.3.9. Eighth Circuit
CRST Expedited, Inc. v. Swift Transp. Co. of Ariz., LLC, 8 F.4th 690 (8th Cir. (Iowa) 2021). CRST and Swift are competing long-haul trucking companies. To help combat a shortage of drivers, CRST offers to pay the cost of a driver training program in exchange for the drivers entering into a driver employment contract, which includes a noncompete clause prohibiting the driver from providing trucking services to a competitor for a certain restrictive term depending on their length of employment. This provision would immediately lapse upon payment of a termination fee. Swift recruited drivers through generalized advertisements that required the potential divers to initiate contact with Swift. When Swift verified prior employment of a CRST driver who had not completed the restrictive term, CRST would notify Swift that the driver was under contract with CRST and was not released from those contractual obligations. In 2016, Swift began hiring even if it received such a contract notice. The issue was whether Swift’s hiring of CRST drivers during the restrictive term could serve as the basis of an interference with the driver employment contract under Iowa law. The court held that it could not, reasoning that inducing a diver to work for Swift was not incompatible with the noncompete clause because the driver could pay CRST the termination fee before driving for Swift. To prevail on its interference claim, CRST must prove that Swift caused drivers not to pay the termination fee.
Perficient, Inc. v. Munley, 2021 U.S. Dist. LEXIS 72506 (E.D. Mo. 2021) (unpublished).Perficient provides consulting and business implementation services for software offered by companies such as Salesforce. Munley was a vice president of field operations at Perficient, overseeing multiple groups including the Salesforce practice. In that role, he had substantial access to confidential information regarding strategy and key customers, including Salesforce. He also spearheaded an effort to prioritize development of a Salesforce Configure, Price, Quote (CPQ) product line. This effort included potential acquisitions of CPQ businesses, re-assignment of key personnel to focus on CPQ, and a presentation of senior Perficient leadership identifying CPQ as an area of development. After being terminated by Perficient, Munley joined Spaulding Ridge as a partner and Salesforce group leader, where he would focus on obtaining referrals from Salesforce, primarily for CPQ. Salesforce is Spaulding’s second largest practice, and CPQ accounts for 95% of that business. The parties moved for summary judgment. At issue was the competitive duties provision of Munley’s noncompetition agreement with Perficient that prohibited him from engaging in any work on behalf of a competing business relating to a competitive product or service. The court found that the provision was enforceable in light of Munley’s role at Perficient because it was limited to duties that are substantially similar to Munley’s responsibilities at Perficient, or involve strategic leadership of a competing company. The 24 month duration of the provision was longer than necessary, and limited to 12 months by the court. The court found that the unlimited geographic scope of the provision was appropriate given the global nature of the software industry and Perficient’s customer relationships around the world. The court ultimately concluded that Munley’s work at Spaulding beached the competitive duties provision. The court further explained that Munley has established relationships with individuals inside Salesforce – with whom he discussed CPQ – and those relationships could be leveraged to Perficient’s detriment while at Spaulding. The court stated that this is the harm the competitive duties provision sought to prevent. See Section 1.6.9 for a summary of the court ruling on the issue of damages.
Perficient Inc. v. Gupta, 2021 U.S. Dist. LEXIS 124893 (E.D. Mo. 2021) (unpublished). Gupta was a principal for Perficient’s order management systems (OMS) practice and left to join a competitor, Blue Yonder, as a vice president also working in OMS solutions. Gupta then contacted one or more of Perficient’s clients with whom he previously dealt while a Perficient employee, including Sally Beauty. Gupta offered competing products and services to Sally Beauty on behalf of Blue Yonder. Perficient moved for, and the court granted a comprehensive TRO enforcing restrictive covenants in its agreements with Gupta, including two year employee and customer non-solicit covenants; a NDA for confidential, proprietary and trade secret information; and a noncompete prohibiting Gupta from performing competitive duties for a business offering similar products or services for two years following his separation from the metropolitan areas in which Perficient offers its products or services. The court found that Perficient demonstrated a likelihood of success on the merits because the restrictive covenants were each were narrowly tailored to keep Perficient’s information secret and retain a competitive advantage, were reasonable in scope because Gupta was a high level and highly compensated executive, the noncompete covenants were for a reasonable time period, and the geographic scope was readily enforceable under Missouri law. The court also found that Gupta would inevitably disclose Perficient’s trade secrets if he was permitted to continue to perform competitive work at Blue Yonder because the nature of his responsibilities at Blue Yonder are akin to those he held for Perficient, and his work requires his consideration of Perficient’s trade secrets and confidential information in the faithful performance of his duties. The court found that Perficient would be subject to immediate and irreparable harm if Gupta was permitted to continue to solicit Perficient’s clients and offer competitive services on behalf of Blue Yonder. Significant to the court’s finding was the statement in the noncompete agreement that a breach would result in irreparable injury and damage to Perficient. The balance of harms favored Perficient because Gupta was only prohibited from duties that are in direct competition with Perficient. The balance of equities favored Perficient because Blue Yonder’s products and services would still be publicly available, and Perficient would suffer irreparable harm without an injunction.
Pitts v. Fire Extinguisher Sales & Servs. of Ark. LLC, 2021 U.S. Dist. LEXIS 117528 (E.D. Ark. 2021) (unpublished). Fire suppression technician Pitts worked for FESSAR, which is in the business of servicing and installation of fire suppression systems. Pitts entered into a noncompetition agreement during his employment at FESSAR where he agreed not to work for or have any ownership interest in an entity that engages in the sale and service of fire extinguishers for two years after the date of his termination within a 150 mile radius of Pine Bluff, Arkansas. Pitts left FESSAR, started his own company, Rapid Action Protection, within the prohibited territory, and began servicing two of FESSAR’s customers. FESSAR sought a TRO enforcing the noncompete. Applying Arkansas common law, the court found that the noncompete was likely enforceable because (1) FESSAR had a valid protectable interest in its customer lists, customer prices, and quotes, (2) Pitts did not challenge the two year time limit, and (3) even though portions of the non-compete were overly broad, the contract contained a severability clause and a reformation clause permitting the court to modify the noncompete if any provisions were found invalid or unenforceable because the scope, duration, or area were too broad or excessive. The court entered a TRO enjoining Pitts from operating Rapid Action Protection within the 150 mile radius. However, because FESSAR did not do business in Louisiana or Tennessee, Pitts was permitted to operate in those states (including within the 150 mile radius) as long as such business did not operate in Arkansas or Mississippi with the 150 mile radius. See 18.5.9 for a summary of the court’s ruling on the issue of trade secret misappropriation.
Powerlift Door Consultants, Inc. v. Shepard, 2021 U.S. Dist. LEXIS 129189 (D Minn. 2021) (unpublished). Powerlift, a hydraulic-lift-door company, entered into a distribution agreement with Rearden Steel, a Powerlift licensee owned by Lynn Shepard. In April 2021, Shepard sent an email to at least 12 Powerlift licensees seeking support to fix what Shepard considered corporate and product-related issues with Powerlift, including a change from a licensee-based system to a franchise-based system. Powerlift terminated the agreement because of statements made in the email. Defendants continued to use Powerlift’s trademarks, and sell products represented to be affiliated with Powerlift. Powerlift moved for a TRO and preliminary injunction enforcing, inter alia, a three year noncompete clause in the distribution agreement. Powerlift argued that the duration of the noncompete was reasonable because Shepard operated as a Powerlift licensee since 2014, built a customer base using Powerlift’s trademarks and confidential information, time is needed to separate customers’ association of Shepard with the Powerlift brand, and the email demonstrated an intent to compete with Powerlift. Shepard argued that the duration should be three months because it was “too restrictive”, but provided no further explanation. The court declined to modify the three year duration, and found that defendants breached the noncompete clause. Based primarily on defendants’ use of Powerlift’s trademarks, the court found that irreparable harm, balance of harms, and the public interest factors weighted in favor Powerlift, and granted the preliminary injunction.
Right at Home, LLC v. Gaudet, 2021 U.S. Dist. LEXIS 16832 (D. Neb. 2021) (unpublished, applying Alabama law). Right at Home, LLC, a franchise business for in-home care for elderly or infirm individuals, entered into franchise agreements with defendants to operate Right at Home franchises in two Alabama territories. The agreements contained noncompete provisions prohibiting defendants from being employed by any business that engaged in the services and business of Right at Home for one and a half years within a ten mile radius of the franchise territory. In November 2020, Right at Home terminated the agreements because defendants were operating off the books. Defendants then took steps to start a new home-care business independent from the Right at Home brand. Defendants closed one of their offices, but continued to operate a home-care business at its other office under the name Gulf Coast Care, serving the same clients, with the same referrals, and the same phone number as their former Right at Home franchised business. Right at Home sued, and sought a preliminary injunction enforcing the noncompete. Although enforceability of the noncompete was not challenged by defendants, the court found that it was the sort of partial restraint permitted under Alabama law, and was reasonable as to time and geographical range. The court also found that the balance of harms weighs in favor of Right at Home because it will be difficult to find a new franchisee with the defendants operating in the territory, and Right at Home’s reputation and goodwill has been damaged by defendants’ breach. The court found that public interest in protecting the right to contract would be served by issuing an injunction, and granted the preliminary injunction.
Ronnoco Coffee, LLC v. Castagna, 2021 U.S. Dist. LEXIS 41707 (E.D. Mo. 2021) (unpublished). Ronnoco, a seller and distributor of coffee, employed Castagna as a territory manager in Texas, and Torres as a territory manager in California. As a condition of their employment, defendants signed a fair competition agreement prohibiting them from working with a Ronnoco competitor for two years after the termination of their employment within 200 miles of any of their work locations. The defendants left Ronnoco and started working for Smart Beverage, a seller of frozen fruit juice beverages. Ronnoco sued and sought a TRO. With respect to choice of law, the court applied the agreement’s Missouri choice of law provision, and rejected application of California and Texas law. The court found that the noncompete provision was enforceable because it protects Ronnoco’s confidential information, customer contacts, goodwill, and its interest in preventing defendants from unfairly competing, and it was adequately restricted in time and geographic reach. Defendants argued that Smart Beverage did not compete with Ronnoco because it did not sell juice beverages. The court rejected this argument because Ronnoco had an 80% ownership interest in Trident Holdings, a seller of juice beverages. The court concluded that Ronnoco was engaged in the business of selling juice beverages, and defendants breached the non-compete by working for Smart Beverage. In granting the TRO, the court found that because defendants were exposed to Ronnoco/Trident’s customer list, customer contracts, and confidential information such as pricing an bid strategy, their use and disclosure of such information appeared inevitable because their responsibilities at Smart Beverage are similar to those they held for Ronnoco/Trident, and they are likely to be in situations were their knowledge of Ronnoco/Trident’s confidential information would help Smart Beverage in competing against Ronnoco/Trident.
United Healthcare Servs. v. Louro, 2021 U.S. Dist. LEXIS 32385 (D. Minn. 2021) (unpublished). Louro was United Healthcare’s vice president of underwriting in its nation accounts segment, which gave him responsibility over pricing for United’s national accounts, overseeing the Aon/Hewitt health exchange, and specialty businesses. Louro’s stock options and restricted stock units contract included a noncompete clause that prohibited Louro from “[e]ngag[ing] in or participat[ing] in any activity that competes, directly or indirectly, with any Company activity, product, or service that [Louro] engaged in, participated in, or had Confidential Information about during [Louro’s] last 36 months of employment with the Company” for one year after his termination. Louro resigned and joined Anthem as a vice president of local accounts underwriting, which is a corollary to United’s key accounts segments. Louro disclosed the noncompete to Anthem, and his position was specifically structured not to overlap with business segments Louro work with at United. United sued and sough a preliminary injunction enforcing the noncompete. United argued that Louro could only work in healthcare or underwriting without violating the restriction if he works on Medicare and Medicaid products, and is insulated from all other business segments. The court found that United’s interpretation of the noncompete was broader than reasonably necessary to protect its business, and is not supported by the balance of the equities. In denying United’s request for an injunction, the court also relied on Anthem’s representation that Louro’s new position would not provide any services for or use any confidential information related to Anthem’s nation accounts segment, and that Louro will not work on the Aon/Hewitt exchange, or in the specialty and public sector segments. See §8.5.9 for a summary of the court’s ruling on the issue of trade secret misappropriation.
§ 1.3.10. Ninth Circuit
Houserman v. Comtech Telcoms. Corp., No. 2:19-CV-00336-RAJ, 2021 U.S. Dist. LEXIS 20885 (W.D. Wash. 2021) (applying Maryland law). Plaintiff Lynne Houserman served as the Senior Vice President and General Manager of the Safety and Security Technologies Group (SST Group) at TCS, a provider of advanced communication solutions for governmental and commercial customers. When TCS was acquired by Comtech, she was promoted to President of the SST Group, where she was responsible for emergency call routing and handling services. While her employment agreement with Comtech did not include a noncompete provision, her agreement with TCS did. Plaintiff was eventually terminated for cause, and several months later, she was hired by Motorola to serve as a Vice President overseeing Motorola’s emergency call handling business. TCS then filed suit against plaintiff, alleging, among other things, that she breached the noncompete provision in her employment agreement. The noncompete provision stated that for a period of one-year, plaintiff shall not “own, manage, operate, join, control or participate in the ownership, management, operation or control of a Competitor” nor “become a director, officer, employee, consultant or lender of, or be compensated by, a Competitor.” The term “Competitor” was defined as “any Person [individual or entity] which sells goods or provides services which are directly competitive with those sold or provided by a business that . . . is being conducted by [TCS, its affiliates, and subsidiaries] at the relevant time and [] was being conducted by Company at any time during the term.”
In deciding whether the noncompete provision was enforceable, the court noted that while the lack of geographic scope and one-year duration are reasonable under Maryland law, the unrestricted scope of prohibited activity rendered the provision overly broad and therefore unenforceable on its face. While the court recognized that the term competitor was limited to entities that were “directly competitive” with TCS, ultimately, this limiting language was not enough to save a provision which otherwise would preclude plaintiff from competing, not only directly against TCS, but from working for any company that sold goods or services that were directly competitive with any good or service sold by TCS, its subsidiaries, and its affiliates. Because the noncompete clause was overbroad on its face, the court was not required to consider the particular facts of the case. However, even if the court were to consider the facts, the outcome would be unchanged. Although plaintiff worked as a senior executive in the specialized field of 9-1-1 call handling, the noncompete would have prevented her from working in any field or for any company that sells goods or offers services that compete with TCS, regardless of whether the employment related to handling emergency calls or not. Under Maryland law, such a restriction is broader than necessary to protect TCS’s legally protected interest. Finally, the court is unable to “blue pencil” the noncompete to render it enforceable, because the provision is not “neatly severable” and the court cannot rearrange the language in or supplement the provision.[24]
SinglePoint Direct Solar LLC v. Curiel, No. CV-21-01076-PHX-JAT, 2021 U.S. Dist. LEXIS 148240 (D. Ariz. 2021) (unpublished). This case concerns the business relationship between SinglePoint, Inc. and defendants Pablo Diaz Curiel, Kjelsea Johnson, and Brian Odle regarding a solar energy brokerage company, SinglePoint Direct Solar, LLC (SDS), which was formed following an Asset Purchase Agreement. Aside from the Asset Purchase Agreement, Diaz was also subject to an Employment Agreement, serving as CEO of SDS. Both the Asset Purchase Agreement and Employment Agreement contained several restrictive covenants, including a noncompete clause. After Diaz and Johnson left SDS, they planned to start a rival solar energy company, and according to plaintiffs, wanted to misappropriate SDS’s confidential data in the process. As such, plaintiffs SDS and SinglePoint sought to enjoin Diaz and Johnson from competing nationally in the solar energy industry and from using any of the assets that were the subject of the Asset Purchase Agreement. However, the court found that neither of the noncompetes were enforceable and refused to grant the injunction.
In Arizona, restrictive covenants cannot be greater than necessary to protect an employer’s legitimate interests, and the scope must be limited in duration and geographic area. The noncompete in the Asset Purchase Agreement provides that, for a period of eight years, the parties may “not, directly or indirectly, render services or assistance to, own, manage, operate, control, invest or acquire an interest in . . . any Person that engages in a Competing Business . . . or otherwise engage in or conduct . . . in a Competing Business.” As this clause is completing lacking in geographic scope, it cannot be enforceable. Plaintiffs attempted to argue that the clause was national in scope by way of its reference to a “Business” and “Competing Business,” but the court was unpersuaded, finding that it could not “extrapolate” a national scope from this language. Moreover, even assuming the agreement did contain a national scope, the scope was broader than necessary to protect the plaintiffs’ legitimate business interests as neither SDS nor SinglePoint operated in all 50 states. Finally, the court was unable to “blue pencil” the noncompete clause to add a geographic scope, as courts are only able to strike provisions, and cannot add language to modify the clause. For similar reasons, the court refused to find the noncompete in Diaz’s Employment Agreement enforceable. This noncompete provided that Diaz “shall not in any manner, directly or indirectly . . . enter into or engage in any business which is engaged in any business directly competitive with the business of the Company . . . within the geographic area of the Company’s business, which is deemed by the parties hereto to be nationwide.” While this language did contain a geographical restriction, for the same reasons as with the Asset Purchase Agreement, the court did not find the geographical scope reasonable and declined to enforce the covenant.
Thomassen v. Gebruder Weiss, Inc., No. CV 20-08308-AB (Ex), 2021 U.S. Dist. LEXIS 144484 (C.D. Cal. 2021) (unpublished). This decision stems from plaintiff Brian Thomasson’s allegation that he was wrongfully terminated by defendant Gebruder Weiss, Inc. in violation of California Business and Professions Code section 16600. While still employed by defendant, plaintiff visit one of defendant’s clients, who expressed an interest in hiring one of plaintiff’s coworkers. Plaintiff replied that his coworker was a great employee. Later on, the coworker’s manager called plaintiff and accused him of helping the client poach the coworker, thereby betraying defendant. Defendant then terminated plaintiff, citing “ongoing concerns regarding his professional performance and judgment.” Plaintiff believes the termination was a direct result of defendant’s mistaken belief that he somehow aided his coworker in receiving a competitive job offer. He then sued, and defendant moved for a partial judgment on the pleadings as to his fifth cause of action for wrongful termination. To establish a case for wrongful termination, a party must prove that the termination was motivated by a violation of public policy. Here, plaintiff alleged that the violated public policy was section 16600, which states that “every contract by which anyone is restrained from engaging in a lawful profession, trade, or business, of any kind, is to that extent void.” Plaintiff’s argument that section 16600 was violated as a matter of public policy fails for four reasons. First, section 16600 only applies to contracts that restrain persons from engaging in their profession, and plaintiff did not allege that he was subject to any contract. Second, while section 16600 can invalidate covenants not to compete, plaintiff does not allege that he was subject to any noncompete agreement. Third, plaintiff does not point to any statement in section 16600 which prohibits an employer from terminating an employee who assists a third party in hiring away a fellow employee. Fourth, plaintiff does not articulate any way in which he, his coworker, or anyone else was restricted from their ability to engage in a profession, trade, or business. Therefore, nothing in section 16600 could shield plaintiff from termination after he assisted his coworker in securing alternate employment. Accordingly, the court dismissed plaintiff’s claim for wrongful termination.
Additional Cases of Note
GlobalTranz Enters. Inc. v. Murphy, No. CV-18-04819-PHX-ROS, 2021 U.S. Dist. LEXIS 58689 (D. Ariz. 2021) (unpublished) (holding that overbroad confidentiality or nondisclosure covenants, even if they are not titled “noncompete agreements,” amount to covenants not to compete and are thus unreasonable and unenforceable).
§ 1.3.11 Tenth Circuit
There were no qualifying decisions within the Tenth Circuit.
Additional Cases of Note
Core Progression Franchise LLC v. O’Hare, 2021 U.S. Dist. LEXIS 63471 (D. Colo. 2021) (unpublished) (granting a preliminary injunction preventing defendants from opening a competing business after finding that a noncompete provision covering a 25 mile radius for one year was likely reasonable and enforceable)[25]; Nav Techs., Inc. v. Fugate, 2021 U.S. Dist. LEXIS 132773 (D. Utah 2021) (unpublished) (denying plaintiff’s request for a preliminary injunction in a case where the defendant had done consulting work for other companies in alleged violation of a noncompete agreement, after determining that the companies were not competitors of plaintiff’s company); Lawson v. Spirit Aerosystems, Inc., 2021 U.S. Dist. LEXIS 202278 (D. Kan. 2021) (unpublished) (finding that a supplier that could theoretically in the future become a competitor does not meet the criteria for a competitor under a noncompete provision); McConnell v. Ima Fin. Grp., 2021 U.S. Dist. LEXIS 43581 (D. Kan. 2021) (unpublished) (finding that a noncompete that does not restrict the employee from competing with the type of business conducted by the employer or geographic area of the employer, but instead only restricts competing by utilizing current, former or prospective customers, is not overly burdensome); TruGreen Ltd. P’ship v. Okla. Landscape, Inc., 2021 U.S. Dist. LEXIS 50135 (N.D. Okla. 2021) (unpublished) (granting a motion to dismiss plaintiff’s claim for breach of a noncompetition agreement since the individual defendants had not consented to the assignment of the agreement, making it unenforceable).[26]
§ 1.3.12. Eleventh Circuit
Boyd v. Mills, 2021 Ala. LEXIS 34(Ala. 2021): Thomas Batey sold all his stock in Batey & Sanders, Inc., and, as part of the transaction, signed a non-compete agreement in favor of the buyers. The buyers agreed to pay Batey over 2 million dollars for the non-compete over the course of ten years. However, Batey died seven years later. After Batey’s death, the buyers ceased making monthly payments, and the personal representative of Batey’s estate sued to enforce the agreement. The buyers argued that the contract was a personal service contract and, thus, the buyer’s obligations under the agreement terminated upon Batey’s death. The estate, however, argued that the contract was not a personal service contract because Batey gave no affirmative promises. Acknowledging that this was an issue of first impression, the Supreme Court of Alabama found that the agreement was not a service contract because it was ancillary to the sale of the business. In other words, the buyers entered the agreement to obtain the business and its good will, not Batey’s expertise. Therefore, the buyers’ obligation survived Batey’s death.
Davenport v. AWP, Inc., 2021 U.S. Dist. LEXIS 78302 (M.D. Fla. 2021): AWP and Davenport had an employment agreement containing restrictive covenants preventing Davenport from working for a direct competitor within 120 miles of AWP for twelve months. When Davenport left AWP, however, he began working for a direct competitor, Guardian, in Fort Myers. Davenport and Guardian sought a declaratory judgment finding the geographic scope of the restrictive covenant unreasonable. The parties settled the case and stipulated to a permanent injunction. For purposes of negotiating the stipulation, Davenport and Guardian shared counsel. The stipulation included a provision stating that, for approximately six months, Davenport would not “perform work for any client outside the Fort Myers Territory, or apply for or accept business from any clients outside the Fort Myers Territory.” However, within six months Davenport began working for a third competitor in Fort Pierce. AWP filed a show cause motion for contempt for violation of the injunction, and Davenport challenged the validity of the injunction on the basis that its geographic scope was impermissibly broad. In defense of the injunction, AWP argued that Davenport freely consented to the injunction and that his consent makes the injunction enforceable despite its sweeping geographic scope. The court soundly rejected this argument, finding that Davenport did not have full knowledge and understanding of the stipulation and, thus, he did not knowingly consent to the injunction’s harsh consequences. The court supported this finding with the fact that Davenport’s participation in the negotiation of the stipulation was limited, and that the effectiveness of Davenport’s representation was undermined by Davenport and Guardian sharing counsel because their interests were not aligned. .
Gallagher Benefit Servs. v. Campbell, 2021 U.S. Dist. LEXIS 56771 (N.D. Ga. 2021): Campbell, Storck, and Taylor were the employees of a benefits and insurance consulting firm. Argus acquired the firm and hired Campbell, Storck, and Taylor. Each of the three employees signed employment agreements with non-competition and non-solicitation restrictive covenants. Taylor left Argus and started a competing company, A2. Storck and Campbell followed Taylor shortly thereafter. Argus alleged that Storck violated her non-compete clause. Storck moved for summary judgment on the grounds that (1) Storck’s job did make her the type of employee that may be subject to non-compete clauses under Georgia’s Restrictive Covenant Act (GRCA) and (2) even if Storck was a covered employee, the non-compete clause was unenforceable. On the issue of whether Storck was subject to the non-compete covenant under Georgia law, the court found triable issues of fact regarding whether Storck’s day-to-day responsibilities (which included directly supervising at least five employees and giving hiring recommendations) made Storck a manager or key employee for purposes of O.C.G.A. § 13-8-53(a)(3) and (4). On the issue of unenforceability, Storck argued that the non-compete covenant was unenforceable because (1) the GRCA expressly permits only client based solicitation—not competition— clauses, and (2) a restrictive covenant that prohibits an employee from accepting unsolicited business from former customers is unreasonable. First, the court found that the GRCA applies to employment related restrictive covenants, including non-compete clauses. Second, the court explicitly disagreeing with two state court decisions and found that, in light of the GRCA, common law no longer controls the enforceability of non-compete clauses. Therefore, as a matter of law, non-compete clauses are not unreasonable if they meet the GRCA’s requirements.
Healthplan Servs. v. Dixit, 2021 U.S. Dist. LEXIS 204958 (M.D. Fla. 2021): HealthPlan contracted with Media Shark to develop a software system. The parties entered into an agreement prohibiting Media Shark from disclosing confidential information and performing services for others that would involve a conflict of interest. However, Media Shark began working for a third party and using information developed for HealthPlan in violation of the agreement. HealthPlan sued Media Shark for breach of contract. It sought over $700,000 in damages, the amount that HealthPlan paid Media Shark for its work. Although the court acknowledged that injunctive relief is the typical remedy for violation of a restrictive covenant, it observed that monetary damages are awarded for breach of restrictive covenants on the theory of lost profits. However, the court found that HealthPlan’s measure of damages was inappropriate because it would put HealthPlan “in the same position had it not received the benefit of the bargain” when “HealthPlan did receive the benefit.” Nevertheless, the court found that the approximately $700,000 award was justified on the theory of unjust enrichment because “Media Shark [was] paid to develop demonstration packages for HealthPlan and [used] those same demonstration packages for its own benefit without incurring those costs.”
Ivc Us v. Huali Group United States, 2021 U.S. Dist. LEXIS 119098, *9-10 (N.D. Ga. 2021): IVC sued four former employees for breach of the employees’ non-compete agreements. The employees, who performed management services at IVC’s Georgia location, left IVC to join a competitor. IVC sought a preliminary injunction to enforce the non-compete agreement, and the court evaluated whether the non-compete covenants were reasonable regarding (1) time, (2) scope of activity, and (3) geographic scope under Georgia’s Restrictive Covenant Act. The court found that the one-year time provision was a reasonable time. It then found that the scope of activity was also reasonable because it was limited to the type of services the employees “conducted, authorized, offered, or provided” while working for IVC. Lastly, the court evaluated whether the geographic scope was reasonable. The agreement provided that the geographic scope was the “‘territory where [the employees were] working at the time of termination,” and the covenant stated that it was anticipated that the territory would consist of the United States and Canada. However, the court interpreted the provision narrowly, stating that the encompassed territory was “limited to the State of Georgia.” Having significantly narrowed the geographic scope, the court found that the covenant was reasonable and, therefore, enforceable. IVC was entitled to the preliminary injunction.
Signature Util. Servs. v. Jernigan, 2021 U.S. Dist. LEXIS 70366 (N.D. Ala. 2021): Signature, a startup business that uses helicopters for aerial vegetation services, sued two of its former helicopter pilots alleging that they breached the restrictive covenants in their employment agreements and misappropriated trade secrets and property for their new employer. The pilots has left signature to work for a direct competitor, Rotor Blade. Signature requested a preliminary injunction enforcing the employment agreements, and the court found that a preliminary injunction was appropriate. In opposition, the helicopter pilots first argued that Signature could not enforce the agreement because Signature did not uphold its own obligations under the agreement and Signature had unclean hands. But the court did not even evaluate the factual basis for these arguments because the “Defendants ha[d] not identified any binding precedent in which a court applying Alabama law refused to enforce an otherwise valid restrictive covenant on the grounds that improper, sloppy, or even shoddy business management practices by the plaintiff.” The helicopter pilots then argued that their specialized training made them professionals under Alabama law, making the non-compete and non-solicitation agreements unenforceable. Acknowledging that there was no authority in the subject, the court analyzed the question and determined that “it is unlikely that helicopter pilots qualify as professionals” for the purpose of making restrictive covenants unenforceable.
Snider Tire v. Chapman, 2021 U.S. Dist. LEXIS 115273 (N.D. Ala. 2021): Snider Tire, Inc. sought a preliminary injunction against a former employee, Chapman, to enforce a non-compete clause in Chapman’s employment agreement. The clause prohibited Chapman from working for a competitor of Snider Tire for twelve months, and Chapman had breached the covenant by taking a job with a direct competitor. In evaluating whether the preliminary injunction was appropriate, the court focused on whether Snider Tire demonstrated a likelihood of irreparable harm. The court noted that Snider Tire took over a month after Chapman began working for the competitor to bring the lawsuit, then took another month to serve Chapman and a third month to file the motion for preliminary injunction. In other words, Snider Tire allowed Chapman to work with its competitor for nearly four months before the court could have imposed the preliminary injunction. The court noted that four months was a significant amount of time in relation to nine-month period of the requested relief, nine months. Because of Snider Tire’s delay in bringing the suite undermined its assertion of imminent irreparable harm, the court denied the preliminary injunction.
Tarpon Transp. Servs. v. Total Quality Logistics, LLC, 2021 U.S. Dist. LEXIS 136574 (M.D. Fla. 2021): Total, a freight brokerage firm, employed Minnis pursuant to an employment agreement with a non-compete clause prohibiting Minnis from competing with Total for a year following termination of his employment. Minnis ended his employment with total and, less than a year later, began working for Tarpon as an independent contractor. Total sued both Minnis and Tarpon in Ohio to enforce the non-compete clause. Subsequently, Tarpon initiated a suit against Total in Florida for (1) declaratory relief finding Minnis’ non-compete agreement was unreasonable and (2) tortious interference. The court found that Tarpon lacked standing to challenge the non-compete clause because Tarpon was not a party to the agreement between Minnis and Total. Regarding the tortious interference claim, however, the court found that Tarpon did have standing to proceed. Total had argued that Tarpon’s lack of standing should preclude the tortious interference claim because it would require a determination of whether the non-compete clause was enforceable. The court rejected this argument and found that Tarpon’s lack of standing to directly attack the clause did not prevent Tarpon from seeking injunctive relief against enforcement of the clause through its tortious interference claim. The court explained that allowing the tortious interference claim to go forward was appropriate because it was directly based on Tarpon’s relationship with Minnis, not Total’s contract with Minnis.
§ 1.3.13. D.C. Circuit
M3 USA Corp. v. Haunert, No. 20-cv-3784 (DLF), 2021 U.S. Dist. LEXIS 89418 (D.D.C. 2021) (unpublished) – in a breach of a noncompete agreement case, the D.C. District court denied an employer’s motion for remand because the employee sufficiently pled an amount-in-controversy. In assessing whether the amount-in-controversy requirement was shown by a preponderance of the evidence, the court considered compensatory damages awarded in related suit against another former employee, the employee’s current salary and value of expertise in field, and Laffey matrices to determine attorney’s fees when compared to expertise of defense counsel. The court reasoned that, in the aggregate, the sum of damages exceeded the required $75,000 threshold and denied the motion for remand.
M3 USA Corp. v. Qamoum, Civil Action No. 20-2903 (RDM), 2021 U.S. Dist. LEXIS 105923 (D.D.C. 2021) (unpublished) – in a breach of a noncompete agreement case, the D.C. District court granted a company’s motion to dismiss because there was no evidence to support a finding of personal jurisdiction alleged by a competing corporation under theories of agency, alter-ego, or close relation. There, in an action alleging violation of noncompete and nonsolicitation agreements signed by the corporation’s former employees who now work the company, evidence established that the employees could not act as agents of company at the time of signing the agreements because the company did not yet exist; alter ego liability could not be imposed because neither employee in violation of the agreements funded, controlled, or owned the company; and the company was not closely related to the agreements because there was no evidence shown that involvement in the current action was foreseeable. In determining foreseeability, the court reasoned that undisputed witness testimony supported the claim that the owner of the company was unaware of the agreements and there was no evidence to suggest the competitor benefitted from the agreements or that the competitor company was made for the purpose of avoiding such agreements. Based on this evidence, the court granted the company’s motion to dismiss without prejudice.
M3 USA Corp. v. Qamoum, Civil Action No. 20-2903 (RDM), 2021 U.S. Dist. LEXIS 105923 (D.D.C. 2021) (unpublished) – the D.C. District court denied an employer’s motion for preliminary injunction to enjoin employees from continuing to violate their noncompete and nonsolicitation agreements because no evidence supported a finding of irreparable harm, despite sufficiently showing a likelihood of success on the merits. There, while evidence showed that the noncompete and nonsolicitation agreements explicitly included language that violation of the agreements would result in irreparable harm, the court reasoned that this alone was insufficient to establish harm. The employer failed to show evidence that the employees were a “fundamental threat” to business, caused reputational damage, or misappropriated information containing the employer’s customer or panelist lists. Based on this lack of evidence, the court denied the employer’s motion for preliminary injunction without prejudice.
§ 1.3.14. State Cases
Additional Cases of Note
PetroChoice Holdings, LLC v. Pearce, 2021 Tex. App. LEXIS 272, at *27 (Tex. Ct. App., 12th Dist. Jan. 13, 2021) (reversing and remanding the trial court’s decision because defendant “failed to establish that the [noncompetition] agreement was unenforceable as a matter of law. Moreover, [plaintiffs] neither conclusively negated an element of [defendant’s] claim nor established in its competing motion that the covenant was enforceable as a matter of law.”).
Webster v. Arthur J. Gallagher & Co., 2021 Tex. App. LEXIS 5393, at *10-13 (Tex. Ct. App. July 7, 2021) (holding the trial court did not abuse its discretion when it issued a temporary injunction against a former employee in the former employer’s suit alleging violation of a confidentiality provision and restrictive covenants because the trial court was called upon only to address whether the status quo should be maintained by issuing a temporary injunction).
§ 1.4. Customer and Employee Non-Solicitation Agreements
§ 1.4.2. First Circuit
Baystate Fin. Servs., LLC v. Pinto, No. 2084CV02507, 2021 Mass. Super. LEXIS 29 (Feb. 18, 2021) (unpublished). The Massachusetts Superior Court affirmed employees’ motion to dismiss general agency’s claims for breach of contract and tortious interference with contractual and advantageous relations stemming from an alleged violation of a nonsolicitation agreement between employees and their employer because agency failed to establish that it was an intended beneficiary of the agreement.
Page v. Boothbay Region Water Dist., 2021 Me. Super. LEXIS 1 (Mar. 8, 2021) (unpublished) – the Maine Superior Court granted client’s motion for judgment on the pleadings against a staffing agency because 26 M.R.S § 599-B applies to restrictive employment agreements regardless of when they were formed and prohibits the enforcement of a nonsolicitation agreement between the parties for the hiring of one of the agency’s employees. There, the client entered into an agreement with the staffing agency for accounting related services that contained a nonsolicitation provision. The provision prohibited the solicitation of the agency’s employees and imposed a $50,000 fine on the client if they were to hire or retain any of the agency’s employees during the term of the agreement and for 180 days after its termination. The court held that a plain reading of the statute showed its purpose was to prohibit the enforcement of restrictive employment agreements, which would occur in a separate legal action filed after the statute’s enactment. Thus, when the contract was formed was not relevant. The court also reasoned that the $50,000 fee combined with the provision’s explicit language forbidding the client from hiring the agency’s employees made the provision a restrictive employment agreement for the purposes of § 599-B. As to the third issue, the court reasoned that § 599-B was rationally related to the legitimate state interests to keep employment inside the state and increase competition in the labor market by allowing workers the opportunity to seek other in-state opportunities that may provide higher pay, better benefits, any other potential advantages. Based on these findings, the court held that the nonsolicitation provision at issue was unenforceable under § 599-B and granted client’s motion for judgment on the pleadings.
Phillips v. Willis Re Inc., No. 20-1635 (FAB), __ F. Supp. 3d ___, 2021 U.S. Dist. LEXIS 75100 (D.P.R. 2021) – the Puerto Rico District Court denied an employee’s motion for preliminary injunction to preclude the employer from enforcing a nonsolicitation clause within an employment agreement because the choice of law provision required Florida law to apply. There, the agreement prohibited the employee from soliciting, accepting, or performing services to employer’s clients, unless for the benefit of employer, for a period of two years after termination. Per the agreement, the state in which the employee was assigned an office would govern the agreement. The issue before the court was based on whether the agreement was governed by Puerto Rico law, which subjected restrictive covenants to a stricter scrutiny, or Florida law. The employee claimed the nonsolicitation provision was subject to the laws of Puerto Rico, and in the alternative, the choice of law provision of irrelevant because Florida law was inconsistent with Puerto Rico public policy. As to the first issue, evidence established that the employer had assigned the employee to a Miami, Florida office, his signature block corresponded to the Miami office, and his LinkedIn profile stated he resided and worked in Miami. In opposition, the employee presented evidence that he had purchased property in Puerto Rico, stayed in hotels in Puerto Rico, and paid taxes in Puerto Rico. Based on this evidence, the court reasoned that the employee merely provided evidence of residency, which was not relevant to the determination of where his assigned office was, which was in Miami, Florida. As to the second issue, evidence established that Florida law favored enforcement of reasonable covenants to compete and conveys a fundamental interest “in the protection and enforcement of contractual rights.” In opposition, the employee cited to a Puerto Rico decision that ultimately deemed a two-year restrictive covenant excessive under the circumstances of that case. The court reasoned that while Puerto Rico judiciary identified an interest against “excessive” restrictive covenants in that decision, that policy is not a “materially greater interest” than the policies provided by the Florida legislature. Based on this evidence, the court held that choice of law provision in the parties’ employment agreement was legally sound and applicable. Therefore, the court denied the employee’s motion for preliminary injunction in favor of the employer.
§ 1.4.3. Second Circuit
Huseby, LLC v. Bailey, 2021 U.S. Dist. LEXIS 141504 (D. Conn. 2021). Huseby LLC, a court reporting firm headquartered in North Carolina, alleged that its former employee, Lee Bailey, violated non-solicitation agreement and non-competition agreements when disclosing confidential information to his new employer. In responding to discovery requests, Huseby objected that the court’s standard protective order was insufficient to protect its confidential information. Huseby then withheld documents several months after discovery responses were due, claiming that said documents required “attorneys’eyes only” protection. The defendants then moved to compel. Because Huseby did not timely move to modify the court’s protective order, the court ordered production of the confidential documents without the “attorneys’eyes only designations.” Furthermore, the court partially granted the defendants’ request for attorney’s fees stemming from production of the documents in question.
§ 1.4.4. Third Circuit
Ecosave Automation, Inc. v. Del. Valley Automation, LLC, _ F. Supp. 3d __ ; 2021 U.S. Dist. LEXIS 94856 (E.D.Pa 2021). After a mass resignation at Ecosave that led to the genesis of rival construction automation firm DVA, Ecosave sued DVA and the departing employees, including its CEO, President and 13 others. In fully denying Ecosave’s preliminary injunction bid on its trade secrets, breach of contract, breach of fiduciary duty, tortious interference, and unfair competition claims, the court deemed Ecosave unable to succeed on the merits of its trade secrets claim because there was conflicting evidence about whether certain customer information actually belonged to Ecosave’s customers; thus, such information was neither a trade secret nor misappropriated. Some of the breach of contract claims were dismissed because there was no evidence that former employees actually subject to a non-solicitation covenant performed any DVA solicitations of former Ecosave customers. Meanwhile, of particular note, the court deemed that the founder and CEO of DVA, who was subject to a non-solicitation restriction, did not engage in ‘indirect solicitation’ because he did not provide any personal assistance to others at DVA who solicited Ecosave customers. Noting it was in accord with certain state courts, the court seemed to break new ground when it held, as a matter of law, that “[t]o find a former employee engaged in indirect solicitation of his former employer’s customers, that employee must make specific acts of personal involvement in the solicitation.” Lastly, the court declined to provide injunctive relief on the tortious interference or unfair competition claims, as the mass resignation and certain misleading statements by DVA employees about whether Ecosave was still in the automation business and whether DVA was affiliated therewith were each discrete past injuries that did not pose immediate, irreparable harm and could thus be compensated with monetary damages.
Matthews Int’l Corp. v. Lombardi, 2021 U.S. Dist. LEXIS 35616 (W.D.Pa 2021) (unpublished). After numerous employees defected from cremation services company Matthews to newly-formed competitor Impact & its subsidiary IR, Matthews sought injunctive relief pursuant to non-compete, non-solicitation, and confidential information restrictive covenants it had with certain defectors. Before the court ruled on the injunction, Defendants entered into a ‘standstill’ agreement where they promised to return any of Matthews’ confidential information taken, to not use such information going forward, to perform an agreed-upon remediation protocol on their computer systems, and to not steal any Matthews customer who uses one of their cremators. In light of this offer by defendants, the court significantly narrowed the dispute, as the standstill agreement disposed of all of Matthews’ concerns about its confidential information. As to the non-compete and non-solicitation provisions, the court refused injunctive enforcement as to all of Matthews’ former employees except one, Esposito. For the other employees, the court found that Matthews had not shown the need for injunctive enforcement of the covenants for a variety of reasons, depending on the individual. For instance, where the breach alleged was of a stock options agreement that prescribed forfeiture of the equity compensation as the penalty for ‘competition’, the court noted that the contract’s plain terms provided only for legal, not injunctive relief. Another employee never signed the contract, instead tendering his resignation rather than signing the document; two others never engaged in competitive work at Impact/IR such that they could have breached the covenants. Another employee never acquired any confidential knowledge while employed at Matthews. Lastly, the court held the covenants unenforceable against an employee who Matthews had fired for performance issues as “[c]learly, then, Matthews determined [the employee] as worthless to its legitimate business interests.” Separately, the court enforced the non-competition and non-solicitation provisions against Esposito because he not only took confidential information with him when he left Matthews, uploaded it to Impact’s computer systems, and actually used said information to compete with Matthews, but also admitted to successfully inducing a fellow Matthews employee to defect to Impact. Given these clear breaches of each restrictive covenant, the court did not think that the standstill agreement provided enough of a guarantee to Matthews that no further breaches would occur and thus ordered the requested injunctive relief against Esposito only.
§ 1.4.5. Fourth Circuit
Superior Performers, Inc. v. Thorton, 2021 U.S. Dist. LEXIS 100403 (M.D.N.C. 2021) (unpublished). Superior Performers is an independent marketing organization (IMO) that recruits and trains sales agents for various insurance companies. Defendants, as a result of their business relationship with Superior, are each party to an agent agreement, which prohibits defendants from soliciting current or recent Superior agents for a period of two years (or one year, if engaged for less than one year), in addition to prohibiting the disclosure of confidential information to third parties or the use of such information for the agent’s own benefit. Superior alleges that defendants Lamb and Ferguson resigned after being recruited to an IMO affiliated with defendant Thornton, and that, at about the same time, Lamb invited Fergus and certain other Superior agents to attend a recruitment meeting on behalf of Thornton’s insurance agency. In response to Superior’s motion for default judgment against defendants, the court found that the nonsolicitation provision in the agent agreements meets the requirements for enforceability because the agreements were in writing, based on valuable consideration in the form of mutual promises to engage in a professional relationship, and the restriction period of one to two years and employee-based territorial restrictions, rather than geographic, have been to be found reasonable by North Carolina courts. The court also found that plaintiff sufficiently alleged that Lamb breached the contract by attempting to recruit multiple agents from defendant during the final month of his relationship with plaintiff and granted default judgment on that claim against Lamb. The court also found that plaintiff failed to allege sufficient facts regarding the additional breaches underlying its claims for breach of contract, including finding that defendants’ alleged relationships with Thorton are insufficient to state a breach of contract claim because he was not an agent of Superior and was not considered a protected person under the agreements when their business relationships allegedly began, and, as such, denied plaintiff’s request for default judgment as to these claims.
Additional Cases of Note
Governmentcio, LLC v. Landry, 2021 U.S. Dist. LEXIS 53905 (D. Md. 2021) (applying District of Columbia law) (unpublished) (denying defendant’s motion to dismiss plaintiff’s breach of contract claims and finding the nonsolicitation provisions plaintiff’s agreement with defendant are not overly broad or unreasonable because, under District of Columbia law, nonsolicitation provisions prohibiting solicitation of employees with whom the defendant worked do not need territorial restrictions and nothing suggests that the nonsolicitation provisions at issue implicated employees with whom defendant never worked, among other reasons)[27]; TitleMax of S.C., Inc. v. Crowley, 2021 U.S. Dist. LEXIS 81388 (D.S.C. 2021) (unpublished) (granting plaintiff’s motion for preliminary injunction related to plaintiff’s claims for breach of the confidentiality and nonsolicitation agreement and breach of the covenants agreement that limited defendant’s ability to use plaintiff’s confidential and trade secret information after the termination of her employment, and finding that plaintiff is likely to succeed on the merits of these claims based on a declaration affirming defendant’s alleged phone calls and conduct towards its customers, which defendant failed to refute, that plaintiff is likely to suffer irreparable harm based plaintiff’s evidence of the possibility of a permanent loss of goodwill, and that plaintiff has shown the balance of equities tip its favor).
§ 1.4.6. Fifth Circuit
Additional Cases of Note
Bureau Veritas Commodities & Trade, Inc. v. Nanoo, 2021 U.S. Dist. LEXIS 99497, at *24-28 (E.D. La. May, 26, 2021) (denying defendant’s motion to dismiss plaintiff’s claims for breach of the nonsolicitation clause, opting instead to exercise the agreement’s severability provision to reform the parts that exceed La. Rev. Stat. § 23:921’s geographic limitation requirement, and requirement that “allows an employee to agree only to refrain from soliciting customers of the employer”).[28]
Neill Corp. v. Shutt, 2020-0269 (La. App. 1 Cir 01/25/21), 319 So. 3d 872, 880 (finding that the lower court erred by enforcing a non-solicitation restrictive period from the date that the preliminary injunction was signed rather than the date of termination, thereby extending the non-solicitation clause in violation of La. R.S. 23:921).[29]
People Source Staffing Prof’ls LLC v. Robertson, 2021 U.S. Dist. LEXIS 95665, at *11-12 (W.D. La. May 19, 2021) (granting defendant’s motion for summary judgment regarding the nonsolicitation of employees agreement because it did “not list the parishes or municipalities to which [the agreement] applie[d],” thus failing “to contain the geographical limits” necessary for a valid nonsolicitaiton agreement under La. Rev. Stat. 66 23:921, rendering the provision unenforceable against the defendant).[30]
Southeastrans, Inc. v. Landry, 2021 U.S. Dist. LEXIS 48318, at *10-11 (W.D. La. Mar. 15, 2021) (denying defendant’s motion for summary judgment regarding the nonsolicitation agreement claim because the agreement did not prohibit him from engaging in a profession, trade or business, but “only bar[red] him from soliciting a ‘small class’ of employees” of the plaintiff’s and defendant did not contend the ability to solicit plaintiff’s employees was central to his ability to engage in his business or profession, evidencing La. Rev. Stat. § 23:921 did not apply).[31]
Traffic Jam Events, LLC v. Lilley, 2021 U.S. Dist. LEXIS 63893, at *11 (E.D. La. Apr. 1, 2021) (granting defendants’ motion to dismiss plaintiff’s claims for the breach of the nonsolicitation clause, adopting the reasoning in Total Safety U.S., Inc. v. Code Red Safety & Rental, LLC, 423 F. Supp. 3d 309 (E.D. La. 2019), because the nonsolicitation clause at issue “is limited to ‘territories’ where [d]efendants provided services to [p]laintiff’s current and potential customers,” meaning the failure to specify the applicable parishes or municipalities is fatal to its enforceability).
§ 1.4.7. Sixth Circuit
Additional Cases of Note
Abington Emerson Cap. v. Adkins, 2021 U.S. Dist. LEXIS 53083 (S.D. Ohio Mar. 2021) (rejecting defendants’ summary judgment motion which contended that only the subsidiary company could be vicariously liable for an employee’s negligence because the non-solicit the employee signed with the parent company helped create a genuine dispute about how had the right to control the employee); Argi Fin. Grp. v. Hardigg, 2020 U.S. Dist. LEXIS 172932 (W.D. Ky. 2020) (granting the plaintiff’s motion for a temporary restraining order after finding that there was evidence of the defendant soliciting the plaintiff’s clients to follow him to a new employer.); Campfield v. Safelite Grp., Inc., 2021 U.S. Dist. LEXIS 62070 (S.D. Ohio 2021) (holding that defendant’s counterclaims of tortious interference, conversion, and conspiracy were preempted by the Ohio Uniform Trade Secret Act (OUTSA) because the underlying factual basis for those counterclaims was the same as their OUTSA counterclaim); Care Servs. Mgmt. v. Premier Mobile Dentistry of Va., 2020 U.S. Dist. LEXIS 178529 (M.D. Tenn. 2020) (holding that documents are not trade secrets under TUTSA or DTSA merely because they are the result of integrating information needed for payment or because the holder took efforts to keep those documents on a secure server); Henderson v. Skyview Satellite Networks, 474 F. Supp. 3d 893 (W.D. Ky. 2020) (finding that the plaintiff violated the non-solicitation and confidentiality agreements of her employment contract by disparaging her supervisors to clients); JTH Tax, Inc. v. Magnotte, 2020 U.S. Dist. LEXIS 131921 (E.D. Mich. 2020) (finding that defendants had violated the non-solicitation provisions of their franchise agreement with the plaintiff by retaining customer lists and contacting plaintiff’s customers after terminating the franchise agreement.); Konica Minolta Bus. Sols. U.S.A., Inc. v. Lowery Corp., 2020 U.S. Dist. LEXIS 120082 (E.D. Mich. 2020) (holding as overly broad a non-solicit agreement which prohibited defendants from soliciting “prospective or potential customers” of the plaintiff, but enforcing the agreement as to any customers defendants had built a relationship with while working for the plaintiff); Slinger v. PendaForm Co., 494 F. Supp. 3d 477 (M.D. Tenn. 2020) (holding that a non-solicit agreement was unenforceable because it had no geographical limits and its time period was for two years); Slinger v. PendaForm Co., 2021 U.S. Dist. LEXIS 3815 (M.D. Tenn. 2021) (ruling that, because the non-solicit clause was unenforceable, it did not provide a defense for the defendant when he failed to pay the plaintiffs their severance, and so the court declined to reopen a bench trial for additional testimony); United Healthcare Servs. v. Corzine, 2021 U.S. Dist. LEXIS 47420 (S.D. Ohio 2021) (holding that plaintiffs showed a strong likelihood that the defendant breached his non-solicitation covenant because he solicited business from a health service provider within a year of his employment termination and with whom he had contact regarding the company’s business); Wild Goose Enters. v. Iron Flame Techs., Inc., 2021 U.S. Dist. LEXIS 79040 (S.D. Ohio 2021) (unpublished) (denying defendant’s motion to dismiss and finding plaintiff-employer properly stated a claim for violations of a non-solicitation agreement against defendant-employee).
§ 1.4.8. Seventh Circuit
HCC Cas. Ins. Servs. v. Day, 2021 U.S. Dist. LEXIS 57433 (N.D. Ill. 2021) (unpublished) (applying Illinois law). Plaintiff HCC Casualty Insurance Services, Inc. brought a breach of contract suit against Day, its former president, claiming that Day violated certain restrictive covenants in his employment agreement. Plaintiff sought monetary and injunctive relief. The dispute arose out of Day’s employment agreement with plaintiff, which was originally effective through April 30, 2019, but which was amended and extended through April 30, 2020. The agreement contained three restrictive covenants around confidentiality, noncompetition, and nonsolicitation. The confidentiality restrictive covenant included plaintiff’s “trade secrets” within the information that Day was supposed to keep confidential. On May 2, 2020, two days following the expiration of his employment agreement with plaintiff, Day resigned from his position as plaintiff’s president. Shortly thereafter, Day then joined another insurance underwriter as its president. Plaintiff claimed that Day violated his previous employment agreement by hiring nine employees from plaintiff, disclosing plaintiff’s trade secrets to his new company, and directly competing with plaintiff. Day filed a motion to dismiss plaintiff’s claims for failure to state a claim. As to the noncompete and nonsolicitation provisions, Day argued that he was not obligated to adhere to those provisions because the employment agreement expired on April 30, 2020, and therefore, when he resigned on May 2, 2020, he was an at-will employee not covered under the agreement. The court rejected this argument, holding that the covenants began to run upon the expiration of the agreement on April 30, 2020. The court said that although Day was not terminated during the “term of employment,” the agreement did not contemplate any employment past the employment agreement’s term. Therefore, Day’s employment was terminated upon the expiration of the employment agreement, and he was bound by the noncompete and nonsolicitation provisions.
Day also argued that the restrictive covenants were overbroad and unenforceable. As to the nonsolicitation provision, Day argued that the provision was overly broad because it prohibited him from “solicit[ing], [recruit]ing, or hir[ing]” any of plaintiff’s employees, presumably janitorial staff. The court, however, noted that it was not prepared to rule on the over breadth challenge to the nonsolicitation provision because the record was not fully developed. The court said that if plaintiff does not hire janitors and only employs underwriters, then the nonsolicitation provision preventing Day from hiring any employee is more reasonable than it would be otherwise.[32]
Additional Cases of Note
Fountain v. Zimmer Inc., 2021 U.S. Dist. LEXIS 96340 (N.D. Ind. 2021) (unpublished) (applying Indiana law) (granting defendants’s motion for summary judgement as to Plaintiff’s allegation that defendants’s breached a confidentiality, noncompetition, and nonsolicitation agreement by failing to pay plaintiff his noncompetition period payments where court found that plaintiff did not meet the contractual requirements for those payments)[33]; Freedman v. Am. Guardian Holdings, Inc., 2021 U.S. Dist. LEXIS 149266 (N.D. Ill. 2021) (unpublished) (finding that plaintiff breached nonsolicitation clause where he solicited employment of a former co-worker in violation of a settlement agreement which contained a nonsolicitation clause).
Savis, Inc. v Cardenas, 528 F. Supp. 3d 868 (N.D. III. 2021) (applying Florida law) (granting summary judgment on employee liability for breach of noncompetition clause because evidence of different methods and tools were not material differences in services offered by the employer and those provided by the former employee).[34]
Teague v. Healthcare Dev. Partners, LLC, 2021 U.S. Dist. LEXIS 37108, at *25 (N.D. Ill. Mar. 1, 2021) (denying summary judgment for defendant because “there is a triable issue of fact as to whether plaintiff was terminated ‘for cause’ and Vizion Health was a ‘Restricted Customer’” under the definition in his employment agreement).[35]
§ 1.4.9. Eighth Circuit
Ikpe v. Aramark, 2021 U.S. Dist. LEXIS 85655 (W.D. Mo. 2021) (unpublished).Ikpe is a dietician who works in the food industry. While employed by Morrison Healthcare, Ikpe was recruited and hired by Aramark for a position as its patient services director at the Adele Hall Campus (CMH). The position fell under a ten-year contract between Aramark and CMH that included a no hire provision preventing salaried employees from working at any CMH facility either directly or indirectly for one year post-employment. Ikpe was unaware of this provision when she was hired. Approximately two months after Ikpe started her job at CMH, she learned that CMH was replacing Aramark at its food services vendor, and the new vendor would be Morrison. Ikpe reached out to her former manager at Morrison, seeking to be rehired and continue on as director at CMH. Morrison declined to hire Ikpe because of the no hire agreement. Ikpe sued Aramark for tortious interference with a business expectancy. In denying Aramark’s motion to dismiss, the court found that Ikpe made a plausible claim that Aramark’s enforcement of the no hire provision constituted an improper restraint of trade because (1) the no hire limited Ikpe’s employment opportunities, (2) Morrison told Ikpe she would not be considered because of the no hire provision, (3) Ikpe was not aware of and did not agree to the no hire, and (4) Ikpe claimed she was not employed long enough to learn any confidential or proprietary information.
Perficient Inc. v. Gupta, 2021 U.S. Dist. LEXIS 124893 (E.D. Mo. 2021) (unpublished).See Section 1.3.9 for a summary of the court’s ruling on enforcement of customer and employee nonsolicit agreements.
§ 1.4.10. Ninth Circuit
Houserman v. Comtech Telcoms. Corp., No. 2:19-CV-00336-RAJ, 2021 U.S. Dist. LEXIS 20885 (W.D. Wash. 2021) (applying Maryland law). Plaintiff Lynne Houserman served as the Senior Vice President and General Manager of the Safety and Security Technologies Group (SST Group) at TCS, a provider of advanced communication solutions for governmental and commercial customers. When TCS was acquired by Comtech, she was promoted to President of the SST Group, where she was responsible for emergency call routing and handling services. While her employment agreement with Comtech did not include a nonsolicitation provision, her agreement with TCS did. Plaintiff was eventually terminated for cause, and several months later, she was hired by Motorola to serve as a Vice President overseeing Motorola’s emergency call handling business. TCS then filed suit against plaintiff, alleging, among other things, that she breached the nonsolicitation provision in her employment agreement.
The nonsolication provision in question prevented plaintiff from “solicit[ing] any client of Company on behalf of or for the benefit of a Competitor.” While there is precedent in which Maryland courts have enforced customer nonsolication agreements that bar solicitation of all the employer’s clients, the law has since shifted, with courts becoming increasingly reluctant to enforce such blanket restrictions on client solicitation. Here, the nonsolicitation agreement imposes this sort of blanket restriction on all of TCS’s clients –not just clients with whom plaintiff has worked, nor just clients in the 9-1-1 call routing and handling business. Acknowledging this, the court found that the restrictive covenant imposed an unnecessarily broad restraint on trade and was therefore wider than necessary to protected TCS’s legitimate business interests. While TCS sought to have the court “blue pencil” the provision, the court found it impossible to narrow the clause, without supplementing or rearranging the language, so as to render it reasonable. Therefore, the court found the nonsolicitation provision facially overbroad and therefore unenforceable.[36]
Precision Indus. Contractors Inc. v. Jack R. Gage Refrigeration Inc., No. C19-5810 TSZ, 2021 U.S. Dist. LEXIS 148078 (W.D. Wash. 2021) (unpublished). Defendant Daniel Jason Hoyt was an employee of Precision Industrial Contractors Inc. (PIC), which provides project management services and products to industrial clients. Hoyt was eventually promoted to general superintendent, where he was granted access to PIC’s confidential information, including PIC’s strategies on how to secure winning bids and information about PIC’s existing and potential clients. Accordingly, he signed an employment agreement which contained customer and employee nonsolicitation agreements. The first clause read: “[D]uring the one (1) year period immediately following the termination of his/her employment . . . Employee will not either directly [or] indirectly induce or attempt to induce any employee of [PIC] to terminate his or her employment or go to work for any other employer. . .” The second clause read: “[D]uring the term of his/her employment hereunder and for a period of one (1) year thereafter[], Employee[] shall not[] directly or indirectly, solicit or contact any customer or client of [PIC] with a view to inducing or encouraging such client or customer to discontinue or curtail any business relationship with [PIC] within territories in which [PIC] conducts business. Employee further agrees that during his/her employment hereunder, and for a period of one (1) year thereafter, he/she will not, directly or indirectly, request or advise any customer or client of [PIC] to withdraw, curtail, or cancel its business with [PIC].” In the past, PIC had won about 75 percent of the bids it submitted for the entity Port Townsend Paper. While Hoyt was employed with PIC, Port Towsend Paper planned a multimillion-dollar expansion project (the OCC project). Shortly after the OCC project was announced, Hoyt abruptly quit PIC. Following this, PIC was only awarded one project for the OCC project even though it submitted five or six bids. Though there were other factors in play, PIC believed that some of the reason it lost its bids is because Hoyt used PIC’s confidential information to submit bids to Port Townsend Paper.
In deciding whether to grant PIC’s motion for summary judgment on its breach of contract claim, the court had two issues to consider. The first was whether Hoyt, in responding to Port Townsend Paper’s invitation to submit bids in a competitive bidding environment, violated the customer nonsolicitation provision of his employment agreement. Specifically, the issue was whether submitting a bid amounted to soliciting or contacting Port Townsend Paper with the intention of encouraging it to curtail its business relationship with PIC. The court decided that there was a “strong likelihood” that responding to a public bid would not constitute a violation of his employment agreement. The second issue was whether Hoyt violated the employee nonsolicitaiton provision of his contract when he unsuccessfully attempted to recruit two PIC employees. Because PIC presented no evidence that it suffered damages as a result of Hoyt’s potential breach, the court decided that a triable issue of fact remained as to this issue. Therefore, the court denied summary judgment as to PIC’s breach of contract claims.[37]
Additional Cases of Note
Markson v. CRST Int’l, Inc., No. 5:17-cv-01261-SB-SP, 2021 U.S. Dist. LEXIS 60368 (C.D. Cal. 2021) (unpublished) (reinforcing the principle that no-poach agreements among competitors are per se violations of the Sherman Act in antitrust cases).
§ 1.4.11. Tenth Circuit
There were no qualifying decisions within the Tenth Circuit.
Additional Cases of Note
Premier Sleep Sols., LLC v. Sound Sleep Med., LLC, 2021 U.S. Dist. LEXIS 63002 (D. Utah 2021) (unpublished) (finding that a nonsolicitation clause restricting the solicitation of employment opportunities from patients does not imply a restriction on soliciting business from patients); TruGreen Ltd. P’ship v. Okla. Landscape, Inc., 2021 U.S. Dist. LEXIS 50135 (N.D. Okla. 2021) (unpublished) (granting a motion to dismiss plaintiff’s breach of a nonsolicitation agreement claim since the agreement was void and against public policy because it banned direct and indirect solicitation of plaintiff’s former customers and would prohibit defendants from contacting individuals who may not be plaintiff’s established customers);
§ 1.4.13. D.C. Circuit
See Section § 1.3.13 for a summary of the court’s ruling on the issue of nonsoliciation agreements in M3 USA Corp. v. Qamoum, Civil Action No. 20-2903 (RDM), 2021 U.S. Dist. LEXIS 105923 (D.D.C. 2021) (unpublished).
§ 1.5. Misappropriation of Trade Secrets
§ 1.5.2. First Circuit
Governo Law Firm LLC v. Bergeron, 166 N.E.3d 416 (2021) – the Massachusetts Supreme Judicial Court vacated a trial court judgment because the trial judge erroneously instructed the jury that the employees’ conduct while employed with employer was not relevant to the employer’s claims of unfair and deceptive trade practices. There, while employed with employer, the employees downloaded the employer’s specialized research library and database as well as administrative files including manuals on office procedures, employee handbooks, marketing materials, and client lists. Prior to resigning, employees offered to purchase the employer’s firm. After employer rejected the offer, employees established their own firm and used the misappropriated files in their practice. Employer subsequently filed the underlying action. At trial, the judge instructed the jury that the relevant state statute did not apply to anything the employees did while they were employed by the employer and that copying employer’s materials prior to their last day as employer’s employees was irrelevant. On review, the court held that the employer’s claim required the jury to determine whether the subsequent use of the employer’s materials was based on unfair or deceptive trade practices and the trial court’s instruction instructed the jury to ignore the evidence on how the employees obtained the misappropriated materials. Therefore, based on these facts, the court held that the instruction was unfairly prejudicial to the employer and warranted a new trial on this claim.
Governo Law Firm LLC v. Bergeron, 166 N.E.3d 416 (2021)– the Massachusetts Supreme Judicial Court remanded a permanent injunction in favor of the employer to be modified in accordance with its opinion to include administrative files that had been stolen. There, while employed with employer, employees downloaded the employer’s specialized research library and database as well as administrative files including manuals on office procedures, employee handbooks, marketing materials, and client lists to thumb drives for their personal use. Prior to resigning, employees offered to purchase the employer’s firm. After employer rejected the offer, employees established their own firm and used the stolen employer’s files in their practice. At trial, the judge ordered a permanent injunction prohibiting the employee’s use of the employer’s research library and databases but notably excluded the use of the employer’s administrative files from the injunction. On review, the court reasoned that while the trial court has broad discretion to determine the scope of injunctive relief, in this case, without explanation and with no evidentiary basis in the record to support the employee’s continued use of the employer’s stolen administrative files, the exclusion of said files constituted an abuse of discretion.
KPM Analytics N. Am. v. Blue Sun Sci., LLC, No. 21-10572-TSH, __ F. Supp. 3d ___, 2021 U.S. Dist. LEXIS 95927 (D. Mass. 2021) – in a trade-secret theft case, the Massachusetts District Court granted corporation’s motion for expedited discovery prior to the corporation’s hearing for preliminary injunction because corporation sufficiently plead a likelihood of success on the merits of its injunctive relief action. The court held that corporation sufficiently demonstrated a likelihood of success on the merits and expedited discovery would allow for a more fulsome record to consider at the preliminary injunction hearing.
Little Bay Lobster, LLC v. Rhys, No. 1:20-cv-00246-DBH, 2021 U.S. Dist. LEXIS 35791 (D. Me. 2021) (unpublished) – the Maine District Court granted a nonparty competitor’s motion to quash a subpoena because the subpoena required disclosing confidential information and the interest of the nonparty in protecting that information was not outweighed by competitor’s need for the information. There, the competitor executed a contract with a supplier to exclusively purchase the supplier’s lobsters for two years in exchange of the purchase of a boat owned by the supplier’s affiliate. Competitor then discovered that the supplier was not exclusively selling to the competitor and continued to fish for one of its direct competitors, the subpoenaed non-party. Competitor filed the underlying suit against the supplier. Competitor then served a subpoena on the nonparty competitor seeking information as to its relationship with the supplier, all records of payment by the nonparty to the supplier in the relevant period, all documents related to the quantity of lobster purchased by the nonparty, and all documents related to the purchase and sales of lobsters during the relevant period. In determining that the nonparty met its burden, the court first held that the nonparty need not allege the information constituted a “trade secret,” because the relevant statute specifically contemplated the protection of “other confidential, commercial information.” Second, the court held that it was well established that sales data has generally been viewed as trade secrets or confidential information. Third, the nonparty sufficiently showed that it safeguarded its pricing and sales data by limiting access to such information within the company, including password-protecting computerized data and that there was a risk that if that data was made available to the competitor, it could use the information to the nonparty’s detriment by undercutting its prices or offering more favorable terms from whom it sources its products. The court also found that the competitor failed to explain why it would need to know the nonparty’s pricing with the supplier, how that information would assist in the competitor’s calculation of damages and failed to state whether it tried to seek the same information from the supplier prior to subpoenaing the nonparty.
Needham Bank v. Guaranteed Rate, Inc., Nos. 146143, 2184CV0661-BLS1, 2021 Mass. Super. LEXIS 51(Apr. 17, 2021) (unpublished) – the Massachusetts Superior Court granted in part employer’s motion for a preliminary injunction because it sufficiently alleged a likelihood of success on its breach of confidentiality and nondisclosure agreements with an employee. At time of hire, the employee signed an agreement with the employer that prohibited disclosure of any confidential information during his employment or thereafter. The agreement defined confidential information to include customer lists, pricing, identity of and information related to employer’s customers, and documents provided by the employer’s actual and potential customers. During employment, the employee referred customers to a competitor of his employer and would also receive referrals from them. After accepting employment with the competitor, the employee sent at least 6 emails to his personal email account containing customer lists that included confidential information of more than 1,000 unique customers of the employer and provided a contact list of customers the employee had personally serviced.
Philips Med. Sys. P.R., Inc. v. Alpha Biomedical & Diagnostic Corp., No. 19-1488 (BJM), 2021 U.S. Dist. LEXIS 8739 (D.P.R. 2021) (unpublished) – the Puerto Rico District Court granted a medical imaging system manufacturer’s motion for protective order against a medical system servicer because the manufacturer’s harm outweighed any risk of disclosure of servicer’s trade secrets. There, the manufacturer alleged that the Puerto Rico based servicer gained access to its proprietary computer software by bypassing its security measures using credentials of former manufacturer employees who now work for the servicer. During discovery, the servicer argued the manufacturer’s interrogatories and requests for production were based on confidential trade secrets. The manufacturer sent the proposed protective order at issue. The servicer alleged that the manufacturer’s in-house counsel should be denied access to all confidential materials because counsel advises the manufacturer on matters related to product security and unauthorized access to products which would create a grave risk of inadvertent disclosure of the servicer’s trade secrets. To make this determination, the court weighed the risk of the inadvertent or accidental disclosure against the burden of the protective order. Evidence established that the manufacturer’s counsel was employed by the manufacturer’s North American division, he resided in Ohio, he did not report to anyone in the manufacturer’s Puerto Rico division, his counsel focused on intellectual property not employment or contract litigation, he would be the only in-house counsel to review the materials, and did not advise the manufacturer on pricing, marketing, design, or business decisions in Puerto Rico. Based on these facts, the court reasoned that the risk of inadvertent disclosure was relatively low. As to the manufacturer’s harm, evidence established that the underlying dispute between the parties involved the manufacturer’s intellectual property, manufacturer’s in-house counsel was responsible for the protection of the very information at issue, counsel had a longstanding familiarity with the case, and counsel had technical knowledge that would assist in facilitating discovery and improving efficiency for all litigants. Based on this evidence, the court held that the harm that would flow from denying the manufacturer’s motion outweighed any risk of disclosure of the servicer’s trade secrets, which was minimal. Therefore, the court granted the manufacturer’s motion for protective order.
§ 1.5.4. Third Circuit
Volpe v. Abacus Software Sys. Corp., 2021 U.S. Dist. LEXIS 112641 (D. N.J. 2021) (unpublished). Volpe was an IT salesperson for Abacus from 2011 until 2019, when his employment was terminated. After the employer notified Volpe of the separation, someone at Abacus allegedly hacked into the ‘find my iPhone’ feature and remotely deleted all of the data on Volpe’s smart-phone. The lost data included personal contact, photo, video, and purchased application data that forensic methods could not restore. Asserting a number of New Jersey state law claims as well as one under the CFAA, Volpe filed suit against Abacus in federal court. Abacus moved to dismiss Volpe’s CFAA claim, partially on jurisdictional grounds, and the court denied their motion. Determining that all of the elements of a civil CFAA claim were met, the court noted that Volpe’s iPhone was a ‘protected computer’ which Abacus was not authorized to access because doing so required the Abacus ‘hacker’ to request a new Apple ID password, which was then sent to Volpe’s old Abacus email address. In concluding that such behavior was ‘knowing’, demonstrated an ‘intent to defraud’, and reflected Abacus’ procurement of something of value – the ability to remotely delete data – from its deceptive acts, the court adopted a few notable points in its motion to dismiss analysis. First, it decided that “‘defraud,’ as used in CFAA § 1030(a)(4) means “wronging one in his property rights by dishonest methods or schemes” and thus does not require proof of the common law elements of fraud. Next, the court held that a Plaintiff asserting a civil CFAA claim need not be the ‘victim’ of the fraud; thus, here it sufficed, at least for pleading purposes, that Abacus deceived Apple, Inc. and that such deception caused Volpe’s data to be permanently erased. Finally, the court adopted the First and Tenth’s Circuit’s definition of ‘anything of value’ under the CFAA as “relative to one’s needs and objectives[;]” therefore, it was of no consequence that Abacus argued Volpe’s permanently destroyed data was not as valuable as Volpe claimed in his Complaint.
Oakwood Labs. LLC v. Thanoo, 999 F.3d 892 (3d. Cir. 2021). After the fourth dismissal of its Complaint alleging trade secret misappropriation – under the DTSA and New Jersey law – of its complex pharmaceutical ‘microsphere’ technology for a lack of specificity, Oakwood successfully appealed to the Third Circuit. The case concerns Oakwood’s two-plus decade journey researching and developing the ‘microsphere’ drugs, which cost $130 Million; a project primarily spearheaded by its former head of Product Development, Thanoo. Just months after confidential discussions to supply the raw materials for the drugs developed using Oakwood’s trade secrets fell apart with fellow pharmaceutical company Aurobindo, Thanoo left Oakwood’s employ to go to Aurobindo. Thanoo’s new employer then announced to investors that it would only cost Aurobindo $6M and would only take one to four years for them to ostensibly catch up to Oakwood in creating their own ‘microsphere’ drugs and bringing them to market. In vacating the district court’s dismissal and allowing discovery, The Third Circuit noted that there was ample circumstantial evidence of trade secret misappropriation based on Aurobindo’s hiring of Thanoo, the timing thereof, and the similarity of Thanoo’s work at both companies. Thus, the appellate court chastised the lower court for “erroneously equat[ing] the concept of “use” with replication” and for emphasizing Aurobindo’s technical to-date failure to develop its own FDA-approved drug. Because “the implication of use, especially at the pleading stage, can flow from circumstantial evidence alone” it was improper for the “district court [to] ask[] for direct proof of misappropriation without permitting . . . discovery.” The circuit also made clear that a trade secret plaintiff need not “allege that its trade secret information was the only source by which a defendant might develop its product[;]” thus, the allegations that Aurobindo’s access to Oakwood’s trade secrets via the talks and hiring of Thanoo had expedited and cheapened the cost of its entry into a specific pharmaceutical marketplace which it knew Oakwood was targeting with those secrets were sufficient to survive dismissal. Finally, since Oakwood’s trade secrets were plausibly misappropriated, by statutory definition, Oakwood suffered ‘harm’, because it “lost the exclusive use of trade secret information” whether Aurobindo was actually selling a competitive drug to-date or not.
Additional Cases of Note
Intech Powercore Corp. v. Albert Handtmann Elteka GmbH & Co., KG, 2021 U.S. Dist. LEXIS 57522 (D. N.J 2021) (unpublished) (granting supplier’s motion for summary judgment on state trade secrets claim because the customer and pricing information was “readily ascertain[able] . . . through proper business channels” since the supplier cold simply ask this customer, with whom they had independent contacts, for the pricing information, and because they could reverse engineer plaintiff’s margins by virtue of their position as the wholesale supplier of the customer’s ultimate product; denying summary judgment on all other claims); Marina Dist. Dev. Co. LLC v. AC Ocean Walk LLC, 2021 U.S. Dist. LEXIS 74571 (D. N.J. 2021) (unpublished) (granting plaintiff’s motion for leave to amend its complaint asserting trade secrets, RICO, tortious interference, and unfair competition claims in this Atlantic City, NJ boardwalk casino row because there was no dispute that certain former employees at the Borgata defected to the Ocean, bringing with them trade secrets about ‘high rollers’; therefore, amendment of the complaint was not futile because evidence showed that Ocean took affirmative steps to circumvent the restrictive covenants to which those former Borgata employees were subjected); KBS Pharm., Inc. v. Patel, 2021 U.S. Dist. LEXIS 107779 (E.D.Pa 2021) (unpublished) (in row between former pharmacist who started nearby competing pharmacy and his former employer where 70% of customers were poached, dismissing CFAA counts against two former employees who were authorized to access the customer information they used to start the competitor; dismissing CFAA claim against the new entity, as it only passively received the customer data; and not dismissing CFAA claim as to the wife of one of the former employees under a co-conspirator theory of liability because she was a partner in the competitor and thus indirectly involved in the scheme to access plaintiff’s data); Etimine USA Inc. v. Yazici, 2021 U.S. Dist. LEXIS 55652 (W.D.Pa 2021) (unpublished) (denying motion to dismiss trade secret, contract, and conversion claims where former top executive of plaintiff divulged plaintiff’s trade secrets, including customer, pricing, logistical, and sourcing information while consulting for plaintiff’s direct competitor, because plaintiff adequately guarded its proprietary logistical and pricing information which qualified as a non-technical trade secret that need not be pleaded with specificity).
§ 1.5.5. Fourth Circuit
Anderson v. Fluor Intercontinental, Inc., 2021 U.S. Dist. LEXIS 45526 (E.D. Va. 2021) (unpublished). Retired United States Army Brigadier General Steve Anderson participated in numerous business ventures after retiring, and prior to being hired by Fluor as its Country Manager in Afghanistan, including having served as Chief Marketing Officer of Relyant Global and owning a stake in Relyant’s holding company, as well as owner and CEO of consulting company Energistics Technologies and performed consulting working for several companies, including LEEP Expeditionary Buildings. As a result, during the hiring process, Fluor informed Anderson that they would need to address his potential conflicts of interests, specifically the risk that Relyant might improperly benefit from Anderson’s inside influence at Fluor. After being hired by Fluor, Anderson entering into a consulting agreement with Relyant and a marketing agreement with LEEP, with whom he communicated his intent to use his position at Fluor for their benefit. After Anderson’s interactions with subcontractors in raised red flags and after Fluor awarded a contract to Relyant, Fluor investigated and terminated Anderson, in addition to recompeting the contract previously awarded to Relyant, who had been provided competitor pricing information that Anderson had obtained as a Fluor employee. Anderson filed this action against Fluor arising out his termination and the disclosure of his suspected conflict of interest violations; Fluor counterclaimed, resulting in the parties’ cross motions for summary judgment. Specifically, as to Fluor’s claim for violation of Virginia Uniform Trade Secrets Act (VUTSA), and after determining that the pricing information at issue qualifies as a trade secret under the VUTSA, the court found that the viability of this claim turns on whether Fluor can “own” a trade secret by merely possessing it, and whether the collateral source rule applies to VUTSA damages. After looking to how other federal courts examined this issue under the Uniform Trade Secret Act, the court found that a plaintiff can “own” a trade secret under VUTSA by lawfully possessing it. The court also found that, although Fluor’s lawful possession of the pricing information at issue can give rise to a VUTSA claim, Fluor failed to identify authority supporting its damages theory, i.e., that the collateral source rule should apply, and, as such, the court granted summary judgment to Anderson on this claim.[38]
Dmarcian, Inc. v. Dmarcian Eur. BV, 2021 U.S. Dist. LEXIS 99380 (W.D.N.C. 2021) (unpublished). Plaintiff is a Delaware corporation providing email protection products and services. Plaintiff owns several types of protected intellectual property, and, as alleged by plaintiff, it also owns trade secrets, including source code, historical customer data, client contacts, business and market intelligence, and sales leads. Plaintiff entered into a business arrangement with defendant, a Dutch corporation, giving defendant a license to use and sell plaintiff’s intellectual property to customers in Europe, Africa, and Russia, in exchange for an option to purchase a majority interest in defendant. The agreement was never reduced to writing. Plaintiff also provided defendant with access to its computer systems and proprietary code for use in continued product and software development efforts by a group of Bulgarian developers working for defendant. Sometime after, defendant asserted an ownership interest in the code developed by the Bulgarian developers, which led to a dispute regarding the terms of the licensing agreement and plaintiff briefly suspending defendant’s access to its computer systems. Defendant’s minority shareholder filed an action in the applicable Dutch court and the parties continued to try to resolve the dispute for several months, but ultimately plaintiff notified defendant that it would not continue to provide its technology, services, customers, and use of its trademarks unless defendant agreed to pay 80 percent of its income as a licensing fee. The parties were unable to agree and plaintiff terminated the intellectual property licensing agreement and access to its computer systems, and alleges in the instant action that defendant continued using plaintiff’s copyrighted software code and trademark to service customers. Plaintiff also alleges that defendant deceived customers into doing business with defendant, rather than plaintiff, such as by setting up confusingly similar websites to misdirect plaintiff’s potential and current customers, and that although defendant claims to only service customers outside of the United States, defendant’s websites, when accessed from within the United States, direct them to defendant’s platform. Plaintiff requested a preliminary injunction as to its claims against defendant, including its claims for misappropriation of trade secrets under the North Carolina Trade Secrets Protection Act (NCTSA) and Defend Trade Secrets Act (DTSA). Defendant did not dispute that it used plaintiff’s trade secrets without authorization, only that it has never done so in the United States. Accordingly, at issue was defendant’s argument that an extraterritorial claim cannot be brought under DTSA unless an act in furtherance of the offense was committed in the United States. The court found that courts interpreting DTSA have established a relatively low bar for acts that are considered “in furtherance of the offense” and the cases it analyzed demonstrate that courts place less import on the scope of the actions committed within the United States than the tie between those actions and the misappropriation. As such, the court concluded that, because defendant originally gained access to plaintiff’s trade secrets within the United States, and the evidence suggests that defendant’s actions led to the use or disclosure of plaintiff’s trade secrets within the United States, the DTSA can be applied to defendant’s conduct. The court ultimately granted defendant’s request for injunctive relief on basis of this claim, among other claims, because plaintiff demonstrated a likelihood of success on the merits and that it would suffer irreparable harm in the absence of an injunction.
Ihs Global Ltd. v. Trade Data Monitor, LLC, 2021 U.S. Dist. LEXIS 101952 (D.S.C. 2021) (unpublished). IHS Global owns and operates Global Trade Atlas (GTA), a database providing comprehensive merchandise trade statistics. GTA was created by defendant Brasher and his brother through Global Trade Information Services (GTIS), which they sold, along with GTA, to IHS through a stock purchase agreement (SPA) that prohibited Brasher and his affiliates from using any confidential information or proprietary information related to GTIS, including GTA, for three years. After the sale of GTIS, Brasher worked as a consultant with IHS and entered into a consulting agreement, which prohibited the use of IHS’s confidential and proprietary information. Defendants Stein and Stringfield also worked for GTIS, and then IHS after the acquisition, at which time they executed employment agreements with IHS the prohibited the use and disclosure of any of IHS’s proprietary information. Approximately 15 months the acquisition of GTIS, Brasher began developing the Trade Data Monitor Production (TDM Product), which plaintiff alleges is a copycat version of the GTA, and then formed defendant Trade Data Monitor (TDM). Shortly thereafter, Stein and Stringfield terminated their employment with IHS and began working for Brasher. Also, still within the three year noncompete period, Brasher’s friend purchased a subscription to GTA through which Brasher and TDM frequently accessed GTA. During this time, Brasher also had access to his work laptop with GTIS’s customer relationship database and Stein and Stringfield had access to a large volume of emails from their time at GTIS, although the parties dispute whether defendants actually relied upon any of this information in building and marketing the TMD Product, which they launched the day after the three year noncompete period ended. IHS alleges that defendants used IHS’s product, supplier, customer trade secrets and proprietary information to create the TDM Product and that they have been using IHS’s confidential customer information to create business. The parties filed competing motions for partial summary judgment. At issue, with regard to IHS’s trade secret claims, is defendants’ request for the court to declare that certain pieces of publicly available information, like IHS’s customer and supplier contacts and raw trade data, cannot constitute “trade secrets” under the South Carolina Uniform Trade Secrets Act and the Defend Trade Secrets Act. The court disagreed, noting that IHS seeks protection for compiled lists and databases, and not the individual pieces of information contained therein and refusing to aid defendants in attempting to nullify well-settled trade secret protections for compilations by arguing the each component part is publicly available and therefore not subject to protection.[39]
Steves & Sons, Inc. v. Jeld-Wen, Inc., 988 F.3d 960 (4th Cir. 2021). Jeld-Wen acquired competitor CMI and four years later one of Jeld-Wen’s customers, Steves and Sons, filed a lawsuit challenging the merger, which led to a jury trial and finding that the merger violated antitrust law and the district court granting Steve’s request to unwind the merger. The district court also held a trial before a different jury regarding Jeld-Wen’s countersuit against Steves for trade misappropriation and, after the jury ruled for Steves on most of Jeld-Wen’s claim, the district court entered judgment for the intervernors, Steve’s two owners and one of its employees, although Jeld-Wen had not brought claims against them. Jeld-Wen appealed various aspects of the district court’s rulings, the majority of which the Fourth Circuit affirmed. As to the trade secrets trial, the Fourth Circuit held that Jeld-Wen failed to demonstrate that the court’s jury instructions were improper, but the court did vacate the entry of judgment for the intervernors. Specifically, the court upheld the district court’s jury instruction regarding the combination trade secret in the case because Jeld-Wen’s argument conflates the concepts of combination trade secrets and the level of secrecy required of trade secrets generally, and the court disagreed with Jeld-Wen’s position that a non-combination trade secret need not be secret. The court also upheld the jury instruction that malicious trade secret appropriation requires an “intent to cause injury or harm” to the plaintiff because Jeld-Wen failed to adequately brief its argument under the Uniform Trade Secrets Act and because, before the September 2017 amendment of the Texas Uniform Trade Secrets Act, which is the version that governs Jeld-Wen’s claims, courts defined “malice” in misappropriation cases as “a specific intent by the defendant to cause substantial injury or harm to the claimant,” which matches the jury instructions provided. The Fourth Circuit vacated the entry of judgment as to the intervenors because an intervenor’s right to participate does not give them a right to judgment on claims that do not exist and none of the cases cited by Steves or the district court suggest that a party can be awarded judgment on a claim or defense that was never raised.
Additional Cases of Note
Brightview Grp., LP v. Teeters, 2021 U.S. Dist. LEXIS 64487 (D. Md. 2021) (unpublished) (finding that Brightview is entitled to summary judgment against all defendants for trade secret claims under the Defend Trade Secrets Act and the Maryland Uniform Trade Secrets Act because there is no material factual dispute that three of the documents at issue contain trade secret information and were misappropriated by defendants because, although former employees Dingman and Teeters were not named in the initial formation documents of defendant Monarch while they were employed by Brightview, they had been working on behalf of the entity at the time of its formation, but also finding insufficient evidence to support an award of monetary and exemplary damages for Brightview’s trade secret claims and a material factual dispute regarding whether Brightview is entitled to recover attorneys’ fees); ComRent Int’l, LLC v. Thomson, 2021 U.S. Dist. LEXIS 84320 (D. Md. 2021) (unpublished) (denying defendants’ motions to dismiss for failure to state a claim and finding that plaintiff sufficiently pled a claim for misappropriation of trade secrets under the Defend Trade Secrets Act (DTSA) and the Maryland Uniform Trade Secrets Act (MUTSA) through its allegations that the documents at issue are trade secrets within the meaning of DTSA and MUTSA and specifically detailing the alleged misappropriation, in addition to disagreeing with defendants’ argument that plaintiff cannot identify any piece of confidential information given that plaintiff had not yet had the opportunity to examine Thomson’s computer); Governmentcio, LLC v. Landry, 2021 U.S. Dist. LEXIS 53905 (D. Md. 2021) (unpublished) (denying defendant’s motion to dismiss plaintiff’s trade secret claims for violation of Defend Trade Secrets Act (DTSA) and Texas Uniform Trade Secrets Act (TUTSA) because plaintiff plausibly alleged the existence of a trade secret and misappropriation when it pled that it kept its personnel information private, required employees to sign nondisclosure agreements, defendant had acknowledged the confidentiality of such information, the information was not readily ascertainable, and a company with access to such information would save significant time and money, in addition to allegations that Landry disclosed the information to FavorTech, based on “information and belief,” which is permissible at this stage given that Landry and FavorTech alone know whether such allegations are true)[40]; GSP Fin. Servs., LLC v. Harrison, 2021 U.S. Dist. LEXIS 16341 (D. Md. 2021) (unpublished) (granting plaintiff’s motion for default judgment and finding that plaintiff sufficiently alleged that defendant accessed its computers without authorization after she was terminated, even though her access to plaintiff’s systems and information was not immediately cutoff, and that such actions by defendant caused loss to plaintiff in the form of substantial business interruption, lost revenues and legal fees); Ilshin Chem., Inc. v. New Co. Strategy, LLC, 2021 U.S. Dist. LEXIS 55314 (E.D.N.C. 2021) (unpublished) (denying motion to dismiss defendant’s counterclaims in part, including dismissing defendant’s counterclaims for misappropriation of trade secrets because defendant had not sufficiently alleged that plaintiff acquired, disclosed, or used a trade secret and defendant’s argument that plaintiff never would have been able to take over its largest customer without obtaining and using defendant’s pricing information was not supported by the allegations); Performance Auto. Grp., Inc. v. Fernandez, 2021 U.S. Dist. LEXIS 55313 (E.D.N.C. 2021) (unpublished) (denying, in part, defendant’s motion to dismiss for failure to state a claim, and finding that plaintiff sufficiently alleged that defendant’s access to plaintiff’s lending software application following his termination was not authorized when it deactivated defendant’s business email upon termination without being aware that plaintiff had enabled his personal email in order to access such files, and, as such, plaintiff plausibly alleged its claims for violation of the federal Computer Fraud and Abuses Act, federal Stored Communication Act, federal Defend Trade Secrets Act, the North Carolina Computer-Related Crime Act, the North Carolina Uniform Trade Secrets Act, and the North Carolina Unfair and Deceptive Trade Practices Act); Philips N. Am. LLC v. Little, 2021 U.S. Dist. LEXIS 120615 (E.D.N.C. 2021) (unpublished) (finding that plaintiff stated facially plausible claims for relief, including with regards to its claims under the Defendant Trade Secrets Act and the North Carolina Trade Secrets Protection Act, when it alleged that, while employed by plaintiff, defendant acted as a consultant for a competitor without disclosing the conflict of interest to plaintiff and defendant used his personal email account to disclose plaintiff’s internal and proprietary documents to third parties without authorization); TECH USA, Inc. v. Milligan, 2021 U.S. Dist. LEXIS 37961 (D. Md. 2021) (unpublished) (granting defendants’ motion to dismiss for failure to state a claim and finding that plaintiff failed to present a plausible claim as to misappropriation of trade secrets under the Defend Trade Secrets Act (DTSA) because plaintiff’s “bare allegation that Milligan met in some capacity with an unknown number of representatives of the ZP Defendants and provided ‘other information’ is insufficient” under the DTSA, in addition to dismissing the remaining state law claims for lack of subject matter jurisdiction); Variable Annuity Life Ins. Co. v. Coreth, 2021 U.S. Dist. LEXIS 77329 (E.D. Va. 2021) (unpublished) (granting, in part, plaintiffs’ motion for a temporary restraining order and preliminary injunction against defendants based on plaintiffs’ breach of contract claim, to which Texas law applies, and plaintiffs’ claims for violations of the Virginia Uniform Trade Secrets Act and Defend Trade Secrets Act, and finding that plaintiffs made a clear showing of likely success on the merits on these claims, which defendants failed to sufficiently challenge, and plaintiffs provided uncontroverted evidence of the actual harm suffered in the form of lost goodwill, lost customer trust, and damage to reputation, and the balance of equities tip in favor of granting plaintiffs’ request).
§ 1.5.6. Fifth Circuit
Additional Cases of Note
Bureau Veritas Commodities & Trade, Inc. v. Nanoo, 2021 U.S. Dist. LEXIS 99497, at *6-17 (E.D. La. May 26, 2021) (granting in part defendants’ motion to dismiss plaintiff’s claims for trade secret misappropriation with respect to plaintiff’s employee lists, and organizational structure, contractor, and laboratory information, because the claims were listed in a “conclusory fashion” and did not explain how the information was “distinct from generally available knowledge”).[41]
Centurum Info. Tech. Inc. v. Geocent, LLC, 2021 U.S. Dist. LEXIS 27661, at *15 (E.D. La. Feb 12, 2021) (granting in part defendants’ application for injunctive relief to prevent defendant from accessing or disclosing plaintiff’s trade secrets because plaintiff demonstrated the information (1) “allows Centurum to achieve unique efficiencies and provides a competitive advantage over other providers,” and (2) “Centurum safeguards its proprietary information generally through company policies, password protection and multi-factor authentication, restricted access, and other means” ).
Chags Health Info. Tech. v. Rr Info. Techs., 2021 U.S. Dist. LEXIS 126855, at *7-8 (E.D. La. May 7, 2021) (denying plaintiff’s motion for entry of temporary restraining order against defendant due to trade secret misappropriation, because the only evidence offered by plaintiff in support of the restraining order was testimony conceding that the data taken “would not necessarily have been confidential information or trade secrets and that it could have been something as innocuous as accessing a work email”).[42]
Hunton Energy Holdings v. Hl Seawater Holdings, No. 4:20-CV-01415, 2021 U.S. Dist. LEXIS 194749, at *12-13 (S.D. Tex. Mar. 4, 2021) (denying Defendant’s motion to dismiss the Texas Uniform Trade Secrets Act claim because, although the TUTSA “only applies to the misappropriation of a trade secret made on or after September 1, 2013” and Defendant alleges that claim arose when Defendant resigned as Plaintiff’s CTO in July 2009, Plaintiff alleged that misappropriated technology was used by Defendant to develop a commercial water production and mineral manufacturing facility and a April 2019 presentation by Defendant regarding that project was attached to the complaint).
SMH Enters., LLC v. Krispy Krunchy Foods, LLC, 2021 U.S. Dist. LEXIS 249570, at *61-62 (E.D. La. May, 28, 2021) (holding that (1) partial summary judgment be granted for defendant regarding identified “features” in trade secrets Nos. 1-12 and 14 because even though “these features [were] identified with sufficient particularity, the evidence reflect[ed] that these outward facing features . . . fall within the common knowledge of those skilled in the industry. Even if they were not, they would not qualify as trade secrets because [plaintiff] failed to take reasonable measures to maintain the secrecy of those outward-facing features,” and (2) partial summary judgment be denied for defendant trade secret No. 13 because it “is not an outward facing feature” and issues of material fact remain).
§ 1.5.7. Sixth Circuit
Royal Truck & Trailer Sales & Servs. v. Kraft, 974 F.3d 756 (6th Cir. (Mich.) 2020). The plaintiff, Royal Truck & Trailer Sales and Services, brought suit against two former employees. The plaintiff alleged that the two defendants had abruptly resigned from their positions and immediately obtained employment with one of plaintiff’s competitors. Id. at 758. After their departures, the plaintiff employed a forensics expert to analyze what the former employees had done on their company computers and cellphones and found that they had emailed company information (which they were authorized to access at the time) to their own personal accounts. Id. The plaintiff argued that this constituted a violation of Michigan law and the Computer Fraud and Abuse Act. Id. On appeal, the question was whether the employees’ misconduct constituted “exceed[ing]” their “authorized access” under the Computer Fraud and Abuse Act. The 6th Circuit held no. Id. at 760. They reasoned that, because the statute defines “exceeds authorized access” as “to access a computer with authorization and to use such access to obtain or alter information in the computer that the accesser is not entitled so to obtain or alter,” the statute only prohibits obtaining or altering unauthorized material in the computer, not general misconduct with authorized material. Id. They further reasoned that the damages and loss provisions of the statute attempt to narrow the scope of the provision to only prohibit hacking information.
This interpretation was later confirmed by the Supreme Court in Van Buren v. United States, 141 S. Ct. 1648 (2021). There, a Georgia police officer was found guilty of violating the criminal prohibition in the CFAA when he ran license plate searches in exchange for money. Id. at 1653. The Supreme Court granted certiorari in order to resolve a split among the Circuits regarding this issue. Id. at 1654. Writing for the majority, Justice Barrett held that the provision did not prohibit misuse of information that a defendant is authorized to access. Id. at 1661. In addition to the textual justifications the 6th Circuit made in Royal Truck, the Court also pointed out that a contrary interpretation of the statute would criminalize even such mundane uses of a computer as checking personal email on a work computer. Id.
Additional Cases of Note
Advance Wire Forming, Inc. v. Stein, 2020 US. Dist. LEXIS 153940 (N.D. Ohio 2020) (holding that the plaintiffs had failed to satisfy their burden of showing they tried to “maintain the secrecy of their trade secret information” because they did not undertake any measures to restrict access to the information); Bankers Life & Cas. Co. v. McDaniel, 2021 U.S. Dist. LEXIS 58145 (M.D. Tenn. 2021) (granting a temporary restraining order where insurance agents broke an agreement to not use or disseminate confidential information or trade secrets by downloading customer information and not returning the information upon resignation); Campfield v. Safelite Grp., Inc., 2021 U.S. Dist. LEXIS 62070 (S.D. Ohio 2021) (applying Ohio law) (unpublished) (finding defendant-employer failed to raise a genuine issue of material fact to prevail under a CFAA claim because the evidence did not establish that plaintiff-employee intentionally accessed a computer without authorization, and defendant-employer’s state law claims for tortious interference with contract were preempted by the Ohio Uniform Trade Secrets Act because they involved “no more than a restatement of the same operative facts that formed the basis of the . . . statutory claim for trade secret misappropriation”); FirstEnergy Corp. v. Pircio, 2021 U.S. Dist. LEXIS 43163 (N.D. Ohio 2021) (dismissing alleged violations of the Defend Trade Secrets Act because the defendant acted as a whistleblower when he divulged company information to the SEC through a lawyer and dismissing alleged violations of the CFAA because the defendant had authorization to access the materials in question at the time that he accessed them); Jannx Med. Sys. v. Agiliti, Inc., 2020 U.S. Dist. LEXIS 237184 (N.D. Ohio 2020) (explaining non-confidential information is by definition not a trade secret); LinTech Global, Inc. v. Can Softtech, Inc., 2021 U.S. Dist. LEXIS 49958 (E.D. Mich. 2021) (holding that a defendant’s motion to dismiss plaintiff’s tortious interference claim was not preempted by the Michigan Uniform Trade Secrets Act because the count involved some allegations that did not touch on the misappropriation of trade secrets); Radiant Global Logistics, Inc. v. BTX Air Express of Detroit LLC, 2021 U.S. Dist. LEXIS 68319, at *30-44 (E.D. Mich. 2021) (applying Michigan law) (unpublished) (explaining of the elements of state trade secret claims in detail); Viera v. Gen. Auto. Ins. Servs. & Permanent Assur. Corp., 2021 U.S. Dist. LEXIS 21424 (M.D. Tenn. 2021) (holding that an employee accessing a former employer’s LinkedIn account and changing their profile to include derogatory content could constitute a breach of the CFAA even though she was originally authorized to have access to the account because when the employer fired her before this incident they had implicitly stripped her of her authorization).
§ 1.5.8. Seventh Circuit
Danaher Corp. v. Lean Focus, LLC, 2021 U.S. Dist. LEXIS 141800 (W.D. Wis. 2021) (unpublished). Baker, a former employee of Danaher, founded Lean Focus, LLC. Both Danaher and Lean Focus provide consulting services to clients based on “lean” manufacturing principles. Among other things, Danaher alleged that Baker and Lean Focus (Defendants) misappropriated Danaher’s trade secrets in violation of the federal Defend Trade Secrets Act and Wisconsin’s Uniform Trade Secrets Act. Among other things, defendants moved for summary judgement with regards to Danaher’s trade secret claims. Defendants argued that Danaher’s business system was not entitled to trade secret protection because Danaher did not make reasonable efforts to maintain the secrecy of its business system and Danaher’s business system was generally known and readily ascertainable outside of Danaher. The court denied defendants’ motion for summary judgment in this respect. First, with respect to whether Danaher had taken reasonable measures to maintain the secrecy of its trade secret, the court noted that this issue is rarely amenable to summary judgement. The court noted evidence sufficient to raise a genuine issue of material fact, alluding to Danaher’s code of conduct, which requires its employees not to reveal confidential information, its annual training modules that require confidential requirements, its password-protected intranet site; the required signing of nondisclosure agreements for certain employees, and its monitoring of any public disclosure of its trade secrets. Second, with respect to whether Danaher’s business system was generally known and readily ascertainable outside of Danaher, the court noted differing expert opinions and said that Danaher raised a general issue of fact as to whether its trade secret was generally known or readily ascertainable.
HCC Cas. Ins. Servs. v. Day, 2021 U.S. Dist. LEXIS 57433 (N.D. Ill. 2021) (unpublished) (applying Illinois law). Plaintiff HCC Casualty Insurance Services, Inc. brought a breach of contract suit against Day, its former president, claiming that Day violated certain restrictive covenants in his employment agreement. Plaintiff sought monetary and injunctive relief. The dispute arose out of Day’s employment agreement with plaintiff, which was originally effective through April 30, 2019, but which was amended and extended through April 30, 2020. The agreement contained three restrictive covenants around confidentiality, noncompetition, and nonsolicitation. The confidentiality restrictive covenant included plaintiff’s “trade secrets” within the information that Day was supposed to keep confidential. On May 2, 2020, two days following the expiration of his employment agreement with plaintiff, Day resigned from his position as plaintiff’s president. Shortly thereafter, Day then joined another insurance underwriter as its president. Plaintiff claimed that Day violated his previous employment agreement by hiring nine employees from plaintiff, disclosing plaintiff’s trade secrets to his new company, and directly competing with plaintiff. Day filed a motion to dismiss plaintiff’s claims for failure to state a claim. Day, among other things, argued that the restrictive covenants were overbroad and unenforceable. As to the confidentiality provision, Day argued that its definition of confidential information was too broad and that it did not contain geographical or temporal restraints. The employment agreement defined confidential information as “any information . . . that relate[d] to any aspect of the Company or its Affiliates or their respective business, finances, operation plans, budgets research, or strategic development.” Plaintiff argued that the confidentiality clause was not overbroad because it defined specific types of information that constituted “confidential information,” such as trade secrets. The court agreed with Day, holding that, unlike the noncompete and nonsolicitation provisions within the employment agreement, it could not “conceive of any set of facts under which it would be reasonable for [plaintiff] to prevent Day from disclosing ‘any information . . . that relates to any aspect’ of its business, in any geographical area, for all time.” (alterations in original). As to plaintiff’s argument, the court said that the specific categories of information were just examples and the employment agreement did not actually limit the broad definition of “confidential information.” Plaintiff’s allegations were dismissed to the extent that they were premised on Day’s breach of the confidentiality provision in his employment agreement.[43]
Additional Cases of Note
Marquis ProCap Sys, LLC v. Novozymes N. Am., Inc., 2021 U.S. Dist. LEXIS 140757 (C.D. Ill. July 27, 2021) (unpublished) (denying defendant’s objection to magistrate judge’s order regarding motion to compel, finding that plaintiff’s description of alleged trade secrets was sufficiently detailed for the discovery stage).
§ 1.5.9. Eighth Circuit
Advanced Control Tech. v. Iversen, 2021 U.S. Dist. LEXIS 124624 (D. Minn. 2021) (unpublished). ACT manufactures float switches and liquid-level sensors. Iversen worked in ACT’s sales department and had access to ACT’s trade secrets and proprietary documents including customer list, manufacturing process data, pricing, customer quotes, company operations, vendor list, and product specifications. Iversen signed a nondisclosure agreement that also required him to return ACT’s property. ACT’s policy manual thoroughly addressed confidentiality obligations. Iversen was terminated by ACT, and later that day sent an email to ACT from his personal email account attaching a purchase order from an ACT customer. ACT asked Iversen to delete the email from his possession, but Iversen refused and suggested he would share ACT’s proprietary information with its customers. Further investigation revealed that Iversen regularly sent emails containing ACT trade secret information from his ACT email account to his personal email account, installed a password recovery tool used to recover credentials belonging to other ACT employees, and that he was in contact with two Chinese companies about manufacturing sensors. Iversen claimed he was entitled to keep ACT’s proprietary and confidential information. The court granted ACT’s motion for summary judgment on its trade secret claim, finding that Iversen was aware he could not use or take ACT’s trade secrets, and that he improperly retained ACT’s trade secrets, and used and threatened to use them to further his own needs. The court granted an injunction against Iversen and his new employer prohibiting use, copying, communicating, disclosure, divulging, or furnishing any of ACT’s trade secrets to any third party.
ATD Tools v. Fisher, 2021 U.S. Dist. LEXIS 27315 (E.D. Mo. 2021) (unpublished). See Section 1.2.9 for a summary of the case background and the court’s ruling on a duty of loyalty issue. The court found that ATD was likely to succeed on the merits of its trade secret misappropriation claim because (1) ATD’s trade secrets included business strategies, such as details on pricing arrangements with vendors, ATD’s process and decisions regarding which products will receive their private brand label, and other strategic plans; (2) ATD took reasonable measures to keep its information confidential and much of its business strategies and details on vendor relationships derive value from their secrecy, and (3) Fisher acquired ATD’s trade secrets while under a duty to maintain its secrecy. Irreparable harm was met because courts generally hold that disclosure of trade secrets, like business strategies, results in irreparable harm, especially where a defendant attempts to cover up their actions. The court also found that the harm ATD would suffer absent an injunction outweighed harm to Fisher if he was enjoined from using ATD’s trade secrets, and that an injunction would preserve the public’s interest in a fair a competitive business market.
Pitts v. Fire Extinguisher Sales & Servs. of Ark. LLC, 2021 U.S. Dist. LEXIS 117528 (E.D. Ark. 2021) (unpublished). See 18.3.9 for a summary of the case background and the court’s ruling on a noncompete issue. Under the terms of a noncompetition agreement with FESSAR, Pitts agreed never to disclose to any third party, any confidential or other non-public information of or relating to FESSAR, including customer information, and pricing and purchasing policies and procedures. The agreement also included a customer nonsolicitation provision. After Pitts was terminated from FESSAR, he emailed himself FESSAR’s customer lists, customer prices, and quotes. FESSAR sued Pitts for misappropriation of trade secrets. The court found that in executing the noncompetition agreement with Pitts, FESSAR took reasonable measures to keep secret its data and information relating to customers, pricing and purchasing policies and procedures, and other trade secrets. Based on Pitts’ email communication with a Pitts customer, and acquisition of two of FESSAR’s long time customers, the court found it is likely that Pitts disclosed or used FASSAR’s trade secrets. The court entered a TRO prohibiting Pitts from opening, looking at, forwarding, relying on, copying, or in any way utilizing FESSAR’s customer lists, company prices, and quotes Pitts emailed himself, or any other confidential information described in the noncompetition agreement. The TRO also prohibited Pitts from soliciting any customer of FASSAR.
Schlafly Trust v. Cori, 2021 U.S. Dist. LEXIS 2880 (E.D. Mo. 2021) (unpublished). Plaintiffs alleged that Cori misappropriated a trade secret database containing a compilation of business contacts and specific information on over 400,000 individuals and organizations, including their donation records, contact information, and other information collected for fundraising efforts over the past 50 years. At issue on a motion to dismiss was whether plaintiffs took reasonable measure to keep the database secret. Cori argued that that plaintiffs failed to take reasonable measures because employees with access to the database did not have confidentiality or noncompete agreements. The court found that plaintiffs took reasonable steps because (1) the database was kept in a locked safe before it was digitized; (2) after being digitized it was available on only one computer kept in a locked office with access granted to only a handful of employees; and (3) the database was not disclosed to any third party except an individual who wrote the source code and application software that allowed management of the database. Despite the lack of confidentiality agreements, the court found that plaintiffs adequately plead that it took reasonable efforts to maintain the secrecy of the database.
Syngenta Seeds, LLC v. Warner, 2021 U.S. Dist. LEXIS 32385 (D. Minn. 2021) (unpublished). Syngenta, an agtech company that develops crop seeds, sued former employees Warner and Sleper and their new employer, Farmer’s Business Network, for trade secret misappropriation. Defendants moved to dismiss arguing that Syngenta had not plausibly alleged trade secret misappropriation. The court’s analysis was guided by several principles, including (1) that misappropriation is plausible when a departing employee had retained trade secrets under suspicious circumstances and there is reason to believe that the employee has used or disclosed the trade secrets in their new employment, and (2) that surrounding circumstances may give rise to a reasonable inference of misappropriation at the pleading stage even without a direct allegation of a specific use or disclosure. Despite no direct allegations that Sleper disclosed a specific piece of trade secret information, the court found that Syngenta had plausibly alleged trade secret misappropriation against him under the specific circumstances of the case because Sleper’s role with Syngenta gave him access to its trade secrets and he had broad confidentiality obligations; in the months before he resigned he discussed building a competing seed breeding program at FBN and had meetings with FBN shortly before he resigned where he reportedly shared “great ideas” about “genomics and phenomics”; he accessed Syngenta’s trade secrets in a behavior consistent with copying the data, but did not return any such data; and months after Sleper joined FBN, it announced a new seed breeding program. For similar reasons, Syngenta had plausibly alleged that FBN misappropriated its trade secrets because Sleper’s main point of a contact was a former Syngenta employee who presumably knew of Sleper’s confidentiality obligations and the types of information Sleper could access; FBN engaged in discussion with Sleper about building a competing seed breeding program, FBN employees shared information they learned from Sleper and Warner; and shortly after Sleper joined FBN, it announced a new seed breeding program. Despite defendant’s different and plausible interpretation of the allegations, the court found that Syngenta had done enough to avoid dismissal of the trade secret claim.
United Healthcare Servs. v. Louro, 2021 U.S. Dist. LEXIS 32385 (D. Minn. 2021) (unpublished). See §8.3.9 for a summary of the case background and the court’s ruling on a noncompete issue. United sought a preliminary injunction on an inevitable disclosure theory of trade secret misappropriation. United argued that because Louro cannot unlearn United’s pricing strategies, formulas, and pricing factors, he will be unable to perform his role at Anthem without using and disclosing United’s trade secrets. The court found that United had not met the high bar for pleading inevitable disclosure. In finding that United was unlikely to prevail on its trade secret claim, the court noted that Louro’s position at Anthem is significantly different from his position at United, and that United had not demonstrated any nefarious motives on Louro’s part. The court also relied upon Anthem’s and Louro’s representations that both parties will take affirmative steps to prohibit Louro from disclosing any of United’s proprietary information.
§ 1.5.10. Ninth Circuit
Precision Indus. Contractors Inc. v. Jack R. Gage Refrigeration Inc., No. C19-5810 TSZ, 2021 U.S. Dist. LEXIS 148078 (W.D. Wash. 2021) (unpublished). Defendant Daniel Jason Hoyt was an employee of Precision Industrial Contractors Inc. (PIC), which provides project management services and products to industrial clients. Hoyt was eventually promoted to general superintendent, where he was granted access to PIC’s confidential information, including PIC’s strategies on how to secure winning bids and information about PIC’s existing and potential clients. In the past, PIC had won about 75 percent of the bids it submitted for the entity Port Townsend Paper. While Hoyt was employed with PIC, Port Towsend Paper planned a multimillion-dollar expansion project (the OCC project). Shortly after the OCC project was announced, Hoyt abruptly quit PIC. Following this, PIC was only awarded one project for the OCC project even though it submitted five or six bids. Though there were other factors in play, PIC believed that some of the reason it lost its bids is because Hoyt used PIC’s confidential information to submit bids to Port Townsend Paper. PIC eventually moved for summary judgment on its federal and state trade secret misappropriation claims, arguing that Hoyt improperly took PIC’s confidential information, including bidding sheets, internal costs, manuals, and other techniques developed internally and exclusively for PIC’s own use. PIC also declared that Hoyt had access to PIC’s confidential and proprietary information, including strategies on how to submit winning bids or proposals and information about new and potential customers, including Port Townsend Paper. Despite this, the court found that while Hoyt may have had access to some of PIC’s confidential information, that in itself did not demonstrate that Hoyt misappropriated the information. Moreover, the court noted that it was undisputed that Hoyt had decades of “know-how and experience,” including with submitting bids for industrial construction projects. In addition, Hoyt testified that he had no idea what PIC’s bids were going to be on the OCC project. In sum, there was no evidence that Hoyt misappropriated PIC’s trade secrets or acquired them through improper means, that he disclosed the trade secrets to his new company, or that he used the trade secrets in connection with submitting bids for the OCC project. Accordingly, summary judgment was denied as to PIC’s claims for trade secret misappropriation.[44]
Additional Cases of Note
Pro Flexx LLC v. Hiroshi Yoshida, No. 20-00512 SOM-KJM, 2021 U.S. Dist. LEXIS 17858 (D. Haw. 2021) (unpublished) (defining the “same proof” standard for claim preemption by the HUTSA: if a non-HUTSA claim would simultaneously establish a claim for trade secret misappropriation, it is preempted, regardless of if additional elements are necessary to establish the non-HUTSA claim); VibrantCare Rehab., Inc. v. Deol, No. 2:20-cv-00791-MCE-AC, 2021 U.S. Dist. LEXIS 79718 (E.D. Cal. 2021) (unpublished) (noting that the CUTSA preempts any claim based entirely on the same factual allegations that form the basis of a trade secret claim); NW Monitoring LLC v. Hollander, No. C20-5572 RSM, 2021 U.S. Dist. LEXIS 73193 (W.D. Wash. 2021) (unpublished) (stating that under the “strong” form of preemption under the WUTSA, a plaintiff may not rely on acts that constitute trade secret misappropriation to support another cause of action, even if the other claim requires proof of additional elements).
§ 1.5.11. Tenth Circuit
Graystone Funding Co., LLC v. Network Funding, L.P., 2021 U.S. Dist. LEXIS 187818 (D. Utah 2021) (unpublished). On April 8, 2019, Jason Gautreau and Cristie North, two high-level employees at Graystone Funding Company, LLC (“Graystone”), left to join a different mortgage lending company, Network Funding, L.P. (“NFLP”). When Kipp Myers, 90% owner of Graystone, found out about Jason Gautreau and Cristie North’s departure, he inquired whether the payment terms in a pro forma provided to him previously would still be available if Graystone merged with NFLP, and when informed by Gautreau that NFLP agreed to this, Graystone agreed to merge with NFLP that same day. On April, 19, 2019, having been disappointed with the payment terms of the offer he received the day before, Kipp Myers called off the merger and on May 20, 2019 Graystone demanded that NFLP and former Graystone employees who joined NFLP (of which there were about 50) return and destroy any Graystone information in their possession.
Graystone sued Gautreau, North, and NFLP, alleging, among other causes of action, that the defendants misappropriated trade secrets. In front of the court was defendants’ motion for summary judgement. Defendants argued that even assuming there is a genuine dispute on the reasonableness of the plaintiff’s efforts to maintain secrecy while Gautreau and North engaged in discussions with NFLP, plaintiffs waived all trade secret claims when it voluntarily disclosed such information after April 8, 2019, when Graystone agreed to merge with NLFP. The court agreed that since the plaintiff provided NFLP with certain information after April 8, 2019, that information lost any trade secret protections at that time, so to the degree plaintiff’s claims are based on alleged misappropriation after the voluntary disclosure, those claims fail as a matter of law. Similarly, for customer databases which were not provided to NFLP but were also not protected from disclosure to NFLP after the plaintiff agreed to the merger with NFLP, the court held that to the extent the customer databases were protected trade secrets, such protection was extinguished at that time, and such claims of misappropriation would fail as a matter of law. On the other hand, to the extent the plaintiff’s claims are based on alleged misappropriation prior to its voluntary disclosure, “the subsequent voluntary disclosure of the information does not destroy the trade secret protection that existed at the time the information was allegedly misappropriated” and such claims are not barred as a matter of law.
Ivanti, Inc. v. Staylinked Corp., 2021 U.S. Dist. LEXIS 146994 (D. Utah 2021) (unpublished). In an action for misappropriation of trade secrets, Ivanti sought a protective order to maintain a Confidential-Attorney’s Eyes Only (CAEO) designation or 734 documents in its case against Staylinked, claiming that the materials contained company proprietary information that would be damaging to share with the opposing side. Ivanti submitted the documents to the court for in camera review and the court made categorical determinations on which types of documents should be allowed CAEO status. Included in the documents determined to require CAEO status were customer names, revenues from specific customers, and computer-generated error logs specific to individual systems and products. The court denied CAEO status to documents in which only small portions contained sensitive information, internal discussions about general awareness of customer problems, internal presentations on staff efficiency and workload, internal meeting agendas and training topics, workplans setting goals and progress for specific employees, and manuals obtained by Ivanti from other companies.
LS3 Inc. v. Cherokee Fed. Sols., L.L.C., 2021 U.S. Dist. LEXIS 186460 (D. Colo. 2021) (unpublished). After losing a contract to defendant companies, plaintiff filed suit against Cherokee Nation companies and its own former employees, alleging breach of contract by the individual defendants, tortious interference with contract by the Cherokee defendants, and civil conspiracy and misappropriation of trade secrets by all defendants under the Defend Trade Secrets Act and the Colorado Uniform Trade Secrets Act. The employee defendants had signed either an “Employment Agreement” or an “Intellectual Property, Non-Interference/Non-Solicitation and Non-Disclosure Agreement” while working for plaintiff. During the hiring process, defendant companies sent the individual defendants an “Incumbent Questionnaire” which asked about their employment with plaintiff, including their job titles, duties, training, and clearance level. Ruling on the defendants’ motion to dismiss, the court dismissed plaintiff’s breach of contract and tortious interference claims, finding that there had been no breach. Turning to the misappropriation of trade secrets claim, the court examined whether the Questionnaire sought information that qualified as trade secrets. Plaintiff argued that because it had used password protection to conceal this information, it was secret and non-public. However, the court found that the information was not a trade secret, since: 1) nothing indicated how much of the information was known outside of plaintiff’s business; 2) plaintiff had not shown that the information was kept secret within its business; and 3) the information was not particularly valuable, hard to duplicate, or critical to the plaintiff’s business. Thus, the court dismissed this claim. Finally, since all other claims were dismissed, plaintiff’s conspiracy claim was dismissed since it was derivative.
Additional Cases of Note
Ace Oilfield Rentals, LLC v. Western Dakota Welding and Fabrication, LLC, 2021 U.S. Dist. LEXIS 191902 (W.D. Okla. 2021) (unpublished) (granting summary judgment on plaintiff’s misappropriation of trade secrets claim since plaintiff’s customer lists and the technical specifications of its hydraulic catwalks were trade secrets due to their independent economic value and the reasonable efforts made by plaintiff to conceal them); Core Progression Franchise LLC v. O’Hare, 2021 U.S. Dist. LEXIS 63471 (D. Colo. 2021) (unpublished) (holding that information disclosed to defendant in an operations manual about plaintiff’s software systems, training methodology, and site selection process while defendant was plaintiff’s franchisee were trade secrets entitled to protection via a preliminary injunction); JCorps Int’l, Inc. v. Charles & Lynn Schusterman Family Found., 2021 U.S. Dist. LEXIS 108017 (N.D. Okla. 2021) (holding that plaintiff failed to show the purported trade secrets derived independent economic value from remaining confidential where plaintiff mentioned that the trade secrets were its “secret sauce,” “held immense value to” plaintiff, and were not available to other organizations that could not achieve similar results to plaintiff, as plaintiff had not “identified anything about the process of developing the purported trade secrets or alleged how their particular value derives from their secrecy”); Snyder v. Beam Techs., 2021 U.S. Dist. LEXIS 207686 (D. Colo. 2021) (unpublished) (denying motion to dismiss trade secret claims on the basis that a former employee failed to take reasonable measures to protect trade secrets where the employee had saved the spreadsheets at question to a “private file” on his work computer and limited disclosure to only portions of the spreadsheet data to a select number of people; further, the court found the plaintiff sufficiently alleged improper acquisition where the defendant took the entirety of plaintiff’s spreadsheets knowingly and without consent, and proceeded to use the spreadsheets without consent); Quest Sol., Inc. v. RedLPR, LLC, 2021 U.S. Dist. LEXIS 82406 (D. Utah 2021) (unpublished) (holding that a plaintiff did not define the trade secrets with the required detail, reasoning that the fact that an oft-repeated portion of the plaintiff’s at-issue confidential discovery response is also found in a non-redacted memorandum “shows how little detail [plaintiff] actually has provided about what its trade secrets are”).
§ 1.5.12. Eleventh Circuit
Argos United States LLC v. Christopher Young & Southeast Ready Mix, 2021 U.S. Dist. LEXIS 140387 (N.D. Ga. 2021): Argos, a corporation specializing in the sale of ready mix concrete, sued former sales manager Young. Argos alleged that Young stole confidential documents to obtain proof supporting Young’s mistaken belief that Argos was engaged in illegal price fixing. In the discovery phase, Argos included a production request with eight categories of trade secrets, two of which were “ [e]lectronic and hard-copy documents Young took from Argos (designation subject to further description upon Young’s return of such materials to Argos)”; and “8. [a]ll photographs Young took of Argos documents (designation subject to further description upon Young’s return of such materials to Argos).” Young argued that the requests lacked reasonable particularity, and the court agreed. The court framed these requests as Argos’ attempt “to obtain whatever discovery it can from Defendant Young on these topics and subsequently designate its trade secrets accordingly.” Argos tried to justify the requests by asserting that its cause of action included a Computer Fraud Abuse Act claim that entitled Argos to discovery regarding any computer information regardless of whether it constituted a trade secret. The court rejected this argument, stating, “it runs contrary to logic that a plaintiff may expand the parameters of allowable discovery as to some claims simply by adding others, and [Young] cites no relevant authority to support this novel proposition.”
Castellano Cosmetic Surgery Ctr., P.A. v. Doyle, 2021 U.S. Dist. LEXIS 140610 (M.D. Fla. 2021): Castellano Cosmetic Surgery Center sued Doyle alleging that Doyle misappropriated trade secrets in violation of the Defend Trade Secrets Act (DTSA) and the Florida Uniform Trade Secrets Act (FUTSA). Castellano’s based its claim on Doyle’s use of a client email list obtained while Doyle was bound by a confidentiality clause in her employment contract with Castellano. In evaluating whether a preliminary injunction was appropriate, however, the court found that Castellano failed to show a substantial likelihood of success on the merits. The court specifically found that Doyle’s duty to maintain confidentiality was unclear. Although Doyle was still subject to the employment agreement’s confidentiality provision when she acquired the email list, Doyle was no longer subject to the confidentiality provision when she used the email list. The court noted that, for purposes of finding misappropriation, “[n]either the text of the [DTSA] nor the case law interpreting it clearly delineate whether the duty to maintain secrecy must exist at the time of use of the trade secret or whether the duty needs to exist only when the trade secret was acquired.” Because neither party briefed the issue, the court left this as an question open.
Decurtis LLC v. Carnival Corp., 2021 U.S. Dist. LEXIS 3163 (S.D. Fla. 2021): Carnival Corp. sued DeCurtis, a wireless communications business, for violation of DeCurtis’s confidentiality obligations. After working for Carnival, DeCurtis worked with direct competitors to develop similar wireless communications systems. Carnival alleged that DeCurtis breached its contract and misappropriated trade secrets under the Defend Trade Secrets Act and the Florida Uniform Trade Secrets Act. DeCurtis moved to dismiss Carnival’s complaint for failure to state a claim. Regarding the misappropriate claims, DeCurtis argued that the complaint failed to describe Carnival’s allegedly misappropriated trade secrets with reasonable particularity. The court noted that, although many plaintiffs lack knowledge of specific facts surrounding misappropriation, courts in the Eleventh Circuit had required reasonable particularity in the description of allegedly misappropriated trade secrets. The purpose of this requirement was to prevent plaintiffs from using the “old trick” of making “vague trade secrets allegations and then try[ing] to fill in the gaps when discovery begins.” The court adopted the reasonable particularity requirement, and found that Carnival’s broad trade secret categorizations failed to state a claim of action for misappropriation of trade secrets.
Gulf South Commc’ns, Inc. v. Woof Inc., 2021 U.S. Dist. LEXIS 109963 (M.D. Ala. 2021): Corbitt was a radio personality for Gulf South Communications. Corbitt left Gulf South to work for a direct competitor, WOOLF. Gulf South sued Corbitt and WOOLF, alleging that Corbitt wrongfully accessed certain information. Gulf Coast’s claims included theories of conversion and trespass to chattel. WOOLF sought to dismiss these claims on the grounds of preemption by the Alabama Trade Secrets Act (ATSA). Gulf Coast argued that it should be able to allege the conversion and trespass to chattel claims as an alternative to an ATSA claim in case there is insufficient proof to show the existence of trade secrets. The court rejected this argument, stating that “if the ATSA does not provide a remedy because the information at issue does not rise to the level of a trade secret, then the preemptive scope of the ATSA, which displaces common law inconsistent with the ATSA, . . . will not allow a conversion or trespass to chattels claim arising from the same facts.” By dismissing the common law counts as preempted by the ATSA, the court made clear that these common law claims and ATSA claims “cannot be pleaded in the alternative.”
Nephron Pharms. Corp. v. Hulsey, 2021 U.S. Dist. LEXIS 6403 (M.D. Fla. 2021), adopted byNephron Pharms. Corp. v. Hulsey, 2021 U.S. Dist. LEXIS 37466 (M.D. Fla. 2021): Nephron, a pharmaceutical company, obtained a Temporary Restraining Order against Hulsey, Nephron’s former employee, and USC, Hulsey’s new employer, to enjoin the both defendants from using or disclosing Nephron’s trade secrets. Upon resigning from Nephron, Hulsey had almost immediately begun working for USC, and. Nephron alleged Hulsey had stolen trade secrets and provided them to her new employer. The court granted a TRO against Hulsey and USC preventing the direct or indirect use of Nephron’s information. Subsequently, the TRO was superseded by a mutually agreed-to consent preliminary injunction (CPI), which prevented the defendants and their agents from using or disclosing Nephron’s trade secrets. Shortly after entering into the CPI, USC hired a second former-employee of Nephron, and Nephron alleged that USC violated the CPI by obtaining information through this second employee. Nephron filed a motion to show cause for contempt because (1) USC failed to notify the second employee of the CPI, (2) the second employee conveyed Nephron’s information to USC to further its business, and (3) USC used the information. USC claimed that the CPI did not encompass information attained through the second employee. Specifically, USC argued that the CPI should be construed in accordance with the operative pleadings at the time the CPI was entered. Consequently, the CPI could only apply to the information obtained by Hulsey because the pleadings did not contemplate information from the second employee. The court soundly rejected this argument, finding that limiting a CPI’s scope in accordance with the operative pleadings would violate contractual principles by contravening the words of the CPI.
§ 1.5.14. State Cases
HouseCanary, Inc. v. Title Source, Inc., 622 S.W.3d 254 (Tex. 2021). HouseCanary, Inc. entered into a licensing agreement that allowed Title Source, Inc. to evaluate and ultimately use HouseCanary’s real estate appraisal technology. The parties later disputed the terms of the agreement, and Title Source sued for breach of contract, claiming HouseCanary failed to deliver what it promised. HouseCanary asserted counterclaims including misappropriation of its trade secrets, alleging Title Source used HouseCanary’s technology to build derivative products in violation of the licensing agreement. The trial concluded with jury findings in favor of HouseCanary, including that Title Source misappropriated HouseCanary’s trade secrets. HouseCanary filed a post-trial motion under Texas Rule of Civil Procedure 76a to seal thirty exhibits used at trial, eight of which it argued contained trade secrets. Title Source and two intervening media organizations opposed the motion, which the trial court denied after a hearing. Because Rule 76a(7) prohibits motions for reconsideration “without first showing changed circumstances materially affecting the order,” HouseCanary filed a motion for reconsideration that expressly did not renew its arguments under Rule 76a but rather relied solely on the Texas Uniform Trade Secrets Act (TUTSA), arguing that it provides a statutory basis for sealing the eight exhibits that supersedes Rule 76a. This time, the court granted the motion and also gave HouseCanary more relief than it requested, ordering a total of fourteen exhibits sealed. The Texas Supreme Court considered whether the TUTSA provides a separate pathway for sealing court records to which Texas Rule of Civil Procedure 76a does not apply.
The Court held that the trial court abused its discretion by sealing records based solely on the TUSTSA. The Court explained that Rule 76a(1)(a)’s presumption that court records are open to the general public cannot be reconciled with TUTSA’s presumption in favor of granting protective orders to preserve alleged trade secrets, including those in court records. This conflict does not supplant Rule 76a entirely, however. HouseCanary failed to show that TUTSA’s lack of procedures (including a public notice requirement) conflicts with and was intended to replace the procedural portions of Rule 76a, which trial courts follow in all cases where records are sought to be sealed. Without such procedures, the TUTSA could not support a motion to seal trade secrets on its own.
Additional Cases of Note
Jim Olive Photography v. Univ. of Hous. Sys., 624 S.W.3d 764, 770-71 (Tex. 2021) (suggesting that the Takings Clauses of both the Federal Constitution and State Constitution protects trade secrets).
Johnston v. Vincent, 20-357 (La. App. 3 Cir 05/05/21) (holding that the trial court erred in declining to categorize a customer list as a trade secret because, unlike cited caselaw finding the contrary, employees did not surrender the customer list, and employer did not rely on the knowledge and memory of its long-time employees).
People Source Staffing Prof’ls LLC v. Robertson, 2021 U.S. Dist. LEXIS 105712, at *18 (W.D. La. June 3, 2021) (granting defendants’ motion for summary judgment regarding appropriation of confidential and proprietary business information plaintiff failed to prove material facts as to misappropriation and no evidence existed demonstrating defendants misappropriated plaintiff’s “confidential information and/or used it in their business”).[45]
§ 1.6. Damages
§ 1.6.2. First Circuit
Anderson v. Trident Eng’g & Inspection Corp., No. 2:21-cv-00149-LEW, 2021 U.S. Dist. LEXIS 113646 (D. Me. 2021) (unpublished) – the Maine District Court denied an employee’s ex parte request for a temporary restraining order to prohibit an employer from accessing employee’s online accounts that contained both business and personal files because the employee failed to show irreparable harm, a balance of the equities that tipped in his favor, or an interest of the public that would favor ex parte relief. In that case, the employee established an online account for a cloud-based hosting service to host both personal files and business files related to his employment. After being terminated from his employment with the employer, employer accessed and modified the online account which prevented the employee and his family from accessing their privileged communications and personal files on the server. In determining whether the employee sufficiently alleged a claim entitled to ex parte relief, evidence before the court showed that the status quo between the parties had been maintained for two months prior to the request for ex parte relief. The court reasoned that during this two-month delay in seeking ex parte relief, a court could have evaluated a request for a preliminary injunction. Furthermore, the fact that the commandeered account contained both personal and business files was the employees own doing. Based on this evidence, the court held that it would exercise its discretion in allowing the employer to respond and denied the employee’s ex parte request.
§ 1.6.3. Second Circuit
Syntel Sterling Best Shores Mauritius Ltd. V. TriZetto Grp., Inc., 2021 U.S. Dist. LEXIS 75875 (S.D.N.Y. 2021). In a New York federal jury trial, Syntel was found to have infringed on one or more of TriZetto Group Inc.’s copyrights and to have misappropriated TriZetto’s trade secretions in violation of New York law. The jury awarded $284,855,192 million in compensatory damages and $569,710,384 million in punitive damages. After the verdict, Syntel renewed its motion for judgment as a matter of law, and alternatively requested a new trial or remittitur. New York Federal Judge Lorna Schofield denied Syntel’s motions, except for its request for remittitur. Judge Schofield reduced punitive damages to $284, 855,192, subject to TriZetto agreeing to remittitur, reasoning that a 1:1 ratio relative to the compensatory award should be the highest permissible outcome. The rationale behind her ruling was that Syntel’s conduct was reprehensible but not egregious. Also, the large compensatory damages award was calculated based on Syntel’s benefit. TriZetto subsequently agreed to remittitur, and Syntel has appealed the judgment.
§ 1.6.4. Third Circuit
Additional Cases of Note
PPG Indus., Inc. v. Jiangsu Tie Mao Glass Co., 2021 U.S. Dist. LEXIS 106961 (W.D.Pa 2021) (unpublished) (awarding $8.8M in monetary damages and $17.6M in exemplary damages, the maximum amount allowed by law, in egregious case of foreign trade secret misappropriation where default judgment was earlier entered).
§ 1.6.5. Fourth Circuit
There are no qualifying decisions within the Fourth Circuit.
§ 1.6.6. Fifth Circuit
Additional Cases of Note
Whitlock v. CSI Risk Mgmt., LLC, 2021 Tex. App. LEXIS 3345, at *34 (Tex. Ct. App., 5th Dist. Apr. 30, 2021) (holding that the jury’s damage award “was not contrary to the overwhelming weight of the evidence, nor was it unsupported by only a scintilla of evidence” and did not become improper because a lack of clarity in the jury’s reasoning for the award was within the range permitted by the evidence).[46]
§ 1.6.7. Sixth Circuit
Babcock Power, Inc. v. Kapsalis, 2021 U.S. App. LEXIS 8925 (6th Cir. (Ky.) 2021) (applying Kentucky law) (unpublished). Babcock Power, Inc. (BPI) and Vogt Power International, Inc. (Vogt) appealed the district court’s ruling reducing the jury’s verdict on their breach of contract claim against Stephen Kapsalis from $202,865 to $1. Kapsalis was hired as BPI’s chief operating officer and, upon being hired, signed a non-compete and nondisclosure agreement in which he promised not to divulge any of BPI’s “confidential information,” which included the company’s technical designs, trade secrets, financial data, marketing strategies, and manufacturing techniques. He also agreed to a non-solicitation agreement, that for one year after his employment, Kapsalis would not divert any business away from BPI. Before leaving BPI and starting a new job as the chief executive officer at Express Group Holdings, LLC (Express), a competitor of BPI’s, Kapsalis downloaded numerous files containing BPI’s confidential information onto an external hard drive. BPI sued Kapsalis under the Computer Fraud and Abuse Act (CFAA) and asserted several state law claims for breach of contract, misappropriation of trade secrets, breach of fiduciary duty, and conversion of intellectual property. The district court granted summary judgment in favor of Kapsalis on all claims except BPI’s claim that he breached the nondisclosure agreement and misappropriated trade secrets. The issue in the case was, under Kentucky law, whether BPI was permitted to recover damages under a “reasonable royalty” theory, when there was no proof of actual damages. The district court found that BPI suffered no evidence of actual damages, and Kapsalis did not profit in any way because he breached the nondisclosure agreement. The circuit court ultimately decided that “[i]n the absence of controlling authority on this specific issue, we apply the basic rule of Kentucky law that a plaintiff may recover actual damages or nominal damages for breach of contract.” As such, BPI did not suffer certain actual damages and the district court did not err in awarding BPI nominal damages.
Additional Cases of Note
Henkel of Am., Inc. v. Bell, 825 Fed. Appx. 243, 2020 U.S. App. LEXIS 26737 (applying Delaware law) (6th Cir. (Mich.) 2020) (ruling that the plaintiffs did have a cause of action for breach of fiduciary duty despite not showing damages because proving damages is not essential to a breach of fiduciary duty claim); Manville & Schell, P.C. v. Stricker, 2020 U.S. Dist. LEXIS 203302 (W.D. Mich. 2020) (The court dismissed the complaint because it found Plaintiff’s calculation for damages unreasonable.); Magnesium Mach. L.L.C. v. Terves, L.L.C., 2020 U.S. Dist. LEXIS 164640 (N.D. Ohio 2020) (holding that, under Ohio, Oklahoma, and U.S. trade secret acts, a misappropriation claim is brought in bad faith and a defendant can recover reasonable attorneys’ fees if the defendant received the information through proper discovery channels, took proper care to protect the information, and if the information did not contain secrets the plaintiff claimed were part of its trade secrets); Trent P. Fisher Enters. v. SAS Automation, 2021 U.S. Dist. LEXIS 62914 (S.D. Ohio 2021) (denying punitive damages in a trade secret misappropriation case because the plaintiff company did not allege sufficient facts to establish that a defendant company was “willful and malicious” in misappropriating plaintiff’s trade secrets).
§ 1.6.8. Seventh Circuit
Additional Cases of Note
Savis, Inc. v. Cardenas, 528 F. Supp. 3d 868 (N.D. III. 2021) (denying summary judgment for employer seeking damages for breach of noncompete clause by former employee because employer presented insufficient evidence of causation that the breach by former employee resulted in any loss of business).[47]
Scalia v. Krieger, 2021 U.S. Dist. LEXIS 17125 (E.D. Wis. Jan 29, 2021) (entering default judgment and holding that plaintiff is entitled to $30,926.86 for employer’s breach of fiduciary duty for failure to remit payments and authorize distribution, and $3,903.53 for lost opportunity costs).
Zurich Am. Ins. Co. v. Hill, 2021 U.S. Dist. LEXIS 78449, at *10 (N.D. Ill. Apr. 23, 2021) (determining Zurich “presented a reasonable basis for computing its damages and established with a reasonable degree of certainty the net loss profits [of $194,700.88] for 2019 that were traceable to Hill’s breach” of the nonsolicitation provisions and post-termination restrictive covenants of the employment agreement).
§ 1.6.9. Eighth Circuit
Perficient, Inc. v. Munley, 2021 U.S. Dist. LEXIS 72506 (E.D. Mo. 2021) (unpublished).See Section 1.3.9 for a summary of the case background and the court’s ruling on a noncompete issue. On a motion for summary judgment, the court considered whether damages resulted from a breach of a noncompete agreement. Because Perficient quickly moved for and obtained injunctive relief, it prevented any actual damages. The court found that attorneys’ fees awarded pursuant to a contractual attorneys’ fees clause established the damages element for a breach of contract claim under Missouri law. The court also found that Perficient could be awarded nominal damages, which would also satisfy the breach of contract damages element.
§ 1.6.10. Ninth Circuit
There were no qualifying cases in the Ninth Circuit.
§ 1.6.11. Tenth Circuit
There were no qualifying decisions within the Tenth Circuit.
[1]See e.g.AMN Healthcare, Inc. v. Aya Healthcare Servs., Inc., 28 Cal. App. 5th 923 (2018) (questioning the “continuing viability” of precedent allowing for reasonable employee non-solicitation agreements, given the clearly “settled legislative policy in favor of open competition and employee mobility”).
[2]See Section 1.5.5 for a summary of the court’s ruling regarding the issue of misappropriation of trade secrets.
[3]See Section 1.3.5 for a summary of the court’s ruling regarding the issue of restrictive covenants.
[4]See Section 1.5.5 for a summary of the court’s ruling regarding the issue of misappropriation of trade secrets.
[5]See Section 1.3.5 for a summary of the court’s ruling regarding the issue of restrictive covenants.
[6]See Sections 1.3.6 and 1.4.6 for summaries of the court’s ruling on the issues of Restrictive Covenants: Covenants Not to Compete and Customer and Employee Nonsolicitation Agreements, respectively.
[7]See Section 1.5.6 for a summary of the court’s ruling on the issue of Misappropriation of Trade Secrets.
[8]See Section 1.6.6 for a summary of the court’s ruling on the issue of Damages.
[9] See Section 1.5.7 for a description of Michigan trade secret law.
[10]See Sections 1.3.8 and 1.5.8 for summaries of the court’s ruling on the issues of Restrictive Covenants: Covenants Not to Compete and Misappropriation of Trade Secrets, respectively.
[11]See Section 1.4.8 for a summary of the court’s ruling on the issue of Customer and Employee Nonsolicitation Agreements.
[12]See Section 1.5.11 for a summary of the court’s ruling on the issue of Misappropriation of Trade Secrets.
[13]See Section 1.5.5 for a summary of the court’s ruling regarding the issue of misappropriation of trade secrets.
[14]See Section 1.2.5 for a summary of the court’s ruling regarding the issue of breach of fiduciary duty.
[15]See Section 1.2.5 for a summary of the court’s ruling regarding the issue of breach of duty of loyalty.
[16]See Section 1.5.6 for a summary of the court’s ruling on the issue of Misappropriation of Trade Secrets.
[17]See Sections 1.2.6 for a summary of the court’s ruling on the issues of Employee Mobility: Breach of Fiduciary Duties.
[18]See Section B for court’s ruling on the issue of Misappropriation of Trade Secrets.
[19]See Sections 1.2.6 and 1.4.6 for summaries of the court’s ruling on the issues of Employee Mobility: Breach of Duty of Loyalty; Breach of Fiduciary Duties and Customer and Employee Nonsolicitation Agreements, respectively.
[20]See Section 1.4.6 for a summary of the court’s ruling on the issue of Customer and Employee Nonsolicitation Agreements.
[21]See Sections 1.4.8 and 1.5.8 for summaries of the court’s ruling on the issues of Customer and Employee Nonsolicitation Agreements and Misappropriation of Trade Secrets, respectively.
[22]See Sections 1.4.8 for summaries of the court’s ruling on the issue of Customer and Employee Nonsolicitation Agreements.
[23]See Sections 1.2.8 and 1.5.8 for summaries of the court’s ruling on the issues of Employee Mobility: Breach of Duty of Loyalty; Breach of Fiduciary Duties and Misappropriation of Trade Secrets, respectively.
[24]See Section 1.4.10 for a summary of the court’s ruling on the issue of Customer and Employee Nonsolicitation Agreements.
[25]See Section 1.5.11 for a summary of the court’s ruling on the issue of Misappropriation of Trade Secrets.
[26]See Section 1.4.11 for a summary of the court’s ruling on the issue of Customer and Employee Non-Solicitation Agreements.
[27]See Section 1.5.5 for a summary of the court’s ruling regarding the issue of misappropriation of trade secrets.
[28]See Section 1.5.6 for a summary of the court’s ruling on the issue of Misappropriation of Trade Secrets.
[29]See Discussion Section for summary of the court’s ruling on issue of and Restrictive Covenants: Covenants Not to Compete.
[30]See Sections 1.2.6 and 1.3.6 for summaries of the court’s ruling on the issues of Employee Mobility: Breach of Duty of Loyalty; Breach of Fiduciary Duties and Restrictive Covenants: Covenants Not to Compete, respectively.
[31]See Section 1.3.6 for a summary of the court’s ruling on the issue of Restrictive Covenants: Covenants Not to Compete.
[32]See Sections 1.3.8 and 1.5.8 for summaries of the court’s ruling on the issues of Restrictive Covenants: Covenants Not to Compete and Misappropriation of Trade Secrets, respectively.
[33]See Sections 1.3.8 for summaries of the court’s ruling on the issue of Restrictive Covenants: Covenants Not to Compete.
[34]See Section 1.6.8 for a summary of the court’s ruling on the issue of Damages.
[35]See Section 1.2.8 for a summary of the court’s ruling on the issue of Employee Mobility: Breach of Duty of Loyalty; Breach of Fiduciary Duties.
[36]See Section 1.3.10 for a summary of the court’s ruling on the issue of Restrictive Covenants: Covenants Not to Compete.
[37]See Section 1.5.10 for a summary of the court’s ruling on the issue of Misappropriation of Trade Secrets.
[38]See Section 1.2.5 for a summary of the court’s ruling regarding the issue of breach of duty of loyalty.
[39]See Section 1.3.5 for a summary of the court’s ruling regarding the issue of restrictive covenants.
[40]See Section 1.4.5 for a summary of the court’s ruling regarding the issue of nonsolicitation agreements.
[41]See Section 1.4.6 for summaries of the court’s ruling on the issues of Customer and Employee Non-Solicitation Agreements.
[42]See Section 1.3.6 for summaries of the court’s ruling on the issues of Restrictive Covenants: Covenants Not to Compete.
[43]See Sections 1.3.8 and 1.4.8 for summaries of the court’s ruling on the issues of Restrictive Covenants: Covenants Not to Compete and Customer and Employee Nonsolicitation Agreements, respectively.
[44]See Section 1.4.10 for a summary of the court’s ruling on the issue of Customer and Employee Nonsolicitation Agreements.
[45]See Section 1.2.6 for summaries of the court’s ruling on the issues of Employee Mobility: Breach of Duty of Loyalty.
[46]See Section 1.2.6 for a summary of the court’s ruling on the issue of Employee Mobility: Breach of Duty of Loyalty.
[47]See Section 1.4.8 for a summary of the court’s ruling on the issue of Customer and Employee Nonsolicitation Agreements.
This article is the third in a series identifying a number of myths related to IP rights, and explaining, in simple terms, steps you can take to recognize and protect the IP your business creates and acquires. In the first installment, the authors discuss trademark myths. In the second installment, they discuss copyright myths.
The final article in this three-part series identifying myths related to IP rights is Patent Myths.
A patent is the exclusive grant of a property right to the inventor to make, use, and sell an invention. It is an exclusionary right, which means no one else may make, use, or sell that invention without the inventor’s permission. There are several types of patents, each protecting different aspects of a product. As one example, a utility patent is suitable for protection of a machine, manufacture, or composition of matter. As another, a design patent protects the ornamental design of a functional item.
U.S. patent law is federal law (35 U.S.C. § 1-387). There is no state law governing patents, and a state cannot grant or enforce a patent. The United States Patent and Trademark Office issues patents. To qualify for patent protection, the subject matter of the invention must be new, useful, and non-obvious (as defined by statute). Generally, utility patents expire 20 years from the filing date of the application and design patents expire 15 years after the filing date.
Patent law is critical to development and protection of new technology. At the same time, the law has many nuances. Below is a high-level overview of some recurring issues that businesses face in connection with development and protection of new technology.
1. Patent law can protect my ideas.
This depends on how the idea is implemented. Almost every invention is based on a new and novel idea, but not all ideas are patent protectable. Patent law protects an idea only if it is implemented in a process, machine, manufacture, or composition of matter. An idea divorced from these categories may not be patent protectable. Indeed, one may not obtain patent protection for mathematical formulas or laws of nature. Nevertheless, ideas can be refined such that they are directed to patentable subject matter. For example, one may implement a new mathematical formula in a software application and transform the idea into patentable subject matter. If an idea is implemented in a practical application, e.g., a machine, most likely the idea will be patentable.
2. I can patent a business method.
Generally, no, unless the business method is tied to a practical application. In patent parlance, a business method is a method of engaging in economic activity or doing business. In 2014, the Supreme Court held in a landmark decision that fundamental economic practices, as well as methods of organizing human activity, are abstract ideas. And an abstract idea may not be patent protectable unless it is implemented in a practical application. Much like any other idea, however, business methods may be implemented in conjunction with new and novel computer systems. The patent office considers such systems as practical applications that transform the abstract idea into a patent eligible subject matter.
3. I have to publicize the details of my invention if I want to obtain a patent.
Not necessarily. An inventor can file a provisional patent application or file a non-provisional application with a request for non-publication. Both of these applications will not be accessible to the public until the application goes through the examination process and receives a notice of allowance. As such, an inventor may keep the invention secret until the invention is allowed to issue as a patent (probably 1 to 3 years after filing the original application). At this point, the invention will be published to the world. Nevertheless, if the invention is not allowed by the Patent Office, the inventor may keep the invention secret and simply abandon the application.
4. I should file for a patent application after my product succeeds in the market.
Generally, this is not recommended. Once an invention is disclosed to the world, the inventor has only a one-year grace period to file a patent application. Selling a product in the market is considered disclosure of the invention. As such, the wait-and-see approach may not work for most products because it may take more than a year for the product to be recognized in the market. By then, the inventor may be prevented from filing a patent application because the inventor’s product will be a novelty-barring disclosure.
5. I have to obtain a patent to be able to prevent others from obtaining a patent for the same idea.
Not true. According to patent law, an invention described in a patent application is entitled to patent protection unless the invention is disclosed in a written publication prior to the filing date of the patent application. A cost-efficient approach to prevent others from obtaining a patent is to publicize a disclosure of the invention. The disclosure may be publicized by posting it online.
6. Obtaining a patent is a lengthy process.
Myth. Recently, the Patent Office has allowed inventors to file what are known as “Track One” applications. These applications are generally examined in a few months after filing, and if the invention is patentable, the inventor may obtain a patent in less than a year.
7. I will not be sued for patent infringement because I imported and sold a simple mechanical product.
False. There are two types of patents: utility patents and design patents. Utility patents cover functional aspects of a product, but design patents protect the ornamental features. In general, one may not easily obtain a utility patent for a simple mechanical product. Nevertheless, it is possible to draft a patent claim that covers an exact replica of the product, i.e., a picture claim. Even though a picture claim is narrow, it is a powerful tool to protect against identical copying. Additionally, the ornamental look of any product, including simple mechanical products, can be protected by design patents. Design patents are easier to procure than utility patents. Therefore, even simple mechanical products can be covered by utility and design patents, and thus a legal review of a product, particularly the imported ones, is highly recommended.
8. I can be sued for patent infringement even though the plaintiff does not have any information about the mechanics or interworking of my system.
This is a myth. Courts increasingly require factual information concerning how the accused product infringes the patent to be included in patent infringement complaints. A simple copy and paste of the claim language is not enough; instead, the plaintiff must allege enough facts to create a basis for alleging how or why the accused product practices at least some of the claim elements. Therefore, a complaint that does not include any factual basis for allegations of infringement may be dismissed.
***
This concludes our three-part series on IP rights myths.
If you have questions or would like to follow-up on the topics discussed in the series, please reach out to any of the authors listed above at Hunton Andrews Kurth LLP.
Connect with a global network of over 30,000 business law professionals
