The Difficulty of Proving Trade Secret Violations

A recent Georgia Court of Appeals opinion highlights the difficulty employers have in proving trade secret violations and thus reinforces the need for employers to use enforceable non-compete and non-solicitation covenants as their primary means of protecting against unfair use of confidential information by former employees.

In Contract Furniture Refinishing & Maintenance Corp. v. Remanufacturing & Design Group, LLC, 730 S.E. 2d. 708 (Ga. App. 2012), the plaintiff-employer sued its former employee and his new company for violations of the Georgia Trade Secrets Act, alleging that  the defendants had used the plaintiff’s sales and marketing reports in connection with the defendants’ competing business.   In affirming summary judgment for the defendants on the trade secrets claim, the Court of Appeals held that the following evidence was insufficient for the claim to proceed to trial:

  • The former employee remained employed by the plaintiff for four months while running operations for his newly formed competing company (without disclosing the new company to the plaintiff, of course);
  • The employee received thousands of pages of marketing and sales reports while employed with the plaintiff;
  • The employee’s new company made two successful bids on jobs for which the plaintiff provided the employee with leads;  both of the bids were nearly identical to bids previously submitted by the plaintiff, and one of them was submitted while the employee was still employed by the plaintiff, while the other was submitted a week after the employee resigned;
  • The employee used the same flash drive on both his personal computer and company-issued laptop on the day he resigned from the plaintiff;
  • The employee’s company-issued laptop, which he returned upon his resignation, had been stripped of all proprietary and customer information of the plaintiff.

As would be expected, the employee denied that he retained hard copies of any of the marketing reports, denied copying or transferring any files or information of the former employer, and denied providing any of the former employer’s information to the new company.   The employee had further explanations for how the new company found out about the two jobs for which it successfully bid without the misappropriation or use of information obtained from the former employer.

It might seem reasonable that the above-described competing evidence would be left for a jury to sort out.  The Court of Appeals even acknowledged that the employer-plaintiff produced “strong” circumstantial evidence of use or disclosure of alleged trade secrets.  In affirming the trial court’s summary judgment ruling against the employer, however, the court relied on the rule of law that “a finding of fact that may be inferred from, but is not demanded by, circumstantial evidence has no probative value against positive and uncontradicted evidence that no such fact exists, provided that the circumstantial evidence may be construed consistently with the direct evidence.”

BURR POINT:  To prevail on a trade secrets claim, an employer will usually need direct, as opposed to circumstantial, evidence of the misappropriation, which is often hard to come by.  Accordingly, employers need contractual non-compete and non-solicitation protection, in addition to that provided by trade secret statutes, to bolster their potential claims against an unfairly competing employee.

Tennessee’s “Rule of Reasonableness” Allows Courts to Modify Non-Compete Agreements

On August 22, 2012, we reported on the Veit v. Event Logistics, Inc., a case pending in the Davidson County Chancery Court, Docket No. 12-945, in which an employee challenged her employer’s non-compete agreement.  The agreement prohibited the employee for a period of two years from (1) engaging in activities competing with the employer within a 50 mile radius of employer’s office in Nashville; (2) soliciting the employer’s customers with whom the employee had contact while employed by the employer; and (3) soliciting any of employer’s employees to terminate his/her employment.

At the temporary injunction stage of the litigation, the Court did not completely enforce or reject the non-compete agreement.  Rather, the Court modified the agreement to allow the employee to engage in certain activities so she could make a living while offering some level of protection for the employer.  In particular, the Court allowed the employee to engage in the same activities she did with the employer (with a monetary cap), but prohibited her from engaging in those activities with the employer’s clients.

The Court’s modification of the non-compete agreement in Veit is a good example of the “Rule of Reasonableness” Tennessee courts apply to non-compete agreements.  Generally, there are four approaches courts around the country will take in enforcing or rejecting a non-compete agreement.

  1. The court will not enforce the non-compete agreement because non-compete agreements are void as a matter of law.
  2. The court will enforce the non-compete agreement as written.
  3. The court will “blue-pencil” the non-compete.  This means the court will only strike offending provisions from the non-compete agreement, but will not add new provisions or otherwise modify the non-compete agreement.  If the “blue-pencil” approach leaves the non-compete agreement incomprehensible or cannot eliminate the offending provision, the court will reject the agreement all together.
  4. The court will equitably reform the non-compete agreement which can result in rewriting the agreement.  This approach balances between the goals of encouraging a free market place and preventing unfair competition.

Recognizing that the “all or nothing” approach of either enforcing or rejecting a non-compete agreement in its entirety and the “blue-pencil” approach led to undesirable results, Tennessee courts adopted the Rule of Reasonableness (“ROR”).  Under the ROR, Tennessee courts may rewrite the non-compete agreement to balance between the employer and employee’s competing interests.  The ROR is consistent with and is an extension of the rule that the terms of the non-compete agreement, including time and geographical limitations, must be reasonable.  The restrictions of the non-compete agreement must be no greater than necessary to protect the employer’s legitimate business interest.  (For a further discussion on the “reasonableness” requirements, see our May 9, 2012 blog post.)

Applying the ROR, the Court in Veit modified the non-compete agreement to allow the employee to make a living while protecting them employer’s interest in its customer base.  Though Tennessee Courts have the power to modify non-compete agreements, employers should carefully draft their agreements to avoid costly and uncertain litigation.  Though the ROR seeks to strike a balance between the employer and employee’s competing interests, a modified non-compete agreement could result in significant harm to the employer.

If you would like additional information on trade secrets law, please contact one of the Burr & Forman Non-Compete & Trade Secrets team members.

Potential Antitrust Implications in Resolving Disputes Over An Employee’s Non-Compete Agreement

Resolving non-compete disputes often involves more than just bringing an employee and her former employer together to reach some agreement; successful resolution may also require the involvement of the employee’s new employer as well. An employer who hires an employee subject to a valid non-compete agreement with a former employer is inviting legal claims by the former employer, including claims for “tortious interference” with contract. The new employer is often named as a co-defendant when a former employer sues the employee for breaching her non-compete. Almost by definition, therefore, when there is litigation between a former employer and a new employer over an employee’s non-compete agreement, this means that there are two competitors involved in the litigation. To resolve such a dispute out of court, an agreement must be reached among competitors. But when two or more competitors sit down and reach an agreement, there exists some risk of anti-competitive effects that could create potential liability under antitrust laws.

One potential antitrust predicament arising out of a dispute over a non-compete agreement can be illustrated by the following hypothetical: Suppose that Acme Widget Company, based in Arizona, has been selling widgets in the Southwest and beyond for 50 years.  As a result of its long track-record and reliable products, Acme Widget has a 90% market share in the Southwestern widget-market, although its market share is lower in the rest of the country (where the demand for widgets is not as great).  Acme Widget’s long-time sales manager, Mr. Wolf, is not sure about Acme Widget’s new business model (which would change the way he sells widgets) and is interested in finding new employment elsewhere.  He learns about a relatively new start-up venture based in Georgia, Coyote Widget Company.  Coyote Widget’s niche is finding customers who have never purchased widgets before, and Coyote Widget has been successfully exploiting the previously-untapped widget-market on the East Coast and in the Southeast.  Coyote Widget does sell widgets to a few customers located in Arizona and does sell to some former customers of Acme Widget.  However, because Coyote Widget’s business model focuses on exploiting previously-untapped markets, Coyote Widget is not particularly interested in selling widgets to Acme Widget’s existing customer-base.

Coyote Widget and Mr. Wolf think that they would be a good fit for one another, but Coyote Widget is concerned about the non-compete agreement that Mr. Wolf entered into with Acme Widget when he became Acme’s sales manager.  Acme Widget, for its part, would just as soon part ways with Mr. Wolf and wants to wish him well in his future endeavors.  Then again, Acme Widget is well aware that Mr. Wolf carries a lot of clout with its established customers and is wary about allowing any other widget-maker ready access to these customers.

The three parties (Acme Widget, Coyote Widget, and Mr. Wolf) remain interested in working out a solution.  At the start of negotiations, Coyote Widget and Mr. Wolf jointly propose that, if Mr. Wolf comes to work for Coyote Widget, he will not contact any customer with whom he worked while at Acme Widget for a two-year period (the term of his non-compete).  Acme Widget likes this proposal but is worried that it could be hard to police and might be subject to cheating.  For example, if one of Mr. Wolf’s former Acme customers contacts him at Coyote Widget, Mr. Wolf could refer him to another salesperson at Coyote Widget.  Mr. Wolf’s referral would likely carry significant weight with the customer, even if Mr. Wolf did not initiate the contact or manage the account himself.  Acme Widget also does not trust Coyote Widget’s representations that its business model is focused on previously-untapped markets and that it is not interested in Acme Widget’s customer-base.  Given Mr. Wolf’s long-time contacts in the industry, Acme Widget is concerned that the temptation could be too great for Coyote Widget; once Mr. Wolf is on staff, it would be too easy for Coyote Widget to start raiding Acme Widget’s customer-base.

However, following several rounds of negotiations, the parties reach what appears to be a solution:  Acme Widget will provide Coyote Widget with a list of customers serviced by Mr. Wolf, and Coyote Widget will agree not to accept business from any customer on this list for the next two years. For good measure, Coyote Widget has also offered to agree not to solicit any new customers in Arizona and has agreed to provide Acme Widget with a list of Coyote Widget’s existing customers in Arizona (a small number in any event). Such an agreement would be easy to enforce — if an Acme Widget customer later moves its account to Coyote Widget, Acme Widget will not have to worry about proving that Mr. Wolf initiated contact with the customer. All that Acme Widget would have to prove is either (i) that the customer moved its account from Acme Widget to Coyote Widget and is listed on Acme Widget’s list or (ii) that the customer is in Arizona and is not on Coyote Widget’s list. From Coyote Widget’s perspective, this agreement has few drawbacks, given Coyote Widget’s focus on the untapped widget-market on the East Coast and in the Southeast.

There is, however, a problem with this solution:  the federal Sherman Act and similar state statutes that may be on the books in states where Acme Widget and Coyote Widget do business. Indeed, whereas many potential antitrust violations are judged under a “rule of reason” analysis (wherein the court will conduct an analysis of potential anti-competitive effects), so-called “horizontal” agreements among competitors to allocate markets may be viewed as per se illegal. The potential antitrust violation in the above hypothetical could subject Acme Widget and Coyote Widget to both criminal and civil liability, and once a per se violation is shown, there are few arguments that either company could make in its defense.  For that matter, given that Acme Widget holds a 90% market share in the Southwestern widget-market and that Coyote Widget is a start-up that has made some inroads (however limited) into this market, this is exactly the sort of scenario that could invite antitrust scrutiny from regulators or from customers unhappy about Acme Widget’s high prices.

In conclusion, employers seeking to resolve disputes about non-compete agreements should be aware of other legal risks and exposures, including antitrust laws.  Too much focus on the non-compete agreement in dispute can sometimes lead to even greater exposures in other areas.

If you would like additional information on trade secrets law, please contact one of the Burr & Forman Non-Compete & Trade Secrets team members.