Don’t Mess With Texas: Texas Appeals Court Confirms Arbitrator’s Authority to Equitably Extend a Non-Compete Agreement

On the eve of celebrating our nation’s independence and hence, presumably preparing for the fireworks to follow the next day, the Court of Appeals for the Fifth District of Texas at Dallas issued a ruling in Nationbuilders Insurance Services, Inc. v. Houston International Insurance Company, Ltd., 2013 WL 3423755 (Tex. App. – Dallas, Jul. 3), confirming that an arbitrator had the authority to grant a one-year extension of a non-compete agreement which prohibited insurance executives from planning a business competing with their former employer  . . . and consequently, reminding folks that you don’t mess with Texas.

Kevin Cunningham and Michael Leamanczyk became employed with Nationbuilders Insurance Services, Inc. (“Nationbuilders”) in 2006, and in conjunction therewith, each signed a non-compete agreement. When Cunningham and Leamanczyk left Nationbuilders in 2010 to work for another insurance group, Nationbuilders filed suit against them. The litigation was resolved via a May 4, 2011 settlement agreement (“the Agreement”) which restricted the men from “engaging in Competition” with Nationbuilders from May 4, 2011 through May 4, 2012.  “Competition” was defined, in pertinent part, as “plan[ning] to conduct” a competing insurance business. The parties to the Agreement consented to the application of Delaware law to govern any disputes, which disputes also would be arbitrated.

During the restricted period of competition, Cunningham and Leamanczyk began planning and preparing to sell competing insurance. For example, they marketed their new business, prepared regulatory filings, and developed underwriting guidelines. Not surprisingly, in January 2012, Nationbuilders filed an arbitration demand claiming that Cunningham and Leamanczyk were in violation of the Agreement.

After the arbitration hearing concluded on April 27, 2012, the arbitrator issued a May 31, 2012 award in Nationbuilders’ favor. The arbitrator concluded that as the two men had planned a competing business during the “dormant period,” they had breached the Agreement such that Nationbuilders should “be restored the benefit of the bargain it made pursuant to the May 4, 2011 settlement agreement.” The arbitrator awarded Nationbuilders an equitable extension of the non-compete agreement for one-year, effective May 5, 2012 through May 5, 2013.  Cunningham and Leamanczyk thereafter obtained an award from the trial court on grounds that the arbitrator went beyond the scope of his authority in fashioning the equitable remedy.  Specifically, the trial court vacated the award under Section 10(a) of the Federal Arbitration Act providing that arbitration awards can be vacated “where the arbitrators exceeded their powers, or so imperfectly executed them that a mutual, final, and definite award upon the subject matter submitted was not made.”  9 U.S.C. Section 10(a).  Nationbuilders appealed.

On appeal, as the men did not dispute that they had, in fact, breached the Agreement by planning a competing business during the restricted period, the Court noted that the only question to be answered in considering whether the award was appropriately vacated under Section 10(a) as a result of the arbitrator exceeding his powers “was whether the award . . . is rationally inferable from the contract.” In concluding that the arbitrator’s award was appropriately issued, the Court noted that the arbitrator simply required the parties to abide by the Agreement – in other words, that Cunningham and Leamanczyk refrain from planning a competing business for one year.  Further, despite Cunningham and Leamanczyk’s arguments to the contrary, the Court held that the arbitrator – although having issued the arbitration award after the restricted period had expired – had not ruled on a moot issue. Though the men argued that enforcement of the restricted period became moot after it expired on May 4, 2012 such that the arbitrator had no jurisdiction to enjoin their competing conduct, the Court differentiated specific performance  - providing that a non-compete enforcement is moot after the contractual period of the covenant expires – from equitable extension, where the award was simply an extension of the restricted period under the arbitrator’s power of equity. As both Delaware and Texas law allowed for equitable extension, the Court concluded that the arbitrator’s decision was in line with the choice of law provision in the Agreement and not in contravention of Texas public policy.

Though the Court reversed the trial court’s ruling vacating the arbitration award, it declined to render judgment in Nationbuilders’ favor confirming the arbitration award or remand the matter to the trial court to confirm the award.  In doing so, the Court noted that the trial court had not addressed Cunningham and Leamanczyk’s two alternative public policy arguments for vacation of the award: (1) whether the award violated public policy by effectively allowing Nationbuilders “up to four years of freedom from competition in an unrestricted geographic location;” and (2) whether the award violated public policy by improperly interfering with their business where Nationbuilders had not suffered any loss of customers or revenue. (Notably, the parties did not address the fact that by the time of the Court’s ruling on July 3, 2013, the equitable extension of the restricted period had expired; thus the Court declined to address that issue).

The take away from Nationbuilders is threefold. First, a non-compete agreement which includes an arbitration clause should specifically outline the penalties for violation of the agreement in the agreement itself. Where an arbitrator disregards the express penalty provisions of a non-compete agreement which were mutually agreed upon by the parties and reduced to writing in the non-compete agreement, an arbitrator very likely will exceed his equitable powers by fashioning alternate remedies. The Agreement in Nationbuilders contained no penalty provisions, hence the arbitrator was within his discretion to fashion an equitable remedy which gave effect to the purpose of the Agreement. Prudence similarly suggests that all non-compete agreements, even those not containing arbitration clauses, should outline the penalties for a breach.

Second, parties should be cognizant of the choice of law provisions in any non-compete agreement. Had the Agreement in Nationbuilders been subject to Louisiana or Massachusetts law where equitable extension is not allowed, for example, the Court presumably would have refused to allow the arbitrator to equitably extend the restricted period.

Third, Nationbuilders reminds us that parties to a non-compete agreement should consider whether it is wise to mess with a Texas arbitrator’s equitable powers.

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

The Computer Fraud and Abuse Act, and Protecting Employer’s Electronic Data

The Southern District of New York recently joined a number of other jurisdictions in foreclosing one avenue of recovery for employers seeking to recover against employees who steal company information for competitors.  In Advanced Aerofoil Technologies, AG v. Todaro,  2013 WL 410873 (S.D.N.Y. Jan. 30, 2013), the court ruled that the Computer Fraud and Abuse Act’s private right of action does not extend to cover employees’ theft of information when it is stolen using channels of access that are authorized.  In doing so, the Southern District joined the Eastern District of New York and the Ninth Circuit in a narrow reading of the statute, while citing opposing holdings out of the First, Seventh, Fifth, and even other courts in the Southern District, which would give the CFAA a more expansive reading.

In Advanced Aerofoil Technologies, the plaintiff company Advanced Aerofoil Technologies (AAT) sued a number of defendants for procuring customer lists and proprietary information and funneling the information to their own new competing venture.  The list of defendants included former employees of AAT who allegedly used their unfettered access to divert clients and investors toward a new company that they formed while still employed.  According to the plaintiff’s summary judgment brief, the defendants continued their employment after the secret formation of their new company for the purpose of collecting information, and deleted entire swaths of information upon their departure in order to cripple AAT.  AAT brought a private suit (allowed under 18 U.S.C. § 1030(g)), citing violations of 18 U.S.C. § 1030(a).  Nevertheless, the court ruled that the language of this section of the statute hinges on subsection (a)(2), which disallows the intentional accessing of a computer without authorization to obtain information with the intent to defraud.  Because the defendant employees in AAT had “unlimited and unfettered access,” by definition they could not have exceeded their authorization.  The court therefore held that there was no violation of the CFAA, and dismissed the case.

What can employers take away from this case?  Simply this: that by carefully defining “authorized use” in personnel policies, employers may give courts that are reluctant to broaden the CFAA a reason to side with them in cases of blatant employee theft.

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

Expansion of the Economic Espionage Act Broadens Protection for Trade Secrets

In the summer of 2009, in an office at Goldman Sachs, in the waning hours of his last day of employment, a computer programmer named Sergey Aleynikov encrypted more than 500,000 lines of source code from Goldman’s proprietary high-frequency trading system, uploaded the code to a server in Germany, and then deleted the history of his computer commands and slipped out the door to attend his going away party.  He later downloaded the code from Germany onto his home computer and other personal devices.  He took portions of the encrypted code to a meeting with his new employer, by whom he had been hired to create the same type of code in an impossibly short span of time.  The FBI arrested Aleynikov at Newark Liberty International Airport as he was returning from the Chicago meeting, flash drives and laptop in hand.  Aleynikov was indicted for violating the Economic Espionage Act of 1996, 18 U.S.C. § 1832 (the “EEA”), among other charges, and was convicted by a jury in the Southern District of New York in 2010.  United States v. Aleynikov, 737 F. Supp. 2d 173 (S.D.N.Y. 2010).  He was sentenced to an eight year prison term.  However, he received a reprieve in 2012 when the Second Circuit performed a detailed textual analysis and determined that the stolen code was neither a product “produced for,” nor “placed in,” interstate commerce, and therefore could not violate the statute as worded.  The Court held that “Aleynikov should have known [his conduct] was in breach of his confidentiality obligations to Goldman, and was dishonest in ways that would subject him to sanctions; but he could not have known that it would offend this criminal law or this particular sovereign.”

In response to this holding, Congress unanimously passed the Theft of Trade Secrets Clarification Act of 2012, which President Obama signed on December 28, 2012.  The Act amends Section 1832(a) to include not only products, but also services, and was designed “to ensure that American companies can protect the products they work so hard to develop, so they may continue to grow and thrive,” according to Senator Patrick Leahy’s comments in a November 27th debate.  The amendment will have a great impact on the financial sector, which relies heavily on proprietary systems that gather information but are not themselves sold in interstate commerce, and may impact computer software companies, and others, as well.  Congress’s rejection of the Second Circuit’s narrow ruling will almost certainly lead to a growth in the number of indictments under this Act.

Congress passed an additional amendment on January 1, 2013, one that still awaits the President’s signature.  This bill, entitled the “Foreign and Economic Espionage Penalty Enhancement Act of 2012,” raises the fines and penalties for violation of the EEA.  Despite these enhancements to the strength of the Act, the EEA still provides no private cause of action.  The lack of such a right leaves companies in the position of continuing to seek redress for trade secret violations at the state level, or, at best, to cooperate with the federal authorities to assist in a criminal case against alleged violators.  Nevertheless, in the face of the Aleynikov case and other similar recent cases (see, e.g., United States v. Agrawal, pending in the Second Circuit), the strengthened EEA creates more protection for company trade secrets.  Employees in the relevant fields should take notice.

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

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DuPont Wins the Battle Over Kevlar . . . But Has It Won the War?

After being slammed with a verdict of $919.9 million against it in September 2011, South Korean-based Kolon Industries suffered its second whammy in August when the United States District Court for the Eastern District of Virginia enjoined it from production of its Heracron aramid fiber line, a competitor to DuPont’s Kevlar aramid fiber line, on the basis of misappropriation of DuPont’s trade secrets.

The District Court’s rulings were the products of litigation instituted by DuPont against Kolon in February 2009, wherein DuPont alleged that Kolon stole trade secrets and confidential information about Kevlar, DuPont’s aramid fiber developed in the 1960s and used in military and first responder protective gear.  More specifically, the suit urged that Michael Mitchell, a former DuPont employee who had worked as a Kevlar marketing executive, stole the trade secrets and passed them along to Kolon when he became employed therewith.  (Side bar: the F.B.I. investigated, Mitchell plead guilty, and he ultimately was sentenced to 18 months in prison).  Kolon denied any wrongdoing.

Following the massive damages award to DuPont in September 2011, DuPont announced that it would press forward with an effort to secure injunctive relief prohibiting Kolon from profiting further from having stolen DuPont’s trade secrets

After being slammed with a verdict of $919.9 million against it in September 2011, South Korean-based Kolon Industries suffered its second whammy in August when the United States District Court for the Eastern District of Virginia enjoined it from production of its Heracron aramid fiber line, a competitor to DuPont’s Kevlar aramid fiber line, on the basis of misappropriation of DuPont’s trade secrets.

The District Court’s rulings were the products of litigation instituted by DuPont against Kolon in February 2009 in E.I. Dupont de Nemours and Company v. Kolon Industries, Inc., No. 3:09-cv-00058 (E.D. Va. Feb. 3, 2009), wherein DuPont alleged that Kolon stole trade secrets and confidential information about Kevlar, DuPont’s aramid fiber developed in the 1960s and used in military and first responder protective gear.  More specifically, the suit urged that Michael Mitchell, a former DuPont employee who had worked as a Kevlar marketing executive, stole the trade secrets and passed them along to Kolon when he became employed therewith.  (Side bar: the F.B.I. investigated, Mitchell plead guilty, and he ultimately was sentenced to 18 months in prison).  Kolon denied any wrongdoing.

Following the massive damages award to DuPont in September 2011, DuPont announced that it would press forward with an effort to secure injunctive relief prohibiting Kolon from profiting further from having stolen DuPont’s trade secrets.

And so it was.  On August 30, 2012, the District Court entered an Order requiring Kolon to return DuPont’s trade secrets by October 1, 2012, prohibiting Kolon’s use of DuPont’s trade secrets permanently, and enjoining Kolon from producing or selling any para-aramid fiber products worldwide for twenty years. In so doing, the Court stated that Kolon showed a “complete disregard for DuPont’s trade secret rights and a disregard for the law that protects such secrets,” further noting that Kolon engaged in stealing DuPont’s trade secrets as “a matter of corporate policy.”  Not surprisingly, Kolon voiced its disapproval of the injunction’s issuance and immediately moved to stay the order pending the appeal of the jury verdict, which was granted by the Fourth Circuit Court of Appeals.

Shortly thereafter, the federal government announced on October 18, 2012 an indictment in United States v. Kolon Industries, Inc., No. 3:12-Cr-137 (E.D. Va. Aug. 21, 2012), charging Kolon with theft of DuPont’s trade secrets, conspiracy, and obstruction of justice, and five of its executives with conspiracy and obstruction of justice, contending that Kolon engaged in a multi-year campaign to recuirt DuPont employees to Kolon for purposes of obtaining Kevlar-related trade secrets.  The United States Department of Justice is attempting to seize $226 million from Kolon, allegedly representing the proceeds of the sale of Heracron fiber from 2006 to June 2012, plus over $300,000 in payments allegedly made to former DuPont employees to provide trade secret information.  If found guilty, the Kolon executives face up to 30 years in prison, and both the executives and Kolon would face millions of dollars in fines. U.S. Attorney Neil MacBride, in discussing the indictment, stated that it “should indicate that industrial espionage is not a business strategy and will not be tolerated by the United States Department of Justice.”

As Kolon has been found liable for civil violations and charged with criminal action related to its alleged trade secret theft from DuPont, DuPont has won the battle.  However, since Kolon has now appealed the civil matter and will contest the criminal action, has DuPont won the war? We will have to wait and see.

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

New Hampshire Enacts Non-Compete and Non-Piracy Legislation Effective July 14, 2012

New Hampshire has joined the ranks of numerous other states with non-compete statutes. On July 14, 2012, New Hampshire’s non-compete and non-piracy law became effective and aims to ensure that advance notice will be provided to employees who will be required to sign a non-compete or non-piracy agreement as a condition of their employment or change in job position:

Prior to or concurrent with making an offer of change in job classification or an offer of employment, every employer shall provide a copy of any non-compete or non-piracy agreement that is part of an employment agreement to the employee or potential employee.  Any contract that is not in compliance with this section shall be void and unenforceable.

Under the new law, an employer is prohibited from sandbagging a new employee by presenting him/her with a non-compete or non-piracy agreement on his/her first day of work after he/she has already accepted the offer, particularly in situations where the employee has quit a job to begin work with the new employer only to learn of the “surprise” agreement at that time.  Now, not only must the employee be informed that a non-compete or non-piracy agreement will be a term of his/her employment should he/she accept an offer, but also the employee must be provided with a copy of the actual agreement itself.  The employee then has an opportunity to review and consider the agreement and the impact thereof, and decide whether to accept the offer and the agreement and if employed, quit his/her current job.  This same analysis applies in the case of an employee who is offered an internal job change (e.g., lateral move, promotion, etc.) which will require him/her to sign a non-compete or non-piracy agreement.

New Hampshire courts will continue to handle “traditional” disputes as to the reasonableness of the geographic scope and duration of non-compete agreements and whether the employer has a legitimate protectable interest.  But, after July 14, those same courts will undoubtedly be asked to decide and handle a variety of debacles arising as a result of the new law and the questions it leaves unanswered, such as whether non-solicitation, non-recruitment, and/or nondisclosure agreements constitute “non-piracy” agreements.  That said, as the penalty for noncompliance with the new law is steep – i.e., invalidation of the entire agreement – employers would be wise to act conservatively and avoid any missteps by ensuring reasonable advance notice is provided, written acknowledgment of the notice is given by the employee, and non-solicitation, non-recruitment, and non-disclosure agreements are treated as non-piracy agreements subject to the new law.

 

Employee Non-Compete a New Requirement in Business Acquisition

When Is Your Continued Employment Contingent Upon Signing a Non-Compete Agreement?

Halifax Media Group recently bought a chain of newspapers known as the New York Times Regional Media Group. With the business acquisition came the requirement of Regional Media Group employees to sign a non-compete agreement. It seemed like a logical business decision.

While The New York Times Co. and Halifax Media Holdings, LLC were busy striking the deal, it brought some sleepless nights for quite a few New York Times media employees. Two days after Christmas the New York Times Co. informed its employees that the New York Times Regional Media Group (“NYTRMG”) was being sold to Halifax Media Group (“Halifax”), owner of the Daytona Beach News-Journal.

The Good News: Current employees would have the option of continued employment with Halifax.

The Bad News: Continued employment with Halifax was conditional on NYTRMG employees signing a non-compete agreement. The agreement would prohibit an employee whose employment with Halifax was terminated, voluntarily or non-voluntarily, to become employed with a competing media company for two years. This applies to any media company working in print, on the air, or online that works in a market that Halifax serves or plans to serve. Essentially, even if an employee was fired from Halifax, the non-compete agreement would prevent journalists and employees from working for any media enterprise in that city.

However, the sixteen newspapers being sold to Halifax are located in the states of Alabama, California, Florida, Louisiana, North Carolina, and South Carolina, all of which have varying laws regarding the validity and enforcement of non-competition agreements. These differences in laws immediately raised questions about the applicability and effectiveness of the non-compete agreement to all newspaper employees.

After receiving serious pushback and dissension from employees, Halifax reconsidered its position and announced that the non-compete agreement will not apply to existing New York Times Regional employees.

So, as existing NYTRG employees were assured that their continued employment with Halifax was not contingent upon the execution of a hefty non-compete agreement, they could now get some post-holiday rest. The employees who may seek employment with Halifax in the future, however, may find themselves counting sheep.

For more information on non-compete agreements and their state requirements contact Burr Forman for more insights on the enforceability of non-compete clauses.