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PREVENTING THE RUSTLING OF NERDS AND PROTECTION OF TRADE SECRETS THROUGH COVENANTS NOT TO COMPETE

SHEILA BETH OWSLEY Greenwich, CT

State Bar of Texas 13TH ANNUAL ADVANCED EMPLOYMENT LAW COURSE

January 20-21, 2005 San Antonio

CHAPTER 3

Preventing The Rustling Of Nerds And Protection Of Trade Secrets Through Covenants Not To Compete Chapter 3

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TABLE OF CONTENTS

I. INTRODUCTION....................................................................................................................................... 1

II. TEXAS IS ANOTHER WORLD – UNDERSTANDING THE HISTORY BEHIND THE REALITY.............. 1

III. CURRENT STATUS OF THE LAW IN TEXAS.......................................................................................... 1 A. Covenant Not To Compete Criteria ........................................................................................................ 1 B. Light v. Centel Cellular Co. of Texas, 883 S.W.2d 642 (Tex. 1994). ........................................................ 1 C. Guy Carpenter & Co. v. Provenzale, 334 F.3d 459 (5th Cir. 2003). .......................................................... 7

IV. CRYSTAL BALL ANALYSIS.................................................................................................................... 8

V. PRACTICAL PRACTICE TIPS................................................................................................................... 8 A. Non -Disclosure Clauses....................................................................................................................... 8 B. Non -Solicitation Clauses...................................................................................................................... 8 C. Implementation and Enforcement .......................................................................................................... 8 D. Steps to Take When Hiring Employees.................................................................................................. 9 E. Steps to Take When Employees Leave the Workplace ............................................................................ 9

VI. JUDICIAL ENFORCEMENT OF COVENANTS NOT TO COMPETE........................................................10 A. Conflict of Law Principles ...................................................................................................................10 B. Enforcement Options ...........................................................................................................................10 C. Potential Causes of Action ...................................................................................................................12 D. Damages.............................................................................................................................................12 E. Settlement or Trial...............................................................................................................................12 F. Summary ............................................................................................................................................13

APPENDIX A...................................................................................................................................................15

APPENDIX B ...................................................................................................................................................17

APPENDIX C ...................................................................................................................................................19

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PREVENTING THE RUSTLING OF NERDS AND PROTECTION OF TRADE SECRETS THROUGH COVENANTS NOT TO COMPETE I. INTRODUCTION

Texas law disfavors covenants not to compete as a restraint on trade. Historically, the Texas Supreme Court has been hostile to covenants not to compete, almost invariably finding some basis for striking down whatever covenant not to compete was before the Court. Yet an important factor in the overall ability of a company to survive and to prosper in today’s competitive environment is the extent to which the company is able to protect its trade secrets and business relationships.

A 1998 survey by the American Society for Industrial Security indicated potential losses from trade secret and other intellectual property theft exceeds $250 billion annually 1. Nearly 75 percent of these losses involve "trusted insiders," employees, former employees and consultants.

One of the most effective ways to prevent the loss of valuable intellectual property is through confidentiality agreements and post-employment restrictive covenants. Although restraints of trade are generally disfavored, courts will enforce a reasonable covenant not to compete if the employer can establish a legitimate protectable interest. II. TEXAS IS ANOTHER WORLD –

UNDERSTANDING THE HISTORY BEHIND THE REALITY Historically, the Texas Supreme Court has been

hostile to covenants not to compete, almost invariably finding some basis for striking down whatever covenant not to compete was before the Court. In 1989, the legislature passed the Covenants Not to Compete Act (the “Act”). Acts 1989, 71st Leg., ch. 1193 § 1. The Texas Supreme Court and the legislature then battled over the enforceability of covenants not to compete from 1989 to 19942. In response, the legislature amended the Act in 1993. Acts 1993, 73rd Leg., ch. 965 § 1. This time, the legislature specifically provided that the Act preempted the common law and created the exclusive criteria,

1 Richard J. Heffernan & Dan T. Swartwood, 1997/98

Trends in Intellectual Property Loss Special Report, American Society of Industrial Security (1998).

2See, Ernest C. Garcia & Fred A. Helms, Covenants Not to Compete & Not to Disclose, 64 Tex. B. J. 32 (2001); Jeffrey W. Tayon, Covenants Not to Compete in Texas: Shifting Sands from Hill to Light, 3 Tex. Intell. Prop. L. J. 143 (1995).

procedure, and remedies for enforcing covenants not to compete3.

III. CURRENT STATUS OF THE LAW IN

TEXAS A. Covenant Not To Compete Criteria

The Act is codified at Tex. Bus. & Comm. Code Ann. §§ 15.50-15.52 (Vernon 2002). Section 15.50 sets out the criteria necessary for a covenant not to compete to be enforceable. Section 15.51 sets out the procedures for enforcing a covenant not to compete and the remedies available. Section 15.52 provides that the Act preempts other law and provides the exclusive remedies and procedures applicable to covenants not to compete.

Section 15.50(a) of the Act describes the criteria required:

[A] covenant not to compete is enforceable if it is ancillary to or part of an otherwise enforceable agreement at the time the agreement is made to the extent it contains limitations as to time, geographical area, and scope of activity to be restrained that are reasonable and do not impose a greater restraint than is necessary to protect the goodwill or other business interest of the promisee [the employer, usually].

Tex. Bus. & Comm. Code Ann. § 15.50(a) (Vernon 2002).

A simple, straightforward reading of the statute would suggest that a covenant not to compete requires the following elements to be enforceable:

o It must be ancillary to, or part of, an

otherwise enforceable agreement at the time the agreement is made; and

o It must contain reasonable limits on the duration of the covenant, the geographic area to which the covenant applies, and the scope of the activity being restrained that are no broader than necessary to protect the goodwill or other legitimate interest of the party in whose favor the covenant runs.

B. Light v. Centel Cellular Co. of Texas, 883

S.W.2d 642 (Tex. 1994). The Texas Supreme Court last visited the subject

of covenants not to compete in Light v. Centel Cellular Co. of Texas, 883 S.W.2d 642 (Tex. 1994), which is

3 See, Acts 1993, 73rd Leg., ch. 965 § 3, codified at

Tex. Bus. & Comm. Code Ann. § 15.52 (Vernon 2002).

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currently the landmark case on covenants not to compete4.

Debbie Light was an at-will employee who signed an agreement containing a covenant not to compete. Light had been hired initially in 1985 to sell pagers. In 1987, Light’s employer obtained a license to sell cellular communication products and services. Light’s employer required her to sign the agreement to keep her job, and before she was allowed to sell cellular products. Light was an at-will employee.

The Texas Supreme Court focused its analysis on the statute’s requirement that the covenant must be “ancillary to or part of an otherwise enforceable agreement at the time the agreement is made.” The Supreme Court reasoned that any promise contained in Light’s agreement would be illusory, and therefore not an “otherwise enforceable agreement,” if the promise depended on continued employment. That is, if doing or providing what was promised would occur only if the employment relationship continued, then the promise was illusory.

In the employment-at-will context, the Court reasoned, the promise would be an illusory one because the party (either party) making the promise would be free to terminate employment at will and so avoid the promise.

For example, the employer’s promise to pay Light a salary would be an illusory promise because the employer always retained the right to fire Light and so avoid any obligation to pay the salary promised.

Since an illusory promise does not constitute an “otherwise enforceable agreement,” the Texas Supreme Court concluded that it could not support or validate a covenant not to compete.

Accordingly, the first step of the Court’s analysis was to examine the agreement containing the covenant not to compete and to identify those promises that were non-illusory and actually bound the party making the promise.

4 Few of these cases reach the Texas Supreme Court.

Tex. Civ. Prac. & Rem. Code Ann. § 51.014(a) (4) permits an interlocutory appeal of an order that grants or denies a request for a temporary injunction. Tex. Gov’t Code Ann. § 22.225(b)(4) deprives the Supreme Court of jurisdiction over such cases, absent a dissent in the Court of Appeals or the Supreme Court’s decision to invoke its “conflicts” jurisdiction. Tex. Gov’t Code Ann. § 22.005 (Vernon 2003 Supp.); see generally, Gonzalez v. Avalos, 907 S.W.2d 443 (Tex. 1995) (discussing Supreme Court’s jurisdiction over interlocutory appeals). Consequently, many of the appellate decisions involve interlocutory appeals by the party that lost the temporary injunction hearing in the trial court -- cases over which the Texas Supreme Court generally lacks jurisdiction.

The Court found three such promises in Light’s agreement: (1) her employer’s promise to provide “initial . . . specialized training” to Light; (2) Light’s promise to give 14 days’ notice to terminate her employment; and (3) Light’s promise to provide her employer an inventory of its property in her possession upon termination. The Court subsequently concluded that Light did have an otherwise enforceable agreement, as required by the statute, and that the otherwise enforceable agreement consisted of the three promises outlined above.

The second step of the Court’s analysis, then, was to determine whether the covenant not to compete was “ancillary to or part of” that otherwise enforceable agreement. Since the legislature did not define the meaning of the phrase, the Court adopted what it called the “designed-to-enforce-a-contractual-obligation standard,” which it borrowed from Justice Stevens’s dissenting opinion in Business Electronics v. Sharp Electronics, 485 U.S. 717, 108 S.Ct. 1515 (1988). From this standard, the Court fashioned a two-part test.

The Court said:

Therefore, in order for a covenant not to compete to be ancillary to an otherwise enforceable agreement between employer and employee: (1) the consideration given by the employer

in the otherwise enforceable agreement must give rise to the employer’s interest in restraining the employee from competing; and

(2) the covenant [not to compete] must be designed to enforce the employee’s consideration or return promise in the otherwise enforceable agreement.

883 S.W.2d at 647.

A covenant not to compete is ancillary to or part of the otherwise enforceable agreement only if both parts of the two-part test are satisfied. A covenant that failed either part of the two-part test would be an unenforceable restraint on trade.

In Light, the Texas Supreme Court held that the employer’s promise to train Light “might involve confidential or proprietary information;” suggesting that it might meet the first part of the test (the employer’s consideration must give rise to the employer’s interest in restraining the employee from competing); but the Court concluded that Light’s covenant not to compete was not designed to enforce her reciprocal non-illusory promises (to give 14-days’s notice of termination and to provide an inventory).

The Court found that Light’s covenant not to compete could have enforced a promise from Light not

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to disclose confidential information she received from her employer; but Light’s agreement included no such promise. 883 S.W.2d at 647 n.15. The covenant therefore failed to meet the second part of the test and was unenforceable, as a matter of law.

1. “[A]ncillary to or part of an otherwise enforceable

agreement at the time the agreement is made.” A covenant not to compete is ancillary to an

otherwise enforceable agreement “if the employer gives an employee confidential or proprietary information or trade secrets5 in exchange for the employee’s promise not to disclose them, and the parties enter into a covenant not to compete[.]” Id. at 647 n.14 (emphasis added).

5 “Any formula, pattern, device or compilation of information which is used in one’s business and presents an opportunity to obtain an advantage over competitors who do not know or use it” constitutes a trade secret. Computer Associates International, Inc. v. Altai, Inc., 918 S.W.2d 453, 455 (Tex. 1994); see, also, Restatement of Torts § 757 (1939). To qualify as a trade secret, the information must generally be confidential. Examples of trade secrets include a formula for a chemical compound, a process of manufacturing, treating or preserving materials, a pattern for a machine or other device, a customer list, pricing information, client information, customer preferences, buyer contacts, and market strategies. Hyde Corp. v. Huffines, 314 S.W.2d 765, 776 (Tex.), cert. denied, 358 U.S. 898, 79 S.Ct. 223 (1958); Miller Paper Co. v. Roberts Paper Co., 901 S.W.2d 593, 601 (Tex. App.--Amarillo 1995, no writ). In Miller Paper Co. v. Roberts Paper Co., 901 S.W.2d 593 (Tex. App.--Amarillo 1995, no writ), the dispute centered on a document known as “the book,” compiled over a 52-year period, and containing a list of all company customers with addresses and other unique information about each customer. The Amarillo Appeals Court found “the book” constituted a trade secret and the company was entitled to protection. In Anderson Chemical Co. v. Green, 66 S.W.3d 434 (Tex. App.--Amarillo 2001, no pet.), the same Court affirmed the lower court’s refusal to enter an injunction where the former employer admitted that anyone in the business could readily identify the potential customers in any given town and the evidence showed that the other information at issue was not unique. See also, Daytona Group of Texas, Inc. v. Smith, 800 S.W.2d 285, 289 n.3 (Tex. App.--Corpus Christi 1990, writ denied) (radio station’s customer list could not be secret because anyone could obtain it by listening to the radio station). If the information is readily available from other sources, then the information may not qualify for protection. Consider the reality that in today’s marketplace, potential customer names and contact information may be readily available over the internet or through industry associations. Additionally, the employer may lose any claim to protection by disclosing the information to outsiders in the form of a list of its customers given to a prospective customer either as a reference or as a demonstration of its bona fides.

The employer’s consideration (the trade secrets) in the otherwise enforceable agreement (exchange of trade secrets for promise not to disclose) gives rise to the employer’s interest in keeping the employee from competing (employer has interest in restraining competition from employee with knowledge of employer’s trade secrets); and the covenant not to compete may serve to enforce the employee’s return promise (the promise not to disclose the trade secrets) in the otherwise enforceable agreement. Id.

On the other hand, a unilateral contract would not support a covenant not to compete even though it might otherwise meet the two-part test. Suppose, for example, that the employee promised not to disclose the employer’s trade secrets, if the employer provided the employee with trade secrets during employment, and the employee signed a covenant not to compete. Even though any “promise” by the employer to give the employee trade secrets “during employment” would be illusory in that it depended on continued employment, the employee’s promise not to disclose could serve as an offer to enter into a unilateral contract, which the employer could accept by performance. Id. at 645 n.6. If the employer accepted the employee’s offer by providing the employee with trade secrets, then a unilateral contract would be formed in which the employee becomes bound by the promise not to disclose. Although this scenario satisfies the two-part test, the Light Court said that a covenant not to compete arising from such a scenario still fails because it does not meet the statute’s requirement of an otherwise enforceable agreement at the time the agreement is made.

The Texas Supreme Court described its analysis thusly:

But such unilateral contract, since it could be accepted only by future performance, could not support a covenant not to compete inasmuch as it was not an “otherwise enforceable agreement at the time the agreement is made” as required by § 15.50.

Id. See also, Anderson Chemical Co., Inc. v. Green, 66 S.W.3d 434, 438 (Tex. App.--Amarillo 2001, no pet.).

Few employers are likely to draft contracts that require them to provide confidential information, trade secrets or specialized training to an employee regardless of whether the employment relationship continues. Yet that is precisely what the Court’s holding in the Light case appears to require. Some employers have argued that their contracts include an implied promise to provide the employee with confidential information. Texas courts have generally rejected these arguments, reasoning that such a

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promise would depend on continued employment and be illusory.

In Strickland v. Medtronic, Inc., 97 S.W.3d 835 (Tex. App.--Dallas 2003, pet. filed), Strickland’s contract said:

[T]his agreement is intended to recognize that Medtronic provides the Employee with information concerning its business, products and customers, and entrusts the Employee with business relationships and good will of great value to Medtronic.

Medtronic argued that the provision was consideration from Medtronic that gave rise to its interest in keeping Strickland from competing. The Dallas Court of Appeals first concluded that the provision created no obligation on the part of Medtronic. The Court then said:

However, even assuming that by this provision Medtronic impliedly promised to provide confidential information, we conclude such a promise is illusory because it necessarily depends on a period of employment. Medtronic could simply avoid this obligation by firing Strickland on the day the employment agreement was executed.

The First Court of Appeals reached the same conclusion in CRC-Evans International Pipeline, Inc. v. Myers, 927 S.W.2d 259, 265 (Tex. App.--Houston [1st Dist.] 1996, no writ).

On the other hand, the First Court of Appeals upheld a temporary injunction on similar facts in Totino v. Alexander & Associates, Inc., No. 01-97-01204-CV, 1998 WL 552818 (Tex. App.--Houston [1st Dist.] Aug. 20, 1998) (not designated for publication).6 There, the at-will employee’s agreement said:

It is understood that in the course of [Employee’s] employment with A&A, [Employee] will become acquainted with A&A Confidential Information.

The evidence showed that the employee had signed his employment agreement on his first day of employment. The Court reasoned:

6 The Court initially designated its opinion in the Totino case as a published opinion. Totino filed a motion for rehearing. While that motion pended, the parties settled the case and moved to dismiss the appeal. The Court dismissed the appeal and, on its own motion, changed the designation to “Do Not Publish.”

Freeman necessarily was given at least some of the indicated confidential information immediately upon his coming to A&A--notwithstanding that the agreement recites that he would receive this information “in the course of” his employment. Otherwise, Freeman could not have performed his duties at A&A. Therefore, A&A’s stipulation that Freeman would receive such confidential information, in exchange for his agreement not to disclose that information was nonillusory and could be an “otherwise enforceable agreement.”

(emphasis in original).

Three other employees in the case had signed employment agreements that said:

A&A shall, in the course of [Employee’s] employment, entrust [Employee] with A&A Confidential Information.

The evidence showed that these three employees signed their employment agreements some time after they began their employment. The Court held that this clause created an illusory promise because it depended on continued employment. The Court said:

[E]ven though A&A’s promise to provide confidential information was mandatory, it was to be carried out “in the course of” employment. This was an illusory promise at the time because (1) these three necessarily had access already to some A&A confidential information, (2) A&A did not show what new, confidential information they were given upon signing the employment agreements, and, accordingly, (3) A&A could have terminated their employment before giving them new information.

It is difficult to reconcile the Court’s holdings. The Court’s distinction -- one was signed on the first day of employment and the others were not -- might make sense if one assumed Freeman was handed confidential information the moment he signed his employment agreement. Otherwise, it is difficult to understand how A&A could have avoided its promise to the other three by firing them, but not have avoided its promise to Freeman in the same manner.

In CRC-Evans International Pipeline, Inc. v. Myers, 927 S.W.2d 259, 263 (Tex. App.--Houston [1st Dist.] 1996, no writ), the Court said that the relevant point in time is the moment that the agreement is



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made7. Past consideration -- such as the employer’s providing confidential information to the employee before the parties sign their contract -- will not support a covenant not to compete. See, American Fracmaster, Ltd. v. Richardson, 71 S.W.3d 381, 388 n.5 (Tex. App.--Tyler 2001, no pet.). 2. The Agreement must contain “reasonable limits

on the duration of the covenant, the geographic area to which the covenant applies, and the scope of the activity being restrained that are no broader than necessary to protect the goodwill or other legitimate interest of the party in whose favor the covenant runs.”

a. Reasonable limits on the duration of the covenant The Act also requires “limitations as to time,

geographical area, and scope of activity to be restrained that are reasonable and do not impose a greater restraint than is necessary to protect the goodwill or other business interest of the promisee.” Tex. Bus. & Comm. Code Ann. § 15.50(a) (Vernon 2002).

Whether a covenant is reasonable depends on the facts developed in each case. It is not possible, therefore, to say that any particular limit will always be found reasonable or unreasonable 8.

Texas courts have upheld two-year covenants not to compete in several cases9. Texas courts have also upheld three-year covenants not to compete10. Texas

7 See also Strickland v. Medtronic, Inc., 97 S.W.3d

835, 839 (Tex. App.--Dallas 2003, pet. filed); Anderson Chemical Co., Inc. v. Green, 66 S.W.3d 434, 438 (Tex. App.--Amarillo 2001, no pet.).

8 See, e.g., Bob Pagan Ford, Inc. v. Smith, 638 S.W.2d 176 (Tex. App.--Houston [1st Dist.] 1982, no writ) (affirming trial court’s decision to reduce three-year covenant to six months); Holiday Hill Stone Products, Inc. v. Peek , 387 S.W.2d 731 (Tex. Civ. App.--San Antonio 1965, no writ) (affirming trial court’s decision to reduce from three years to one year covenant prohibiting Peek “from engaging in the manufacture of cast stone” while affirming the trial court’s decision to enforce three-year covenant prohibiting Peek from “attempting to sell cast stone or cast brick”).

9 See, e.g., Property Tax Associates, Inc. v. Staffeldt, 800 S.W.2d 349 (Tex. App.--El Paso 1990, writ denied); AMF Tuboscope v. McBryde, 618 S.W.2d 105 (Tex. Civ. App.--Corpus Christi 1981, writ ref’d n.r.e.); Wilson v. Century Papers, Inc., 397 S.W.2d 314 (Tex. Civ. App.--Houston 1965, no writ); Mosimann v. Employers Cas. Co., 354 S.W.2d 171 (Tex. Civ. App.--Houston 1962, no writ); Weber v. Hesse Envelope Co., 342 S.W.2d 652 (Tex. Civ. App.--Dallas 1960, no writ); Park v. Essa Texas Corp., 315 S.W.2d 197 (Tex. Civ. App.--Austin 1958, writ ref’d n.r.e.).

10 See, e.g., Integrated Interiors, Inc. v. Snyder, 565 S.W.2d 350 (Tex. Civ. App.--Fort Worth 1978, writ ref’d n.r.e.); Arevalo v. Velvet Door, Inc., 508 S.W.2d 184 (Tex.

courts have likewise upheld five-year covenants not to compete11. The trial courts declined to enforce three-year covenants not to compete and, instead, reduced the time of restraint to six months and one year, respectively, in Bob Pagan Ford, Inc. v. Smith, 638 S.W.2d 176 (Tex. App.--Houston [1st Dist.] 1982, no writ), and Holiday Hill Stone Products, Inc. v. Peek , 387 S.W.2d 731 (Tex. Civ. App.--San Antonio 1965, no writ). The appellate courts affirmed the trial court’s decision in both instances. The trial court declined to enforce covenants not to compete that carried a ten-year duration in Recon Exploration, Inc. v. Hodges, 798 S.W.2d 848 (Tex. App.--Dallas 1990, no writ). The Court of Appeals affirmed and, in the process, mentioned the ten-year duration as one possible ground on which the trial court could have based its decision to deny a temporary injunction.

Texas courts have regularly refused to enforce covenants not to compete that provide for an indefinite duration of the covenant. For example, in Emergicare Systems, Inc. v. Bourdon, 942 S.W.2d 201 (Tex. App.--Eastland 1997, no writ), Emergicare contracted with hospitals to provide emergency room doctors and employed Bourdon as a doctor for that purpose. The contract between Emergicare and Bourdon included a covenant not to compete that prohibited Bourdon from working for any hospital that contracted with Emergicare for one year after the termination of the contract between Emergicare and the hospital. Since the Emergicare-hospital contract could continue for decades, the Court held the duration of the covenant was unreasonable. The Courts reached similar conclusions in General Devices, Inc. v. Bacon, 888 S.W.2d 497 (Tex. App.--Dallas 1994, writ denied (covenant continued until 30 days after termination of relationship between employer and employer’s customer); Cawse-Morgan v. Murray, 635 S.W.2d 348 (Tex. App--Corpus Christi 1982, no writ) (covenant ran for one year from the date on which employee was enjoined from competing); and Cardinal Personnel, Inc. v. Schneider, 544 S.W.2d 845 (Tex. Civ. App.--Houston [14th Dist.] 1976, no writ) (holding unreasonable covenant not to compete that would continue for six months from whenever court entered an injunction).

Civ. App.--El Paso 1974, writ ref’d n.r.e.); Martin v. Kidde Sales & Service, Inc., 496 S.W.2d 714 (Tex. Civ. App.--Waco 1973, no writ).

11 See, e.g., Stone v. Griffin Communications and Security Systems, Inc., 53 S.W.3d 687 (Tex. App.--Tyler 2001, no pet.), Chandler v. Mastercraft Dental Corp. of Texas, Inc., 739 S.W.2d 460 (Tex. App.--Fort Worth 1987, writ denied), and Spinks v. Riebold, 310 S.W.2d 668 (Tex. Civ. App.--El Paso 1958, writ ref’d).

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b. Reasonable limits as to geographic area to which the covenant applies Generally, the territory in which the employee

worked while employed is a reasonable area in which to prohibit the employee from competing12. But, what is reasonable in any particular case depends heavily on the evidence. At least one Texas court has held that the Covenants Not to Compete Act does not require an express geographic restriction where the covenant not to compete is limited to customers with whom the employee had personal dealings while employed. Totino v. Alexander & Associates, Inc., No. 01-97-01204-CV, 1998 WL 552818 (Tex. App.--Houston [1st Dist.] Aug. 20, 1998) (not designated for publication). The modern trend, however, is to require a correlation between the restraint and the employee’s activities on behalf of the employer. Therefore, the cases enforcing a flat prohibition in a given geographic area are of questionable vitality absent unusual circumstances13.

12 See, Justin Belt Co. v. Yost, 502 S.W.2d 681 (Tex. 1973); Property Tax Associates, Inc. v. Staffeldt, 800 S.W.2d 349 (Tex. App.--El Paso 1990, writ denied); Martin v. Linen Systems for Hospitals, Inc., 671 S.W.2d 706 (Tex. App.--Houston [1st Dist.] 1984, no writ).

13 Examples of cases in which Texas courts have upheld geographic restrictions include: Curtis v. Ziff Energy Group, Ltd., 12 S.W.3d 114 (Tex. App.--Houston [14th Dist.] 1999, no pet.) (covenant restricting work for oil-and-gas consulting firms in North America for six-month period where employee had been “Vice President of Pipelines and Energy Marketing” heading employer’s practice in areas of consulting about pipeline/transportation issues and energy marketing); Isuani v. Manske Sheffield Radiology Group, 805 S.W.2d 602 (Tex. App.--Beaumont 1991, writ denied) (15-mile radius from identified hospital); Wilson v. Chemco Chemical Co., 711 S.W.2d 265 (Tex. App.--Dallas 1986, no writ) (twenty-one counties in four states where employee had been previously assigned); Gillen v. Diadrill, Inc., 624 S.W.2d 259 (Tex. App.--Corpus Christi 1981, writ dism’d) (marketing area served by the employee during the period of his employment by employer); Eberts v. Businesspeople Personnel Services, Inc., 620 S.W.2d 861 (Tex. Civ. App.--Dallas 1981, no writ) (100-mile radius of Dallas County courthouse); AMF Tuboscope v. McBryde, 618 S.W.2d 105 (Tex. Civ. App.--Corpus Christi 1981, writ ref’d n.r.e.) (100-mile radius upheld where evidence showed employees’ territory was area within approximately 100 miles of office); Integrated Interiors, Inc. v. Snyder, 565 S.W.2d 350 (Tex. Civ. App.--Fort Worth 1973, writ ref’d n.r.e.) (within 50 miles of employer’s principal place of business); Arrow Chemical Corp. v. Pugh, 490 S.W.2d 628 (Tex. Civ. App.--Dallas 1972, no writ) (Dallas and Tarrant Counties); Traweek v. Shields, 380 S.W.2d 131 (Tex. Civ. App.--Tyler 1964, no writ) (75-mile radius of Houston, Texas).

Examples of cases in which Texas courts have declined to enforce geographic restrictions include: Weatherford Oil Tool Co. v. Campbell, 340 S.W.2d 950 (Tex. 1960) (any area where the employer may be operating or carrying on

Texas courts have refused to enforce geographic restrictions that are indefinite as to the area of the restriction. For example, in Butts Rental, Inc. v. Diversified, Inc., 840 S.W.2d 770 (Tex. App.--Beaumont 1992, writ denied), the Court refused to enforce a covenant prohibiting competition in the “metropolitan area.” To similar effect are: Gomez v. Zamora, 814 S.W.2d 114 (Tex. App.--Corpus Christi 1991, no writ) (“existing marketing area” and “future marketing area”), and Hice v. Cole , 295 S.W.2d 661 (Tex. Civ. App.--Beaumont 1956, no writ) (“trade territory heretofore served by him . . . which might lie upon the borders of Orange County”).

All of these cases pre-date the Covenants Not to Compete Act, however. The Act provides that the court “shall reform” the covenant to the extent necessary to make it reasonable if the court concludes the original covenant is overbroad. Tex. Bus. & Comm. Code Ann. § 15.51(c) (Vernon 2002). It remains to be seen whether the Act requires the court to reform a covenant that defines an area that is too indefinite to be enforced. c. The scope of the activity being restrained is no

broader than necessary to protect the goodwill or other legitimate interest of the party in whose favor the covenant runs The modern trend is to require a correlation

between the scope of the activity restrained and the nature of the employee’s activities on behalf of the employer. In Diversified Human Resources Group, Inc. v. Levinson-Polakoff, 752 S.W.2d 8 (Tex. App.--

business); Evan’s World Travel, Inc. v. Adams , 978 S.W.2d 225 (Tex. App.--Texarkana 1996, no writ) (prohibition applying to Harrison and Gregg Counties was unreasonable where the employee had worked only in Harrison County); Deaton v. United Mobile Networks, 926 S.W.2d 756 (Tex. App.--Texarkana 1996, no writ) (affirming trial court’s decision to reduce geographic restriction from 150 miles outside boundary of business activity to 100-mile radius from fixed point); Webb v. Hartman Newspapers, Inc., 793 S.W.2d 302 (Tex. App.--Houston [14th Dist.] 1990, no writ) (60-mile radius of any of employer’s newspapers); Cukjati v. Burkett , 772 S.W.2d 215 (Tex. App.--Dallas 1989, no writ) (12-mile restriction in connection with veterinary practice unreasonable where evidence showed most pet owners travel only a few miles for pet care); Diversified Human Resources Group, Inc. v. Levinson-Polakoff, 752 S.W.2d 8 (Tex. App.--Dallas 1988, no writ) (50-mile radius of any city in which employer operated); Allen J. Richardson & Assoc., Inc. v. Andrews, 718 S.W.2d 833 (Tex. App.--Houston [14th Dist.] 1986, no writ) (nationwide); Cawse-Morgan v. Murray, 635 S.W.2d 348 (Tex. App--Corpus Christi 1982, no writ) (25 miles of any existing or thereafter-established office of employer); American Speedreading Academy, Inc. v. Holst, 496 S.W.2d 133 (Tex. Civ. App.--Beaumont 1973, no writ) (affirming trial court’s decision declining to enforce 1,000-mile restriction).

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Dallas 1988, no writ), the employee, Polakoff, worked for a placement agency where she recruited only data processors. Since she had no experience, Diversified trained her. Diversified fired Polakoff after nine months. She then began working for another placement agency, this time recruiting “insurance underwriting professionals.” The covenant at issue sought to prohibit Polakoff from working for any placement agency for six months. The Court held that the covenant’s scope was unreasonable. The Court concluded that, while Diversified might have a legitimate interest in preventing Polakoff from recruiting data processors, a covenant that prohibited her from placing personnel in any other non-related field was simply too broad to be reasonable.

Cases to similar effect include: Weatherford Oil Tool Co. v. Campbell, 340 S.W.2d 950. 952 (Tex. 1960); McNeilus Companies, Inc. v. Sams, 971 S.W.2d 507 (Tex. App.--Dallas 1997, no pet.), and Recon Exploration, Inc. v. Hodges, 798 S.W.2d 848 (Tex. App.--Dallas 1990, no writ). Consequently, while one can find older cases that enforced a flat prohibition against competitive activities in a specified geographic area, the continued vitality of such cases is questionable. In John R. Ray & Sons, Inc. v. Stroman, 923 S.W.2d 80 (Tex. App.--Houston [14th Dist.] 1996, writ denied), the Court held that it is unreasonable to restrict an employee in a personal services occupation from competing for clients with whom the employee had no dealings during his employment. The Court relied heavily on the Texas Supreme Court’s opinion in Peat Marwick Main & Co. v. Haass, 818 S.W.2d 381 (Tex. 1991). The Haass cased involved a liquidated-damages clause signed by an accountant, which the Court concluded operated to prevent competition and so the Court analyzed it as a covenant not to compete. The Supreme Court held that the liquidated-damages clause was an unenforceable restraint on trade because, among other problems, it prohibited Haass from competing for clients of the firm with whom he had no contact and no opportunity to develop a rapport.

The Court said:

The fundamental legitimate business interest that may be protected by such covenants is in preventing employees or departing partners from using the business contacts and rapport established during the relationship of representing the . . . firm to take the firm’s customers with him. . . . Inhibiting departing partners from engaging accounting services for clients who were acquired after the partner left, or with whom the accountant had no contact while associated with the firm, does not further and is not reasonably necessary to protect that interest.

Id. at 317-18.

An earlier Supreme Court case, styled Henshaw v. Kroenecke, 656 S.W.2d 416 (Tex. 1983), is not entirely consistent with the decision in the Haass case. In the Henshaw case, the Court upheld a covenant not to compete that placed off-limits all of the company’s customers, including, presumably, those with whom Kroenecke had no personal dealings. There, Henshaw had a preexisting business. Kroenecke and Henshaw formed a partnership to pursue the same business. The evidence showed that the covenant not to compete was an integral part of the negotiations. The Court described Henshaw’s interest as being “to protect himself from the possibility that Kroenecke would establish a rapport with the clients of the business and upon termination take a segment of the clientele with him.” Yet, without discussion of the subject, the Court enforced the covenant against Kroenecke even though (presumably) the business had clients with whom Kroenecke had no contact. C. Guy Carpenter & Co. v. Provenzale , 334 F.3d

459 (5th Cir. 2003). The Fifth Circuit Court of Appeals recently took a

different approach in Guy Carpenter & Co. v. Provenzale, 334 F.3d 459 (5th Cir. 2003). In 1993, Provenzale signed an employment agreement with Sedgwick Payne Co. to serve as “Senior Vice President-Branch Manager.” That agreement contained a one-year covenant not to compete and a non-disclosure covenant. The agreement provided for Provenzale to receive a severance payment if he was terminated without cause, so it appears he was not an at-will employee.

In 1999, in connection with a merger between Sedgwick Payne’s successor and Guy Carpenter & Company, the parties signed an amendment to the employment agreement. Sedgwick paid Provenzale $35,000 to sign the amendment.

Provenzale resigned during 2001 and began working for a competitor. The Fifth Circuit concluded that Carpenter’s promises to pay salary and a bonus were illusory because those promises depended on a period of employment. The Court concluded, however, that Carpenter’s promise to pay severance to Provenzale if it terminated him without good cause and its payment of $35,000 for Provenzale to execute the amendment were non-illusory promises. The Court likewise found non-illusory promises by Provenzale and so concluded that the 1999 amendment met the “otherwise-enforceable -agreement” test.

The Fifth Circuit’s analysis on this point does not differ from that found in the Texas cases, except that the Court treated the covenant not to compete as one of Provenzales’ non-illusory promises.

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Where the Fifth Circuit’s analysis diverged substantially from that of the Texas cases is its analysis of the requirement that the employer’s consideration must give rise to its interest in restraining the employee from competing. Provenzale’s employment agreement provided:

Employee acknowledges that during the course of his employment, whether voluntarily or involuntarily, he will have access to confidential information, proprietary information and/or trade secrets.

Provenzale argued that any promise to provide him with confidential information found in the foregoing clause was illusory because it depended on continued employment. Therefore, Provenzale reasoned, the agreement to exchange trade secrets for Provenzale’s covenant not to compete failed to meet the requirements set out in the Light case.

The Fifth Circuit rejected Provenzale’s argument. The Court said:

We decline to adopt this construction of Light’s “ancillary to or part of” test. [citation omitted.] To hold otherwise would pin the enforceability of non-solicitation agreements on whether an employer discloses confidential information at the time the employee signs an employment contract. This is not what Light, or § 15.50 intends or requires.

The 5th Circuit neither discussed, nor distinguished, any of the cases from the Texas Courts of Appeals that seem to have read the Light case in the exact manner that the Fifth Circuit rejected. Instead, the Fifth Circuit seems to have adopted the view that so long as the employer has made some enforceable promise, the employer need not make an enforceable promise to provide the employee access to confidential information, at least so long as the employee has, in fact, enjoyed access to such information. IV. CRYSTAL BALL ANALYSIS

In 2004, Texas Courts issued a mishmash of opinions regarding covenants not to compete. Austin’s 3rd Court of Appeals held covenants not to compete are valid only in cases where confidential information was given to the employee simultaneously with his signature on the agreement. Providing the information on the heels of signing the agreement, or as soon as possible thereafter, is insufficient. Trilogy Software Inc. v. Callidus Software Inc., 143 SW3d 452 (Tex. Civ. App.- Austin 2004, no writ); Alex Sheshunof Management Services, LP v. Johnson, 124 SW3d 678 (Tex. Civ. App.- Austin 2003, rev. granted).

The 9th Court of Appeals, in Beaumont, has recently held its ok to give the information to the employee at a later date. Wright v. Sports Supply Group, Inc., 137 SW3d 289 (Tex.Civ.App.- Beaumont 2004, no writ).

On September 10, 2004, the Texas Supreme Court granted a writ in Sheshunof. Oral arguments were held on November 10, 2004. As of the date of this drafting, the Texas Supreme Court has not ruled on this matter. A good bet is that the Court will side with the Beaumont Court of Appeals and the 5th Circuit Court of Appeals, finding that the whole idea of giving the information immediately to the employee is not only inconvenient; but rather a silly notion.

V. PRACTICAL PRACTICE TIPS A. Non -Disclosure Clauses

Since non-compete agreements must be predicated on the protection of a legitimate business interest, and since that interest commonly takes the form of confidential information or trade secrets, it is important to include in a non-compete agreement a detailed provision explaining what information of the business is considered to be confidential. Additional provisions regarding non-disclosure of confidential information also should be added. B. Non -Solicitation Clauses

Non-solicitation provisions and customer restrictions may substitute for geographic limitations. Additionally, courts may view a non-solicitation of customers provision as less intrusive to the employee than non-competition provisions because a prohibition against solicitation of certain customers permits the employee to work in his chosen field. An agreement containing post-employment restrictive covenants also should include a prohibition against soliciting the Company’s employees to leave employment with the Company and join the former employee in his or her new venture. Such a provision can help guard against employee raiding. C. Implementation and Enforcement

Drafting appropriate agreements is the first step in the process of enforcing restrictive covenants and confidentiality agreements. It is important, however, for employers to develop an effective and cohesive strategy for implementing and enforcing these agreements.

Employers must consider which of their employees should be required to sign restrictive covenant agreements. It also is important that employers enforce these agreements in a consistent manner. Where employers selectively enforce these agreements or enforce them inconsistently, they may have difficulty establishing to a court that



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comprehensive enforcement of a particular agreement is warranted. D. Steps to Take When Hiring Employees

Post-employment restrictions may have greater utility today than ever before. A company's investment in key employees is no less significant than other business investments. Allowing employees to jump ship and take with them important proprietary information can be costly. Although a company cannot prevent someone from resigning, it can prevent that employee from defecting to a competitor in certain circumstances. Due to various state law restrictions, however, the use of covenants in restraint of trade must be drafted carefully and only after review of the state law requirements of the forum where the agreement will be enforced.

Employers should always inform prospective employees of requirements to enter into a restrictive covenant before or at the time of the offer of employment. Failing to do so will damage employee morale and influence a court against granting injunctive relief when a restrictive covenant is breached. At worst, failing to inform the employee will render the agreement unenforceable.

Employers have two significant trade secret concerns when hiring new employees. First, the employer must consider what actions to take to avoid being the target of unfair competition litigation from the candidate’s former employer. Second, the employer must consider what actions to take to protect its own trade secrets and customer goodwill.

During the interview and recruitment process, care must be taken not to take actions or make inquiries which could trigger an unfair competition lawsuit, or which would otherwise restrict the applicant’s ability to work for the employer.

If the applicant is subject to an employment agreement with post-employment restrictions, the agreement should be assessed for enforceability. Additionally, the hiring of the applicant should be weighed against the possibility of litigation. If hiring the candidate remains desirable, efforts should be made to alter the candidate’s prospective responsibilities so that the employee is performing different tasks or working in a different area than he or she did for the prior employer, to position the company to best defend a lawsuit.

Employers should ask applicants to identify any employment agreements with their prior employers which contain any covenants not to compete or confidentiality provisions and applicants should be told during the interview process not to solicit or recruit any co-workers for employment. Further, the applicant should be encouraged to view the recruitment and interview process with the potential new employer as completely confidential.

Employees generally should not be recruited as a team or group. Nor should a company contact one candidate and induce him to recruit co-employees while he is still employed by the former employer.

In the event the new employer is interviewing more than one applicant from another company, the interview and hiring processes for each applicant should be kept completely separate, offers of employment should be made on an individual basis; and one candidate’s offer should not be made contingent on another’s.

The new employer should advise applicants not to solicit their former employer’s clients until they have resigned their employment and have physically left the premises. Again, reference should be made to any agreement between the applicant and former employer containing restrictive covenants to determine whether there are any enforceable post-termination obligations, such as the ability to solicit clients and vendors.

New hires should not bring any items to their new employer that contain or could be construed to contain the employer’s proprietary, confidential or trade secret information. This includes, but is not limited to, computer disks, Rolodexes, customer lists, manuals, etc., that relate to or are the property of the previous employer.

The applicant should be encouraged to conduct an extensive search for any such materials and should be in a position to warrant to the new employer that he has returned all such materials and is bringing nothing to the new employer which is of a proprietary nature.

It may be useful to consider implementing an acknowledgment form whereby applicants are informed that the company prohibits new hires from bringing with them any property from their prior employer which was not given to them to keep. The acknowledgment should note that your company respects other employer’s trade secrets and confidentiality agreements, and that you expect all applicants and employees to honor all applicable restrictive covenants. The new employer should review any materials the new employee brings to the new job to ensure that the materials do not belong to the previous employer. E. Steps to Take When Employees Leave the

Workplace Once the applicant accepts a job with a new

employer, he should be encouraged to resign immediately from his previous employment in writing. As part of that resignation, the applicant should follow all of his prior employer’s policies and procedures regarding the cessation of the employment relationship, such as the return of any of the prior employer’s property (e.g., disks, Rolodexes, manuals and computers).


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Departing employees should be asked to sign a termination agreement that restates all of the duties the employee is required to adhere to after separation from the company.3

Exit interviews are an opportunity to remind the employee of his or her obligations regarding confidentiality as well as to elicit information about the nature of the employee’s new position. An effective exit interview should normally include an in-house attorney, as well as the employee’s supervisor and/or a human resources representative to serve as a witness.

An effective exit interview requires preparation. For example, the employee may be reluctant to provide information regarding his new position to management. By checking with co-workers, management may be able to identify the new employer. As another example, the employee may have recently been seen copying unusual amounts of information.

The employer should remind the employee of his or her obligations regarding confidentiality information. The interview should include a discussion regarding the types of confidential information the employee had access to during his or her employment; any agreements with the employee regarding confidentiality or competition issues; the employee’s obligation to return any confidential information; the duties of the employee’s new position; the employee’s responsibility not to use confidential information; and the employee’s responsibility to contact the employer if there are any questions regarding confidential information.

The employer should request that the employee sign an acknowledgment that he or she has been provided the above information. Such an acknowledgment can be persuasive evidence that the information was treated as confidential and that the employee was aware of his or her obligations. See Schalk v. State , 823 S.W.2d 633 (Tex. Crim. App. 1991)(affirming employee’s conviction for theft of trade secrets in part based on the employee’s exit interview acknowledgment).

If the new employer is known and if it appears that the new job may involve the use or disclosure of trade secrets, the departing employee and the new employer should be informed of this concern as soon as possible. Even if disclosure of trade secrets or confidential information does not appear to be inevitable, the new employer should be advised in writing that the departing employee worked with confidential information and given a copy of the pertinent employment agreements. Depending upon the law of the state involved, however, employers must be careful in such communications to avoid being the

3 See Appendix B for Exit Acknowledgment form.

target of a claim for tortious interference with the employee’s new position.

VI. JUDICIAL ENFORCEMENT OF

COVENANTS NOT TO COMPETE A. Conflict of Law Principles

Conflict of law principles used in determining contracts are applied in cases involving covenants not to compete. Most states will uphold choice of law provisions provided that there are reasonable contacts with the forum selected.

To determine reasonableness, courts look to the location of the contract’s signing or performance, whether the parties could reasonably have expected to be "hauled into court" in that forum, whether the contract was aggressively negotiated, whether both parties were represented by counsel and whether the choice of law provision is clearly written in plain language.

Regardless of any choice of law provision, the forum state’s rules will govern procedural matters, such as the standards for granting a preliminary injunction. Further, even if a choice of law provision calls for another jurisdiction's law, that law may not necessarily apply substantively at the preliminary injunction stage. For example, in Genalco, Inc. v. Turcotte, No. 33-78-38, 1992 Conn. Super LEXIS 3097 (Conn. Super. Ct. 1992), the Court upheld a choice of law provision in a covenant not to compete agreement, but went on to find that Connecticut law controlled whether a temporary injunction would issue:

Although the agreement provided that it was to be construed according to Massachusetts law, whether the remedy sought should be granted is governed by Connecticut law. This is especially true since normally no appeal can be brought from the issuance of a temporary injunction.

Id.

Finally, certain states with more stringent requirements regarding the enforcement of non-compete agreements, such as California and Georgia, will not apply the law of another state if the other state’s law would represent a violation of its own state’s public policies.

B. Enforcement Options 1. Blue Pencil Rule

Where the restrictions in the covenant not to compete are unenforceable because they are overbroad, courts have used the "modified blue pencil" or "partial enforcement" technique to reform the covenant by making the restrictions more narrow. Under such circumstances, a court will edit a covenant to the point

http://www.TexasBarCLE.com/CLE/PMCasemaker.asp?table=TX_caselaw&volume=823&edition=S.W.2d&page=633&id=101189_01


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where it is reasonable without striking the entire covenant.

Where applicable, the court will cross out unreasonable terms and enforce the remaining provisions, but will not rewrite the terms of the agreement. Courts have held that they may "blue pencil" a covenant when the parties have indicated an intent to make its terms severable. Where courts are faced with an unreasonable clause that does not lend itself to being edited, the court will strike the entire clause rather than fashion a new one. If, however, the clause is drafted so that certain parts of it can be deleted, courts may pare the clause rather than strike it entirely. Still, it is important to remember that the decision of whether to "blue pencil" an agreement at all rests in the sound discretion of the trial court. If the covenant is overbroad in more than one respect, for example, a court may decide not to reform it, even though the court has the power to do so. 2. Arbitration

Courts may apply general contract principles to determine the enforceability of an arbitration provision. Arbitration provisions, however, must be drafted carefully to permit the employer to seek injunctive relief in court to stop a former employee’s breach of a non-compete or other post-employment restriction. 3. Choice of Forum

In the case of a national or regional company, the choice of forum is the first issue to address when deciding whether to file an action. It is likely that the covenant not to compete agreement was drafted and is to be interpreted under the law of the state where the employer’s home office or headquarters is located. Depending on the state’s long-arm statute and the activities and travels of the former employee, an action may usually be brought in the home state even though the employee was working in a remote state.

Depending upon the state selected in the agreement or the state where litigation otherwise may occur, it may be desirable, if possible, to commence the action in federal court. There are two ways to acquire federal jurisdiction in a restrictive covenant case. First, diversity of citizenship will provide a basis for federal jurisdiction, assuming the jurisdictional requirements are met including (1) both sides are from different states and (2) the amount in controversy exceeds $75,000. Second, federal jurisdiction can be invoked where a misappropriation action is pendant to a federal cause of action (i.e., copyright infringement). 4. Injunctions

Injunctions are the most important remedy available for breach of a covenant not to compete. Damages for breach of a covenant not to compete may be difficult, if not impossible, to prove and once a trade

secret is lost, it is lost forever. Moreover, seeking immediate injunctive relief sets the tone for the case by demonstrating to the court and to opposing parties that an employer takes its restrictive covenants seriously. Indeed, failing to seek injunctive relief in a timely manner is inconsistent with a claim of irreparable harm and may doom the chance to later obtain an injunction.

Covenants not to compete are won or lost at the injunction stage. Since such covenants typically expire by their terms before a full trial would be held, the injunction hearing is often the only, and always the most important, "trial." Consequently, counsel should put the same effort into an injunction hearing that the counsel would put into a trial.

In order to succeed in an injunction hearing, an employer must investigate with a focus on two areas. First, investigate the former employee’s activities in the days and weeks before his or her resignation. Second, investigate the new employer. An investigation of the former employee’s activities before departure should include, at a minimum, the following:

1. Examinations of e-mail, computer files and laptop computers;

2. Examinations of files to look for missing materials;

3. Interviews of co-workers; 4. Reviews of recent work assignments; and 5. Interviews of clients or customers (if

appropriate). The investigation of the employee’s activities in the time preceding his departure should focus on identifying any breach of the duty of loyalty. A breach of the duty of loyalty – actions by the former employee harmful to the employer and taken while still on the employer’s payroll – provides the most palpable example of wrongdoing and demonstrates the former employee’s propensity and intent to ignore contractual and common law obligations.

An investigation of the new employer should include obtaining marketing materials on the new employer’s products or services, articles from newspapers and trade publications on the new employer and collecting publicly-available information on the new employer’s products and services. In addition, if the new employer maintains a website, you should obtain virtually every page of information available on the site.

In appropriate cases, an employer may also wish to retain expert witnesses to testify in the injunction hearing. Such expert witnesses might testify on the trade secret itself, an employer’s reasonable efforts to protect its trade secrets or the competitive relationship between the current and former employer. On occasion, such witnesses also testify as to why the length of the restriction is reasonable. If substantial


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business has already been lost, an expert witness can be helpful in valuing that business and in assessing current and future lost profits.

One should also consider the advantages and disadvantages of communicating with the new employer before filing a lawsuit. By communicating with the new employer, the parties may be able to reach an accommodation without resorting to a lawsuit. If the parties are unable to reach an accommodation, the former employer may also obtain additional information that may be helpful in obtaining an injunction. In a few cases, however, the former employer may prefer simply to file suit and avoid providing the new employer with time to prepare for an injunction hearing. C. Potential Causes of Action

The potential causes of action that may be brought in a covenant not to compete case includes:

1. Breach of duty of loyalty 2. Breach of contract 3. Civil conspiracy 4. Violation of the Uniform Trade Secrets Act 5. Conversion 6. Fraud 7. Violations of the Lanham Act (federal

trademark infringement and unfair competition)

8. Misappropriation of trade secrets 9. Unfair trade practices 10. Statutory theft 11. Tortious interference with business relations l2. Unjust enrichment 13. Replevin

D. Damages 1. Attorneys’ Fees

Damages may be difficult to establish in actions alleging breach of a covenant not to compete. Liquidated damages may be appropriate, provided they do not represent a penalty. Nevertheless, liquidated damage provisions may destroy the employer’s ability to obtain an injunction if the liquidated damages purport to be the measure of full relief.

In this regard, an attorneys’ fees provision may be the only way to ensure that an employer is made whole when an employee breaches a covenant not to compete. 2. Other Theories for Recovery

Because of the difficulty of establishing damages for breach of a covenant not to compete, an employer should also allege a violation of an unfair trade practices act whenever available, since such statutes often permit an award of attorneys’ fees and multiple/punitive damages that are not available in breach of contract actions.

An employer may have an additional damage theory available in cases involving a breach of the duty of loyalty. In some states, employees who breach their duty of loyalty must forfeit any compensation earned during the period of disloyalty. Such states recognize an implied contractual obligation that a servant will perform the duties incident to his or her employment honestly, will do nothing injurious to the employer’s interest and if the servant proves radically unfaithful to this trust or is guilty of gross misconduct, he forfeits all right to compensation. Finally, in some states, tort claims for breach of duty of loyalty, tortious interference with contract and unfair competition can give rise to punitive damages. E. Settlement or Trial Many covenant not to compete cases are resolved at the preliminary injunction stage. If, however, the preliminary injunction is not granted, the employer may face a dilemma because taking the case to trial may be longer than the duration of the covenant. If pursued to trial, the testimonial evidence becomes critical. Testimony by the employer’s representatives may cause problems when motives are discussed. For instance, testimony that one of the purposes of the agreement is to keep employees from quitting can damage the company’s case. Such a statement could defeat a preliminary or permanent injunction because a court will consider the agreement an unreasonable restraint on the employee’s opportunity to work and earn a living. As with the preliminary injunction hearing, employers at trial should also consider using expert testimony to demonstrate the protected interest is substantial and to establish the basis for damages. Employers should be particularly prepared to present evidence of the fair treatment of the former employee (and other employees) because former employees invariably cite poor working conditions as a motivation for their departure. Non-compete litigation is often unproductive for both parties, creating substantial litigation costs, disrupting bus iness operations and risking the loss of trade secrets. As with all litigation, the parties should make a realistic assessment of the damages available at trial. In addition to avoiding such expense, settlement may also permit the parties to obtain relie f that would not be available in court. For example, in order to avoid exposure for damages and attorneys’ fees, parties frequently agree to extensions of covenants not to compete, additional or different restrictions that may be more appropriate at the time of the litigation and restrictions on the recruitment of additional employees for a specified period.


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F. Summary Employers can maximize their efforts to protect proprietary information and enforce contractual agreements through statutory and common law actions. To bolster the case, employers should:

1. Put the Company in the best possible light. 2. Communicate with the employee’s new

employer. 3. Inform the employee and new employer what

your view of the facts is and give them the opportunity to refute the facts.

4. Avoid ambiguities. 5. Use private investigator to obtain evidence. 6. Move very quickly; time is of the essence to

protect your property rights. 7. File a lawsuit as soon as possible. 8. Consider seeking immediate relief (TRO)

and consider offering to pay the breaching party’s salary for the period of the injunction.

9. Take discovery with the goal of getting into court immediately.

10. Treat the injunction hearing for what it is: probably the only chance you will ever have to present your case. Take discovery and otherwise prepare for the hearing vigorously.


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APPENDIX A STATES THAT HAVE ADOPTED THE UNIFORM TRADE SECRETS ACT Alabama (Ala. Code §§ 8-27-1 to 8-27-6) Alaska (Alaska Stat. §§ 45.50.910 to 45.50.945) Arizona (Ariz. Rev. Stat. Ann. §§ 44-401 to 44-407) Arkansas (Ark. Code Ann. §§ 4-75-601 to 4-75-607) California (Cal. Civ. Code §§ 3426 to 3426.11) Colorado (Colo. Rev. Stat. Ann. §§ 7-74-101 to 7-74-110) Connecticut (Conn. Gen. Stats. §§ 35-50 to 35-58) Delaware (6 Del. Code Ann. §§ 2001-2009) District of Columbia (D.C. Code Ann. §§ 48-501 to 48-510) Florida (Fla. Stat. Ann. §§ 688.001 to 688.009) Georgia (Ga. Code Ann. §§ 10-1-760 to 10-1-767) Hawaii (Haw. Rev. Stat. §§ 482B-1 to 482B-9) Idaho (Idaho Code §§ 48-801 to 48-807) Illinois (Ill. Comp. Stat. §§ 1065/1 to 1065/9) Indiana (Ind. Code Ann. §§ 24-2-3-1 to 24-2-3-8) Iowa (Iowa Code Ann. §§ 550.1 to 550.8) Kansas (Kan. Stat. Ann. §§ 60-3320 to 60-3330) Kentucky (Ky. Rev. Stat. Ann. §§ 365.880 to 365.900) Louisiana (La. Rev. Stat. Ann. §§ 51:1431 to 51:1439) Maine (Me. Rev. Stat. Ann. tit. 10 §§ 1541 to 1548) Maryland (Md. Code Ann., Commercial Law §§ 11-1201 to 11-1209) Minnesota (Minn. Stat. Ann. §§ 325C.01 to 325C.08) Mississippi (Miss. Code Ann. §§ 72-26-1 to 75-26-19) Missouri (Mo. Rev. Stat. § 417.450) Montana (Montana Code Ann. §§ 30-14-401 to 30-14-409) Nebraska (Neb. Rev. Stat. Ann. §§ 87-501 to 87-507)


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Nevada (Nev. Rev. Stat. Ann. §§ 600A.010 to 600A.100) New Hampshire (N.H. Rev. Stat. Ann. §§ 350-B: 1 to 350-B: 9) New Mexico (N.M. Stat. Ann. §§ 57-3A-1 to 57-3A-7) North Carolina (N.C. Gen. Stat. § 66-152) North Dakota (N.D. Cent. Code §§ 47-25.1-01 to 47-25.1-08) Ohio (Ohio Rev. Code Ann. §§ 1333.61 to 1333.69) Oklahoma (Okla. Stat. tit. 78, §§ 85 to 94) Oregon (Or. Rev. Stat. §§ 646.461 to 646.475) Rhode Island (R.I. Gen. Laws §§ 6-41-1 to 6-41-11) South Carolina (S.C. Code Ann. §§ 39-8-1 to 39-8-11) South Dakota (S.D. Codified Laws §§ 37-29-1 to 37-29-11) TEXAS – NO! Utah (Utah Code Ann. §§ 13-24-1 to 13-24-9) Vermont (Vt. Stat. Ann. tit. 143 §§ 4601 et seq.) Virginia (Va. Code Ann. §§ 59.1-336 to 59.1-343) Washington (Wash. Rev. Code Ann. §§19.108.010 to 19.108.940) West Virginia (W. Va. Code §§ 47-22-1 to 47-22-10) Wisconsin (Wis. Stat. Ann. § 134.90)


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APPENDIX B EXIT ACKNOWLEDGMENT

_________________________

_________________________

_________________________

_________________________

_________________________

Commencement of New Employment: _________________________

_________________________

By signing below, I acknowledge the following:

1. that the undersigned representative of the Employer conducted an exit interview with me and

provided me with a copy of the Agreement that I have with the Employer; 2. the undersigned representative of the employer has answered any questions I have about the

Agreement. I understand that if I have additional questions concerning the Agreement’s terms, I will contact [representative of the Employer];

3. I understand my obligations contained within the Agreement and reaffirm its terms; 4. I have been advised that I cannot disclose to others, or use for my own benefit or the benefit of

others, any proprietary information or trade secrets to which I have had access at the Employer; and 5. I returned to the Employer all company property in my possession, including, but not limited to,

computer disks, notes, notebooks, manuals, drawings, formulas, business plans, financial documents and computer printouts.

___________________________

___________________________

___________________________

Date: ___________________________


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APPENDIX C January 20, 2005

PRIVILEGED & CONFIDENTIAL VIA FACSIMILE ( )AND REGULAR MAIL

Re: Potential Litigation Against__XXX_______ Dear __________:

I am writing in response to your request for legal advice regarding recommended “internal discovery” to conduct in preparation for potential litigation against ___________.

1. Computers (regular/laptop/network/backup system/e-mail system)

- Look for documents that constitute or reflect efforts by Mr. ____________ to establish new business, accept new employment, solicit co-workers and/or to move business to his new employer

- Such documents might show intent to steal secrets and solicit business - They also might show that he was working for the new employer while he was being paid to

work for you - They also might show that he was deferring business until he obtained new employment - Check hard drives - Run Norton Utilities or other disc restoration program to check on files that might have been

“deleted”. (If your MIS people cannot do this quickly and confidentially, let me know and we will arrange to have the computer Federal Expressed to our vendor, who can do this tomorrow.)

- Check on backup systems

2. T&Es

Check on any unusual charges or patterns in past six months 3. Entry

- Check on any entries during unusual hours in past six months (Check key pass system, sign- in book and with guard)

- See if Mr. ______________ signed onto the computer, or used the e-mail during unusual

hours


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4. Photocopying

- Check to see if any high volume copying was done at unusual hours during the past few months

- Check with Mr. ______________’s secretary to see if he recently made any unusual

requests or removed documents

5. Phone records

- Check on the numbers he called and from which he received calls, and the numbers he faxed and from which he received faxes, in the past six months (wireless and hard wire)

6. Affidavits

- We should discuss the possibility of getting statements from those he tried to solicit, including the conversations, e.g., the locations, dates, times and duration of the communications, and what Mr. __________ said, inc

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