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Protecting trade secrets, biz goodwill across state lines

According to a recent study, more than half of all employees admit to stealing employers’ confidential data.

Meanwhile, a key employee has just left your company for a competitor. Whether this employee would steal your information or not, at a minimum she knows some of your most important trade secrets. She also controls many significant client relationships.

Your company is based in New England. She left for a job in Louisiana, or worse (from the standpoint of protecting company interests), she lives in California and took a job there.

This scenario has become more common in recent years, as employees have become ever more mobile and are changing jobs with increasing frequency.

It is hard enough to protect your company’s interests when the former employee remains local. So how will you protect your interests when the employee is in a distant state?

 

• Why is cross-border protection a problem?

There is no federal private right of action for a company to protect it trade secrets. Nor is there a federal law protecting a business’s goodwill.

Rather, with the exception of criminal statutes and certain federal causes of action that tread around the edges of these issues, a company is relegated to state law protections, and each state has its own laws. Some provide extensive protections, while others do not.

And while many laws may seem quite similar, they can vary wildly in the details.

 

• What do you need to know?

In order to ensure the greatest possible protections, you first need to understand what laws exist, the ways in which they vary from state to state, and how they relate to one another.

As a general rule, two laws come into play: Those governing trade secrets and those governing employee restrictive covenants (i.e., noncompetition agreements, nonsolicitation agreements, no-raid agreements, nondisclosure agreements and the like).

Trade secrets

As of Jan. 9, all but three states have abandoned their preexisting trade secret laws for some version of the Uniform Trade Secrets Act. (Only Massachusetts, New York and Texas have not.)

That development has helped to provide some uniformity, although significant differences remain both in the aspects of the UTSA adopted and how it is interpreted and applied.

Perhaps most significantly, while some states will prevent a former employee from working for a competitor in a job in which the employee will “inevitably” use or disclose his former employer’s trade secrets (the so-called “inevitable disclosure doctrine”), other states will not.

At a more fundamental level, determining what information actually qualifies as a trade secret is an inherently fact-based analysis.

And, unfortunately, the statute does not lend much assistance, relegating the courts to revert to their pre-UTSA standards for guidance.

Restrictive covenants

While restrictive covenants come in many forms, the “gold standard” for purposes of protecting a company’s trade secrets and goodwill is a covenant not to compete (or “noncompete”). All but three states enforce (in varying degrees) noncompetes entered into as part of an employment relationship.

The three that do not are California, North Dakota and Oklahoma. Even in those states, however, the rules can be more nuanced than they might otherwise appear.

For example, although employee noncompetes have been statutorily void in California since 1872, the federal courts in 1987 developed a “narrow restraint,” essentially permitting the enforcement of noncompetes that restrict employees from only a limited part of the business, trade or profession.

In 2008, however, the California Supreme Court unequivocally condemned that federally created exception, though expressly noting that it was not addressing noncompetes used to protect trade secrets.

Not surprisingly, certain federal court decisions in California have seized on that exception to enforce noncompetes to protect trade secrets, despite the California Court of Appeals’ doubts as to the viability of such an exception.

While the remaining 47 states do not ban employee noncompetes, they do vary in their willingness to enforce them. At the far end of the continuum from California is Florida, where, by statute, noncompete agreements enjoy a presumption of enforceability. Other states fall somewhere in between.

Further, states vary on how they handle overly restrictive agreements. Some states, such as Virginia, invalidate the entire agreement (the “all or nothing” or “red pencil” approach).

States like Arizona engage in a process called “blue penciling,” in which they strike the offending language, enforcing the balance of the restriction if it still makes sense with the offending language omitted.

And, finally, states like Massachusetts “reform” (or rewrite) the agreement to make it reasonable.

The laws, they are a changing

Complicating matters is that the laws are changing. In the past year alone, in addition to myriad lower court decisions issued across the country, the supreme courts of Colorado, Connecticut, Illinois, Montana, Texas and Virginia made significant changes to their trade secret and/or noncompete laws.

Further, Georgia passed a statute (and related constitutional amendment) fundamentally altering its noncompete law, and New Jersey adopted the UTSA.

This, of course, ignores the fact that Idaho, Illinois, Massachusetts, New Hampshire, New York and Virginia are all currently considering statutory changes to their laws.

• So what are you to do?

Your options are set at the moment the employee leaves.

Prior to her departure, if you have not taken affirmative steps to protect the company, you are relegated to existing laws — quite possibly of the jurisdiction in which the employee resides or to which she has moved.

Hopefully, the company will have taken appropriate steps to maintain the confidentiality of its trade secrets, so as to be able to satisfy the basic elements of the law protecting them. As for the goodwill, unless there is something more than the mere departure of the employee (e.g., use of trade secrets to solicit the customers or tortious interference with customer relationships), the customer relationships are in jeopardy.

Restrictive covenants can be a game changer — if they are done properly.

Through the covenants, the company should be better able to prevent the employee from using its trade secrets and from soliciting its customers. Indeed, in many instances, the company will be able to prevent the employee from working for a competitor at all, even in a state like California, which typically will not enforce such restrictions.

Properly drafted forum selection and choice of law clauses will in most instances be helpful. As a general rule, courts typically will not allow someone to “flee” to a state to avoid the chosen forum and application of the selected law. Consistent with that, many courts will not condone the “race to the courthouse” to take advantage of a more sympathetic forum.

However, some states, regardless of the parties’ contract, defer to the state in which the employee is located, as it will be up to that state to ultimately decide whether to enforce an injunction.

For example, in Louisiana, choice of law and forum selection clauses are ignored unless the employee “expressly, knowingly and voluntarily agreed to and ratified” the selection “after the occurrence of the incident” involved.

To address those issues, the agreements should be written to treat employees in noncompete-friendly states differently from employees in noncompete-unfriendly states. For example, while noncompete agreements should usually be narrowly tailored to protect the company’s interests, it is even more important in all-or-nothing/red pencil and blue pencil jurisdictions.

Similarly, some states apply bright-line tests (rather than a rule of reason), such as limiting the geographic scope by county or limiting the scope of restricted activities to those activities in which the employee was engaged for a certain period immediately preceding their departure from the company. Agreements that may be applied in those jurisdictions should be written to accommodate those tests.

For jurisdictions likely to be extremely hostile to noncompetes, consider a mandatory arbitration provision.

Contract formation differences must also be addressed. Some states have procedural requirements for execution of noncompetes (e.g., some require advance notice of the requirement of a noncompete), and some review the sufficiency of consideration (e.g., some states require more than “mere” continuation of employment for at-will employees required to sign noncompetes after commencement of employment).

Accordingly, in some instances, it may even make sense to apply these more strict procedural requirements to all noncompetes, regardless of the jurisdiction in which they are executed.

Separate from the noncompete covenant, companies should use “back-up” protections as well. For example, companies should have their employees sign nondisclosure agreements, nonsolicitation agreements, no-raid agreements, etc.

Companies should also take other steps to limit the damage that could be done by a departing employee when a court is unwilling to enforce the agreed-upon restrictions. Avoid “single-threading” customer relationships through multiple points of contact with important customers so that the departure of one employee does not mean the departure of the customer.

In addition, perform regular trade secret audits and ensure that information is “locked down” and, if possible, that no employee has access to the full details of any mission-critical trade secrets.

Taking these steps may not guarantee the protection of your company’s information and goodwill, but at least it will put you in the best possible position.

Russell Beck is a business and intellectual property litigator and founding partner of Beck, Reed Riden
in Boston. He can be contacted at rbeck@beckreed.com.

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