Nothing Up the Sleeve: Who Has What Rights When There is No Written Covenant Not to Compete?

The increased mobility of the American workforce, combined with growing competitive pressures and the fact that the most valuable assets of many employers walk out the door every evening, has resulted in a significant increase in litigation involving covenants not to compete, trade secrets and the duty of loyalty. Although much of this litigation involves express covenants not to compete or to solicit customers, there are many situations where there is no such covenant. In addition, in some states such as California, by statute or case law these covenants are not enforceable.

In those cases, employees may mistakenly think that there are no constraints on their ability to work for competitors, former employers may not be aware of potential remedies they may have, and employers who are hiring employees from competitors may unknowingly find themselves embroiled in expensive litigation with former employers involving claims of misappropriation of trade secrets and tortious interference with contracts. This article briefly examines what lawyers need to think about in counseling clients when there is no written covenant, from three perspectives: the departing employees, the former employer, and the new or prospective employer.

In addition, the pervasive use of computers in the workplace means that much of the information which is of concern to employers is in electronic form. The Computer Fraud and Abuse Act (CFAA), 18 U.S.C. §§1030, et. seq., is a sweeping Federal statute which prescribes both criminal and civil penalties. Although previously used primarily to deal with computer hacking, the CFAA is increasingly becoming a powerful litigation tool in cases involving mobile employees. For a comprehensive look at this potentially powerful statute in the context of employment litigation, see the paper at www.abanet.org.

Counseling Employees Going to Work for Competitors
At the outset, it is critical for counsel to review any relevant documents from both the old employer (offer letters, employee handbooks, confidentiality and nondisclosure agreements, employment agreements, bonus and stock option agreements, etc.) and the new employer.
Work Product Usually Belongs to the Old Employer. The employee should be cautioned that, as a general principle, the work done by the employee for the former employer belongs to the former employer, and that they should not take anything with them other than their personal belongings. Employees often think that they have the right to take copies, electronic or otherwise, of their work product with them when they leave. Employees also seem to think that they have a right to delete things from the computers they were working on before leaving. Both of these actions can be very detrimental to the employees if legal action should occur.

Duty of Loyalty. Employees owe a duty of loyalty to their current employers. This means that as long as the employee still works for the soon-to-be former employer, business opportunities that appear belong to that employer and cannot be diverted. So too, if the employee made a bid for new work on behalf of his or her prior employer, serious issues can be raised if the employee then also bids for the work at the new employer, because doing so will necessarily result in the employee using their prior knowledge to the detriment of the former employer. While many jurisdictions recognize some limited ability of employees to “prepare to compete” while still employed by someone else, there are significant limitations to this right.

Solicitation of Other Employees. Don’t forget to ask the employee if he intends to try and have someone else leave with him. This can raise additional issues, especially if there are covenants not to solicit employees to leave (breach of contract) or if the employee is aware of noncompetition covenants such other employees may be subject to (tortious interference).

Trade Secrets and Confidential Information. Almost all employees have information that their prior employer will not want to have given to their competitor, including trade secrets, customer information, and financial information. Even if such information does not rise to the level of trade secrets, it may still be protected from disclosure by common law principles and/or it may be covered by some confidentiality agreement the employees signed when they first started work for the old employer. It is therefore important to have the employee detail for you both what he or she did for the old employer and the nature of the work he will be doing for the new employer, the kind of tasks he will be called on to perform and the data he will be analyzing.

If it appears that the employee may be placed in a position by the new employer where he could violate contractual or statutory obligations to his prior employer, then steps need to be taken to avoid that. Such steps might include speaking with the new employer and getting an understanding that the employee will not be put in a conflicting position. In addition, you should counsel the employee regarding what constitutes a trade secret or confidential information, give concrete examples to the employee and explain why it needs to be kept confidential. Whether the departing employee can use customer lists that he remembers, but does not take an actual copy of, may vary by jurisdiction and should be carefully analyzed. Many jurisdictions make no distinction between memorized trade secrets and trade secrets embodied on paper or some electronic media.

Ownership Interests/Fiduciary Duties. There are times when the departing employee has an ownership interest in the prior employer or held fiduciary positions such as being an officer or director, which may give rise to additional loyalty and even noncompete obligations.
For a more detailed checklist of specific issues to consider in counseling employees moving to a competitor, you may view the full paper by Tom Christopher and Arnold Pedowitz starting in July 2005 by visiting the Section Publications page and clicking the "Committee Meeting Papers" link.

Counseling the Former Employer
Ongoing Preventive Measures. Hopefully the client will already have in place an ongoing, comprehensive trade secret and confidential information protection program. Such a program cannot only help to prevent disclosure of confidential and proprietary information, it also positions the former employer to proceed aggressively and with confidence should there be litigation. Such a program would include identification of trade secret information throughout the organization and creation of appropriate documentation to demonstrate both that the employer took reasonable measures to insure confidentiality and that employees were on notice that the information was confidential. Confidentiality provisions should be included in employment and independent contractor agreements, contracts with third-parties such as vendors, suppliers and licensees, and in the employee handbook. A system of internal electronic and physical security controls should be in place, including procedures for screening proposed articles or trade conference presentations. Employers may require their employees to maintain customer contacts and other key information solely in media supplied by the employer to facilitate the return of the information upon the employee’s termination. Employers should also periodically distribute memoranda to remind employees of their obligation to maintain confidentiality.

Handling the Resignation. Although advance notice of an employee’s resignation is helpful in most other circumstances, it can present unique problems when employees are joining a competitor. In most cases the employees should be immediately relieved of any duties that would expose them to company information or customers. This may mean that the company terminates the employment relationship immediately. However, termination by the employer may allow the employees to argue that the equities of the case should shift in their favor. Another option is to keep them on the payroll while serving out the notice – but relieve them of any meaningful job duties. This can buy the employer some additional time to assess the situation and prepare for the appropriate response. Employers might also consider offering the employees severance packages in exchange for contractual nondisclosure provisions.

Prevent Further Access To Company Information. Disable all of the former employees’ passwords and e-mail accounts, in addition to requiring the return of keys or building passcards and notifying security that the individual should not be on the premises. The company should also take immediate steps to secure the return of any company-owned equipment (such as a laptop or PDA) that may contain business information.
Protect The Evidence. Employers should preserve all evidence of the employee’s pre-resignation activities, such as copying or downloading of company information or communicating about the move to a competitor. Electronic evidence plays a prominent role in many unfair-competition cases, so a former employee’s computer is often the best place to start (subject to state-law privacy protections). Note that careless efforts to extract information from a computer can destroy or compromise critical evidence. The well-intentioned manager who logs onto a former employee’s computer to investigate could render evidence useless or irretrievable. Suspend regular document destruction policies which might impact securing evidence. A letter to the employee that he or she should preserve all related information (electronic and otherwise) may be appropriate as the company evaluates its legal options.

Determine What Information The Employees Know. Begin steps to determine exactly what trade secrets or confidential information the employees know from their employment. For example, if the employee attended meetings where company plans or business strategies were discussed, determine if any documentation exists to confirm the employee’s attendance, or if any handouts were provided that might contain sensitive information.

Legal Options: The Inevitable Disclosure Doctrine. Several states have recognized the inevitable disclosure doctrine, under which courts effectively create a constructive noncompetition agreement if the new employment would necessarily require the employee to use protected information of the former employer. See, e.g., Pepsico, Inc. v. Redmond, 54 F.3d 1262, 1270 (7th Cir. 1995). The inevitable disclosure doctrine has been rejected by a number of courts, but the doctrine is still evolving around the country and many courts have not yet considered it.
Common-Law Protection of Confidential Information. The Uniform Trade Secrets Act displaces conflicting law concerning trade secrets, but it explicitly does not affect “other civil remedies that are not based on misappropriation of a trade secret.”

Common-Law Tort of “Unfair Competition”. Some jurisdictions have recognized a common-law tort of “unfair competition.” Although sometimes limited to claims of “passing off” products as those of a competitor, other states extend the tort to a wider range of conduct that may include misappropriation of confidential information (whether a statutory trade secret or not) or other commercial practices.

Employee Fiduciary Duty and Duty of Loyalty. Most states recognize some form of fiduciary duty and/or duty of loyalty attendant to the employment relationship. Basic preparations to leave a job are usually permissible, but courts have placed limits on pre?resignation conduct. Usurping business opportunities or soliciting customers or co?workers to follow the employee to the new company have been held to violate these common-law duties, for example. See generally EMPLOYEE DUTY OF LOYALTY: A STATE-BY-STATE SURVEY (Brian M. Malsberger et al. eds., 2nd ed. 1999 & Supp. 2004).

Trade Regulation Statutes. Many states have adopted the Uniform Deceptive Trade Practices Act, which defines a deceptive trade practice to include disparaging another business by false or misleading representations of fact. Thus, suppose several employees leave Acme Corp. for a competitor and start a campaign of lying to customers about faults in Acme’s products or the certain demise of the company. Even in the absence of a noncompetition agreement, the employees’ conduct could be actionable as a deceptive trade practice.

Consider Other Sources of Obligation. In the absence of a noncompetition or nondisclosure contract, consider other potential sources of similar obligations. For example, does the company have an employee handbook or a code of business ethics that address the use of information after the employment ends? Was there a signed offer letter which contained restrictions? Any bonus or stock option agreements which contained post-employment restrictions? Depending on the circumstances, such provisions could be actionable under state law as a contract or otherwise.
For a more detailed discussion of the specific issues to consider in counseling an employer whose employee is moving to a competitor, go to the paper by Justin Flamm and Cassandra Ferranini at www.abanet.org.

Counseling the New or Prospective Employer
Review the Key Documents. Secure and review any agreements between the employee and his or her current employer, including any type of confidentiality or non-competition restriction in any handbook, operating manual, or procedure manual. Determine what state’s law will likely apply in determining what is a trade secret. Determine the likely validity of any relevant agreements.

Determine What Kinds of Trade Secrets are Likely At Issue. Determine from the client what information is considered confidential in the industry and what information is readily ascertainable or generally known, and to what extent the employee will be dealing with similar or related issues in his or her new position.

Advise the Client to Handle Communications Cautiously. Ensure initial and subsequent pre-employment interviews are conducted carefully. Review all written communications between the employee and the new employer. Caution the new employer concerning the use and content of email and other forms of written communication with the potential new employee. Ensure all discussions with the potential new employee are conducted after regular business hours.

Carefully Consider the Terms Offered the New Employee. Ensure terms of employment offered are not considered as providing an incentive to steal business. Assign the new employee if possible with accounts and territories over and above his or her old accounts and territory.

Old Employer Information. Any information of the former employer of the type considered confidential by the new employer should not be turned over to or requested by the new employer. If it has been, then it should be returned or delivered to counsel. Instruct the new employee not to download, copy or email any documents or files of the former employer before departing (or thereafter) absent express permission, and to confirm that permission in writing if it is granted. Instruct the new employee to purge all information of the former employer from any personal computer after copying to a disk and sending back to the former employer. The new employee likewise should return any documents of the former employer that he/she has retained at home. The new employee should turn in his or her cellular phone upon resignation and not use it to deal with the new employer. In addition, the new employee should be instructed to return all property of the old employer, including laptop computers, hand-held devices, credit cards, cell phones, etc. even if the former employer does not ask for them. Nothing should be deleted from the company computers or hand-held devices before they are returned. Instruct other employees not to discuss information about the former employer with the new employee, or assist him or her in soliciting accounts of the former employer.

Relationships With Old Employer. Ensure the new employee resigns all offices and director or manger positions with the former employer at the time he or she turns in a resignation or gives notice of a resignation. Have this done in writing. Instruct the new employee not to “warehouse deals” before resigning, or advise accounts that he or she is leaving while still employed. Instruct the new employee not to engage in any work for the new employer before resigning.

Communicating With Customers. Counsel should be involved in developing a strategy regarding to what extent and how the new employee will deal with potential new customers consistent with any applicable contractual restrictions. In many cases communications may need to be limited to an announcement of the new position rather than any solicitation of business or sales-type information. Be certain that communications do not run afoul of the Lanham Act and its restrictions on deceptive advertising. The new employee should log all unsolicited contacts by former customers. Remind the new employee and the new employer that the customer may not be the only person who reads them; a judge or jury may also read them.

Solicitation of Former Co-Workers. Instruct the new employee not to solicit employees of the former employer and to refrain from discussing their activities with his or her former co-workers. Any calls to the new employee by former co-workers concerning potential employment should be handled by stating the employee is not at liberty to discuss the topic with them, or simply referring the employee to the HR director.

Documenting Preventive Measures Taken. Have the new employee sign an agreement representing he or she is not a party to any agreements or court orders other than specific ones provided. Send the new employee a memo indicating that the employee is not to use or disclose to the new employer legally protected trade secrets of any third party, should not retain or use any documents of the former employer, and should advise the new employer if any assignment calls for the employee to use trade secrets of the former employer.

CAUTION!: Be cognizant of the fact that discussions and written communications between counsel for the new employer and the incoming employee or his/her counsel will not be privileged.

For a more detailed checklist of specific issues to consider in counseling the new or prospective employer in hiring employees of a competitor, you may view the full paper by Charles Poplstein and Robert Whitman starting in July 2005 by visiting the Section Publications page and clicking the "Committee Meeting Papers" link.

¹ Davis Wright Tremaine, Seattle. Management Co-Chair, Subcommittee on Covenants Not to Compete, Trade Secrets and Duty of Loyalty. This is a brief summary of the papers presented by the Subcommittee at the 2005 Mid-Winter Meeting of the Employment Rights and Responsbilities Committee. Authors of the underlying papers were Tom Christopher, Cassandra Ferrannini, Justin Flamm, Arnold Pedowitz, Charles Poplstein, and Robert Whitman. The full papers will be available online in July by visiting the Section Publications page and clicking the "Committee Meeting Papers" link.