1997 New York Law Publishing Company
New York Law Journal
November 17, 1997, Monday
SECTION: SUPPLEMENT: CORPORATE COUNSEL; Pg. S2
LENGTH: 3543 words
HEADLINE: Hiring Competitors' Empoyees: A Trade Secrets Perspective; Simple Rules of Thumb Can Be Misleading
BYLINE: BY VICTORIA A. CUNDIFF; Victoria A. Gundiff, a partner in the New York office of Paul, Hastings, Janofsky & Walker LLP, specializes in trade secrets law and departing employee issues.
BODY: MANY EMPLOYERS follow simple rules of thumb when considering hiring an employee of a competitor: If the employee has no non-compete agreement, they can put the employee to work in any capacity, no matter how similar to the former job. If the employee has a non-compete, however, he or she cannot be hired. But as many recent lawsuits have shown, both of these "rules" can be wrong.
Even though Bill Redmond had no non-compete with Pepsico, for example, an Illinois federal court enjoined him for five months from performing particular kinds of work for the Gatorade/Snapple division of Quaker Oats.
Pepsico, Inc. v. Redmond, 54 F3d 1262 (7th Cir. 1995).
Even though Gary Lyon had no non-compete agreement with Merck, a North Carolina federal court enjoined Glaxo from even discussing certain topics with him for up to two years, since he had previously worked on launching Merck's rival over-the-counter Pepcid product. n2
Merck & Co. v. Lyon, 941 F.Supp. 1443 (M.D.N.C. 1996).
And even though Otto Berkes had had no restrictive covenant barring him from working for a competitor on directly competing software, the Second Circuit had little difficulty in affirming a determination that both Berkes and his new employer were liable for misappropriating the trade secrets of his former employer, Vermont Microsystems. The new employer had kept Berkes in a directly competing position despite both warnings from Vermont Microsystems and evidence that Berkes was actually using his ex-employer's secrets. n3
Vermont Microsystems, Inc. v. Autodesk, Inc., 88 F3d 142 (2d Cir. 1996), affirming finding of liability and remanding for recomputation of $ 25.5 million damage award.
As the court said in Pepsico, in certain cases, for the employee to function in the new position without using secrets learned in the old, "he would have to have an uncanny ability to compartmentalize information;" otherwise "he would necessarily be making decisions about [the new company's products] by relying on his knowledge of [the former company's] secrets. n4 Use or disclosure of secrets in such cases is "inevitable."
Pepsico, 54 F3d 1269-70.
By contrast, even though Walter Slijepcevich had a one-year non-compete agreement with Caremark mail order prescriptions, the same court that had entered an injunction barring Redmond's proposed activities refused to enforce the non-compete, saying "the knowledge Slijepcevich gained at Caremark . . . comes 'within the realm of general skills and knowledge which he was free to take and use in later pursuits.'" n5
Slijepcevich v. Caremark, Inc., U.S. Dist. LEXIS 110 (N.D. Ill. Jan. 4, 1996). See also Briskin v. All Season Services, Inc., 206 AD2d 906 (4th Dept. 1994) (refusing to enforce restrictive covenant on basis that "while employee was a knowledgeable and experienced sales representative" he did not know trade secrets); Amroc Investments Inc. v. Sizer (Sup. Ct. N.Y. Co. Nov. 6, 1997 (Cahn, J.) (reducing covenant not to compete from 12 months to two months because broker was privy to very little confidential information).
The conscientious employer wishing to hire a talented workforce without facing litigation -- or worse, discovering down the road that a competitor's secrets have been improperly leaked or used -- thus needs to do more than simply focus on whether the prospective employee has a non-compete agreement. Regardless of the answer to that question, the hiring employer needs to carefully think through what the new employee will actually be called upon to do in the new position, whether those activities will likely place the former employer's secrets at risk, and, if so, whether meaningful precautions to reduce that risk can be sensibly installed. This is not an area where bright lines can, or perhaps even should, exist. It is an area for careful, honest thought before hiring the employee.
Careful thought is not just a nicety; it may be a legal necessity. Under the recently adopted Economic Espionage Act, intentionally acquiring or knowingly receiving another's secrets through an ex-employee could even result in criminal penalties. n6 To avoid liability or reduce penalties under the Act, employers will need to show that they took appropriate steps and established genuine safeguards in advance to reduce the risk that they would receive stolen secrets.
While the legislative history to the Act, 18 USC @@1831-1839, says that "the government cannot prosecute an individual for taking advantage of the general knowledge and skills or experience that he or she comes by during his tenure with a company," Senate Report 104-359, 104th Cong., 2d Sess. (1996), "where the employees stole or without authorization appropriated a trade secret from their employer, they may be prosecuted under @1832, assuming, of course, that the other elements can also be satisfied." Manual for Federal Prosecution of Violations of Intellectual Property Rights, United States Department of Justice, May 1997, p. 81.
Regardless of whether the employee under consideration has a non-compete agreement or not, the employee is not entitled to use or disclose the former employer's trade secrets, and the new employer is not entitled to use the employee as a conduit to gain the benefit of the former employer's secrets.
These principles do not mean, however, that everything an employee learns at a job is a trade secret, or that the only way to protect a secret is to curtail the employee's future employment options, through a restrictive covenant or otherwise. Courts have recognized that "A man's attitudes, his skill, his dexterity, his manual or mental ability . . . ought not to be relinquished by a servant . . . they are his own property; they are himself.
Realism by the new employer, the former employer, and the employee should help strike the appropriate balance in a given case.
Herbert Morris, Ltd. v. Saxelby, 1 A.C. 688, 714 (Mass. 1916), a frequently quoted formulation.
Who and How to Interview
In recruiting new employees, the goal should always be to hire a good employee, not to buy trade secrets n8 or to destroy the competition. Sears, for example, was recently enjoined from soliciting Montgomery Ward's employees, which it otherwise would have been free to do, in light of a Sears internal e-mail urging Sears personnel to "BE PREDATORY ABOUT PEOPLE" and hire Ward's employees to "hasten [Ward's] weakening state." Similarly, in an ongoing California action, Borland has asserted that Microsoft hired its employees not because it needed them -- it allegedly put them on immediate vacation -- but simply to deprive Borland of their services.
See, e.g., E. I. duPont de Nemours & Co. v. American Potash & Chem. Corp., 41 Del. Ch. 533, 200 A.2d 428 (1964) (fact that the only place a California company advertised for technical employees was in Wilmington, Del., the competitor duPont's hometown, held to be evidence of improper effort to obtain duPont's secrets).
Hiring a competitor's employees out of such improper motives rather than to gain good employees may well lead to a finding of "unfair competition," whether or not trade secrets are involved.
Interviews should not turn into intelligence-gathering missions. Companies should routinely advise all applicants at the outset that they are interested in learning about the applicant and seeing whether there is a fit, not in learning anyone's confidential information. Interviewers should be careful not to ask questions designed to elicit trade secrets, and to change the course of the interview if secrets appear to be presented. A candidate who seems too eager to disclose "the inside story" may simply be nervous -- but may be real trouble.
What if the employee has a restrictive covenant or an agreement not to solicit customers or other employees for a period of time? That fact should be determined before extending an offer. At the least, such an agreement signals that the soon-to-be former employer takes departures seriously and may believe that it has legal interests to protect. Sometimes that judgment is wrong. The purported prohibitions may be too long, too sweeping or simply contrary to law. Or, prohibitions that might be enforceable in some contexts may not be appropriate in the specific situation due to various equitable considerations.
Sometimes, however, the restrictions may seem to be appropriately tailored and fully enforceable. This fact may lead to negotiations with the former employer, or to a determination that an offer simply should not be extended.
Since there is no federal law governing restrictive covenants, in determining whether a particular prohibition is likely to be enforced, the new employer should carefully focus on the applicable state law. This is an area where a little learning can be a dangerous thing.
Do not assume that a contractual choice-of-law provision will be honored. And do not automatically assume that the fact that the employee intends to work in a state disfavoring restrictive covenants, such as California, means that a covenant not to compete directed at such an employee will always be unenforceable, n9 or that lesser restraints, such as customer non-solicitation agreements, will not be enforced. n10 Indeed, California courts have even entered at least three temporary restraining orders blocking competitive employment under the "inevitability doctrine" where there was no restrictive covenant. Trade secrets need to be protected regardless of what law applies.
See, e.g., Shipley Company v. Kozlowski, 926 F.Supp. 28, 40 (D. Mass. 1996) (following choice-of-law provision and enforcing a non-compete agreement against an employee working in California).
See, e.g., Morlife, Inc. v. Perry, 56 Cal. App. 4th 1514 (1997) (affirming grant of injunction and award of damages for solicitation of customers in breach of confidentiality agreement).
Issues to Consider
If there is no restrictive covenant, and especially if there is, do not ignore the practical reality that too close an overlap in jobs may pose an unlawful risk to the former employer's trade secrets. Here are some factors to consider:
* What has the employee been doing? Without learning the specific details of the work the employee has been doing, the new employer should begin considering whether some potential activities will have to be off limits, or even whether there is an irreconcilable conflict between what the employee has been doing and what he or she will be asked to do in the new position. As Bill Redmond learned, working on a focused "attack plan" to defeat a particular competitor in particular markets can make it impossible, for some time, to fairly lead a competitor's efforts to repel that very plan. Is the employee currently at work on any active bids? While the "inevitability doctrine" has not been read to impose customer non-solicitation obligations on employees, n11 it may lead a court to conclude that an employee who was immersed in a specific bidding process should not be permitted to work on that same bid for a competitor. n12
Cf. Abalene Extermination Co. of New Jersey, Inc. v. Elges, 137 N.J. Eq. 1 (1945) ("In the absence of a restrictive covenant, and when no fraud is practiced, a former employee will not be enjoined from soliciting the customers of his former employer.").
See, e.g., American Totalisator Co. v. Autotote Ltd., No. 7268, 1983 WL 21374 (Del. Ch. 1983); Air Products & Chemicals, Inc. v. Johnson, 296 Pa. Super. 405, 442 A.2d 1114 (1982); and Emery Industries, Inc. v. Cottier, 202 U.S.P.Q. 829 (S.D. Ohio 1978) (granting inevitability doctrine injunctions in part based on employee's immersion in ongoing bids).
* What is the nature of the business? Is it heavily based on technology or science? Are competitors able to react quickly to one another's plans? Is the market in a highly competitive phase? Is the industry highly price-sensitive? Is it an industry where being "first to market" is critical? All of these factors may make a competitive hire more risky.
* Are the companies truly competitive? While Microsoft and a niche applications software development company both make software, there may not in fact be substantial, or even any, overlap in the software the two companies are creating. There may thus be very little risk that trade secrets will be lost in a move. This fact may not necessarily invalidate a restrictive covenant, but it can be an important equitable factor. It should certainly reduce the risk that an inevitability injunction will be granted.
How competitive are the two companies? A move from No-Name Rental Co. to Hertz may be less risky than a move from Hertz to Avis n13 (although if No-Name has just made a major breakthrough it could indeed be at risk). Similarly, a high-tech employee's move to a company that has little ability to invest in new technology may not pose an imminent risk, n14 at least to technology-related secrets.
See, e.g., Lumex, Inc. v. Highsmith, 919 F. Supp. 624, 628 (EDNY 1996) (enforcing restrictive covenant).
See, e.g., Standard Brands, Inc. v. Zumpe, 264 F.Supp. 254 (E.D. La. 1967).
* Does the employee have high-level or in-depth knowledge of the ex-employer's secrets? An employee who simply saw the same generalized information available to virtually everyone else at the company will be less likely to pose an inherent risk of use or disclosure than the employee who actually drove the research process or signed off on the strategic plan.
* Has the former employer been able to achieve results the new employer has sought in vain for substantial time to achieve? If so, think two or three or four times before assigning the employee to work in that precise area to achieve identical results. n15
See, e.g., National Starch & Chem. Corp. v. Parker Chem. Corp., 530 A.2d 31, 219 N.J. Super 158 (App. Div. 1987); Air Products; Allis-Chalmers Mfg. Co. v. Continental Aviation & Eng. Corp., 255 F.Supp. 645 (E.D. Mich. 1966). See also Continental Group, Inc. v. Kinsley, 422 F.Supp. 838 (D. Conn. 1976) (enforcing restrictive covenant); Vermont Microsystems.
* What precautions did the former employer use to protect secrets? While inquiry into this factor should not be used as a way of unmasking a competitor's operations, if the competitor routinely circulated its circuit diagrams to third parties without restriction, for example, there is less risk that the competitor has circuit diagram secrets to protect.
* How much discretion will the employee have in the new position? An employee who is truly being hired simply to implement a pre-existing plan that cannot be readily changed may be unable to do much damage. n16 An employee who is actually going to be developing a competitor's strategic or product plan may be far more dangerous. n17
Campbell Soup Company v. Giles, 47 F3d 467 (1st Cir. 1995) (no "inevitability injunction for mid-level employee hired to carry out existing plan in which there was only minimal room for competitive maneuvering").
Cf. Pepsico ("The evidence did not show that Redmond would simply be implementing a business plan already in place."). See also Emery Industries.
In looking at this factor, be honest. Had Redmond and his new employer focused early on the fact that despite the widespread internal discussions of possible strategic plans, none had yet been finalized and Redmond himself would have major decision-making authority in directing and shaping the plan, they might have made more effective efforts to structure his job -- and have avoided the finding that in describing his job Redmond had engaged in "out and out lies."
* Will the employee be working with other former employees from the same company? There may be danger in numbers. That was the theory underlying Dow Chemical's complaint earlier this year that in hiring 14 members of a Dow team of scientists in a specialized area of plastics, G.E. was effectively acquiring Dow's trade secrets. When hiring a number of people from the same company, it may make sense to separate them so that their shared memory does not lead to misuse of secrets.
Will the employee be given a substantial increase in pay to assume the new position? Make sure this is not a "trade secrets premium." There may be perfectly legitimate reasons for such an increase, but make sure the employee is not in the position of testifying, "Loyalty and ethics had their price; insofar as [I am] concerned, [the new employer] was paying the price." n18 Similarly, consider whether a stock option or bonus program is likely to put an undue influence on the employee to use or disclose the former employer's secrets. It may make sense to include a provision in the option or bonus program rules that use or disclosure of another's secrets is grounds for forfeiture of benefits.
B. F. Goodrich v. Wohlgemuth, 117 Ohio App. 493 (1963).
None of these factors is dispositive. Some may be more, or less, important in a particular case. But all can be helpful in sizing up what work the prospective employee can safely do without putting the new employer at risk of improperly gaining trade secrets.
Armed with an intelligent assessment of the risks, the new employer can install and document appropriate safeguards. Certainly there should be a written caution not to disclose -- or use -- trade secrets. The "use" point is critical and often ignored. An employee can just as surely jeopardize an ex-employer's secrets by using them to guide work on formulations or strategies as by disclosing them outright.
But where there is a serious risk of gaining trade secrets, a careful employer should do much more. Some activities may need to be put off limits. If the employee is to have no role in particular bids, or particular R & D projects, or particular strategic planning efforts, spell that out in writing. This will guide the employee, protect the new employer and perhaps assuage the former employer's concerns.
Be careful not to give prudent instructions but ignore reality. One of the reasons Autodesk was found liable to Vermont Microsystems for trade secrets misappropriation is that it shut its eyes to evidence of misappropriation "because of market pressures." It "chose a policy of delay rather than a complete and unbiased investigation of VMI's claims." n19
1994 U.S. Dist. LEXIS 1873.
Counsel the new employee in writing to bring nothing from the former employer (other than personal employment records) whether in hard copy or computer form and to return any materials later discovered. This caution does not mean that all documents of a former employer are in fact confidential, or that transporting documents is necessarily misappropriating trade secrets. n20 But the surest way to avoid problems is to direct that nothing be brought from the former employer.
See, e.g., Innovative Networks, Inc. v. Young, 1997 U.S. Dist. LEXIS 14355 -37 (SDNY Sept. 17, 1997). But see, e.g., Morlife, supra.
It should go without saying that a new employer that instructs its new hire to remove documents from the former employer is courting trouble. Employers should also make sure that new hires do not start soliciting or transferring business before leaving their prior company. That is almost always unfair competition. n21
See, e.g., IDS Life Insurance Company v. Sun America, Inc., 958 F.Supp. 1258 (N.D. Ill. 1997).
Finally, the hiring company should counsel the employee not to lie to the former employer about his or her intentions. A court is not likely to conclude that an ex-employer's secrets are safe in the head of an employee who has not been scrupulously honest. However, the hiring employer should also be aware that even where the employee is unquestionably honest, the former employer's secrets may nonetheless be at substantial and inevitable risk if adequate precautions are not installed, or cannot be. n22
The employee's honesty was specifically commentated upon in, e.g., Lumex, National Starch, and Emery Industries; nonetheless, the courts granted injunctions.
If the former employer writes to protest the hiring, take those concerns seriously. The former employer may be overreaching or ill-advised. The new job may pose no genuine threat to legitimate interests. Not every restrictive covenant is enforceable. And while the "inevitability" doctrine has led to some uncertainty and more debate, it has not become the "conceivability" doctrine.
But neither is the "inevitability" doctrine the "unthinkable" doctrine. A former employer may in fact have serious and legitimate concerns that can be protected only by limiting an employee's activities, through a restrictive covenant or otherwise, to prevent the likely use of another company's secrets. Time well spent in assessing these concerns before hiring should prevent serious trouble later.
GRAPHIC: Illustration, no caption, ILLUSTRATION BY JOHN MCDONALD
LOAD-DATE: December 3, 1997
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