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Litigation Over Alleged Improper Competition on the Rise: Steps Companies Can Take to Minimize Their Exposure

December 31, 2000

Court dockets in 2000 suggest that companies are more willing than ever to go to court to enforce their asserted rights to be free from another's competition. Although litigation over alleged improper competition is by no means a new phenomenon, the emergence of the high-tech economy has only intensified competitors' long-held interests in assuring that business rivals do not gain an unfair competitive advantage when employees move from one company to another. In EarthWeb v. Schlack, 2000 U.S. App. LEXIS 11446 (2d Cir. May 18, 2000), for example, a federal appeals court in New York affirmed the denial of an injunction prohibiting an Internet executive from working in the industry, finding that there was no imminent risk that the executive would disclose or make use of trade secrets of his former employer. In Heartland Securities Corp. v. Gerstenblatt, 2000 WL 303274 (S.D.N.Y. Mar. 22, 2000), a securities industry employer unsuccessfully sought to enforce an agreement precluding employment with a competitor for two years following termination. When disputes of this nature arise, courts are called upon to reconcile the tension between an employer's right to protect its legitimate interests and the rights of employees and competitors to fairly engage in their own business activities – a process that is sure to continue into the future.

The reasons for this enhanced appetite to litigate these issues are apparent: first, as the currency of the new economy increasingly becomes information, companies have an ever greater interest in protecting their sensitive information; second, the confidential and proprietary nature of business information is placed at risk when employees who develop, utilize, and maintain it decide to leave one company for another, an increasingly common occurrence with employee mobility at an all-time high. To be sure, when employees walk out the door, valuable information may leave with them, whether or not the information is taken by improper means or for improper purposes. If that happens, a company may feel compelled to mount a legal challenge. Depending upon the particular circumstances and the adversaries' differing perspectives, such a decision may be viewed as a necessary act of self-preservation or an unwarranted means of thwarting lawful competition. Viewed from either side of the equation, however, it makes sense for companies to take steps both to reduce the likelihood of having to go to court to protect or defend their competitive rights and to enhance their prospects of prevailing should litigation become necessary.

In a typical scenario, Company A has an employee with access to certain business information, whether technical, financial, strategic, and/or commercial, which Company A values as secret and proprietary. When that employee decides to depart for Company B, a direct competitor, Company A springs into litigation mode. The resultant lawsuit may allege torts of misappropriation of confidential and proprietary information or trade secrets against both the former employee and Company B, tortious interference with business relations (or business advantage) against Company B, and unfair competition against both defendants. If the employee had previously signed a restrictive covenant prohibiting competition against Company A for a period of time after the employee leaves that company, throw in a breach of contract claim against the employee and a claim of aiding and abetting of that breach against Company B. If, by chance, there is reason to believe that the employee had made preparations on behalf of Company B before leaving Company A, cap it off with a claim for breach of the employee's duty of loyalty owed to Company A and another aiding and abetting claim against Company B. The list of potential causes of action for the same or related conduct is, to say the least, considerable. More significant than the particular characterization of the wrongdoing, however, is the likelihood that such an action will be accompanied by a request for temporary restraining order and a preliminary injunction, to prevent irreparable harm to the company whose competitive advantage allegedly has been jeopardized.

This by-now familiar fact pattern often plays out in an intense legal battle, and the battle lines generally are drawn around the request for injunctive relief. Whether the plaintiff prevails, and the employee is temporarily enjoined from working for a competitor (or is limited in the kind of work he or she can do), or loses, and the injunction is denied, the dispute may be effectively resolved because, in practical terms, the case on the merits may not be worth pursuing to conclusion by the party defeated at the preliminary injunction stage. The losing company will have forfeited either of two important interests: its right during the pendency of a typically lengthy civil litigation either to protect its prized information, or, alternatively, to gain the services of its latest prized recruit.

Companies potentially facing the problems associated both with protecting confidential information from disclosure to a competitor and with defending against accusations of improperly acquiring a competitor's information can take relatively low-cost steps to minimize their exposure and better position themselves in a litigation. These steps include the following:

The sensible use of appropriately tailored employee covenants. Companies should require all employees who have access to sensitive information to execute reasonable covenants protecting the employer's legitimate business interests. Such covenants may cover a variety of interests, including the confidentiality of information, the ownership of inventions, a restriction on the solicitation of customers and/or employees, and a restriction on competition. As a general matter, courts will uphold restrictive employment covenants if they are narrowly tailored to protect legitimate interests, but not if they are punitive or unreasonable.

A confidentiality covenant will, almost invariably, be reasonable, and should provide that all information used or acquired by the employee while employed by the company that is deemed confidential or proprietary must never be disclosed by the employee. Similarly, any employee engaged in a technical or creative capacity can expect to be asked to execute a "work for hire" agreement, entitling the employer to the ownership of all inventions, copyrights, trademarks, and/or trade secrets. Likewise, non-solicitation agreements, if not unduly broad, have been upheld by most courts as adequately protecting an employer's right to ensure that a former employee does not poach customers or employees. Indeed, even employees who lack access to sensitive information may be properly asked to execute a non-solicitation agreement.

The most controversial of restrictive employment covenants is the covenant not to compete. Many courts are skeptical that they can ever be reasonable. Indeed, California has outlawed such restrictions by statute, as against public policy, with only limited exceptions. Most jurisdictions, however, still recognize that non-competition covenants can be enforceable, if narrowly drawn in terms of duration (usually a maximum of one year after the termination of employment), geographic scope, and definition of competing business or entity. Employers who wish to require their employees to enter into agreements not to compete should, with the assistance of counsel, take care that the terms of such agreements are limited to protecting their legitimate interests; while some courts will revise, or "blue pencil," overly broad agreements to ensure that they do not overreach, other courts have held, simply, that unreasonably broad non-competition covenants are wholly unenforceable.

These kinds of employee covenants are important not only because they seek to ensure that the employer's legitimate interests will be upheld in court (should it ever become necessary) but, just as significantly, they have the prophylactic effect of deterring employees from acting contrary to their terms.

Treatment of assertedly confidential and proprietary information in a manner calculated to maintain its secrecy. It is not uncommon in a litigation for a company to assert the confidentiality of certain of its information, only to have it revealed during discovery that it took no precautions to safeguard the secrecy of the material at issue. Such a revelation can effectively defeat a claim for misappropriation of confidential information, even where a former employee is bound by a confidentiality agreement, and even where there is evidence of intent by a competitor to appropriate the information. In short, no proprietary right attaches to information that is not truly confidential, as determined by the substantive nature of the information as well as by the manner in which the possessor treats it. Accordingly, companies intent upon claiming legal protection of information must safeguard that information in the workplace, either by keeping it under lock and key, strictly limiting access to those with a "need to know," password protecting it in computerized databases, or by other similar precautions.

Communication with departing employees who have had access to sensitive information and their new employers regarding the confidential and proprietary nature of certain information. When faced with the inevitable departure of an employee who has had access to sensitive information, an employer should consider sending letters to both the departing employee and the new employer, setting forth the company's rights and the employee's continuing obligations with respect, as applicable, to confidentiality, return of property, ownership of inventions, non-solicitation, and non-competition. Depending on the circumstances, a company might seek written assurances from the company with which the employee is becoming employed that neither that company nor its new employee will violate any contractual or common-law rights of the prior employer; depending on the circumstances (and perhaps in order to defuse potential litigation), the new employer might be willing to provide such assurances.

The inclusion in offer letters to new employees of a request for a representation that they are not bound by any restrictive covenant and an agreement that the employees will indemnify the company against claims made by former employers. Employers who wish to prevent surprise arising from the existence of a prospective employee's restrictive covenant with another company may include in their written offers of employment a request for a representation that the prospective employee is not bound by any such restriction. Employers may further require that their new employees agree to indemnify the company against any such contractual claims. (Of course, where a uniquely valuable individual is involved, it may be the prospective employee who demands such an indemnity.) Even where a prospective employee is restricted by a contractual covenant with a former employer, the new employer can better understand its potential exposure by learning of the existence and particulars of those restrictions – and perhaps ways to resolve them – before entering into the employment relationship.