Non-Competes in the Sale of a Texas Business

Non-Competes in the Sale of a Texas Business

If you’re buying a business in Texas and the seller agrees to a non-compete, will it hold up in court? The short answer is yes, but the non-compete should be reasonably limited to the purpose of protecting the goodwill that you are acquiring with the other assets of the business. It’s also a good idea to have the purchase agreement recite that the purchased assets include the goodwill of the business.

To understand why, let’s start with the two requirements in the Texas Covenants Not to Compete Act, affectionately known as TCNCA: (1) a non-compete must be “ancillary to an otherwise enforceable agreement” (whatever that means) and (2) a non-compete must be reasonably limited in time, geographic area, and scope of activity.

How do you make a non-compete “ancillary” to an otherwise enforceable agreement? As I explain in this short video, the most common way is to have a non-compete tied to a confidentiality agreement between an employer and an employee. This is usually sufficient to meet the “ancillary” requirement, as long as the agreement explicitly or implicitly promises to provide confidential information to the employee and the employer actually provides confidential information.

A sale of a business is different. In a typical sale, the buyer acquires the assets of the business, including goodwill. And in this information age, the goodwill is often the most valuable asset of the business.

Trouble is, you can’t just load goodwill on a truck like it’s office furniture or shop tools. Goodwill primarily consists of relationships with customers or clients, and in many cases the customer relationship is with an individual who works for the business, not so much the business itself.

A non-compete is ancillary to the sale of the goodwill because it is necessary to make the transfer effective. See, e.g., Chandler v. Mastercraft Dental Corp. of Texas Inc., 739 S.W.2d 460, 464-65 (Tex. App.–Fort Worth 1987, writ denied) (“the covenant was necessary to protect the business goodwill, the key asset”). Imagine if the seller, after selling the goodwill, could set up a new business the next day and start soliciting the sold business’s customers. Then the buyer would not really get the benefit of the transferred goodwill.

If the law refused to enforce a non-compete in this situation, it would hurt the buyer and the seller. No buyer is going to pay the full value of the goodwill without assurance that the seller cannot immediately start competing for the customers of the business. And then business owners would not be able to cash out the full value of their businesses.

So, if anything, enforcing a non-compete makes more economic sense in the sale of a business than in the employer-employee context. That explains why even California, which generally prohibits non-competes, has an exception for the sale of a business. See Cal. Bus. & Profs. Code § 16600-16602.5.

It also explains why Texas courts have said that “[a] noncompete signed by an owner selling a business is quite different than one signed by an employee.”[1] Texas courts have been more inclined to enforce long, or even limitless, time periods barring competition after a sale of a business.[2] For example, in Oliver v. Rogers, 976 S.W.2d 792, 801 (Tex. App.—Houston [1st Dist.] 1998, pet. denied), the court held that the lack of a time limitation did not render a non-compete unreasonable when it was part of the sale of a business.

But let’s not get carried away. Since 1989, all Texas non-competes are governed by the TCNCA. In addition to the “ancillary” requirement, the statute requires a non-compete to contain “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. & Com. Code § 15.50(a). To the extent that any Texas case—especially a pre-1989 case—suggests that these limitations are not required in the sale of business, it should be taken with a grain of salt.

The non-compete statute does give the buyer of a business one advantage that may not be immediately obvious. In an employment agreement, the burden of proving the reasonableness of the non-compete is usually on the employer. But in the sale of a business, the burden of proof will usually be on the seller to show that the non-compete is unreasonable. See Tex. Bus. & Com. Code § 15.51(b) (placing burden of proof depending on whether the “primary purpose” of the agreement is to obligate the promisor to render “personal services”).

But again, reasonableness is still required. And here’s the slightly counter-intuitive part: if you represent the buyer in the sale of a business, you don’t want to go overboard on drafting a super-broad non-compete. In fact, it will usually be in your client’s interest to tailor the non-compete as narrowly as possible to the legitimate purpose of protecting the goodwill of the business. Anything more is too much.

What does that mean specifically?

First, you should include a reasonable time period. The time period should be no longer than necessary to protect the goodwill. Will the previous owner’s relationships with customers really have significant value four or five years later? Consider whether a two or three year period would be enough.

Second, you should include a geographic area. This will depend on the type of business, but generally a reasonable geographic area will coincide with the area where the company is doing business with its existing customers.

Third, the scope of activity restrained should be limited. This is perhaps the most neglected limitation. Remember, the purpose is to protect the goodwill of the business, which means relationships with existing customers. If the non-compete would bar the seller from competing in any way, for any customers, a judge might consider it an unenforceable “industry-wide exclusion.” The case law prohibiting industry-wide exclusions focuses on the employer-employee context, but the same concept can be applied to the sale of a business.

Ok, the seller of a business might say, but why not draft the non-compete as broadly as possible, and then if there’s a dispute you negotiate down from there?

Good question. Texas non-compete law is quite “pro-reformation,” especially in comparison to some other states. If a non-compete is unreasonably broad, that’s not the end of the story. The statute requires the trial court to reform the agreement to the extent necessary to make it reasonable. So, all is not lost if the buyer’s lawyer drafts the non-compete too broadly.

But there is a cost to be paid for making the non-compete too broad. First, if things go wrong and the seller of the business starts competing for the business’s customers, the new business owner may need to go to court to get a temporary injunction enforcing the non-compete. As a litigator who handles temporary injunction hearings, I can tell you it will be easier to make a case for a temporary injunction if the non-compete is already reasonably limited.

Second, if the non-compete is written too broadly, it effectively means that the buyer will be unable to recover damages for the seller’s breach. See Tex. Bus. & Com. Code §15.51(c). That’s a big bargaining chip to give away by making the non-compete too broad.

So if you represent the buyer, consider making the non-compete as narrow as you can while still protecting the goodwill your client is buying.

That brings up one more tip: the agreement should actually provide for the sale of the goodwill. If the purchase agreement does not expressly identify the goodwill as part of the assets being sold, there is a risk that a judge could say that the non-compete was not ancillary to an otherwise enforceable agreement.[3]

You could argue the sale of the goodwill is implied when all the other assets of the business were sold.[4] But why chance it? Unless there is a good reason not to include the goodwill (maybe a tax reason?), the safer course is to include an express recitation that the goodwill is part of the assets being sold.

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IMG_4571Zach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation at his firm Fleckman & McGlynn, PLLC. Occasionally he writes a boring, useful post. 

These are his opinions, not the opinions of his firm or clients, so don’t cite part of this post against him in an actual case. Every case is different, so don’t rely on this post as legal advice for your case.

[1] Heritage Operating, L.P. v. Rhine Bros., LLC, 02-10-00474-CV, 2012 WL 2344864, at *5 (Tex. App.—Fort Worth June 21, 2012, no pet.) (mem. op.).

[2] Id. (citing cases).

[3] See, e.g., Bandera Drilling Co. v. Sledge Drilling Corp., 293 S.W.3d 867, 872-75 (Tex. App.–Eastland 2009, no pet.).

[4] The Texas Supreme Court has recognized that an agreement, such as an agreement to provide confidential information, can be implied in a non-compete. Mann Frankfort Stein & Lipp Advisors, Inc. v. Fielding, 289 S.W.3d 844 (Tex. 2009).

Can Your Business Avoid a Fraud Claim by Putting Magic Words in the Contract?

Can Your Business Avoid a Fraud Claim by Putting Magic Words in the Contract?

If you run a business and use contracts drafted by a lawyer, there’s a good chance you’ve seen a clause like this:

This Contract contains the complete agreement between Buyer and Seller concerning the sale of the Products and Services and replaces any prior oral or written communications between them. In entering into this Contract, Buyer is not relying on any representation made by Seller that is not stated in this Contract.

The first part is called a “Merger Clause.” The idea is that it “merges” all prior representations, understandings, and agreements into the written Contract. The second part is called a “Disclaimer of Reliance.”

The main point of the Disclaimer of Reliance is to prevent Buyer from making a fraud claim if the deal goes south. The word “fraud” sometimes intimidates non-lawyers, but the basic concept is simple: if you lie to someone in a business deal and they take action in reliance on the lie, that’s fraud.

One special flavor of fraud is “fraudulent inducement.” It sounds legalistic, but the idea is simple: if I lie to you to get you to sign a contract, that’s fraudulent inducement.

When a business deal goes bad, fraudulent inducement is a popular theory, for two reasons. First, if you prove fraudulent inducement you may be able to avoid all the self-serving terms the other guy’s lawyer put in the contract. Second, you may be able to recover actual damages and even punitive damages.

But once upon a time, a smart lawyer figured this out and put the Merger Clause and the Disclaimer of Reliance in the contract he drafted for his client. The hope was that these clauses would prevent the other party from later claiming fraudulent inducement. The idea caught on, and soon his form went viral.

So today, any time a client needs a contract, a lawyer is going to pull up some form that likely includes both a Merger Clause and a Disclaimer of Reliance. For simplicity, let’s focus on the Disclaimer of Reliance.

If a party to the contract tries to claim fraudulent inducement—either to get out of the contract or to try to get damages—the smart litigator representing the other party is going to say, “sorry, Disclaimer of Reliance.”

Not so fast. The equally smart litigator representing the party claiming fraudulent inducement has an ace up her sleeve too. The Disclaimer of Reliance is ineffective, she’s going to argue, because the entire contract—including the Disclaimer of Reliance—was induced by fraud.

Expecto patronum!

Of course, whether the seller actually lied to the buyer to induce him to sign the contract is almost always in dispute. But let’s assume for the sake of argument that the seller made material misrepresentations to the buyer that caused the buyer to sign the contract.

I know, this is Texas. Like Robert Earl Keen says, “nobody steals, nobody cheats.” But just as a hypothetical, what are courts to do with this common situation?

What Rule Should Apply to a Disclaimer of Reliance?

Let’s consider four different rules courts could choose:

A. A Disclaimer of Reliance has no effect on a fraudulent inducement claim.

B. A Disclaimer of Reliance defeats a fraudulent inducement claim.

C. A Disclaimer of Reliance is effective if, when signing the contract, the parties lit incense, struck a ceremonial gong, and recited the Latin phrase caveat emptor in unison.

D. It depends on the circumstances.

I know, choice C sounds silly, but stay with me.

Choices A through C have one clear benefit: they are what lawyers call “bright-line” rules.

Of course, there could always be a factual dispute about whether the incense was actually lit, or a legal dispute about whether the original public understanding of “gong” included a cymbal. But let’s put those quibbles aside. Choices A through C draw clear, bright legal lines that judges can apply with certainty.

But which outcome is more just? The case for Choice A is that “fraud vitiates everything.” The idea is that when one party fraudulently induces the other party to sign the contract, the whole contract is tainted. There is also a certain “realist” case to make for Choice A: the Disclaimer of Reliance is almost always standard “boilerplate” that was not specifically negotiated by the parties. So it should have no effect.

The problem with Choice A is that it tends to encourage more litigation and less certainty. Any party who regrets doing the deal can claim fraudulent inducement, even if the claim has no merit, and it can take months—or years—and thousands of dollars in legal fees to resolve that claim.

That’s why many lawyers—especially transactional lawyers—would pick Choice B: the Disclaimer of Reliance defeats the fraud claim. The rationale for B is that it may mean less justice in a handful of cases where there is real fraud, but overall it’s better for business if companies don’t have to spend time and money litigating fraud claims. Better to stick to what’s in black and white in the contract.

But there’s an obvious counter-argument to Choice B, too. If courts adopt a bright line rule that a Disclaimer of Reliance bars a fraudulent inducement claim, then everybody is going to put a Disclaimer of Reliance in their contracts (as almost everybody already does). Then you have effectively abolished the fraudulent inducement theory.

And what about Choice C, the incense ritual? No one would seriously pick Choice C, and the reason is obvious. Why should the parties’ legal rights depend on whether incense was lit and the gong was struck? Modern judicial decisions should not turn on such ritualistic formalism.

Ok, but isn’t Choice B effectively the same as Choice C? If we say that a business can avoid a fraudulent inducement claim simply by reciting the magic words “disclaimer of reliance” in the contract, is that really any different from the “gong” rule, in principle?

I think this very point—the reluctance to attach too much significance to “magic words”—is why most courts are going to pick Choice D: It depends. Courts recognize that, while a bright-line rule can provide certainty, reality is just too messy to pick one result that should apply in all cases.

That’s a less satisfying answer—especially for non-lawyers—but it’s an answer that allows courts to enforce contract terms generally, while recognizing that justice may require exceptions in some cases.

At least that’s the theory. Let’s look at a case study to see how it applies.

Big Trouble for Big Blue?

Lufkin Industries manufactures machinery and equipment for the energy industry. It needed to upgrade its business operations software, so it called a little company called International Business Machines, which I call “IBM” for short. IBM recommended its “Express Solution for SAP.”

Before the contract was signed, IBM represented to Lufkin that the Express Solution was a preconfigured system that could be implemented within four to six months and meet 80% of Lufkin’s requirements without any enhancements. Oh, and IBM knew this was false (allegedly).

Would you believe the implementation of the software system did not go well? On the day of the “go-live-ugly” (what a great term), Lufkin followed IBM’s instruction to deactivate its old system. But the IBM system didn’t work. Lufkin was unable to use the Express Solution to invoice customers, manage inventory, track orders, calculate payroll, or pay employees and vendors. In short, the system failure crippled Lufkin’s business.

A jury later found that IBM fraudulently induced Lufkin to sign the contract and awarded over $20 million in damages.

But guess what was tucked away in the IBM-Lufkin contract? That’s right, a Disclaimer of Reliance and a Merger Clause. Section 2 of the Statement of Work said:

In entering into this SOW, Lufkin Industries is not relying upon any representation made by or on behalf of IBM that is not specified in the Agreement or this SOW, including, without limitation, the actual or estimated completion date, amount of hours to provide any of the Services, charges to be paid, or the results of any of the Services to be provided under this SOW. This SOW, its Appendices, and the Agreement represent the entire agreement between the parties regarding the subject matter and replace any prior oral or written communications.

These were the facts of IBM v. Lufkin Industries, decided by the Texas Supreme on March 15, 2019.[1]

So what rule did the Texas Supreme Court apply to determine if this clause was effective?

In theory, the court applied a version of Choice D: It depends.

The court started by noting its decision in Italian Cowboy Partners that said a merger clause, standing alone, does not bar a fraudulent inducement claim. But a disclaimer of reliance, in contrast, can be effective: “a clause that clearly and unequivocally expresses the party’s intent to disclaim reliance on the specific misrepresentations at issue can preclude a fraudulent-inducement claim.”

gong-701647_1920
Bang a Gong

On the other hand, “[n]ot every such disclaimer is effective,” and courts “must always examine the contract itself and the totality of the surrounding circumstances when determining if a waiver-of-reliance provision is binding.” In other words, the court must look to both extrinsic and intrinsic facts concerning the contract.

The most important fact is whether the contract was a settlement agreement that resolved a lawsuit or other dispute. Under the Schlumberger case, a disclaimer of reliance in a settlement agreement will usually be effective to bar a later fraud claim. The idea is that there has to be a way for parties to sign an agreement that ends litigation with certainty.

But most business contracts are signed at the beginning of the relationship, before any dispute. In that case, the relevant factors include whether:

(1) the terms of the contract were negotiated, rather than boilerplate, and during negotiations the parties specifically discussed the issue which has become the topic of the subsequent dispute;

(2) the complaining party was represented by counsel;

(3) the parties dealt with each other at “arm’s length”;

(4) the parties were knowledgeable in business matters; and

(5) the release language was clear.

When two businesses negotiate a contract and lawyers are involved, factors (2)-(5) will almost always apply. And in most cases the second part of (1) will be true. It’s hard to see how there could be a genuine fraudulent inducement claim if the issue in dispute was not discussed before the contract was signed.

All of those factors were present in the IBM case. With at most one factor weighing against enforcement, the court said it had “no trouble” concluding that the factors supported a finding that the disclaimer of reliance was effective. “The parties negotiated the Statement of Work at arm’s length,” the court said, “they were both knowledgeable in business matters and represented by counsel, and the two clauses expressly and clearly disclaim reliance.”

The court didn’t say much about the first half of the first factor: whether the merger clause and disclaimer of reliance were negotiated terms or mere boilerplate. I think we can assume the latter. And I think the court’s silence on that factor tells us the court doesn’t care too much about it.

So, despite the IBM opinion’s touchy-feely language about multiple factors and “totality of the surrounding circumstances,” it comes pretty close to this “bright-line” rule: when two businesses represented by lawyers negotiate a contract that contains a clear disclaimer of reliance, there is no fraudulent inducement claim, even if the disclaimer is boilerplate.

I think the “factors” and “circumstances” language is intended to give the court some wiggle room to allow a fraudulent inducement claim in a truly egregious case, e.g. where the party duped into signing the contract is an unsophisticated consumer not represented by a lawyer. But in most business cases, fraudulent inducement is out in Texas.

As long as you said the magic words.

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IMG_4571Zach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation at his firm Fleckman & McGlynn, PLLC. This post is dedicated to 80s supergroup The Power Station. 

These are his opinions, not the opinions of his firm or clients, so don’t cite part of this post against him in an actual case. Every case is different, so don’t rely on this post as legal advice for your case.

[1] Int’l Bus. Machines Corp. v. Lufkin Indus., LLC, No. 17-0666, 2019 WL 1232879, __ S.W.3d __ (Tex. Mar. 15, 2019).

Metroplex Courts Push Back on Broad Application of TCPA

Metroplex Courts Push Back on Broad Application of TCPA

If you just returned from a two-year sabbatical to the Himalayas, you should know the Texas Citizens Participation Act (TCPA) has become kind of a big deal in Texas litigation.

You remember the TCPA, right? It’s the “anti-SLAPP” statute the legislature passed to solve the problem of people filing lawsuits “regardless of whether the claim is valid.” See the Fort Worth Star-Telegram, Your right to share your opinion is threatened by this proposed state law.

The TCPA has taken on a surprising life of its own. This is partly because Texas courts have applied the statute’s broad definitions literally, allowing defendants in cases the legislature never intended to file motions to dismiss that require the plaintiff to prove its case before taking any discovery.

But in a pair of recent opinions, the Dallas-Fort Worth appellate courts have pushed back on broad application of the TCPA, especially to the kind of “departing employee” case I often handle.

First, in Kawcak v. Antero Resources, the Fort Worth Court of Appeals held that the TCPA’s broad definition of “right of association” is not so broad that it includes a conspiracy between a departing employee and a single alleged co-conspirator.[1] After a painstaking textual analysis of the statute’s phrase “common interest,” the court said “[o]ur opinion is long but our holding is narrow: the plain meaning of the word ‘common’ in TCPA section 27.001(2)’s definition of ‘the right of association’ requires more than two tortfeasors conspiring to act tortiously for their own selfish benefit.”

Second, the Dallas Court of Appeals held in Dyer v. Medoc Health Services that the TCPA’s broad definitions of “right of association” and “right of free speech” are not so broad that they encompass communications between a departing employee and an alleged co-conspirator about misappropriating an employer’s proprietary software and confidential information to set up a competing business.[2]

You see a theme here?

These propositions may sound uncontroversial. But other Texas appellate courts have applied the TCPA’s expansive definitions more literally. For example, the Austin Court of Appeals has held that the TCPA applies to allegations that a departing employee disclosed a company’s trade secrets to his new employer, and to a claim for conspiracy to misappropriate trade secrets. The Tyler Court of Appeals and Houston Court of Appeals have made similar rulings. See the cases summarized here.

But in Dyer, the Dallas Court of Appeals was just not having it. The court found that applying the TCPA to an alleged scheme to misappropriate confidential information would be illogical and even absurd:

Because the text messages between Basiti and Dyer were private communications related to an alleged conspiracy between the two men and did not involve public or citizen’s participation, it would be “illogical” to apply the TCPA to those communications.

Further, construing the statute such that appellants would have a “right of association” based solely on Dyer’s and Basiti’s private communications allegedly pertaining to the misappropriation of appellees’ proprietary software and confidential business information is an absurd result that would not further the purpose of the TCPA to curb strategic lawsuits against public participation.[3]

The Fort Worth Court of Appeals reached a similar result, but it was not so quick to blow open the “absurd results” escape hatch. The Kawcak opinion is notable for the lengths Justice Bassel went to justify the holding on textualist grounds—citing no less than four dictionaries and Scalia and Garner’s Reading Law. It shows you just how much cache textualism has acquired among a significant chunk of Texas appellate judges.

There was a more pragmatic era when Texas judges would have brushed aside the defendant’s argument in Kawcak without giving it a second thought. As if to say, “The ‘right of association’ includes a conspiracy between two people? Don’t be silly.”

Don’t get me wrong. Kawcak is not a bad opinion. It is meticulously written and reasoned. But part of me wonders if we really need so much textualist hand-wringing. When interpreting a statute gets down to parsing the order of different definitions in different dictionaries, have we perhaps lost our way?

But these days Texas appellate courts don’t like to say a statute is ambiguous. As the Kawcak court said, “if an undefined term has multiple common meanings, it is not necessarily ambiguous; rather, we will apply the definition most consistent with the context of the statutory scheme.”[4] Rather than calling a statute ambiguous, some judges prefer to explain why one—and only one—side’s interpretation is reasonable.

This isn’t necessarily wrong. But maybe we should cut to the chase and acknowledge the obvious: the definitions in the TCPA have more than one reasonable interpretation. When a text has more than one reasonable interpretation, it’s ambiguous. Or at least vague. When a statute is ambiguous or vague, the courts are free to adopt the reasonable interpretation that makes the most sense.

Of course, you can also look to the purpose of the statute (as the TCPA itself tells courts to do). But the “purpose” of a statute almost always has two sides. In this case, for example, the purpose of the TCPA is to protect constitutional rights and to protect the right to file meritorious lawsuits. So, the purpose is really a wash. The real task, I think, is for the court to pick the interpretation that makes the most public policy sense.

Isn’t that what Kawcak and Dyer are really doing anyway? I’ll save that for my upcoming dissertation, tentatively titled Toward a Legal Realist Critique of TCPA Jurisprudence (The Texas One, Not the Telephone Consumer Protection Act).

The more practical question for litigators who handle departing employee cases is how far Kawcak and Dyer reach. Both cases involved communications about an employer’s confidential information between two individuals. What happens when a departing employee communicates with a group of people about starting or joining a competing venture? (This is not unusual in such cases.) Does that implicate a “common interest” as defined in Kawcak, making the TCPA apply? That’s a harder case.

And would it make a difference if the alleged conduct is not as egregious as it was in Kawcak and Dyer? There is more than a whiff of moral disapproval running through both opinions. One might read the pair of cases as holding that the TCPA does not apply when two or more defendants join together to engage in some kind of wrongdoing.

But that would be going too far. The meanings of “right of free speech” and “right of association” as defined in the TCPA cannot turn on whether the defendants are accused of wrongdoing. The plaintiff is always going to allege that the defendants did something wrongful. This is something the press and the politicians don’t always grasp: there is no quick and easy way to sort out at the beginning of a lawsuit whether the plaintiff is the good guy or the bad guy.

You might even say this is the fundamental problem at the root of the TCPA, from which all its errant branches spread.

It will be up to the Texas Supreme Court to decide which way the branches grow. This recent pair of decisions from the Metroplex sets up a conflict with the cases from the Austin Court of Appeals and other courts that apply the TCPA’s definitions more literally.

If you take another long sabbatical now, we might know the answer by the time you get back. But maybe go somewhere a little warmer this time.

*Reminder: If you love these TCPA issues—and who doesn’t?—then check out the webcast I moderated for UT Law CLE here.

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IMG_4571Zach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation at his firm Fleckman & McGlynn, PLLC. His first law job was in that big building with the green lights. 

These are his opinions, not the opinions of his firm or clients, so don’t cite part of this post against him in an actual case. Every case is different, so don’t rely on this post as legal advice for your case.

[1] Kawcak v. Antero Resources Corp., 02-18-00301-CV, 2019 WL 761480, at *1 (Tex. App.—Fort Worth Feb. 21, 2019, no pet. h.).

[2] Dyer v. Medoc Health Servs., LLC, 05-18-00472-CV, 2019 WL 1090733, at *5-7 (Tex. App.—Dallas Mar. 8, 2019, no pet. h.).

[3] Id. at *5.

[4] Kawcak, 2019 WL 761480 at *9 (quoting Thompson v. Tex. Dep’t Licensing & Regulation, 455 S.W.3d 569, 571 (Tex. 2014)).

I Can’t Drive 25 (Requests for Production)

I Can’t Drive 25 (Requests for Production)

Senior Texas lawyers despair, the last vestiges of the “trial by ambush” era are being swept away like the Imperial Senate.

It looks like changes to the discovery rules are coming to Texas in 2019. Some of the changes will be significant improvements, while others will be less consequential tweaks. But there is one proposed change that is just a bad idea: limiting each side to only 25 requests for production of documents. More about that later.

The Discovery Subcommittee of the Texas Supreme Court Advisory Committee has been working on changes to the discovery rules for a few years now. I wrote about this two years ago in Proposed Changes to Texas Discovery Rules Threaten Law Firm Revenue. As I wrote then, the two biggest changes are requiring Federal-style initial disclosures and making communications with testifying experts undiscoverable.

These changes struck me as basically a good idea, with the potential to reduce gamesmanship and litigation expense. I say “reduce” because you’re never going to eliminate gamesmanship from discovery. This is litigation, after all. Plus, one man’s “gamesmanship” is another man’s proper use of the rules to protect his client’s interests.

In any case, the changes I wrote about—and others—may be coming soon. On February 11, 2019, the Discovery Subcommittee transmitted its recommended rewrite of the Texas discovery rules to the Supreme Court Advisory Committee.

I’ve only got five minutes, so I won’t try to cover all the changes, but here are some highlights:

  • Rule 190.4 would require a Federal-style initial conference followed by a discovery control plan and docket control order. I often find the initial conference a waste of time—it’s too early to address all those issues—but it’s relatively harmless.
  • Rule 192.4(b) would change “the burden or expense of the proposed discovery outweighs its likely benefit” to “the discovery sought is not proportional to the needs of the case.” In other words, the proposal writes proportionality into the rule, although proportionality is already implicit.
  • Rule 193.2(a) targets “prophylactic” objections: “An objection must state whether any responsive materials are being withheld on the basis of the objection.” This sounds like a good rule, but expect it to be routinely ignored.
  • Rule 194 would now require Federal-style initial disclosures. Unless otherwise agreed or ordered, both sides would have to serve them within 30 days after the defendant’s answer. For Texas practice, this completes the decades-long shift in philosophy from “trial by ambush” to putting your cards on the table from the start. Also, like the federal rule, the new rule would allow “a description by category and location” in lieu of actually producing the documents—I’ve never understood the point of this.
  • Rule 195.5(a)(4) would expand the scope of expert disclosures to be closer to Federal Rule 26.
  • Rule 195.5(c) would generally exempt communications with testifying experts from discovery (like the Federal rules–notice a pattern?). Overall, this is a good change for reasons I explained in my “Proposed Changes” post.
  • Rule 199.1(b) would add total hour limits for depositions (50 hours for a typical case).
  • Proposals for addressing ESI and spoliation are still being discussed.
  • Rule 196.1(c) would provide: “Unless otherwise stipulated or ordered by the court, a party may serve on any other party no more than 15 requests for production or for inspection in a Level 1 case or 25 requests for production or for inspection in Level 2 or Level 3 cases, including discrete subparts.” [record scratch]

Wait, what?! You’re telling me in a typical case I only get to serve 25 requests for production?

If you’re not a lawyer, or if you’re a lawyer who doesn’t litigate, that probably doesn’t sound unreasonable. But trust me, 25 requests for production is not a lot.

I’ve been practicing business litigation in Texas for over 20 years. That’s not as long as most of the people on the Supreme Court Advisory Committee, but it’s still a pretty good run. I don’t think I’ve ever had a case of even the slightest complexity where each side served fewer than 25 requests for production.

My fellow litigators understand that you don’t know what you’re going to get when you serve that first broad set of requests for production. And you usually don’t know what the real factual disputes are until you get some substantive documents from the other side and take one or two depositions.

That’s not all. It’s hard enough to get the documents to prove your claim or defense when the other guy is cooperating. When opposing counsel is actively trying to obstruct your efforts to get the documents you need, it’s even harder. For example, I had a fairly simple non-compete case where I had to serve about a dozen sets of requests for production because the opposing party was so slippery.

Surely I’m not alone. I’m a little surprised that the highly experienced litigators on the Supreme Court Advisory Committee would endorse a 25-request limit. I’d be curious to know how many of them have ever had a business lawsuit where 25 requests for production were adequate.

IMG_7223
Take my license, all that jive

Maybe they’ve seen too many cases with an excessive number of requests for production. But there is already an inherent reasonableness limit. Let’s say a party has already served 75 requests for production in three separate sets and then serves a fourth set of 25 more requests. If those requests are unreasonable or duplicative of prior requests, then the responding party can file a motion for protective order asking the judge to limit the number of requests. I don’t think anyone doubts the trial court judge’s discretion to grant a motion like that.

If, on the other hand, those new requests are relevant to issues in the case, reasonably tailored, and not duplicative of prior requests, I say they should be allowed.

But we must reduce the cost of discovery, right?

I’m all for trying to contain the cost of discovery. But it’s not the number of requests for production that is driving up the cost of discovery. In my experience, it’s really two things: (1) emails, and (2) fighting over discovery.

The impact of emails on the cost of litigation is well known. That ship has sailed.

The other factor that makes discovery so expensive is when the lawyers can’t get along. It’s really the discovery battles that drive up the cost. These skirmishes are usually the result of requesting lawyers serving unreasonably broad requests and/or responding lawyers making a litany of unreasonable objections. The problem is then compounded when trial court judges don’t want to get their hands dirty.

These are the main factors that make discovery expensive, not the number of requests for production.

I don’t know how to fix these problems. But I do know that limiting parties to 25 requests for production isn’t going to make lawyers more cooperative, and it isn’t going to change the fact that reviewing and producing thousands of emails is expensive.

If anything, this new speed limit is likely to increase gamesmanship and battles over discovery. If you only get 25 requests, your incentive is to make them broad. That’s going to lead to more objections and more discovery motions. And don’t get me started on arguing about “discrete subparts”; we already know from interrogatories how much time lawyers can waste on that.

Proponents of the limit will point out that you won’t need as many requests for production because the other party has to produce their evidence as part of the new initial disclosures. That’s a fair point, but it doesn’t help me with getting the documents I need to prove my case.

In fairness to the proposal, I also have to point out the preamble: “Unless otherwise stipulated or ordered by the court . . .”

That’s a good safety valve. It leaves the parties free to agree on a greater number of requests for production, and I expect a lot of litigants—especially in complex cases—will avail themselves of that option. And even if the parties don’t agree, the judge can order a greater number of requests if a party offers a good reason.

So the proponents of this revision would say, listen dude (that’s what they call me), you’re overreacting.

But I still don’t think we should start with the presumption that 25 is a reasonable number of requests for production. When the parties can’t agree, some judges are likely to fall back on the number in the rules. So if we’re going to have a number, it should be a good number. Even better, let’s have no presumptive limit and just rely on an inherent limitation of reasonableness.

That was the decision the Texas Supreme Court effectively made when it adopted the “new” discovery rules back in 1999, when I was a new lawyer and Gary Cherone was singing for Van Halen. Those rules limited the number of interrogatories a party could serve but left the number of requests for production open-ended.

The Supreme Court Advisory Committee should do the same thing now. Most of the proposed changes look good. Just take out that 25-request limit.

And May the Force be With You.

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IMG_4571Zach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation at his firm Fleckman & McGlynn, PLLC. He likes both David Lee Roth and Sammy Hagar. 

These are his opinions, not the opinions of his firm or clients, so don’t cite part of this post against him in an actual case. Every case is different, so don’t rely on this post as legal advice for your case.

Legislation Aims to Reign in the TCPA, Protect Non-Compete Suits

Legislation Aims to Reign in the TCPA, Protect Non-Compete Suits

Winston Churchill said democracy is the worst possible form of government, except for all the alternatives. I recall that sentiment any time I think about the Texas legislature. I also think of the words of another wise man, Obi-Wan Kenobi, when he described Mos Eisley spaceport to a young Luke Skywalker.

But sometimes the legislature surprises you and does something halfway sensical.

To wit: on February 28, 2019, Representative Jeff Leach (R-Plano) filed House Bill 2730, which would amend the Texas Citizens Participation Act (“TCPA”). My Fivers already know the TCPA is the hottest thing in Texas litigation right now, and that it could use some amending.

The bill would make these fundamental changes:

  • The TCPA would be limited to suits implicating the constitutional rights to petition, speak freely, or associate, as those rights are applied by state and federal courts—not as those rights were broadly defined in the original TCPA.
  • The TCPA would not apply to suits to enforce non-competes or NDAs.

Notably, the bill does not exempt suits brought under the Texas Uniform Trade Secrets Act (TUTSA) from application of the TCPA.

The bill would also make these less fundamental, but still important, procedural changes:

  • Certain motions—including a motion to compel and a motion for summary judgment—would not trigger the right to file a TCPA motion to dismiss.
  • The TCPA would expressly state that its purpose is procedural (to avoid application in federal court?)
  • At least 14 days’ notice of a hearing on a TCPA motion would be required.
  • The responding party could avoid the TCPA motion—and any award of attorney’s fees—by filing a nonsuit at least three days before the hearing.
  • The statute would not apply to a compulsory counterclaim.

In departing employee litigation, the overall effect would be to shift the balance of power back towards companies who sue to stop their former employees from working for competitors.

More bills have since been filed. Senator Angela Paxton (R-McKinney) introduced SB 2162, which matches HB 2730. Rep. Joe Moody (D-El Paso) has offered a narrower bill, HB 3547, that would exclude trade secret and non-compete claims from the definition of “right of association.” And Rep. Dustin Burrows (R-Lubbock) has offered House Bill 4575, another more limited rewrite, which would exempt DTPA and non-compete claims.

You can find a useful comparison chart of these bills here at Sean Lemoine’s “Anti-Slapp Texas” blog, which is a great source for TCPA developments generally.

How the Sausage Gets Made

No doubt these bills were in response to Five Minute Law’s call for reform in It’s Alive, It’s ALIVE! How to Kill a TCPA Motion in a Trade Secrets Lawsuit. Right?

More likely it was in response to the chorus of Texas appellate judges saying something has to be done to limit the TCPA it to its stated purpose of protecting constitutional rights. Nobody really intended the statute to apply to, for example, an ordinary departing employee lawsuit alleging breach of a non-compete and/or misappropriation of trade secrets.

On the other hand, I doubt much happens in the legislature unless either (1) some powerful donor or interest group is pushing for a change (I was going to say “special” interest group, but that would be somewhat redundant), or (2) some issue has personally irritated a legislator.

Then it hit me. Leach, a Republican representing parts of Collin County, practices complex commercial and civil litigation with Gray Reed. So I’ll bet he has some firsthand experience with TCPA motions.

Plus, as I speculated in Can You “Plead Around” the TCPA?, “[c]ompanies that want to enforce their non-competes and protect their (alleged) trade secrets are going to push back on broad application of the TCPA.” You had to think that business groups were going to get behind some effort to reign in the TCPA.

And right on cue, “Texans for Lawsuit Reform” circulated an 18-page report urging changes to the TCPA. See TLR Comes Out Swinging Against the Texas Anti-SLAPP. From the press I’ve seen, it appears that TLR is backing the more sweeping changes in the bills offered by Leach and Paxton.

Naturally, this has produced a counter-offensive from media interests and free speech groups, resulting in editorials like the Fort Worth Star-Telegram’s Your right to share your opinion is threatened by this proposed state law. The Star-Telegram prefers Moody’s narrower bill, warning that the broader rewrites “would allow anyone to file a lawsuit against a speaker or writer regardless of whether the claim is valid.” (Can you imagine?!)

For more articles, see Media Groups Come Out Swinging Against Changes to the Texas Anti-Slapp.

This is politics, of course, so you don’t always know exactly who is backing what and with what motives. But I can tell you that the opinions you find in the editorials have very little to do with the actual reality of TCPA practice. When practicing litigators who actually handle TCPA motions read the heated rhetoric, we just kind of shake our heads and chuckle.

If I Ran the Zoo . . .

Some have asked me, as a lawyer who handles a lot of departing employee litigation, what I think about the proposed legislative changes. But I’m a guy who thinks Texas should have a state income tax, so that tells you how much currency my opinions hold.

As with so many things in politics, I don’t even know where to begin.

If it were up to me, Texas would encourage more competition by only allowing non-competes in the sale of a business. This would mean less non-compete litigation, thus less billable work for me. On the other hand, employers would just shift to suing former employees for misappropriation of trade secrets—the “de facto” non-compete—so maybe my business wouldn’t dry up.

And if I made the rules, we wouldn’t have special-interest legislation that adopts a different set of rules for one particular type of litigation. So the TCPA (and a lot of other statutes) would have never passed in the first place.

But of course, we are not writing on a blank slate. In politics, as in law, you have to take the world as it is, not as you wish it to be. Considering Texas has a non-compete statute that allows reasonable non-competes and a TCPA that has the stated purpose of protecting constitutional rights, it does make sense to change the TCPA’s broad definitions and to carve non-compete suits out of the statute.

The Preemption Predicament

But does the TCPA apply to non-compete lawsuits in the first place? Section 15.52 of the Texas Covenants Not to Compete Act states that its criteria for enforceability, procedures, and remedies for non-competes are exclusive and preempt other law. Citing this provision, some have argued that the non-compete statute already preempts the TCPA.

Similarly, Section 134A.007 of the Texas Uniform Trade Secrets Act states that it “displaces conflicting tort, restitutionary, and other law of this state providing civil remedies for misappropriation of a trade secret.” Does this mean that TUTSA preempts the TCPA?

Texas appellate courts have yet to rule on these preemption questions.

Ironically, if House Bill 2730 becomes law, it could imply that the non-compete statute never preempted the TCPA. If the non-compete statute already preempted the TCPA, one could argue, there would be no reason for the legislature to add an exemption for non-competes to the TCPA. After all, the law is a seamless web.

And what would passage of the legislation mean, if anything, for trade secrets claims?

As with so much legislation, the proposed changes to the TCPA in House Bill 2730 and the other bills would answer some questions but raise others. Every time the legislature messes with the civil justice system, there are unintended consequences. But this is how we do it.

As Obi-Wan might say, “Who is more foolish? The fool or the fool who follows him?”

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IMG_4571Zach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation at his firm Fleckman & McGlynn, PLLC.

These are his opinions, not the opinions of his firm or clients, so don’t cite part of this post against him in an actual case. Every case is different, so don’t rely on this post as legal advice for your case.

 

The Sunk-Cost-Fallacy Fallacy

The Sunk-Cost-Fallacy Fallacy

Donald Trump made news when he suggested it might be time to pull American troops out of Afghanistan. U.S. military forces have been there about 18 years. That’s an easy number for me to remember because my daughter is 18 years old. She was born in 2001. Then 9-11 happened, and I’m kind of glad she wasn’t old enough to remember it.

Going into Afghanistan seemed like a no-brainer at the time. The Taliban controlled Afghanistan and were harboring Al-Qaeda. It seemed the only people who opposed President George W. Bush’s decision to send U.S. troops into Afghanistan were the kind you can count on to oppose virtually any U.S. military action (far left with a sprinkle of libertarian types). In the wake of the worst attack on American soil in my lifetime, W’s approval rating was high even among Democrats.

Of course, that didn’t last. Opinions on the Iraq war were more divided, and today it seems there is a broad consensus that Iraq was a mistake. Not only that, people are even questioning whether it makes sense to stay in Afghanistan. Eighteen years later the Al-Qaeda threat looks significantly diminished, yet Afghanistan seems like an endless quagmire.

More traditional hawks tend to reject this Afghanistan revisionism. If we leave Afghanistan now, aren’t we admitting that going in to get Bin-Laden and Al-Qaeda was a mistake? After all the dollars spent and American lives lost, how can we just give up?

This, of course, is the Sunk Cost Fallacy. It’s primarily a principle of economics, but it applies in a wide range of scenarios. The idea is that in deciding whether to spend additional money or resources on a project that is in progress, a rational actor should consider whether the future benefits are likely to outweigh the future costs. It is a fallacy to consider costs incurred in the past—the “sunk” costs—because there is nothing you can do to change them.

In other words, it’s a fallacy to continue pursuing a venture that is not going to be profitable on the ground that you’ve already invested time and money in it.

Sound familiar, litigators? If you have any experience with litigation, you have probably experienced the sunk-costs fallacy firsthand. Let’s consider an example from my favorite hypothetical lawsuit, Paula Payne Windows v. Dawn Davis.

The Sunk Cost Fallacy in Litigation

Dawn Davis was the top sales person at Paula Payne Windows, but she became disgruntled when her business development budget was cut and she couldn’t do her annual trip to Vegas with her best customers. So she accepted a job offer from Paula Payne’s fierce competitor, Real Cheap Windows.

Then Paula Payne sued Dawn, claiming breach of contract and misappropriation of trade secrets. But the judge thought the non-compete was too broad and denied Paula Payne’s motion for a temporary injunction.

Six months later, Paula Payne had obtained no relief and spent over $50,000 on legal fees. Documents produced by Real Cheap showed that Dawn had brought several customers to Real Cheap, generating about $100,000 in revenue. Paula Payne’s CFO estimated that Paula Payne would have made about $20,000 in profit on those sales if the customers had stayed with Paula Payne.

“Paula, we’ve got to make a decision,” the company’s lawyer said to the founder and CEO. “Our trial date is only six months away,” he said, “and we need to hire a CPA as a damages expert.” And here’s the kicker: “I know a good one we can use, but he’ll need a deposit of $15,000.”

Paula grimaced. “Ok, and how much are your fees going to be from now through the trial?” she asked. “Hard to say,” her lawyer said, “but you’re looking at paying us at least another $50,000.” “So you may want to think about settling,” he said, “especially considering your damages may be less than $50,000.” He added that Real Cheap’s lawyer already indicated Real Cheap would be willing to do a walk-away settlement.

“No way,” Paula shot back. “What was the point of suing Dawn and Real Cheap and paying you $50,000 if I’m just going to quit now?”

And there it is. The Sunk Cost Fallacy. A rational business person would coldly look at the cost of going forward (around $65,000), the potential benefit (let’s assume a recovery of around $50,000), and the chance of success. Even assuming a better than even chance of success, it looks like the smart move for Paula Payne would be to settle for whatever she can get, or even to walk away.

The Sunk-Cost-Fallacy Fallacy

But of course real people—even sophisticated business people—don’t think like that. It doesn’t feel right to spend $50,000 on a project and then decide to shut it down. It’s easy to understand that emotion.

If want to put it in economic terms, you could say there is a psychological cost to giving up on a venture when you have already invested your time, money, and energy in it. The mental pain that Paula will feel if she quits is real, and in theory you could assign a dollar value to it. Isn’t that similar to what juries do when they consider “mental anguish” damages?

When you take that pain into account, then maybe the economic critique of the Sunk Cost Fallacy is itself a fallacy. The economic problem with the critique is that it doesn’t take all of the relevant costs into account.

Putting aside economics, there’s a more practical problem for Paula Payne’s lawyer. If he approaches the issue from purely an economic standpoint, he’s going to under-appreciate the importance of Paula’s emotions, and he won’t have a happy client. In other words, presenting the issue to Paula as purely dollars and cents doesn’t reflect high “emotional intelligence.”

It turns out there is a second principle at play: the Sunk-Cost-Fallacy Fallacy. It’s a fallacy to think that a client who has sunk costs should make decisions based purely on a rational assessment of the future economic costs and benefits. After all, Paula’s not a robot. In the words of Bob Schneider, she’s only blood and bones.

The First Law of Holes

Let’s assume that Paula Payne’s lawyer gets that. He has high emotional intelligence and is aware of the Sunk-Cost-Fallacy Fallacy. That means he will not be too quick to dismiss Paula’s objection that she has already spent $50,000 on the lawsuit. He will understand that for Paula, simply giving up is not an option, even if walking away makes economic sense. He will “feel her pain.”

dark-excavation-graphic-1601495
I’m fixing a hole, where the rain gets in

So, full speed ahead! Forget the fact that Paula Payne may have to spend over $65,000 on lawyer and expert fees to go to trial on a $40,000 lost profits claim. At least she’ll be able to look herself in the mirror and know she stood up for the rights of her company. Right?

Maybe. But here’s the problem. Chances are, the case is still going to settle. I’ve taken a non-compete case to trial before, but it’s rare. A trial of any kind of case is rare. Nine times out of ten (or more), it’s just a question of when the case settles, and for how much.

Let’s assume that six months in, Paula Payne Windows decides to keep moving forward. Then she spends another $30,000 on legal fees over the next three months. At that point, Real Cheap offers $20,000 to settle the case. Now Paula has an even more difficult decision. Settling is going to be even more painful because now she’s spent over $80,000.

This brings us to a third principle: the First Law of Holes. The First Law of Holes says when you find yourself in a hole, stop digging.

Yes, the pain of walking away after spending a lot of money is real. But that pain is only going to increase after you’ve spent even more money. In our hypothetical, Paula would have been better off—and probably felt better about the outcome—if she had stopped digging at the six-month mark.

So we’ve come full circle. In a sense, the First Law of Holes is just a version of the Sunk Cost Fallacy. But the First Law of Holes brings home the crucial point that sunk costs keep increasing. Better to cut your losses now than later.

That doesn’t necessarily mean the U.S. was wrong to go into Afghanistan, or that Paula Payne made a mistake when she decided to sue Dawn Davis and Real Cheap Windows. She understandably felt she had to do something to protect her company. And it is not to say that business people should never press forward with a lawsuit. Then I would be out of a job.

But whether we’re dealing with litigation, foreign policy, or day-to-day business decisions, we should be self-aware enough to recognize when the Sunk Cost Fallacy is tugging at our heart strings. Even if it’s just human nature, we should resist that pull. And sometimes the right decision will be to stop digging.

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IMG_4571Zach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation at his firm Fleckman & McGlynn, PLLC.

These are his opinions, not the opinions of his firm or clients, so don’t cite part of this post against him in an actual case. Every case is different, so don’t rely on this post as legal advice for your case.

Can You “Plead Around” the TCPA?

Can You “Plead Around” the TCPA?

Does the First Amendment protect the right to burn the American flag? Well, it depends. Consider three scenarios:

  1. A Boy Scout troop burns a worn-out American flag because that is the proper and respectful way to dispose of it. See 4 U.S.C. § 8(k) (“The flag, when it is in such condition that it is no longer a fitting emblem for display, should be destroyed in a dignified way, preferably by burning.”)
  2. A radical burns the flag at a lawful protest while yelling “down with American imperialism” (which tells you the radical is probably old enough to qualify for Medicare).
  3. A teenager lights an American flag in the school gym as a prank, setting off the sprinkler system and fire alarm.

One of these things is not like the other. The first two examples arguably involve some expressive component. Burning the flag is intended to express a certain viewpoint. But in the third example, there is no real communication, just conduct. Thus, the teenager would be hard pressed to argue that his flag-burning was a communication protected by the First Amendment.

But of course, communication is conduct, so we shouldn’t overstate the distinction. The point is that some conduct does not involve communication.

Conduct vs. communication in TCPA litigation

This point is important in other areas of law, too. Like, oh I don’t know, the Texas Citizens Participation Act (TCPA).

Coincidentally, I may be arguing about the TCPA in court today, and I will give a presentation on it tomorrow for the Houston Bar Association.

The conduct vs. communication distinction can be critical in TCPA litigation. How? First, let’s back up and review what we’ve learned before:

  • The TCPA is an “anti-SLAPP” statute that allows a defendant to file a motion to dismiss that requires the plaintiff to offer evidence to support all elements of its claim.
  • The TCPA applies to any lawsuit that is based on a communication about a “matter of public concern,” which can be just about anything.
  • The TCPA is not limited to its stated purpose of protecting constitutional rights; Texas courts have interpreted the TCPA’s definitions broadly to apply to just about any type of lawsuit.

As a result, the TCPA has fundamentally changed Texas litigation, including departing employee litigation, which I often handle. It has also produced some of Five Minute Law’s greatest hits, like A SLAPP in the Face to Texas Trade Secrets Lawsuits, How to Kill a TCPA Motion, and Houston Judge Calls Out Texas Supreme Court’s Simplistic “Textualist” Approach to TCPA.

As the promotional announcement for my presentation says, the TCPA has “swept through the Texas litigation world like a prairie fire.” Now that’s good marketing.

But sooner or later, you know the Empire is going to strike back. Companies that want to enforce their non-competes and protect their (alleged) trade secrets are going to push back on broad application of the TCPA. But what can they do?

One option is to try to “plead around” the TCPA. I touched on this in Much Ado About Nothing? The TCPA broadly applies to claims that are based on communications. So maybe you can avoid the TCPA by alleging conduct, not communication.

Does the TCPA apply to securities litigation?

This approach was successful in a recent case that involved yet another type of lawsuit, Texas Securities Act litigation. I also have some experience with that, having co-authored Claims and Defenses Under the Texas Securities Act, which critics have praised as the longest Texas Securities Act paper they have ever seen. But I digress.

The case was Smith v. Crestview.[1] It involved a failed investment in a scheme to develop a vaginal rejuvenation product derived from human amniotic cells.

This reminds me of the sage advice my grandpappy gave me before he passed: “Put your money into real estate. They can’t make any more of it. Oh, and one more thing. Don’t ever invest in an unproven vaginal rejuvenation product derived from human amniotic cells.”

But seriously, while the product was unusual, the basic fact pattern was all too familiar. The crucial conversation went something like this:[2]

Armstrong: Hi, Mr. Crestview Managing Partner. I’m Mary Armstrong. I’ve got a great investment opportunity for your company.

Crestview: Well, that sounds interesting, but we adhere to a conservative investment strategy, so I’ll need a lot of information.

Armstrong: No problem. I own a startup called NuVivo Bioscience Solutions. We’ve got a novel product derived from human amniotic cells.

Crestview: That sounds like a pretty speculative investment. How do I know we’ll get a good return?

Armstrong: Let me tell you what we’ve already done. We’ve manufactured prototypes. We’ve hired doctors at Stanford to test it. We have a sales force ready to go. Several surgeons have verbally committed to using the product, and we should be ready to sell it in less than 120 days.

Crestview: 120 days? What about FDA approval?

Armstrong: That’s the beauty of it. It’s a human-cellular or tissue-based product, so it’s not subject to federal testing, approval, and labeling regulations.

Crestview: Ok, that sounds good, but what if it doesn’t work?

Armstrong: Oh, I know it works. I had myself injected with the product, and it worked just like we expected.

Crestview: I’m glad to hear that but still, you’re just one person. I don’t think I can risk our partners’ money on something this risky.

Armstrong: Wait, did I mention that Dr. Jesse Smith has agreed to provide the product? We even have his name on our proposed website design.

Crestview: Dr. Smith, the renowned Fort Worth plastic surgeon? Why didn’t you say so?

Crestview then decided to invest and wired $500,000 to Armstrong’s company.

Let’s just pause here for a moment. Those of you who have experience with securities litigation probably know where this is going.

The rest of you will be shocked to learn that:

  • After receiving the half-million-dollar investment, Armstrong stopped communicating with Crestview.
  • Armstrong spent almost half of the 500 grand, mostly on personal expenses, including a trip to Vegas where she met Dr. Smith. [I will omit the joke my wife cracked when I shared this fact from the case.]
  • Armstrong’s company made no sales of the product.

If these allegations are true, then Crestview probably has a pretty good case against Armstrong. But do you think Armstrong is good for a judgment in excess of $500,000? Probably not.

Does aiding and abetting require a communication?

So, Crestview did what investors often do in these cases. It found a deeper pocket, suing Dr. Smith for aiding and abetting Armstrong’s securities fraud.[3]

Dr. Smith’s lawyers apparently read Five Minute Law, because they knew that Texas courts have broadly applied the TCPA. They filed a TCPA motion to dismiss, contending that the Texas Securities Act claim was “designed to chill Dr. Smith’s First Amendment rights of free speech and association.” The trial court denied the motion, and Dr. Smith appealed.

Crestview’s lawyers, no doubt remembering the flag-burning case from their Con Law course, responded with the conduct vs. communications distinction. They argued that the securities claim was based on Smith’s conduct, not his communications, and the Fort Worth Court of Appeals agreed.

The Court of Appeals relied heavily on Crestview’s pleading:

In this case, Crestview specifically and narrowly alleged that Smith’s actions aided Armstrong in her violations of the TSA, not his communications. None of the allegations leveled against Smith referred to communications with Armstrong. Rather, Crestview focused on Smith’s actions and inactions . . .

Aha! So you can plead around the TCPA. Just be sure to allege only conduct, not communication, by the defendant. For example, in a trade secrets case just allege that the former employee used the employer’s trade secrets after going to work for the competitor, rather than pleading that the employee disclosed the trade secrets to the competitor.

Not so fast. The Crestview court was careful to “recognize that artful pleading cannot be a detour around the TCPA.” Still, the court rejected Smith’s argument that the “actual, yet unpleaded” nature of Crestview’s claim was based on communications with Armstrong.

It appears two factors were important to the court. First, while Smith testified at his deposition that he had discussions with Armstrong about the product, “these discussions are not the basis of Crestview’s narrow claim against him.”

Second, the court did not want to open the floodgates: “The practical effect of Smith’s position—any action he took as an aider under the TSA necessarily involved communications—would seem to extend the definition of communication, and thus the reach of the TCPA, to noncommunications.”

So, Crestview teaches us that the TCPA does not apply to a claim for aiding and abetting liability that is not expressly based on communications between the “aider” and the primary actor.

We can build, a beautiful city . . .

The Crestview holding does not strike me as unreasonable. But it’s a little unsatisfying.

The first problem with the Crestview approach is that communication is implicit in just about any conduct someone can get sued for, but the case doesn’t really tell us how to distinguish between a claim that is based on the communication and one that isn’t. Perhaps the test is whether the cause of action could survive without proof of the communication. Or is it whether the communication was a factor that motivated the plaintiff to sue? We don’t know.

The second problem is more practical. The Crestview holding seems to open the door to plaintiffs “pleading around” the TCPA through “artful pleading.”

Imagine that I burn an American flag outside the Houston City Hall to protest the City’s rules against food trucks parking on downtown streets. To retaliate, the City charges me with burning property without a permit and, to try to get around the First Amendment, the City doesn’t say anything about any communication. Would that legal action be based on communication, or conduct?

As much as I like taco trucks, let’s not test it.

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IMG_4571Zach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation at his firm Fleckman & McGlynn, PLLC. The only time he was part of any flag-burning was in Boy Scouts.

These are his opinions, not the opinions of his firm or clients, so don’t cite part of this post against him in an actual case. Every case is different, so don’t rely on this post as legal advice for your case.

[1] Smith v. Crestview NuV LLC, __ S.W.3d __, No. 02-18-00220-CV, 2018 WL 6215763 (Tex. App.—Fort Worth Nov. 29, 2018, no pet. h.).

[2] Obviously I’m making up this dialog and have no knowledge of how the discussion actually went. But this does give you the gist of the facts recited in the court’s opinion.

[3] The Texas Securities Act does not actually use the words “aiding and abetting,” but the traditional phrase just has a nice ring to it.