When Is a Customer List a Trade Secret?

When Is a Customer List a Trade Secret?

Imagine if I said to every salesperson in Texas: I don’t care whether you signed a non-compete or not. If you quit your job and try to take your customers with you to a new company, your original employer can sue you in federal court and get an injunction to prevent you from contacting any of your customers.

That would amount to saying every salesperson has a de facto non-compete.

Surely this cannot be true, right? But here’s how you get there:

  1. Almost every salesperson has some kind of list of his own customers, even if it’s just contacts on a smartphone. The salesperson knows the identity of the customers, their contact information, what they buy, and the prices they pay.
  2. A customer list is a trade secret under both the Texas Uniform Trade Secrets Act (TUTSA) and the federal Defend Trade Secrets Act (DTSA).
  3. Under the DTSA, the employer can file a trade secrets claim in federal court.
  4. The court can enter a preliminary injunction barring the salesperson from contacting anyone on the customer list.
  5. If the salesperson can’t contact his customers, the effect is about the same as a reasonable non-compete.

Hey, you had a good run, sales people. But you’re stuck where you work now, unless your employer agrees you can leave.

Wait. Is it really that bad?

Not quite. Because I’ve overstated one step in the analysis above: Step no. 2. A sales person’s customer list can be a trade secret, but it’s not always a trade secret. It depends.

That gives judges an important role. It’s up to them to police the boundary between when a customer list is a trade secret and when it isn’t. If judges set the bar too low for giving trade secret protection to a customer list, the result will be what I said: de facto non-competes for all sales people.

The Austin Court of Appeals made this very point the Trilogy Software case: “[I]nformation that a firm compiles regarding its customers may enjoy trade secret status under Texas law. But this does not mean that trade secret status automatically attaches to any information that a company acquires regarding its customers; if it did, it would amount to a de facto common law non-compete prohibition.”[1]

So, preservation of American free enterprise as we know it depends on courts holding companies to their burden of proof when they claim that customer lists are trade secrets.

To prove the customer list is a trade secret, the company has to show three things:

(1) the customer list has “independent economic value”

(2) it is not “readily ascertainable” by competitors

(3) the employer took “reasonable measures” to keep it secret

It’s usually not that hard to establish element no. 3, reasonable measures. Did the company avoid sharing the information publicly, require employees to sign confidentiality agreements, and maintain password protection on company computers? Those things are typically enough.

What about element no. 1, “independent economic value”? That’s a harder one. But it’s usually going to follow from element no. 2. If the customer list is not readily ascertainable by a competitor, that’s a good sign it has independent economic value. If it was readily ascertainable, it wouldn’t have much value.

One warning: there are still some Texas cases that say a readily ascertainable customer list can be a trade secret. This is a mistake, for reasons I explained in my longest-titled blog post ever, Customer List Confusion: The Pesky Persistence of the Brummerhop Rule in Texas Trade Secret Litigation.

No, a readily ascertainable customer list is not a trade secret. But how readily is “readily”? It is of course a matter of degree. If a competitor could compile the same list from spending a day running Google searches, that’s probably “readily” ascertainable. If it would be extremely difficult to compile the list from public sources, that’s not readily ascertainable. Most cases fall in the middle. It’s going to be a fact-intensive issue.

That means it will often be a fact question for either the jury (at trial) or the judge (at a temporary injunction hearing). In those cases, the jury verdict or judge’s ruling will hold up as long as there is at least a little evidence to support it.

For example, in Amway Corp. v. bHIP Global, Inc., there was testimony that the customer contacts and information the employee provided were his own contacts he had previously developed. This was sufficient evidence to support the jury’s conclusion that the information was not a trade secret.[2]

Conversely, in 360 Mortgage Group, LLC v. Homebridge Financial Services, Inc., No. A-14-CA-00847-SS, 2016 WL 900577, at *4 (W.D. Tex. Mar. 2, 2016), there was sufficient evidence that the customer list was a trade secret. The fact that the employee emailed herself a copy of the broker list was evidence the list was not readily available elsewhere. And the list provided more than simply names and addresses. It also included compensation rates that could be used to “undercut” the employer. (See also The Price Undercutting Theory in Trade Secrets Litigation.)

As these cases illustrate, whether a customer list is a trade secret often presents a fact issue. But in some cases, the undisputed facts will establish as a matter of law that the customer list is not a trade secret.

For example, in Alliantgroup, LP v. Feingold, the court granted summary judgment that a client list was not a trade secret. It was undisputed that the client list was very short (under 15 names), the information was limited, and the names were readily ascertainable.[3]

Parker Barber & Beauty Supply, Inc. v. Wella Corp. was a similar case involving, strangely enough, the barber and beauty supply industry. The court held that “basic customer contact and limited sales information” that the company provided about 39 of its customers was readily ascertainable and therefore not entitled to trade secret protection.[4]

In Numed, Inc. v. McNutt, Numed argued that its pricing structure, marketing research, customer lists, and renewal dates were trade secrets. But the court disagreed: “The evidence reflects much of the information Numed wishes to protect is not secret. Instead, it is contained in the contracts distributed to Numed’s customers, which in turn may be discovered by anyone.”[5] This was a pre-TUTSA case, but the principle should still apply.

Finally, Guy Carpenter & Co. v. Provenzale was a pre-TUTSA case where the federal district court denied the employer’s motion for a preliminary injunction, and the employer appealed. The Fifth Circuit, applying Texas law, noted that a “customer list of readily ascertainable names and addresses will not be protected as a trade secret,” citing numerous cases. The court then said:

. . . the district court implicitly found the customer lists were readily ascertainable. We agree. Evidence in the record indicates participants in the reinsurance market freely disclose the identity of their reinsurance broker and the nature of the reinsurance products they regularly consume. We also note that Provenzale’s list of customers was relatively short—it included only those companies he personally serviced while at Guy Carpenter. He could easily reconstitute this list even without the aid of a trade publication. Even though Guy Carpenter took steps to protect its customer list and Provenzale signed a contract stating the customer list was confidential, we conclude the customer list was not a trade secret because it was readily ascertainable.[6]

So, if the employee offers evidence like this, the court may reject trade-secret status of the customer list as a matter of law.

These cases suggest some good deposition questions to ask if you are the lawyer representing the employee:

  • How long is the employee’s customer list in comparison to the entire customer list for the company?
  • Does the company require all of its customers to keep their transactions with the company secret? If not, how is the identity of the customers a secret?
  • Do customers freely share the identity of companies they buy from?
  • Could the employee easily reconstruct her short customer list? If so, doesn’t that suggest the information is readily ascertainable?
  • Are you saying a competitor would pay real money for this customer list? If not, how can you say it has “independent economic value”?

These can be tough questions for the company. But the company’s lawyer always has the best comeback: if the customer list is readily ascertainable and doesn’t have any economic value, why did the employee take 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.

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] Trilogy Software, Inc. v. Callidus Software, Inc., 143 S.W.3d 452, 463 (Tex. App.—Austin 2004, pet. denied) (emphasis added).

[2] Amway Corp. v. bHIP Global, Inc., No. 4:10-CV-549, 2013 WL 2355083, at *2 (E.D. Tex. May 29, 2013).

[3] Alliantgroup, LP v. Feingold, 803 F.Supp.2d 610, 626 (S.D. Tex. 2011).

[4] Parker Barber & Beauty Supply, Inc. v. Wella Corp., No. 03-04-00623-CV, 2006 WL 2918571, at *17 (Tex. App.—Austin Oct. 11, 2006) (mem. op.).

[5] Numed, Inc. v. McNutt, 724 S.W.2d 432 (Tex. App.—Fort Worth Feb. 5, 1987, no writ).

[6] Guy Carpenter & Co. v. Provenzale, 334 F.3d 459 (5th Cir. 2003).

Key Issues in Departing Employee Litigation

Key Issues in Departing Employee Litigation

On September 19 I gave a one-hour presentation on Key Issues in Departing Employee Litigation to the Houston Bar Association Litigation section. If you couldn’t make it, this is the five-minute version.

Five key issues in five minutes. For each one, I’ll give you a practice tip (or two) and a key case that will help you understand the issue.

Here we go.

No. 1: Preservation of ESI

What’s the first question a lawyer should ask the client in a departing employee case? I say it’s “what company documents did the employee take?” As I explain in this video, the departing employee almost always takes—or keeps—something, even if it’s not for any sinister reason.

This is important to know, whether you represent the original employer, the employee, or the new employer. This fact tends to color all the other issues. A judge is more likely to enforce a non-compete, for example, if there is evidence that the employee downloaded the company’s confidential customer list on the way out the door.

And of course the question is relevant to misappropriation of trade secrets. As a practical matter, the documents taken will determine the strength of any trade secrets claim. I call this Wolfe’s First Law of Trade Secrets: whatever company documents the employee takes will be the alleged “trade secrets” in the subsequent lawsuit.

Practice Tip:

Press the client for details about documents early in the case. This is important for the reasons I’ve already mentioned, but also to meet the duty to preserve relevant electronically stored information (ESI).

You’ve got to press, especially if you represent the employee, because it’s too easy for the employee to say “no, I don’t have anything” without really thinking it through. No, you don’t have a “customer list,” but what about the contacts on your iPhone?

Cases to Read:

In re Methodist Primary Care Group, No. 14-18-00191-CV, 2018 WL 3061321 (Tex. App.—Houston [14th Dist.] 2018) (orig. proceeding). In Weekley Homes, the Texas Supreme Court laid out the procedure for obtaining direct access to another party’s computer or other device in discovery. This case applies the Weekley Homes standard to a departing employee dispute.

First Western Capital Mgmt. Co. v. Malamed, No. 16-cv-1961-WJM-MJW, 2016 WL 8358549 (D. Colo. Sept. 30, 2016). I wrote about this case here. It’s a good lesson on what not to do if you’re the employee in a customer list case. It also illustrates a Catch-22 for the employee: admit the customer list is a trade secret you help the plaintiff prove its case; if you deny the customer list is a trade secret, the judge may see this as evidence you intend to use it.

No. 2: Confidentiality Agreements

Usually the departing employee signed an employment agreement that includes a confidentiality clause or “NDA.” Often the NDA will require the employee to delete or “return” confidential company documents after termination of employment.

But as I explained here, deleting or returning company documents is not always advisable. First, deleting documents could violate the duty to preserve relevant evidence when litigation is reasonably anticipated. Second, the employee might need those documents to prove her own case, especially if there is a dispute about whether the employee is owed compensation. Then there’s the practical problem: how do you “return” electronic files?

Practice Tip: Exercise judgment about deleting or “returning” company documents. On this issue there is no one-size-fits-all solution. You have to think through the issues and make a judgment call. You may decide, for example, to return that portable hard drive the employee used but to have an expert make a forensic copy that you retain in case of litigation.

Case to Read:

Daugherty v. Highland Capital Management, L.P., No. 05-14-01215-CV, 2016 WL 4446158 (Tex. App.—Dallas Aug. 22, 2016, no pet.) (mem. op.). In this case, evidence that the employee took confidential information supported granting a permanent injunction against the employee, despite the jury’s finding of zero damages.

No. 3: Non-Competes

Texas has a lot of case law on non-competes. If you’ve got 30 minutes you can watch my video series Essentials of Texas Non-Compete Litigation.

But if you only have a minute, I can sum up Texas law on non-competes in just seven words. I call it Wolfe’s First Law of Texas Non-Compete Litigation: you can’t take your customers with you.

It’s just a general rule. But most of the time it will hold true.

Practice Tips:

First, evaluate the confidential information issue early. In the typical case where the non-compete is tied to a confidentiality agreement, the issue is whether the employer made the agreement enforceable by following through on its commitment to provide confidential information to the employee. If the employee is going to take the position that he didn’t receive any confidential information, you need to test that position and, if it holds true, prepare the employee to stick to it.

Second, if you represent the employee or his new employer, you need to understand the business plan. Is the employee going to go after new customers he didn’t deal with at his previous company? Then the non-compete probably won’t be a problem. But if the plan is to bring all of the employee’s old customers over to the new company, you may have a problem.

Case to Read:

Republic Services, Inc. v. Rodriguez, No. 14-12-01054-CV, 2014 WL 2936172 (Tex. App.—Houston [14th Dist.] June 26, 2014). This is a good example of a Texas case upholding a non-compete. The court rejected the employee’s argument that the employer never provided confidential information, citing the employee’s testimony that she received training on software, access to the company’s invoices, and information on pricing. The court also rejected the employee’s argument that the non-compete was a prohibited “industry-wide exclusion,” where there was evidence the employee could work in the legal services industry without working for a competitor of the company.

No. 4: Trade Secrets

Big trade secrets cases tend to grab headlines. There was the Waymo v. Uber trial, where Google accused a former employee of stealing its confidential self-driving car technology. There was the recent Zhang case where the FBI arrested a former Apple engineer as he was getting ready to board a plane to China with Apple’s secret technology for . . . you guessed it, self-driving cars.

But the typical trade secrets claim does not involve cutting-edge technology. More often it’s the company’s customer list or pricing information. The company will argue that information about the identity and needs of customers is a trade secret, and that knowledge of the company’s confidential prices would allow a competitor to “undercut” the company and take its customers.

Practice Tip: Understand the client’s industry. Whether customer information or price information is a trade secret is usually a fact-intensive issue that requires understanding how the industry works.

Is it an industry where everyone knows who the target customers are? Are prices widely available in industry publications? Do the prices change daily, weekly, monthly? These are the kinds of facts that will determine whether the information at issue is “not readily ascertainable,” which is the key to trade-secret protection.

Case to Read:

SP Midtown, Ltd. v. Urban Storage, L.P., No. 14-07-00717-CV, 2008 WL 1991747, at *6 (Tex. App.—Houston [14th Dist.] May 8, 2008) (mem. op.). This case illustrates that even the most mundane information can potentially be a trade secret. The court held there was a fact issue on whether the company’s daily rental logs constituted trade secrets where “[t]he information would allow competitors to slightly undercut Space Place’s prices and take its business.”

No. 5: “Fiduciary” Duty

What if the employee didn’t have a non-compete? What if there are no trade secrets? The employer may still have a claim against the employee for breach of fiduciary duty.

The employee doesn’t have a true “fiduciary” duty, because there is a lot the law allows an employee to do that a true fiduciary couldn’t do. Texas law says it is not a breach of the employee’s fiduciary duty for the employee to make plans to compete with the employer and to conceal those plans from the employer. That’s why I call it “Fiduciary Duty Lite.”

But if there’s one thing an employee shouldn’t do, it’s diverting customers to a competitor while still employed by the company, especially if the employee receives compensation for doing so. That would be a breach of the employee’s fiduciary duty.

Practice Tip:

Don’t assume the Texas Pattern Jury Charge question and instruction on fiduciary duty applies to employees.

If you’re the plaintiff, you love the Texas Pattern Jury Charge question and instruction on breach of fiduciary duty. It places such a heavy burden on the defendant. For example, the defendant must prove it “acted in the utmost good faith and exercised the most scrupulous honesty” toward the plaintiff. How can an employee who concealed his plans possibly meet that standard?

He can’t, and that just shows that the Pattern Jury Charge question and instruction on breach of fiduciary duty was not intended for departing employee cases.

Case to Read:

Orbison v. Ma-Tex Rope Co., No. 06-17-00112-CV, 2018 WL 2993012 (Tex. App.—Texarkana June 15, 2018). In this case, the employee started competing with his employer before leaving, resulting in the court ordering the employee to forfeit a portion of the salary earned at the first company and two weeks of his salary from his subsequent employer. The dollar amounts at issue were small, but the principle provides a warning for any employee thinking about diverting customers to a competitor while still employed.

Of course I’ve only scratched the surface of these issues here. Send me an email if you have questions, or to book me for your next one-hour time slot.

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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.

 

Do’s and Don’ts for Departing Employees

Do’s and Don’ts for Departing Employees

Specialization has benefits. A lawyer who repeatedly handles the same type of case will tend to become an expert in that type of case, understanding the nuances, tricks, unanswered questions, and grey areas. See Do I Need a Specialist to Handle My Texas Non-Compete Case?

But becoming an expert on an area of law can have a less obvious downside: the tendency to forget that things that are self-evident to you may not be so obvious to a client.

For example, if you’re a plaintiff’s personal-injury lawyer, it’s pretty obvious that a person who claims he suffered a debilitating injury probably shouldn’t post photos on Facebook showing himself water-skiing at the lake last weekend. But as I discussed here, you still might need to tell the client to avoid posting social media content that could hurt his case.

Let’s apply this to the type of case I often handle. If you’re an employee planning to quit your job and go to work for a competitor, it’s probably a bad idea to lie to your employer about where you’re going. But even an honest employee could make a mistake like this when caught off guard.

This is just one example. There are a lot of things departing employees should and shouldn’t do.

That’s one reason it’s a good idea for a departing employee to consult with her own lawyer ahead of time. Many common mistakes can be avoided by getting some basic advice from an attorney.

But what if your lawyer inadvertently leaves something out? What if the one thing your lawyer forgets to mention on the phone is the one crucial mistake you make on the way out the door?

If only someone could come up with a simple list of do’s and don’ts for departing employees. Some kind of form that could be shared with both lawyers and clients.

Wait a minute. I could do that.

Here it is: Wolfe’s Do’s and Don’ts for Departing Employees. Download it, study it, follow it, critique it. Whatever you want. Just don’t ignore it.

Of course, I need to accompany this with the usual MASSIVE LAWYER DISCLAIMERS:

*This list is for general educational purposes only. Every case is different. If you are the employee, consult with your own lawyer,  Don’t rely on this as legal advice for your particular case.

*Even if you’re a lawyer, keep in mind these are only general tips that apply to most departing employee scenarios. They don’t cover specific substantive legal questions, like Is the Employee’s Non-Compete Enforceable?, Is the Company’s Pricing Information a Trade Secret?, or How Should a Departing Employee “Return” Company Documents? You may need to consult your friendly neighborhood litigation blogger about these issues.

But hopefully these tips will help people avoid some common mistakes. Like posting that water-skiing photo.

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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.