Does “Misappropriation” of Trade Secrets Require “Use” or “Disclosure”?

Does “Misappropriation” of Trade Secrets Require “Use” or “Disclosure”?

If a windmill kills a bird in the forest, and there is no one there to hear it, does it make a sound?

That has always struck my literal mind as a silly question. Of course it makes a sound. It doesn’t make a difference whether someone is there to hear it or not.

But obviously there is more to it than that. There are more philosophical points embedded in the question. Is our reality determined by our experience of reality? Does it matter whether something happens, if no one experiences it?

The same kind of point comes up in trade secrets litigation. I see it a lot. (But disclaimer: my hypothetical is not based on any particular case; if it seems similar to your case, that’s just because the same kind of thing tends to happen in a lot of cases.)

Let’s say our favorite hardworking sales person, Dawn Davis, gets frustrated with her employer, Paula Payne Windows, and decides to quit to join a competitor, Real Cheap Windows.

During her last week on the job, Dawn logs into the Paula Payne computer system using her password and opens six months of sales reports. She downloads them to her personal laptop (which she uses for work), or transfers them to a USB drive, or emails them to her personal Gmail account. This kind of thing happens a lot.

Dawn goes to work for Real Cheap the next week. When Paula Payne finds out that Dawn joined a competitor, she has Fred, her “IT guy,” investigate. Fred discovers that Dawn downloaded the sales reports. Paula Payne Windows sues Dawn and Real Cheap, claiming misappropriation of trade secrets and asking for an injunction to stop Dawn from working for Real Cheap.

Let’s assume for the sake of argument that the sales reports contain trade secrets, although this is usually a contested issue. See When Is a Customer List a Trade Secret. Let’s also assume that Dawn had authorization to access the computer system but was not authorized to access the particular sales reports at issue.

“Yes, I told Real Cheap’s President I had the sales reports,” Dawn says, “and we discussed generally what kind of information they contained.” But Dawn claims she never provided any of the Paula Payne Windows documents to Real Cheap, and that she never used them for any purpose.

Of course, Paula Payne Windows is skeptical. Paula Payne suspects that Dawn provided the documents to Real Cheap and used the confidential pricing information in the sales reports to undercut Paula Payne and poach some of its customers. But Paula Payne Windows has no evidence to prove this.

This fact pattern is similar to the scenario in the Waymo v. Uber case, one of the biggest trade secrets trials in recent years.

Variations on this theme are common. Employee behaves badly and takes confidential documents, Employer sues, and Employee denies using or disclosing the documents.

It raises several key practical and legal issues.

1. If the defendant wrongfully acquired the trade secrets but did not use or disclose them, is there “misappropriation”?

Let’s start with acquisition of the trade secrets. If the defendant wrongfully acquired the trade secrets, does the plaintiff have to prove the defendant also used or disclosed them?

The short answer is no. Here is the definition of “misappropriation” in the Texas Uniform Trade Secrets Act:

Tex. Civ. Prac. & Rem. Code § 134A.002(3). The federal Defend Trade Secrets Act has the same definition. 18 U.S.C. § 1839(5).

In short, TUTSA “provides six theories under which a plaintiff can establish misappropriation of trade secrets.” Six Dimensions, Inc. v. Perficient, Inc., 969 F.3d 219, 230 (5th Cir. 2020). These six theories can be grouped under two categories: (1) “acquisition of a trade secret” and (2) “disclosure or use of a trade secret.” Id.

So there you have it. “Acquisition” can be misappropriation, even without use or disclosure, if it meets the definition of misappropriation in the statute.

Yet courts have struggled with this question. In StoneCoat of Texas, LLC v. ProCal Stone Design, LLC, 426 F. Supp. 3d 311 (E.D. Tex. 2019), Judge Mazzant carefully surveyed Texas case law on whether “use” is an essential element of a trade secrets claim. He noted that some Texas cases say use is required, while others say it is not. Id. at 340-44. But ultimately, it was unnecessary to resolve that question because there was sufficient evidence to raise a fact issue on whether two defendants used the secret “French formula” at issue. Id. at 344-45.

Judge Mazzant returned to this issue in Accresa Health LLC v. Hint Health Inc., No. 4:18-cv-00536, 2020 WL 3637801, at *8-11 (E.D. Tex. July 6, 2020), discussing the StoneCoat opinion and other Texas opinions in detail. Again, he found that even assuming “use” is required, there was sufficient evidence to create a fact issue on whether the defendant used the alleged trade secrets. Id. at *11.

The cases stating that “use” is an element of a trade secret claim should be taken with a grain of salt. You have to start with the plaintiff’s theory of the case. If the plaintiff’s theory is that the defendant used or disclosed the trade secrets, then it will be accurate for the court to say evidence of “use” or “disclosure” is required. If, on the other hand, the plaintiff relies on an “acquisition by improper means” theory, then evidence of use may not be required.

In short, under the plain language of the statute’s definition of “misappropriation,” the “acquisition” theory is still a potentially viable theory.

But persuading a judge that “use” of the trade secrets is not required may be an empty victory. Because there is an obvious follow-up question: if the defendant didn’t use the trade secrets, how was the plaintiff damaged? Isn’t it the proverbial tree falling in the forest that no one hears?

2. If the evidence proves that Real Cheap Windows acquired the trade secrets from Dawn Davis but did not use them, what are the actual damages?

In theory, it may be possible to prove that Dawn Davis’s acquisition of the trade secrets—without any use or disclosure—caused actual damages to Paula Payne Windows. But in practice it will be difficult. Let’s say Paula Payne Windows cannot show that it lost any customer sales as a result of Dawn downloading the confidential sales reports. In that case it may have no actual damages.

But wait, Paula Payne, will protest. How can you say we were not damaged? Suppose our IT guy had to spend many hours investigating Dawn’s computer activity, and then we had to pay a forensic expert to investigate further. Then we had to pay our lawyer a huge amount of fees to send Dawn a demand letter, file a lawsuit, seek a Temporary Restraining Order, etc. How can you say we were not damaged?

Paula would have a point, but there’s a threshold problem with her argument. Generally, under Texas law a plaintiff cannot recover attorneys’ fees as actual damages. Worldwide Asset Purchasing, L.L.C. v. Rent-A-Center East, Inc., 290 S.W.3d 554, 570 (Tex. App.—Dallas 2009, no pet.). There are some exceptions, but none that fit the typical trade secrets dispute.

What about the forensic expert fees? Could Paula Payne Windows recover those expert fees as actual damages? The argument would be that but for the acquisition by improper means, the forensic investigation would not have been necessary.

If there is evidence that the employee’s misconduct naturally led to the company needing to hire a forensic expert to investigate, the fees may be recoverable as actual damages. See Sandberg v. STMicroelectronics, Inc., 600 S.W.3d 511, 528-29 (Tex. App—Dallas 2020, pet. filed) (forensic expert fees were recoverable as actual damages where they resulted from employee taking laptop computer with confidential information on it home after termination and not returning it for four days).

But whether the misappropriation caused those fees will depend on the specific facts. Was the forensic investigation caused by Dawn’s improper acquisition of the trade secrets, or did the forensic investigation cause the company to discover the improper acquisition? If it’s the latter, that may not be a viable actual damages theory. Similarly, if the internal IT guy is on salary, it’s probably an uphill battle to claim damages for time spent on the investigation.

So, when the misappropriation theory is acquisition by improper means, rather than use or disclosure, there may be some viable arguments for recovering actual damages, but usually those damages will be relatively minor. (I say “relatively,” because forensic expert fees, like attorneys’ fees, can add up quickly, easily reaching six figures or more in some cases.)

That’s good news for the employee, but it doesn’t lessen the sting of attorneys’ fees the employee will have to pay to defend a lawsuit.

Most of my trade secrets cases are not Google vs. Uber. They’re more like Jim Bob’s Oilfield Supply vs. Vince’s Valves. That means the cost of defense is sometimes a bigger factor than the amount of actual damages.

In many cases, that’s exactly what the plaintiff is counting on. If the company suing my client has more money and more determination, it may try to use the cost of litigation to bully my client into submission.

That brings up the next question.

3. If Dawn really didn’t use or disclose the information in the documents, how can she get the lawsuit dismissed without spending a small fortune on attorneys’ fees?

I encounter this practical problem a lot. There are several procedural options, but most of them have a low success rate.

a. Rule 12(b)(6) Motion in Federal Court

If Paula Payne Windows sues Dawn Davis in federal court and doesn’t allege specific facts establishing that Dawn used or disclosed the trade secrets, Dawn’s lawyer can file a Rule 12(b)(6) motion to dismiss. I cover this in Set Phazrs to Stun: Motions to Dismiss in Texas Trade Secrets Litigation.

(Practice Tip: This is one factor that favors filing your trade secrets suit in state court. But of course there are many factors.)

As I wrote in the Phazr post, I’m usually not a big fan of filing a motion to dismiss, but in this scenario it makes some sense. If the plaintiff does not allege specific facts establishing that the defendant used or disclosed the trade secrets, there is a decent chance the court will grant the motion. See, e.g., Phazr, Inc. v. Ramakrishna, No. 3:19-CV-01188-X, 2019 WL 5578578, at *1-2 (N.D. Tex. Oct. 28, 2019).

On the other hand, all the plaintiff has to do is allege facts sufficient to make a plausible case that the defendant used or disclosed the trade secrets. See, e.g., Computer Sciences Corp. v. Tata Consultancy Servs., Ltd., No. 3:19-cv-970-X(BH), 2020 WL 2487057, at *6 (N.D. Tex. Feb. 7, 2020) (denying motion to dismiss where plaintiff alleged facts sufficient to plausibly allege misappropriation by unauthorized disclosure and use to develop a competing software platform).

So, even in federal court it’s usually difficult to get a motion to dismiss granted.

In Texas state court? Forget about it. At least, that’s what people used to say.

b. Rule 91a Motion in Texas State Court

Times have changed. Texas now has Rule 91a, which allows you to file a motion to dismiss a cause of action on the grounds that it has “no basis in law or fact.” A cause of action has no basis in law “if the allegations, taken as true, together with inferences reasonably drawn from them, do not entitle the claimant to the relief sought.” That’s pretty similar to the federal standard, so even if Dawn Davis gets sued in state court, her lawyer could give it a try.

But it’s probably an uphill battle. It’s not clear that Rule 91a incorporates the “Twiqbal” plausibility standard that applies in federal court. See Reaves v. City of Corpus Christi, 518 S.W.3d 594, 610 n.10 (Tex. App.—Corpus Christi 2017, no pet.) (“this Court has rejected the argument that rule 91a replaced Texas’s notice-pleading standards with federal fact-pleading standards”). And if the court denies Dawn’s motion to dismiss, it could order her to pay Paula Payne’s attorneys’ fees. Tex. R. Civ. P. 91a.7.

c. TCPA Motion in Texas State Court

There was a brief, exhilirating era when you could file a motion to dismiss a trade secrets claim under the Texas Citizens Participation Act (TCPA), the Texas “anti-SLAPP” statute, but those days are over. Texas courts have been steadily narrowing the scope of the TCPA, and the legislature has now carved trade secrets claims out of the TCPA. See my post Shrinkage: TX Legislature and 5th Circuit Cut the TCPA Down to Size. Or if you want something more scholarly, see Targeting the Texas Citizen Participation Act: The 2019 Texas Legislature’s Amendments to a Most Consequential Law.

d. Special Exceptions in Texas State Court

If you were a defense lawyer in Beaumont in 1979, you probably loved special exceptions. They’re delightfully old-fashioned. A special exception usually asks the court to order the plaintiff to plead a vague claim more specifically, or else to go hence without day.

Special exceptions are something of a throwback. These days, when there is so much pretrial discovery, judges tend to say that the better way for the defendant to pin down the plaintiff on specifics is through discovery devices like interrogatories, Rule 194 disclosures, and depositions.

But in this case, special exceptions may be just what the doctor ordered. If the plaintiff has no specific evidence of use or disclosure and just relies on broad conclusory allegations, I’ll file a special exception that asks the court to order the plaintiff to plead the specific facts supporting the allegation and, if the plaintiff cannot do so, to dismiss the trade secrets claim. If nothing else, it sets me up to try to spike the ball with a later motion to dismiss or motion for summary judgment.

e. Motion for Summary Judgment

This is the grand-daddy. If Paula Payne Windows has no real evidence that Dawn Davis used or disclosed the alleged trade secrets, then a motion for summary judgment is the most direct way to attack that defect.

The problem, in a word, is discovery.

If Dawn’s lawyer files a motion for summary judgment at the start of the case, the lawyer for Paula Payne Windows is going to object that discovery has to come first. That means serving and responding to requests for production of documents, scheduling and taking depositions, and fighting over discovery disputes in pretrial hearings. All of that takes a lot of time and money. So it usually defeats the purpose of trying to get an unfounded claim dismissed quickly and inexpensively.

This is a problem in all kinds of litigation, not just trade secrets litigation. The Texas legislature and Texas courts have tried to do something about it—such as passing the TCPA—but there’s no easy answer. Unless you’re going to cut off a plaintiff’s right to seek discovery to support its claim, litigation is just going to be expensive. There’s no way around it.

Kind of like a forest.

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Zach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation. Thomson Reuters named him a 2020 Texas Super Lawyer® for Business Litigation.

Follow @zachwolfelaw on Instagram to keep up with his latest shenanigans.

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.

Geographic Area of a Texas Non-Compete – Part 2

Geographic Area of a Texas Non-Compete – Part 2

If Part 1 was a flashback to the vinyl era, then this Part 2 moves us into the cassette era. That’s more my time. I never actually had a Peter Frampton record, but I can still remember recording The Name of This Band is Talking Heads on to a blank cassette tape.

The theme of Part 1 was the Sales Territory principle, which says that a reasonable geographic area for a Texas non-compete should usually coincide with an employee’s actual sales territory. This principle goes all the way back to the first vinyl era, the Jazz Age, when Texas courts reasoned that an employee is going to develop goodwill only in the area where he has personal contact with customers.

But of course, not every case involves the typical sales employee who is responsible for a certain territory. What about cases where physical territory is not important, or where the employee is a high-level executive?

In such cases, the Sales Territory principle may be less useful, and Texas courts may be more likely to follow what I call the Holistic principle. The Holistic principle considers the reasonableness of the geographic limitation not in isolation, but in combination with other factors, such as the employee’s rank in the company, the employee’s knowledge of high-level confidential information, the nature of the business, and perhaps most important, the scope of activity restrained by the non-compete.

This leads us to General Rule No. 5.

General Rule 5: No geographic limitation or broad geographic limitation + non-compete limited to existing customers = probably reasonable.

The Sales Territory principle was rooted in the idea that customer goodwill is usually tied to a certain geographic territory. This idea goes back at least as far as the City Ice Delivery case in the 1920s. But Texas courts also recognized decades ago that even a non-compete with no geographic limitation at all can be reasonably limited to protecting customer goodwill, if the scope of activity it restrains is narrow.

Consider Stocks v. Banner American Corp., 599 S.W.2d 665 (Tex. Civ. App.—Texarkana 1980, no writ). Stocks sold his stock in Banner and agreed not to compete with Banner for three years. Banner’s business included manufacturing and selling blank cassette tapes, selling blank labels for cassette tapes, and custom duplication of cassette tapes. Banner’s customers included Tandy Corporation and Apple Computers. Id. at 666.

Stocks apparently could not leave the cassette game behind, because he somehow became an owner of Xalon Corporation, which sounds like an evil company from Aliens or Terminator. Despite the lack of any geographic limitation in the non-compete, the trial court enjoined Stocks and Xalon Corporation from doing business with Tandy, Apple, or a list of other Banner customers. Id. at 666-67.

The Court of Appeals found that the lack of a geographic area was not fatal to the non-compete. See id. at 667 (“Failure to include a territorial limitation will not void a covenant to compete”). The court cited Justin Belt Company, Inc. v. Yost, 502 S.W.2d 681 (Tex. 1973), where the court held that a non-compete that was “unlimited both as to time and to space” could be enforced to a reasonable extent. Id. The court also reasoned that non-competes may be construed more broadly in the sale of a business than in an employment relationship. Id. (citing Seline v. Baker, 536 S.W.2d 631 (Tex. Civ. App.—Houston [1st Dist.] 1976, no writ)).

Thus, the non-compete could be enforced to some extent, despite the lack of a geographic limitation. But to what extent? The Stocks court cited two cases approving injunctions limited to prohibiting a former employee from contacting certain listed customers. Id. at 667-68 (citing Toch v. Eric Schuster Corp., 490 S.W.2d 618 (Tex. Civ. App.—Dallas 1972, writ ref’d n.r.e.), and Arrow Chem. Corp. v. Anderson, 386 S.W.2d 309 (Tex. Civ. App.—Dallas 1965, writ ref’d n.r.e.)). The takeaway was that “[t]he use of a customer list as an alternative to setting a specific geographical limit is a reasonable means of enforcing a covenant not to compete.” Id. at 668.

Apple Computers was one of the key customers in the Stocks case decided in 1980

From the Stocks rule we can deduce this common-law principle of Texas non-compete law: a non-compete that is limited to prohibiting a former employee or owner from doing business with the company’s existing customers may be reasonable and enforceable even if it lacks a geographic limitation. See also Investors Diversified Servs., Inc. v. McElroy, 645 S.W.2d 338, 339 (Tex. App.—Corpus Christi 1982, no writ) (non-compete limited to clients securities salesmen contacted or learned about while working for company was enforceable despite lack of defined territory).

The logic of the rule is that the point of requiring a geographic limitation was to protect customer goodwill. If the non-compete is otherwise limited to protecting customer goodwill—because it is limited to the company’s existing customers—then a geographic limitation may not be necessary. This is the most basic formulation of the Holistic principle.

But this was a common-law rule. Did the Stocks rule survive the enactment of the Texas non-compete in 1989? Let’s just say the Stocks rule fared better than cassette tapes at the end of the 80s.

Even though the statute expressly requires a geographical limitation, Texas courts continued to hold that a geographic limitation may be unnecessary if the scope of activity restrained is sufficiently narrow.

In Totino v. Alexander & Associates, Inc., No. 01-97-01204-CV, 1998 WL 552818 (Tex. App.—Dallas Aug. 20, 1998), former employees of an insurance brokerage argued that the their non-competes violated the statute because they contained no geographic limitation, but the court rejected this argument. Id. at *3. The statute’s reasonable geographic restriction parallels a similar common-law requirement, the court reasoned, and Texas courts had held that a geographic limitation was not necessary where the non-compete was limited to clients the former employee had contact with. Id. at *3-4 (citing McElroy and Stocks). The non-compete “implicitly” contained a reasonable geographic restriction because it was limited to clients of the brokerage. Id. at *4.

The First Court of Appeals followed the same approach in Gallagher Healthcare Insurance Services v. Vogelsang, 312 S.W.3d 640 (Tex. App.—Houston [1st Dist.] 2009, pet. denied). The non-compete in Gallagher had no geographic limitation, but it was limited to clients the employee had worked with in her last two years at the company. Id. at 654. “A number of courts have held that a non-compete covenant that is limited to the employee’s clients is a reasonable alternative to a geographical limit,” the court said, citing Stocks, Totino, and McElroy. Id. at 654-55. The court held the limitation to clients the employee worked with while employed by the company was a “reasonable alternative to geographical area.” Id. at 655.

As these cases illustrate, the scope of activity restrained is usually a more important factor than geographic area. Even a non-compete that has a reasonable geographic area will be unenforceable if the scope of activity restrained is too broad. See Burning Down the Haas: The Industry-Wide Exclusion Rule in Texas Non-Compete Litigation.

The employee’s position in the company is also an important factor, which leads to the next general rule.

General Rule 6: No geographic limitation or broad geographic limitation + non-compete not limited to specified customers + high-level executive = It depends.

We have seen that a broad geographic area—or even the lack of any geographic area—may be found reasonable if the non-compete is limited to existing clients or customers. But what if the non-compete is not limited to existing clients or customers?

This is where it gets hard. In a case like this, other factors, such as the employee’s rank in the company and knowledge of the company’s confidential information, become more important.

The Stocks rule lasted longer than these bad boys

Judge Ellison considered the issue in detail in M-I LLC v. Stelly, 733 F.Supp.2d 759 (S.D. Tex. 2010). In that case, Knobloch resigned from his position as Manager of Sales for the Americas at M-I, an oilfield services company. He started his own oilfield services company and allegedly started “raiding” employees from M-I. Id. at 769-70.

Knobloch’s non-compete restricted doing business with existing M-I customers, but it did not end there. Like many non-competes, it also prohibited Knobloch from engaging in any business “involving oilfield displacement tools or services or any other businesses then conducted by Employer.” Id. at 794. These restrictions applied “in any geographic area” where the company did business, which effectively meant North America, South America, and the Caribbean. Id. at 797.

Knobloch argued that his non-compete was unenforceable because the geographic area was too broad, but Judge Ellison disagreed, citing his own formulation of the Holistic principle. “[N]on-compete covenants with restrictions covering a wide geographic area may be reasonable if they are limited in scope to a firm’s current or prospective clients such that they do not pose a greater restraint than necessary to protect the firm’s goodwill,” he said, citing his own opinion in TransPerfect Translations (I love that flex). Id. at 797-98.

He also cited a version of the Sales Territory principle: “Covenants with wide geographic areas have been upheld frequently in Texas courts, especially when the area covered constitutes the employee’s actual sales or work territory.” Id. at 798.

Applying these rules, Judge Ellison acknowledged that “a geographic area covering the Western hemisphere is broad, reaching to the outer limits of a restriction.” But he ruled that this broad geographic area was reasonable, even where the non-compete was not limited to existing customers, where:

  • Knobloch had “extensive job responsibilities” and held a position in “upper management” (Manager of Sales for the Americas). He was “much more than a manager and salesman for his former employer.” He oversaw the company’s “relationships with major international clients.”
  • His actual territory did span the Americas.
  • Knobloch knew the company’s technical confidential information: “An engineer by training, Knobloch participated in the design of [the company’s] tools and in facilitating wellbore completions. He delivered technical presentations internationally, formulated company growth strategies, and discussed product development with engineers.”

Id. at 798-99.

In short, in M-I v. Stelly the geographic area covering the entire Western hemisphere was reasonable where the employee was a high-level executive, he was actually responsible for that territory, and he had knowledge of the company’s confidential technical information.

M-I v. Stelly took a “holistic” approach

Texas cases since M-I v. Stelly have tended to find broad geographic areas reasonable when the former employee was a high-level executive.

Consider Daily Instruments Corp. v. Heidt, 998 F.Supp.2d 553 (S.D. Tex. 2014). In that case, the non-compete broadly applied to the United States and any country in which Daily Instruments did business. Id. at 567. Daily Instruments specialized in the narrow field of reactor thermometry, which involved electrical temperature measurement devices used in reactors for the refining, chemical, and petrochemical industries. Id. at 557.

The court found the non-compete reasonable for three reasons. First, the employee was a high-level sales manager with responsibility for a very large territory and with access to the company’s confidential information regarding worldwide clients and sales. Id. at 567-68. Second, the field of reactor thermometry was very narrow, with a narrow customer base, few competitors, and a global scale. Id. at 568. Third, the non-compete had a reasonable limitation on scope because it did not bar the employee from working in the industry, but only from performing the kind of work he had performed in his last two years of employment in the narrow field of reactor thermometry products, and from disclosing confidential information. Id.

Similarly, in Ameripath, Inc. v. Hebert, 447 S.W.3d 319, 335 (Tex. App.—Dallas 2014, pet. denied), the court found a broad geographic area reasonable considering the employee was a member of employer’s “highest level management team.” The employee cited the Sales Territory principle and argued that he only worked in two counties, while the geographic scope of the non-compete was much broader. Id.

But the court said “the breadth of enforceable geographical restrictions in covenants not to compete must depend on the nature and extent of the employer’s business and the degree of the employee’s involvement in that business.” Id. (citing Butler v. Arrow Mirror & Glass, Inc., 51 S.W.3d 787, 793 (Tex. App.—Houston [1st Dist.] 2001, no pet.). The restriction on working anywhere for a company that operated in the Dallas-Fort Worth area was reasonable, the court reasoned, because the employee’s “management knowledge of and experience with [the company’s] Dallas-area operations would be valuable to his new employer.”

And in McKissock, LLC v. Martin, 267 F.Supp.3d 841, 856-57 (W.D. Tex. 2016), the court found a nationwide geographic area reasonable, where the company had a national customer base, the employee taught online courses available to the national customer base, and the employee held an upper-level position as Senior Appraisal Instructor.

Hmm. “Senior Appraisal Instructor.” I’m wondering how “upper-level” that really was. In theory, I don’t have a problem with the Holistic principle applied in M-I v. Stelly and subsequent cases. Courts should remember that the primary rationale for requiring a geographic limitation is to protect a company’s goodwill.

But I fear that in practice, dispensing with the geographic limitation requirement or allowing an extremely broad geographic area can have a real chilling effect on the ability of businesses to hire the best executive talent. I’ve seen this in my practice.

Maybe it’s time to hit rewind.

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Zach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation at his firm Fleckman & McGlynn, PLLC. Follow @zachwolfelaw on Instagram to keep up with his latest shenanigans.

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.

Geographic Area of a Texas Non-Compete – Part 1

Geographic Area of a Texas Non-Compete – Part 1

The reasonable geographic area requirement of Texas non-compete law is delightfully dated. It’s an analog throwback in a digital era. When Texas courts say a non-compete must be limited to a reasonable geographic area, you can just feel the needle dropping into the well-worn grooves of your uncle’s vinyl copy of Frampton Comes Alive!

But some of you will object that requiring a geographic limitation in a non-compete is an obsolete relic of a bygone era, like Microsoft stores. We’re in the WFH era now. The physical location of an employee doesn’t matter. You might argue a sales person with a cell phone and a laptop can do just as much damage to your business from a beach chair in Fiji as a cubicle in Pearland.

Maybe so. But if the non-compete says “within Pearland,” you’re kind of stuck with that. Plus, the Texas non-compete statute still requires a non-compete to have a reasonable limitation as to “geographical area.” Tex. Bus. & Com. Code § 15.50(a).

The traditional connection between physical proximity and customer goodwill

This is perhaps the most old-fashioned part of Texas non-compete law. It hearkens back to a time when physical proximity was the key to a salesman maintaining goodwill with the customer.

Consider Randolph v. Graham, 254 S.W. 402, 403-4 (Tex. App.—San Antonio 1923, writ ref’d), where the court held that a medical practice non-compete was reasonable and enforceable, despite having no time limitation, because it was limited to practicing medicine within a 20-mile radius of Schertz, Texas.

The court didn’t explain why the geographic area was reasonable, but it’s easy to understand. People like to go to a doctor with an office near them. So, if a doctor sells his practice in Schertz and moves to Austin, it is unlikely his patients will follow him. (The drive from Schertz to Austin is 65 miles up I-35, which usually takes 5-7 hours.) A 20-mile radius sounds about right to prevent the doctor from taking advantage of the goodwill he developed with his patients.

Two years later, the geographic limitation requirement took shape in City Ice Delivery Co. v. Evans, 275 S.W. 87 (Tex. Civ. App.—Dallas 1925, no writ). The court said the test for enforceability of a non-compete in an employment contract was whether it imposed “any greater restraint than is reasonably necessary to secure protection of the business of the employer or the good will thereof.” Id. at 90.

Applying this principle to the geographic area of the non-compete, the court held that the employer was entitled to an injunction against the employee competing in the ice delivery business in the territory where he had delivered ice to the company’s customers, but not against competition outside of the territory, where the company had no goodwill based on the employee’s “personal contact” with customers. Id.

Again, we can see why it made sense to limit the non-compete to the employee’s delivery area. In a business that involves physical delivery of the product to the customer, it was unlikely that a salesman was going to develop goodwill with customers outside his delivery area. Especially in 1925, when the ice would melt if you had to go too far.

So there you have it. Two keys to the geographic area requirement: (1) it should be limited to the territory where the employee interacted with customers, because (2) that is the area where the employee developed goodwill with the customers on behalf of the company.

64 years later, the Texas legislature enacted the 1989 non-compete statute. It provides that a non-compete must 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).

How have Texas courts interpreted the statute’s reasonable geographic area requirement? In principle, not much has changed since City Ice Delivery.

The Sales Territory principle

In most cases, where the employee worked in some kind of customer-facing sales role within a defined territory, the reasonableness of the geographic area will turn on whether it matches the employee’s sales territory. Let’s call this the Sales Territory principle.

When the case involves a sales person or other low to mid-level employee, the Sales Territory principle will usually explain why the court found the geographic area reasonable or unreasonable. In other words, the Sales Territory principle usually applies when the case does not involve a high-level executive. That leads to our first general rule.

General Rule 1: Non-executive + no geographic limitation = probably unreasonable

The easiest cases are those involving a non-executive who has a non-compete with no geographic limitation.

One of the first cases to apply the statute’s geographic area requirement was Zep Manufacturing Co. v. Harthcock, 824 S.W.2d 654 (Tex. App.—Dallas 1992, no writ). That case involved a non-compete between Zep, an industrial chemical manufacturer, and Harthcock, an industrial chemist. Id. at 656-57. Harthcock’s non-compete barred him from performing services similar to those he performed for Zep for two years following termination, with no geographic limitation. Id. at 660.

The court cited the general principle that “what constitutes a reasonable area generally is considered to be the territory in which the employee worked while in the employment of his employer.” Id. (citing two pre-statute cases, Justin Belt Co. v. Yost, 502 S.W.2d 681, 685 (Tex. 1973), and Diversified Human Resources Group v. Levinson-Polakoff, 752 S.W.2d 8, 12 (Tex. App.—Dallas 1988, no writ)).

The court then said the non-compete failed to comply with the statute because it contained no limitation as to geographic area. Id. at 661. Thus, the non-compete would prohibit Harthcock from working as an industrial chemist anywhere, regardless of whether it was in an area not serviced by Zep or Harthcock.

“Noncompete covenants with broad geographical scopes have been held unenforceable,” the court said, “particularly when no evidence establishes that the employee actually worked in all areas covered by the covenant.” Because the non-compete contained no geographic restriction, the court held it was unenforceable. Id.

But today, most Texas lawyers are smart enough to include some geographic limitation in the non-compete. What then?

General Rule 2: Non-executive + ill-defined geographic limitation = probably unreasonable

Texas courts have reached similar conclusions when the non-compete has some geographic limitation, but is so broad or vague that it has no connection to protecting the goodwill developed by the employee.

For example, in TENS Rx, Inc. v. Hanis, No. 09-18-00217-CV, 2019 WL 6598174, at *1 (Tex. App.—Beaumont Dec. 5, 2019, no pet.) (mem. op.), the non-compete applied “in any state or geographical territory in which Employer is conducting, has conducted or anticipates conducting its business.”

The employee filed a motion for summary judgment that the non-compete was unenforceable because the geographic limitation and scope of activity restrained were unreasonable. Id. at *2. The employer argued that the employee was bound by the contractual stipulation that the geographic restriction was reasonable, stating it was “disingenuous” for the employee to now assert the contrary. Id. at *3.

This brings up one of my pet peeves: lawyers for the first employer love to argue that the employee is being dishonest or “disingenuous” when the the non-compete recites that its limitations are reasonable and the employee later argues they’re unreasonable. I don’t find this persuasive, and I’m guessing most judges don’t either. Almost every non-compete contains self-serving recitals like this. Even when I’m representing the employer trying to enforce the non-compete, I would rather just demonstrate that the limitation is reasonable than play this game.

In any case, the trial court in TENS Rx didn’t buy the “disingenuous” argument. It granted summary judgment that the non-compete was unreasonable in geographic scope and scope of activity restrained. Id.

Because the non-compete related to provision of personal services, the employer had the burden to prove the non-compete was reasonable. Id. at *4. On appeal, the employer cited no authority that the restrictions were reasonable, instead merely arguing that the employee was bound by the contract’s stipulation that the restrictions were reasonable. Id. at *4. The court appeared to reject this argument, instead looking to Texas case law on reasonableness of a geographic limitation. Id.

The question is “whether the covenant contains limitations that are reasonable as to geographical area and do not ‘impose a greater restraint than is necessary to protect the goodwill or other business interest of the promisee.’” Id. (citing Marsh USA Inc. v. Vook, 354 S.W.3d 764, 777 (Tex. 2011)).

“The territory in which the employee worked for an employer is generally considered to be the benchmark of a reasonable geographic restriction,” the court said. Id. “Noncompete covenants with broad geographical scopes have been held unenforceable, particularly when no evidence establishes that the employee actually worked in all areas covered by the covenant.” Id.

“Here, there is no definite territory stated and no evidence that Hanis worked in all areas covered by the covenant,” the court said. “It is also unreasonable to impose a condition upon Hanis that would require her to know where TENS ‘anticipates doing its business.’” Id.

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Sales territory is usually the benchmark for a reasonable geographic area

TENS Rx shows the risk of making the geographic limitation too abstract. Sure, there is some logic to defining the area as “the employee’s sales territory.” What better way to comply with the Sales Territory principle? But the risk of defining the geographic area this way is that the court may say it is too indefinite. How are the employee—and the court—to know what the sales territory is if it’s not spelled out in the contract?

On the other hand, the company may not know in advance what the employee’s sales territory will be. What if the employee works for the company for over a decade and the territory changes? I don’t have any foolproof solution to this problem, other than to say that usually the better practice is to include a specific geographic area that predicts, as well as the company can, what the employee’s likely sales territory will be.

Let’s say the employer tries to do that and limits the non-compete to a specific, concrete geographic area, such as “within Harris County, Texas.” Is that reasonable? It will probably depend on the employee’s actual sales territory, which leads us to the next general rule.

General Rule 3: Non-executive + well-defined geographic area broader than sales territory = probably unreasonable

When the employee is not a high-level executive and the non-compete has a specific geographic area, the question will be whether the geographic area is broader than the employee’s actual sales territory.

This creates an obvious problem. Dozens of Texas cases say that the reasonableness of a non-compete is a question of law. But how can a judge decide the reasonableness of the non-compete’s geographic area without considering extrinsic evidence about the facts?

Suppose the non-compete’s stated geographic area is “within Harris County, Texas and surrounding counties.” On a motion for summary judgment, the Employee signs a sworn affidavit stating “my sales territory was limited to Harris County,” while the Employer’s CEO signs a sworn affidavit stating “Employee’s sales territory included Harris County and all the surrounding counties.” In other words, conflicting evidence. How can the trial court decide that issue as a question of law?

It can’t. And this illustrates why Texas courts are simply wrong when they declare that the reasonableness of a geographic limitation is always a question of law. On the other hand, if the facts regarding the employee’s sales territory are undisputed, then the reasonableness of the geographic area could present a question of law for the court.

Consider Fomine v. Barrett, No. 01-17-00401-CV, 2018 WL 6376500, at *1 (Tex. App.—Houston [1st Dist.] Dec. 6, 2018, no pet.), which prohibited a chiropractic case manager from competing within a 500-mile radius of the clinic’s location. The former case manager, Barrett, moved for summary judgment that the geographic limitation was unreasonable, extending beyond her work responsibilities for the clinic. Id. at *2.

The Court of Appeals affirmed summary judgment for Barrett. The court began by citing the Sales Territory principle, i.e. “[t]he territory in which an employee worked for an employer is generally considered to be the benchmark of a reasonable geographic restriction.” Id. at *3.

The clinic argued that a 500-mile radius was reasonable because Barrett marketed to patients throughout the State of Texas, but the court rejected this argument. Even assuming Barrett’s sales territory included all of Texas, a 500-mile radius would include all of Louisiana and significant portions of Alabama, Arkansas, Mississippi, Oklahoma, and Mexico. Id. at *3. The geographic scope was therefore “significantly broader” than the geographic scope of Barrett’s employment with the clinic, and the non-compete was therefore unenforceable as written. Id. at *4.

Fomine shows the importance of the employer offering evidence that an employee responsible for generating sales actually worked in the entire geographic area stated in the non-compete. Otherwise the area may be found broader than necessary to protect the employer’s goodwill.

The Sales Territory principle can also apply when the defendant is not a sales employee. Ortega v. Abel, 562 S.W.3d 604 (Tex. App.—Houston [1st Dist.] 2018, pet. denied), was a non-compete case involving the sale of a Hispanic-themed grocery store chain. The geographic area was a 10-mile radius from each of the five stores sold, which equated to most of the Greater Houston area. Id. at 611. The defendants’ expert testified that a three-mile radius would be more than sufficient to protect the goodwill of each store, reasoning that people in a city like Houston rarely travel more than 10 to 12 minutes to go to the grocery store. Id. The plaintiff, Ortega, did not present any evidence to contradict this testimony. Id. at 612.

The Court of Appeals held that the evidence was sufficient to support the trial court’s determination that the 10-mile radius in the non-compete was greater  than necessary to protect Ortega’s goodwill. Id. The court reasoned that “[t]he goal of a covenant not to compete is to establish the restraints on trade reasonably necessary to protect the goodwill or other business interest of the promise, not to prevent any competition.” Id. The expert’s testimony supported the trial court’s conclusion that a 3-mile radius was sufficient. Id.

General Rule 4: Non-executive + geographic area basically matching sales territory = probably reasonable

The next application of the Sales Territory principle is where the employee is a sales person or other lower to mid-level employee, and it is undisputed that the geographic area matches the sales territory the employee actually worked (or is at least pretty close).

That presents a fairly easy case for the court to hold that the geographic area is reasonable.

For example, in Gehrke v. Merritt Hawkins & Associates, LLC, No. 05-18-001160-CV, 2020 WL 400175, at *4 (Tex. App.—Dallas Jan. 23, 2020, no pet. h.), the non-compete between a national physician recruiting firm and a salesman prohibited competition in states in which the salesman worked during his last year with the firm. The court held that the multi-state geographic restriction was enforceable because the salesman actually worked within those states. Id.

But of course not every case involves an ordinary sales-level employee. What if the employee was a high-ranking executive who knew everything about the company and was responsible for all of the company’s customers?

I feel like I should save that for Part 2.

Do you feel like I do?

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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. Follow @zachwolfelaw on Instagram to keep up with his latest shenanigans.

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 Jury Charge in Texas Trade Secrets Litigation

The Jury Charge in Texas Trade Secrets Litigation

When you hear “misappropriation of trade secrets,” you might picture some elaborate heist where the thief is lowered into the secure underground vault from an opening in the AC duct, like Tom Cruise in Mission Impossible. The thief hacks into the company’s server, downloads the secret weapons technology, then boards a plane to China where he hands the flash drive to a shadowy figure in exchange for a briefcase full of cash.

Of course, most trade secrets lawsuits are nothing like that.

For one thing, the typical trade secrets claim involves boring “soft” trade secrets like customer lists, pricing, and other customer information. And even in cases involving “hard” trade secrets like the literal or figurative secret sauce, the parties to the dispute usually had some legitimate business or employment relationship with each other before things went south.

That means in most trade secrets lawsuits, the person who allegedly “misappropriated” the trade secrets initially acquired them lawfully.

For example, in the typical departing employee dispute, an employee legitimately acquires the company’s trade secrets while working for the company. Another typical scenario is a contract between two companies containing an NDA. It might be an agreement between a vendor and a customer, or an agreement between two companies pursuing some kind of joint venture. They voluntarily share confidential information with each other, agreeing not to use it outside of that particular transaction.

In these situations, the initial acquisition of the trade secrets is not tortious. The claim is that misappropriation happened later, when the person did something with the trade secrets that he wasn’t supposed to do.

Both the Texas trade secrets statute and the federal trade secrets statute anticipate this kind of claim in the same way: a complicated multi-pronged definition of “misappropriation.”

“Misappropriation” means stealing, using, or disclosing

The definition of “misappropriation” is the same in both the Texas and federal trade secrets statutes. See Tex. Civ. Prac. & Rem. Code § 134A.002(3); 18 U.S.C. § 1839(5).  I would quote it but that would just confuse you. Instead, I’ll just sum it up as Wolfe’s Second Law of Trade Secrets Litigation: You can’t steal a trade secret, and you can’t use or disclose a trade secret without the owner’s consent.

(In case you missed it, Wolfe’s First Law of Trade Secrets Litigation says whatever company information the employee takes on the way out the door will be the alleged “trade secrets” in the company’s subsequent lawsuit.)

My Second Law is, of course, an oversimplification. And the statute doesn’t use the word “steal.” But Wolfe’s Second Law does capture the essence of “misappropriation.”

What I call stealing is what the statute calls “acquisition” of a trade secret by someone who knows or has reason to know that the trade secret was acquired by “improper means.”

The statute has a non-exclusive definition of “improper means” that includes “theft, bribery, misrepresentation, breach or inducement of a breach of a duty to maintain secrecy, to limit use, or to prohibit discovery of a trade secret, or espionage through electronic or other means.”

As you can see, “acquisition” through “improper means” is not limited to stealing a trade secret. It also includes getting a trade secret from someone you know (or should know) stole it. But for simplicity, let’s stick with “stealing.”

Stealing is fundamentally different from the other kind of misappropriation, use or disclosure. If you steal a trade secret, you can be held liable, even if you never do anything else with it. In other words, if you steal a trade secret in the woods and nobody hears it, it still makes a sound.

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Is this where they keep the trade secrets?

This distinction between stealing and using/disclosing becomes important in litigation. If you’re thinking ahead, you can see where this is going: the use or disclosure of a trade secret will often cause compensable damages to the owner of the trade secret, but how does mere acquisition of a trade secret harm the owner?

To make this more concrete, suppose an employee walks out the door on his last day with the company’s entire secret customer list, throws it in a drawer, and never looks at it again. How does that cause any damages?

Hold that thought.

The Casteel problem in jury trials

In most cases, the trade secrets damages question will be for a jury to decide, if the case gets that far. The Court’s Charge will give the jury questions, definitions, and instructions to guide the decision.

Typically, a trade secrets charge will have three key questions: (1) is the information actually a trade secret? (2) did the defendant “misappropriate” the trade secret? (3) what damages, if any, did the misappropriation cause?

But why only three questions? What if there are multiple trade secrets at issue in the case? And what if there are multiple ways the defendant allegedly “misappropriated” the trade secrets? In cases like that, it seems like it would be more precise to break these broad questions down into more specific questions.

Well, that’s not the way we typically do it. Texas law requires “broad-form” submission of questions to the jury, at least when “feasible.” There is a mountain of literature on what broad-form submission means, but to save you time I’ll sum it up as follows: the trial court should submit one broad question on each element of a cause of action, except when there is a good reason not to.

Let’s apply this to the most ordinary kind of lawsuit, a personal injury claim arising from a car accident. Typically, there will be one damages question that combines multiple elements of recoverable damages. The instruction might look like this:

In determining the damages Big Trucking caused Ms. Smith, you may consider:

    1. Physical pain and mental anguish.
    2. Loss of earning capacity.
    3. Physical impairment.
    4. Medical care.

Yawn. What could be more ordinary?

But suppose during the trial Ms. Smith’s lawyer offered no evidence whatsoever regarding loss of earning capacity. And suppose Big Trucking’s lawyer specifically objected to this instruction ahead of time, saying “Your Honor, you can’t include loss of earning capacity in the instruction because there’s no evidence.”

The judge brushes aside the objection, the jury returns a verdict for $90,000 in damages, and the trial court enters judgment for Ms. Smith in that amount. What should the Court of Appeals do with that?

A. Affirm the judgment. Any error is harmless, because the jury could have based the $90,000 on the other three elements of damages.

B. Reverse the judgment and order that Ms. Smith gets nothing. Her lawyer shouldn’t have included loss of earning capacity in the charge.

C. Reverse the judgment and remand for a new trial. Including an element for which there was no evidence is reversible error because there is no way for Big Trucking to show whether the $90,000 improperly included some amount for loss of earning capacity.

There is a case to be made for A, emphasizing judicial economy and respect for jury verdicts. If you picked B, you might be a sociopath. But if you picked C, you are in sync with the Texas Supreme Court.

These were essentially the facts of Harris County v. Smith, 96 S.W.3d 230 (Tex. 2002), except the defendant was Harris County, not Big Trucking. Harris County held that it was an error for the trial judge to submit a broad-form question that included an element for which there was no evidence, and that this was a harmful error because it prevented the appellate court from determining whether the jury based its verdict on an invalid element of damages. Id. at 234.

The court based this decision on a precedent from two years earlier, Crown Life Ins. Co. v. Casteel, 22 S.W.3d 378 (Tex. 2000). Casteel had followed the same reasoning, except that Casteel involved a liability question (not damages), and the objectionable element in Casteel was improper because it was legally invalid (not because of lack of evidence).

In Harris County the Texas Supreme Court found these distinctions immaterial. It therefore established a general principle for Texas jury trials: If a question to the jury includes an element that should not have been submitted, either because it is legally invalid or there is no evidence to support it, and if the complaining party timely and specifically objects to that defect, then the jury’s affirmative answer cannot stand.

Appellate lawyers now call this a Casteel error. They could call it a Harris County error, but that doesn’t have the same ring to it.

Ok, but what does this appellate procedure detour have to do with trade secrets litigation?

The definition of “misappropriation” is custom-designed to create a Casteel problem

It is easy to see how a trade secrets lawsuit could create a Casteel error. This is likely to happen in several ways.

First, suppose the plaintiff claims that it has two kinds of trade secrets. Maybe one is a customer list and the other is a proprietary software program. Suppose there is evidence that the software is a trade secret, but insufficient evidence that the customer list is a trade secret. If the judge submits a single broad question asking whether the plaintiff owned a trade secret and the jury answers “yes,” how do we know if the jury improperly based that answer on the customer list?

Second, let’s assume the court submits a single damages question, but the plaintiff advances multiple theories about what was a trade secret and how the trade secrets were misappropriated, some of which have no evidence to support them. How do we know which theory the jury based the damages on?

Third, and most to the point here, there is the question on “misappropriation.” Let’s say the plaintiff claims both kinds of misappropriation, i.e. stealing and using/disclosing. What if there is no evidence of stealing? If the jury answers yes, there was misappropriation, there is no way to know if the jury based that answer on stealing or not.

In other words, a Casteel problem.

Fortunately, we have the Texas Pattern Jury Charges to help.

The Texas Pattern Jury Charge tracks the statute’s definition of “misappropriation”

A committee of the State Bar of Texas publishes the Texas Pattern Jury Charges, affectionately known as the PJC. The PJC provides standardized jury questions, definitions, and instructions. It is not legally binding on judges, but most judges will follow it most of the time.

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The 2016 PJC included trade secrets questions for the first time

In 2016 the PJC added new questions specifically addressing trade secrets claims. These questions line up with the three questions I outlined earlier, i.e. (1) existence of a trade secret, (2) “misappropriation” of a trade secret, and (3) damages.

Reviews were largely positive. See Book Review: The New Texas Pattern Jury Charge on Trade Secrets. As one reviewer wrote:

The new questions and instructions on trade secret misappropriation do what the Pattern Jury Charge is supposed to do. They provide a template for submitting trade secrets misappropriation questions that is consistent with Texas law and broad enough to apply to different kinds of cases.

Above all, the one thing you want to avoid in a jury instruction is misstating the law. The PJC question on misappropriation of trade secrets tries to avoid this by asking one simple question, “Did Don Davis misappropriate Paul Payne’s trade secret,” and following that question with instructions that track the statutory definition of “misappropriation.” This is a common PJC approach.

You can see the appeal of this. How can the other side complain about your proposed jury instruction if it quotes the language of the statute verbatim?

The problem with the Pattern Jury Charge approach to “misappropriation”

Still, tracking the language of the statute is not always the best approach, and sometimes it’s even the wrong approach, as we will see.

The problem is that the statutory language may not fit the facts of the case. As one reviewer noted back in March 2017:

There is a danger of rote use of the PJC questions when more specific questions tied to the facts of the case would be more appropriate and more understandable to the jury. . . . If the dispute is about whether the former employee used the employee’s customer list, why not just ask “did Don Davis use Paul Payne’s customer list?”

Ok, I confess. That reviewer was me. But still, it’s a valid point.

As I explained in my review, I tend to prefer more factually-specific trade secrets questions. “I like my questions better than the PJC questions,” I wrote. “They get right to the point and are easier for the jury to understand.”

But I neglected to mention another benefit of a trade secrets question that is specifically tailored to the facts of the case: it helps you avoid a Casteel problem.

A case study on “misappropriation” and the Casteel problem: Title Source v. HouseCanary 

The San Antonio Court of Appeals applied Casteel to a trade secrets claim in Title Source, Inc. v. HouseCanary, Inc., No. 04-19-00044-CV, 2020 WL 2858866 (Tex. App.—San Antonio June 3, 2020, no pet. h.). The jury question tracked three alternative elements of the statutory definition of “misappropriation” and quoted the statutory definition of “improper means.” The problem, Title Source argued, was that there was no evidence to support one of those elements.

The stakes for this technical issue of appellate procedure? Only a $706 million verdict, the largest in Bexar County history (according to Title Source’s brief).

The case arose from a contractual relationship in which acquisition of the alleged trade secrets was initially lawful. Title Source, a company affiliated with Quicken Loans that provides services including real estate appraisals, contracted with HouseCanary, a real estate analytics company, to develop an iPad app that could be used to perform appraisals more efficiently. The parties signed several contracts that included nondisclosure obligations.

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Title Source hired HouseCanary to create an iPad app for real estate appraisers

The facts detailed in the opinion are worth reading, but suffice to say that Title Source claimed the app didn’t work, while HouseCanary claimed that in the course of the relationship Title Source misappropriated HouseCanary’s trade secrets to develop its own app, called MyAVM. The jury answered yes to the misappropriation question and then found actual damages of $235.4 million and punitive damages of $470.8 million. Id. at *1-6.

There were also some juicy allegations that came out after the trial, including alleged collusion between HouseCanary and a Title Source officer and “hush money” paid to HouseCanary employees. You can read about that in Title Source’s Brief. (I would also include HouseCanary’s brief, but it was filed under seal.)

The Court of Appeals didn’t need to reach these spicier issues, because it focused on the Casteel problem presented by the misappropriation question. That question told the jury it could find misappropriation based on either a “use” theory” or an “acquisition by improper means” theory (my “stealing”). Id. at *9.

HouseCanary argued that the evidence showed that Title Source used HouseCanary’s trade secrets by relying on the information to assist or accelerate its own research and development. Id. at *10. And there seemed to be at least some evidence to support this argument.

The problem was that the jury question on misappropriation included elements for which HouseCanary had no evidence, i.e. a Casteel error.

The question went wrong in two ways. First, it quoted the statutory definition of “improper means” verbatim. It was therefore a correct statement of the law, but the definition of “improper means” included “bribery” and “espionage,” and there was no evidence that Title Source acquired the trade secrets through bribery or espionage. Because there was no evidence to support those theories, they should have been omitted from the “improper means” definition submitted to the jury. Id.

Hold on a minute. In HouseCanary’s defense, what if no one ever said anything about bribery or espionage in the trial? What is the chance that the jury actually based its answer on a theory that was included in the definition but never argued? This seems like a hyper-technical application of Casteel.

HouseCanary argued this very point, citing a Casteel exception: “a Casteel issue is not reversible if the reviewing court can be ‘reasonably certain’ the jury did not base its findings on the invalid theories.” Id. (citing Romero v. KPH Consol., Inc., 166 S.W.3d 212, 227-28 (Tex. 2005)). HouseCanary never pursued bribery or espionage theories at trial, it argued, so it was reasonably certain the jury did not base its answer on those theories.

But the Court of Appeals sidestepped this argument by focusing on the second problem with the misappropriation question. The question allowed the jury to find misappropriation based on acquisition of the trade secrets through “breach of inducement of a breach of a duty to maintain secrecy, to limit use, or to prohibit discovery of a trade secret.” And HouseCanary argued that theory throughout the seven-week trial, and on appeal. Id.

“But there is no evidence that TSI actually acquired the trade secrets through those breaches,” the Court of Appeals said. “Instead, the evidence shows those breaches, if any, occurred after HouseCanary willingly turned over its data under the NDA, the licensing agreement, and Amendment One.” Therefore, “those breaches do not support a misappropriation finding.” Id.

This was harmful error under Casteel, especially considering the arguments made by HouseCanary’s counsel in the trial. “[B]ecause HouseCanary so heavily emphasized the evidence it presented to the jury of TSI’s alleged post-acquisition breaches, we cannot rule out the possibility that the jury found misappropriation based on those breaches.” Thus, including the acquisition by improper means language in the charge was reversible error. Id.

The result: the Court of Appeals poured out the $700+ million trade secrets verdict and remanded the trade secrets claim for a new trial. Id. at *11. (According to legal-lingo.net, “pour out” is slang for “to deny (a claimant) damages or relief in a lawsuit.”)

Suppose instead that HouseCanary had submitted a simpler misappropriation question like the one I suggested in my review of the PJC, something like “did Title Source use HouseCanary’s trade secrets to aid or accelerate development of its own app?”

Do you think the jury still would have answered yes? Would the verdict and judgment have stood up on appeal?

We’ll never know for sure, and most of my cases don’t involve $700 million verdicts, so what do I know. But I can at least say this simpler question might have avoided the Casteel problem that got the judgment reversed.

Does the Pattern Jury Charge do more harm than good?

To be fair, the PJC question on trade secrets misappropriation anticipates the kind of problem illustrated by Title Source v. HouseCanary. Tucked away in the Comment section to PJC 111.2 (Question and Instructions on Trade-Secret Misappropriation), you will find these nuggets:

For further discussion, see PJC 116.2 regarding broad-form issues and the Casteel doctrine.

The above instruction lists these six alternative improper methods of acquisition, use, or disclosure in brackets, but only the method(s) supported by the pleadings and evidence should be submitted. 

Only those [improper] means raised by the evidence should be submitted.

Only the methods or means raised by the evidence should be submitted! It’s right there in the PJC comments. They even mention Casteel by name.

So, defenders of the PJC could say, with some justification, that the problem in Title Source v. HouseCanary was not that the judge followed the PJC on “misappropriation,” but that the judge didn’t follow the PJC closely enough.

Still, it makes me wonder. Does the PJC question on misappropriation of trade secrets do more harm than good? Might it be better just to tell trial courts to look at the statute and then apply it to the specific facts in dispute?

Keep in mind, it is likely that most Texas trial court judges have never submitted a trade secrets case to a jury. This is based on purely anecdotal evidence, but I’d be willing to bet money on it. Even if I’m wrong, I guarantee most of them could count their trade secrets jury trials on one hand.

I don’t mean this as a criticism, just to point out that jury trials on trade secrets claims are very rare.

As a result, most trial court judges may feel a little unsure of themselves when deciding how to charge the jury on a trade secrets claim. They will tend to fall back on the PJC and the language of the statute, because that feels like the safer thing. It wouldn’t surprise me if that is what happened in Title Source v. HouseCanary.

But the safer thing is not always the best thing.

Just ask Tom Cruise in Mission Impossible.

*Update: The San Antonio Court of Appeals issued a new opinion on rehearing on August 26, 2020. Stay tuned for analysis.

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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. Follow @zachwolfelaw on Instagram to keep up with his latest shenanigans.

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.

Use the Force (Majeure)

Use the Force (Majeure)

Even if you’re not a lawyer, you’ve probably heard the phrase force majeure, which is French for “use the force, Luke.” Not as clumsy or random as the Latin, vis major. It’s an elegant phrase, for a more civilized age.

Force majeure actually means something like “superior force,” and it’s a concept you find in contract law. It’s the idea that a party to a contract is excused from strict performance of the contract’s terms if some extraordinary event beyond that party’s reasonable control prevented performance.

Force majeure is closely associated with an English phrase, “act of God,” which gives you an idea of the kind of event we’re talking about: hurricanes, tornados, cats and dogs living together.

Force majeure in contract law

Force majeure is an exception to the general rule of contract law. Unlike the law of negligence, contract law is usually not concerned with fault. If a party fails to perform a material requirement of a contract, it has breached the contract and is liable for the resulting damages to the other party. Generally, it doesn’t matter if the breaching party has a good excuse. You might say contract law imposes “strict liability” on the breaching party. It’s a “no fault” regime.

Is that fair?

Here’s one way to look at it: the whole point of a contract is to allocate risk between the contracting parties. Let’s say Pop Tarts are currently trading at $2.00 per box. If we sign a contract that says I will deliver a truckload of strawberry Pop Tarts to your store in 30 days for $2.00 a box, I’m taking the risk that the price will go up, and you’re taking the risk that the price will go down. If there’s a run on Pop Tarts after we sign the contract and the price doubles, I don’t get to complain that the contract price we agreed on isn’t fair.

That’s what I mean here by “strict liability.”

But this concept has its limits. In 1712, the King’s Bakers Company signed a contract to deliver 13 dozen strawberry tarts to Ye Olde Tavern for 15 shillings per dozen. An extraordinary cold snap destroyed that year’s strawberry crop, and the King’s Bakers could not deliver. The English court adopted the rule of force majeure, holding that this act of God was an unforeseen circumstance that excused the seller from performing.

Ok, I made that case up, but that was basically the common-law rule of force majeure. Then lawyers started incorporating this concept into the contracts they wrote. Today, force majeure is no longer a common-law rule that applies to all contracts. The issue now is interpreting the scope of the particular force majeure clause the parties agreed to (if any).

This should make it easy to figure out if a particular occurrence qualifies as a force majeure event. Just look at the definition in the contract.

But I know my Fivers. You’re shaking your heads no. You know it’s going to be more complicated than that.

A typical force majeure clause

Let’s look at an example. Here’s a typical force majeure clause:

Screen Shot 2020-03-14 at 10.10.06 PM.png

I’m sure you see the obvious problem: no Oxford commas. But let’s set that aside.

This definition has a two-part structure that you see in many legal definitions, whether in a contract or a statute. It defines a key concept by listing specific instances followed by a broader “catch-all” clause.

In this case, there are seven instances listed:

  • fire
  • flood
  • storm
  • act of God
  • governmental authority
  • labor disputes
  • war

Those are the specific enumerated events that qualify as force majeure. They are followed by the catch-all: “any other cause not enumerated herein but which is beyond the reasonable control of the Party whose performance is affected.”

It is, of course, a little more complicated than that, because one of the seven specific things is “act of God,” which is also a kind of catch-all. But you get the idea.

The interesting thing about this kind of structure is that the catch-all informs interpretation of the enumerated events, while the enumerated events inform interpretation of the catch-all. (The latter principle is called ejusdem generis–again with the foreign languages!)

We don’t want to take the specific events out of context. Let’s say I can’t deliver the truckload of Pop Tarts because I set fire to my warehouse to get the insurance money. Under a literal interpretation, the force majeure clause would apply.

But obviously, that’s not the kind of “fire” the parties intended. You can see that from the catch-all, which shows the parties intended an enumerated event would only excuse performance if it was beyond the reasonable control of the party affected.

Should we apply force majeure clauses literally?

Let’s take a harder case. Say there’s a thunderstorm in the Houston area the day the truck is scheduled to arrive, and it causes such bad traffic that the truck is late. That’s a “storm,” and it is not an event under the reasonable control of the seller, so if the storm actually prevented timely delivery, the force majeure clause would apply, right?

Most of you are instinctively resisting this conclusion. But why? If you interpret the clause literally, it seems to apply. Shouldn’t a court enforce the “plain meaning” of the words the parties freely negotiated and agreed to?

I think the problem is that, for all our hard-nosed talk about plain meaning and strict liability, we can’t entirely avoid importing our moral notions of fairness into interpretation of the contract.

Our moral intuition tells us it’s not fair for the seller to avoid the contract just because there happened to be a thunderstorm and bad traffic that day. On the other hand, it doesn’t seem fair to hold the seller liable if the truck couldn’t get to the store because Hurricane Harvey flooded the roads.

Is there a way to rationalize this moral instinct, so that judges have an objective rule they can follow to determine whether a particular event falls under the definition the parties agreed to?

A recent case applying a force majeure clause

Let’s look at a fairly recent attempt to do that. In a 2-1 decision in TEC Olmos, LLC v. ConocoPhillips Co., 555 S.W.3d 176 (Tex. App.—Houston [1st Dist.] 2018, pet. denied), the majority tried to solve this problem with a concept that was not stated in the contract but is pervasive in the law: foreseeability. The dissent, in contrast, tried to solve the problem with textualism.

Did either succeed?

The contract in TEC Olmos was a farmout agreement to test-drill land in search of oil and gas. The contract set a deadline to begin drilling and included a liquidated damages clause requiring Olmos to pay $500,000 if it missed the deadline. Id. at 179. By pure coincidence, the force majeure clause in the contract was exactly the same as the example I used above.

Of course, something unexpected happened after the parties signed the contract. In the summer of 2014 the price of oil was over $100 a barrel. By December 2015 it was around $40. As a result of the significant drop in the global oil market, Olmos could not get the financing it needed to do the drilling. So Olmos tried to invoke the force majeure clause to extend the deadline.

The response from ConocoPhillips? You owe us $500,000.

But Olmos had a simple argument for avoiding liability: under the plain meaning of the force majeure clause, the worldwide drop in oil prices and resulting inability to obtain financing was “beyond the reasonable control” of Olmos.

The Court of Appeals disagreed. The court held that the change in the oil and gas market making it impossible for Olmos to obtain financing was not a force majeure event as defined by the contract. The court reasoned that a “foreseeable” event—such as a decline in the oil and gas market—cannot qualify as force majeure under the “catch-all” provision of the force majeure clause. Id. at 181-82, 186.

Foreseeability was part of the common-law force majeure doctrine, but it was not mentioned in the clause the parties agreed to. So was unforeseeability an implied requirement? The court said yes. “A term’s common-law meaning will not override the definition given to a contractual term,” the court said, but “we may consider common law rules to ‘fill in gaps’ when interpreting force majeure clauses.” Id. at 181.

The court explained that “when parties specify certain force majeure events, there is no need to show that the occurrence of such an event was unforeseeable.” Id. at 183. But when the party seeking to avoid performance relies on a catch-all provision, it must show that the event at issue was unforeseeable. Id. 183-84.

The majority reasoned that it would make no sense to allow a foreseeable event to satisfy the catch-all clause. “To dispense with the unforeseeability requirement in the context of a general ‘catch-all’ provision,” the court said, would “render the clause meaningless because any event outside the control of the nonperforming party could excuse performance, even if it were an event that the parties were aware of and took into consideration in drafting the contract.” Id. at 184.

I’m not sure I follow this reasoning. Dispensing with the unforeseeability requirement may render the clause broad—and maybe broader than what is fair—but it doesn’t render the clause meaningless. And shouldn’t we apply the plain language of the contract the parties agreed to? The word “foreseeable” didn’t appear in the force majeure clause.

The textualist dissent

Justice Brown made this point in his dissent. “The contract does not say that an event must have been unforeseeable to suspend performance,” he wrote. “I dissent because the Texas Supreme Court has repeatedly told us that it is this state’s policy to enforce contracts as they are written.” Applying this policy to the force majeure clause, Justice Brown said “[i]f parties wish to limit the scope of their negotiated force majeure provisions to require that an event must have been unforeseeable to excuse performance, it is not difficult to insert that single adjective into their written agreements.” Id. at 189.

Rather than reading an unforeseeability requirement into the force majeure clause, Justice Brown focused on the language of the clause. He emphasized that the clause used the word “hindered,” which dictionaries define to include “get in the way of” and “to make difficult.” “The word hinder suggests a low threshold before the force majeure clause applies,” he wrote. “The party does not have to be prevented from performing, only hindered.” Id. at 199.

In short, Justice Brown took a textualist approach to interpreting the force majeure clause, rejecting the majority’s notion that unforeseeability was implied.

I’m skeptical about whether textualism provides a definitive basis for deciding if a force majeure clause applies. It’s usually going to come down to a question of whether the event at issue falls within the “catch-all” clause, and the catch-all clause is always a little “fuzzy.” The reason there’s a dispute in the first place is that it’s debatable whether the event at issue is covered by the language of the clause. Still, I tend to agree with Justice Brown that the express language of the clause should take priority over a superimposed concept of foreseeability.

Plus, even aside from the the text, there’s a more fundamental problem with making the scope of a force majeure clause turn on whether the event at issue was “foreseeable.”

The problem with “foreseeable”

The majority in TEC Olmos assumed—and the parties apparently agreed—that a worldwide decline in the market causing an inability to obtain financing was foreseeable. Id. at 181 n.1. This was in part due to precedent that a downturn in the oil and gas market is foreseeable. Id. at 183 (citing Valero Transmission Co. v. Mitchell Energy Co., 743 S.W.2d 658 (Tex. App.—Houston [1st Dist.] 1987, no writ)).

But is an extraordinary global market crash any more “foreseeable” than the other “acts of God” typically listed in a force majeure clause? A hurricane, for example, is surely the type of event that can trigger a force majeure clause, but the parties to a contract can foresee that hurricanes happen, especially if they are on the Gulf Coast. An event that has its own “season” can’t be that unpredictable. I would guess a hurricane hits the Gulf Coast more often than the global oil market crashes.

The problem is that you can almost always make a reasonable argument that a given event is or is not “foreseeable.” No, the parties don’t sign the contract expecting that a fire is going to destroy the warehouse. On the other hand, the parties know fires sometimes happen. That’s why people buy fire insurance. So is a fire “foreseeable”?

Foreseeability is a common concept in the law, but after doing litigation for over 20 years, I don’t think the concept is that useful for reasoning our way to a conclusion. I think “foreseeable” is just a label we apply to an event or risk that our intuition tells us a party should be responsible for.

It’s not a binary question of whether an event is foreseeable or not. It’s really a question of how likely the event is, and to what extent the performing party has the ability to mitigate the risk of that event occurring. It’s a sliding scale with these two components.

I think this is the basic calculation we intuitively perform when we decide whether a particular unexpected event is the kind of event that should excuse a party from performance. I confirmed this with a scientific process: going through several hypotheticals with my wife and two kids while we ate tacos at the dinner table. It got a little heated.

But I think my wife hit on something when I asked why a global market drop would not satisfy the force majeure clause. “A market drop is beyond the party’s reasonable control, and that’s what the contract says,” I argued.

“But that’s just not how business works,” she responded. “It’s common sense!”

Common sense. Ultimately, I think that’s the best guide to deciding a force majeure dispute. And whether you agree with that or not, I think that relying on common sense and basic intuitions about fairness is usually what judges are doing anyway, regardless of how they write the opinion.

That’s not very satisfying as an objective basis for deciding disputes. But we just have to muddle through somehow. And based on TEC Olmos v. ConocoPhillips, if you’re a lawyer arguing a force majeure issue, you have to speak the language of “foreseeability.”

Do, or do not. There is no try.

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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 had to cut the whole section on ejusdem generis because, hey, this is *Five Minute* Law.

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.

 

Texas Supreme Court Says Emails “Subject To” Later Agreement Do Not Establish “Definitive Agreement”

Texas Supreme Court Says Emails “Subject To” Later Agreement Do Not Establish “Definitive Agreement”

I don’t always agree with Nathan Hecht, Chief Justice of the Texas Supreme Court. But I’ll give him this. The man knows how to start an opinion.

Here’s part of his intro to the opinion issued last Friday in Chalker Energy Partners III, LLC v. Le Norman Operating LLC:

Email can be a convenient way to reach agreement, but it is also a distinctly conversational, informal medium. Hitting send may be deliberate; it may be hasty. And so in this brave new world, or at least this braver new world, we must decide whether an email exchange reflected the meeting of minds required for a contract, given the nature of the transaction and the parties’ expressed contemplations. And we must begin to give certainty to this developing area of contract law.

This is what marketing experts call a “tease.” It draws the reader in, promising something exciting. A brave new world! Certainty!

But then the opinion fails to deliver.

You see, the Texas Supreme Court’s Chalker Energy opinion isn’t really about emails. It’s about a “No Obligation” clause. Chalker Energy held the communications at issue did not constitute a “definitive agreement” required by the No Obligation clause in the parties’ preliminary agreement.

It just happens that the communications at issue were emails. The reasoning of the opinion shows the result would have been the same if the communications had been faxed letters, for example. So we will have to wait for another opinion to deliver the promised certainty for the brave new world of contracting by email.

Still, Chalker Energy is an important case for businesses and the lawyers who represent them. It’s worth looking at what the court decided and what it didn’t.

The “rule” of Chalker Energy

In the first year of law school they teach us to “brief” a case by outlining its facts, holding, reasoning, and rule. The “rule” is the hard part. It’s the abstract principle to be derived from the case and applied to future disputes.

The rule of Brown v. Board of Education, for example, is that the doctrine of separate but equal has no place in public school education. The rule of Texaco v. Pennzoil is that they’ll name a law school library after you if you make enough money.

So what is the Chalker Energy rule?

Before I take a stab at it, let’s understand what a No Obligation clause is. It’s a provision in an initial agreement between the parties to a contemplated business deal. It says the parties will have no legal obligation concerning the potential transaction until they sign a final written agreement.

The purpose? A No Obligation clause allows the parties to communicate freely about the terms of a deal without fear that their communications will establish a binding contract. It also provides certainty (hopefully) about whether the parties do or do not have a legally binding agreement.

With that understanding, the rule established by Chalker Energy is this:

An agreement on deal terms in written communications between the parties is not a definitive agreement contemplated by a No Obligation clause, where the communications reflect that the parties intended the agreement to be “subject to” signing a more detailed written agreement later, even if (a) the agreement is reached after the bidding process the parties agreed to has ended and (b) there is some evidence that the parties thought the emails established a binding agreement.

I realize that’s a fairly complicated “rule.” But that’s because Chalker Energy is a fairly fact-intensive opinion. You may see headlines that proclaim more broadly “Texas Supreme Court Rejects Agreements by Email” etc., but don’t believe the hype. Change one or two key facts, and the result could be different.

But which facts would make a difference?

Ah, there’s the rub. Now we have to get down in the weeds, at least a little.

The essential facts of Chalker Energy, shorn of any extraneous details

Chalker represented a group of working interest owners holding 70 oil and gas leases in the Texas Panhandle worth hundreds of millions of dollars. Chalker invited bids from potential buyers, who had to sign a Confidentiality Agreement. If a seller accepted a bid, the buyer and seller would sign a definitive purchase-and-sale agreement, or PSA.

The Confidentiality Agreement contained the following No Obligation clause:

Screen Shot 2020-02-29 at 7.54.58 PM.png

It came down to two bidders, LNO and Jones Energy. Both of them submitted bids the sellers did not accept.

The sellers then offered to sell 67% of the assets. In response, LNO sent an email with the subject line “Counter Proposal.” The email listed seven key terms, including price, a closing date, and execution of a PSA.

Then the best part of the email: “We will not be modifying or accepting any changes to the base deal described above and don’t want to be jerked around anymore.”

Oops, I promised no extraneous details.

Anyway, the sellers responded with an email stating they were “on board to deliver 67% subject to a mutually agreeable PSA. We were calling to discuss next steps and timing. Chalker et al will be turning a PSA tonight to respond to your last draft.”

Various emails ensued. One of the sellers congratulated one of LNO’s private equity investors on “winning the bid.” Jones Energy got wind of the deal and emailed a seller, saying it “heard that we lost the deal again.”

Did Jones Energy give up? Come on, this is a Texas oil and gas case about whether two parties had a binding multi-million-dollar contract. You know there’s going to be a third party who stole the deal.

Jones Energy made a new offer, the sellers accepted, and Chalker and Jones Energy signed a PSA. “That same day, unaware of what had happened, LNO’s general counsel sent Chalker a redlined PSA.”

I love that little detail too. I’ve been waiting for redlining to make an appearance in a major contract case. That’s almost as good as a discussion of fonts. Plus, you can just picture LNO’s people going ballistic after finding out Chalker had already done a deal with Jones Energy.

And when business people go ballistic, they file lawsuits.

The exciting “procedural history”

LNO sued the sellers for breach of contract, arguing that the sellers breached the agreement to sell 67% of the assets reflected in the emails.

The trial court granted summary judgment for the sellers, concluding that the parties did not intend to be bound, a PSA was a condition precedent (pre-see-dent) to contract formation, and the No Obligation clause precluded a binding contract without an executed, delivered PSA. (A condition precedent is an event that must occur before a binding contract is formed.)

The First Court of Appeals (Houston) disagreed with the trial court. It held that whether the alleged contract was subject to the bidding procedures in the Confidentiality Agreement and whether LNO and the sellers intended to be bound by the terms in the emails were fact issues, which preclude summary judgment. That meant there would have to be a trial.

The Texas Supreme Court’s reasoning

The Texas Supreme Court disagreed and reversed the Court of Appeals. The Supreme Court reasoned as follows:

  • No Obligation clauses are enforceable under freedom-of-contract principles, especially for “arms-length” negotiations between sophisticated business entities.
  • In two prior Texas Supreme Court cases cited by LNO, there were fact issues about whether a contemplated formal document was a condition precedent to contract formation, but neither case involved the kind of No Obligation clause in Chalker’s agreement.
  • The facts were more similar to WTG Gas Processing, a case where the Fourteenth Court of Appeals (also Houston) held that a No Obligation clause precluded a binding contract where the parties never signed a PSA.
  • The emails in Chalker were more akin to a preliminary agreement than a definitive agreement to sell, and the parties’ dealings suggest they intended a more formal PSA would satisfy the definitive agreement requirement.
  • LNO’s email referred to a PSA, and the sellers’ acceptance was made “subject to a mutually agreeable PSA.”
  • The court threw in one more little fact: no agreement was “executed and delivered” as required by the No Obligation clause.

The Supreme Court rejected the Court of Appeals’ reasoning that the emails set out the key provisions such as the assets, the price, and the closing date, noting there were still key agreements to be negotiated including an escrow agreement, non-compete agreement (my favorite!), and a joint operating agreement.

The Supreme Court also rejected the Court of Appeals’ reliance on evidence that some of sellers thought they had a deal:

  • Chalker declared the group was “committed to sell”
  • One seller sent a congratulatory message to LNO
  • Chalker referred to assets as “what is being sold to LNO”
  • Several sellers testified that they intended to sell the assets to LNO as of the date of the email

Pish posh. The Supreme Court said these “one-off musings” of a few sellers out of 18 owners “could be construed many ways” and could not create a fact issue in light of the unambiguous No Obligation clause.

“If mere proposals that contemplate a later-executed PSA and the subsequent exchanging of unagreed-to drafts are sufficient to raise a fact question on the existence of a definitive agreement,” the court said, “No Obligation Clauses will be stripped of much of their meaning and utility.”

The court also rejected the argument that the sellers waived the condition precedent created by the No Obligation clause.

I gather from all this that the Chalker Energy decision rested on two key facts: (1) the preliminary agreement had an unambiguous No Obligation clause requiring a definitive agreement, and (2) the emails LNO relied on made it clear the deal was “subject to” a PSA the parties intended to sign later.

In short, when the parties agree to a No Obligation clause and it’s undisputed they intended to sign a more detailed agreement later, you don’t have a definitive agreement, even if the parties exchange written communications stating agreement on key terms.

That’s the Chalker Energy rule in a nutshell.

What Chalker Energy did not address

But how far does the Chalker Energy rule go?

Let’s change the facts a little. Suppose the emails didn’t reference a later PSA. Let’s even suppose the offer email stated “your acceptance of this offer by reply email will create a legally binding definitive agreement between us,” and the reply email simply stated “we accept.”

That would be a definitive agreement, right? The Chalker Energy rule wouldn’t apply. The condition precedent in the No Obligation clause would be satisfied.

But hold on. There’s a problem. Some of you might remember something else the No Obligation clause said. It didn’t just require a definitive agreement; it required an “executed and delivered” definitive agreement. (Executed is a fancy legal word for signed.)

Can an exchange of emails regarding key terms be an “executed and delivered” agreement?

We don’t know yet. Like I said, the Texas Supreme Court’s Chalker Energy opinion is not really about the brave new world of emails.

So did the opinion promise more than it delivered? Hecht, yes!

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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. Follow @zachwolfelaw on Instagram to keep up with his latest shenanigans.

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.

 

When Is a Forfeiture Clause a Non-Compete?

When Is a Forfeiture Clause a Non-Compete?

Sometimes a Texas non-compete will take the form of forfeiture clause rather than an express prohibition on competing. For example, let’s say a company awards equity ownership to a valued employee, with a clause stating that the employee will forfeit that ownership if he competes. Is that a non-compete? And does it matter whether a court classifies it as a non-compete or something else?

*Disclaimer: This is an issue in a case I’m currently litigating. I said it once before, but it bears repeating: everything in this post is just my personal opinion, not the opinion of my firm or clients. Although in this case, my personal opinion aligns with my client’s position pretty well, so it’s not a big deal.

In my opinion, the answers should be yes, the agreement is a non-compete and no, it does not ultimately matter because either way, the scope of the clause must be reasonable.

But the issue is open to debate, and there are several plausible answers under current Texas case law:

A. The forfeiture clause functions as a non-compete and therefore must meet the requirements of the non-compete statute.

B. The forfeiture clause is not a non-compete because it doesn’t actually prohibit the employee from competing; it just says the employee will forfeit some benefit if he competes.

C. Whether the forfeiture clause is a non-compete depends on the nature of the incentive plan; if it is a non-contributory profit-sharing plan, it probably isn’t a non-compete, but if the employee owns vested shares in the company, it probably is a non-compete.

D. Regardless of whether the forfeiture clause is a non-compete, it must be reasonable to be enforceable.

The bottom line is that the answer is unclear.

So for Texas lawyers who draft non-competes for employers, there are two things to remember. First, putting the non-compete in the form of a forfeiture clause won’t necessarily avoid the requirements of the non-compete statute. Second, regardless of what you call it, a Texas court probably will not enforce a forfeiture clause that functions as an unreasonably broad non-compete. So you might as well make the scope of the discouraged competition reasonable.

If that’s all you need to know, you can skip the rest. If you want to understand why, keep it tuned right here.

Conflicting Cases?

The trouble is that we have two Texas Supreme Court opinions that cut in different directions on this issue.

In Peat Marwick Main & Co. v. Haass, 818 S.W.2d 381, 385 (Tex. 1991), the court held that an agreement that does not expressly prohibit competition but imposes a financial penalty for competition is subject to the requirements of the non-compete statute.

But in Exxon Mobil Corp. v. Drennen, 452 S.W.3d 319, 329 (Tex. 2014), the court said that a forfeiture clause in an employee’s non-contributory profit-sharing plan is not a “covenant not to compete,” reasoning that it does not restrict the employee’s future employment but only makes the employee choose between keeping the profit-sharing and working for a competitor.

There are several plausible ways to interpret these apparently contradictory holdings:

  1. Drennen implicitly overruled Haass, establishing a broad rule that places form over substance by simply asking whether the agreement expressly prohibits competition.
  2. Drennen established a narrow exception to Haass for forfeiture of unvested shares that had been awarded but not yet delivered pursuant to a non-contributory profit-sharing plan; it does not apply to forfeiture of vested shares the employee already owns.
  3. Drennen and Haass can be reconciled based on some other distinguishing factor.
  4. It ultimately doesn’t matter whether Drennen conflicts with Haass, because regardless of whether you call a forfeiture clause a non-compete or not, it still must be reasonable in scope.

In my opinion, no. 1 is the worst interpretation, nos. 2 and 3 are reasonable, and no. 4 is the simplest and best way to reconcile the cases. To understand why, let’s dig into these two cases and see how Texas courts have applied them.

Haass said a clause that functions as a non-compete should be treated as a non-compete

Haass involved an agreement between an accounting firm and one of its partners, Haass. The agreement had a liquidated damages clause requiring Haass to compensate the firm if he withdrew and took clients with him. Id. at 383. Haass left, opened his own firm, and clients followed. Id. at 384. The firm argued that the damages clause was not a non-compete, while Haass contended it operated as a non-compete and therefore had to be reasonable. Id.

The court agreed with Haass that the damages clause was effectively a non-compete. Writing for a 7-2 majority, Justice Gammage acknowledged that the damages clause did not expressly prohibit Haass from providing accounting services to clients of the firm. Rather, the clause provided that if Haas did compete, he had to pay the liquidated damages. Id. at 385.

Surveying case law from other jurisdictions, the Haass court said:

Most courts have analyzed such provisions as restraints on trade sufficiently similar to covenants not to compete to be governed by the same general reasonableness principles in order to be enforceable. Even those courts that have declined to treat such damages provisions as restraints on trade have required them to be reasonable to be enforced.

Id. (internal citations omitted). Noting that the reasonableness test in either case was essentially the same, the court concluded that “the view adopted by most courts, that such covenants should be subject to the same standards as covenants not to compete, is the correct one.” Id.

Haass cited two additional reasons for treating a damages clause as a non-compete. First, the court reasoned that “[i]f the damages provided are sufficiently severe, then the economic penalty’s deterrent effect functions as a covenant not to compete as surely as if the agreement expressly stated that the departing member will not compete.” Id. at 385. “The practical and economic reality of such a provision,” the court said, “is that it inhibits competition virtually the same as a covenant not to compete.” Id. at 385-86.

Second, Haass said treating the damages provision as a non-compete was consistent with the court’s prior cases. Id. at 386 (citing Henshaw v. Kroenecke, 656 S.W.2d 416 (Tex. 1983), and Frankiewicz v. National Comp Associates, 633 S.W.2d 505 (Tex. 1982)).

Applying the reasonableness standard for non-competes, the Haass court went on to hold that the damages clause was overbroad and unenforceable because it imposed an industry-wide exclusion.

Haass established two broad common-sense principles:

First, a contractual provision that does not expressly prohibit competition can still be a non-compete if it imposes a significant financial penalty for competing. The “practical and economic reality” of the clause is more important than the label.

Second, regardless of whether a contractual penalty is classified as a non-compete, it must meet the same reasonableness requirements as a non-compete to be enforced.

Following Haass, Texas courts treated forfeiture clauses as non-competes regardless of how the clauses were worded or labeled.

For example, in Valley Diagnostic Clinic, P.A. v. Dougherty, 287 S.W.3d 151 (Tex. App.—Corpus Christi 2009, no pet.), the forfeiture clause expressly stated that it was not a covenant not to compete, but the court was not persuaded. “Although the provision at issue here is a forfeiture clause and expressly states that it is not a covenant not to compete,” the court said, “the Texas Supreme Court has analyzed such clauses in the same manner as covenants not to compete because they share the same objective—to restrain a former employee from competing against the employer.” Id. at 155.

Drennen said a forfeiture clause triggered by the employee competing is not a non-compete

But then the Texas Supreme Court muddied the waters in Exxon Mobil v. Drennen, 452 S.W.3d 319 (Tex. 2014).

Drennen was an ExxonMobil VP who received restricted stock subject to the terms of an incentive program. Id. at 322. The agreements included both a New York choice-of-law clause and a forfeiture clause allowing ExxonMobil to terminate outstanding stock awards if the employee engaged in “detrimental activity,” which included becoming employed by a competitor. Id.

When Drennen left ExxonMobil and went to work for Hess, another large energy company, ExxonMobil cancelled Drennen’s outstanding restricted stock awards based on his employment by a competitor. Id. at 323. Drennen sued for a declaratory judgment that (1) the detrimental activity clause was a non-compete, (2) the non-compete was unenforceable because it was not limited in time, geographic area, or scope of activity, and (3) therefore ExxonMobil’s purported cancellation of the restricted shares was invalid. Id.

The Houston Court of Appeals held that the forfeiture provision was an unreasonable and unenforceable non-compete and refused to apply New York law because the result would be against fundamental Texas policy. Id.

The Texas Supreme Court disagreed and reversed. The court viewed the forfeiture clause as similar to the provision at issue in Haass. But the court did not interpret Haass as holding that a forfeiture clause is a non-compete. “While we ultimately determined that the provision in Haass was an unreasonable restraint of trade,” the Drennen court said, “we never concluded that the damage provision was, itself, a covenant not to compete.” Id. at 329.

Let’s pause on that point. Drennen’s interpretation of Haass is strained at best. The Haass opinion expressly stated that a forfeiture clause should be judged by the same reasonableness standard as a non-compete and then applied that standard to the forfeiture clause at issue. Haass, 452 S.W.3d at 385-87. The reasoning of Haass was that a forfeiture clause that functions as a non-compete should be treated as a non-compete. For Drennen to say that Haass never actually held that a forfeiture clause is a non-compete seems like an academic distinction.

But that was not the worst part. Drennen went on to say the following:

There is a distinction between a covenant not to compete and a forfeiture provision in a non-contributory profit-sharing plan because such plans do not restrict the employee’s right to future employment; rather, these plans force the employee to choose between competing with the former employer without restraint from the former employer and accepting benefits of the retirement plan to which the employee contributed nothing. See Dollgener v. Robertson Fleet Servs., Inc., 527 S.W.2d 277, 278–80 (Tex. Civ. App.—Waco 1975, writ ref’d n.r.e.). Whatever it may mean to be a covenant not to compete under Texas law, forfeiture clauses in non-contributory profit-sharing plans, like the detrimental-activity provisions in ExxonMobil’s Incentive Programs, clearly are not covenants not to compete.

Id. at 329 (emphasis added).

This sort of thing bothers me. The court pretends the issue is easy, cites one Waco case from 1975, and then gets the answer wrong.

In my view, a forfeiture clause conditioned on the employee competing is obviously a non-compete and should be treated as such. But even if I’m wrong, the Drennen court at least should have acknowledged there is a reasonable disagreement on the issue. Heck, three justices on the Court of Appeals ruled the other way, citing Haass in support of holding that the forfeiture clause was a non-compete. Is Drennen saying they’re just morons?

My beef is not so much with the result. It’s the way Drennen gets there. The court could have acknowledged that there are two reasonable arguments, discussed both sides of the issue, and then explained which argument it found more persuasive and why.

Instead, Drennen simply made the statement quoted above and then said “we hold that, under Texas law, this provision is not a covenant not to compete.” Id. 329.

But to the court’s credit, it added this important qualification: “Whether such provisions in non-contributory employee incentive programs are unreasonable restraints of trade under Texas law, such that they are unenforceable, is a separate question and one which we reserve for another day.” Id.

That statement is important because it acknowledges that a forfeiture clause, even if it is not a non-compete, may still be an unenforceable restraint of trade. Keep in mind, section 15.05 of the Texas Business and Commerce Code provides that all contracts in restraint of trade or commerce are unlawful. The Texas non-compete statute provides an exception to that rule for non-competes that meet the requirements of the statute.

So, Drennen leaves open the argument that, even if a forfeiture clause is not a non-compete, an unreasonably broad forfeiture clause is an unenforceable restraint of trade.

Buc-ee’s follows Haass and interprets Drennen narrowly

Drennen also leaves open the argument that a clause requiring forfeiture of vested shares the employee already owns is a non-compete subject to the requirements of the non-compete statute.

This distinction finds support in the one case Drennen cited for the distinction between a forfeiture clause and a non-compete, Dollgener v. Robertson Fleet Services, Inc., 527 S.W.2d 277 (Tex. App.—Waco 1975, writ ref’d n.r.e.).

Dollgener, decided long before enactment of the non-compete statute, held that a forfeiture provision in a noncontributory profit-sharing trust was not a covenant not to compete. Id. at 278-80. Thus, like Drennen, Dollgener did not involve forfeiture of vested shares the employee had already earned.

The Houston Court of Appeals recently applied this very distinction in Rieves v. Buc-ee’s, Ltd., 532 S.W.3d 845 (Tex. App.—Houston [14th Dist.] 2017, no pet.), a case I wrote about here. The court held that an agreement that imposes a severe economic penalty on an at-will employee for quitting must meet the reasonableness requirements for non-competes, even if the agreement does not expressly prohibit competition. Id. at 851. Quoting Haass, the Buc-ee’s court reasoned that the “practical and economic reality” of such a contractual penalty is that it inhibits employee mobility in virtually the same manner as a non-compete. Id.

The employer in Buc-ee’s cited Drennen for the proposition that a forfeiture provision is not a non-compete, but the Court of Appeals rejected this argument. Characterizing Drennen as a “choice-of-law case,” the Buc-ee’s court distinguished Drennen as involving “cancellation of future payments of unvested stock options that had been awarded but not delivered to Drennen, an ExxonMobil vice president, under a non-contributory profit-sharing plan.” Buc-ee’s, 532 S.W.3d at 852. One critical distinction was that “Drennen did not involve ExxonMobil seeking the return of Drennen’s salary or any stock options that had already vested.” Id. (emphasis added).

So, Buc-ee’s also supports the argument that Drennen does not apply to a contract requiring forfeiture of vested shares the employee already owns. This is interpretation no. 2 outlined above. It reconciles Haass and Drennen based on whether the forfeiture involves equity ownership interests that have already vested.

Is this the right way to reconcile Haass and Drennen? As a practical matter, we won’t know the answer until the Texas Supreme Court addresses the issue. When it is unclear whether two cases conflict or can be reconciled based on some distinguishing factor, the answer really depends on how the third case treats them. And we don’t have that case yet.

But we don’t need that third case to know that regardless of whether a forfeiture clause is classified as a non-compete or not, it must be reasonable. An unreasonably broad forfeiture clause would be an unenforceable restraint of trade. Haass and Drennen seem to agree on that point.

So, if an employer wants to use a forfeiture clause to discourage employees from competing, the lawyer who drafts the agreements should at least include reasonable limitations on the scope of competition that triggers the forfeiture. The safer course is to assume the clause will be treated like a non-compete, and to include reasonable limitations on time, geographic area, and scope of activity restrained.

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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. Follow @zachwolfelaw on Instagram to keep up with his latest shenanigans.

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.

 

 

Let’s Roll: Do’s and Don’ts for Texas Trade Secrets Injunctions

Let’s Roll: Do’s and Don’ts for Texas Trade Secrets Injunctions

Recent case offers lessons on how to get (or avoid) a trade secrets injunction in Texas

When I say “drywall installation,” I’m guessing “trade secrets” is not the first thing that pops into your mind. Personally, I think of John Goodman’s character Dan Conner from the TV show Roseanne.

But a recent opinion from a federal district court in Dallas may change that. See Marek Brother Systems, Inc. v. Enriquez, No. 3:19-CV-01082, 2019 WL 3322162 (N.D. Tex. July 24, 2019).

Marek Brother Systems offered commercial and residential construction services, including ceilings, “acoustical solutions,” flooring, and paint. Juan Enriquez was a Marek project manager. Id. at *1. It does not appear that Enriquez signed any non-compete.

Enriquez did two typical things before resigning from Marek to run his own business. First, he formed an LLC, JP Acoustics and Drywall. Second, he sent a Marek customer list to his personal email address.

Let’s pause here for just a moment. Neither one of these things is necessarily wrongful, but both are a bad idea.

Under Texas law, it is not a breach of an employee’s limited fiduciary duty to make plans to compete with his employer. This can even include forming the entity the employee plans to use to compete. See Fiduciary Duty Lite: What Employees Can and Can’t Do Before Leaving.

But employees, why would you want to do this? Forming an LLC is relatively quick and easy. You can do it the day after you resign, and that’s one less thing for the employer to complain about.

Likewise, sending a company customer list to your personal email address is not necessarily wrong. In most businesses, it’s not unusual for employees to email or transfer company documents to their personal devices or accounts for work at home or on the road. This often happens, even when the company prohibits such personal use on paper. So, if a salesman emails himself an open orders list every week, it’s less suspicious if he does so the week before leaving, and if everybody at the company knows employees sometimes do this.

But again, unless you’re certain you will stay with the company until retirement, why would you do this? You should keep in mind Wolfe’s First Law of Trade Secrets Litigation: whatever company information the employee takes on the way out the door will be the alleged “trade secrets” in the company’s subsequent lawsuit.

Enriquez’s third mistake was naming the company “JP Acoustics and Drywall.” I would have called it “JP Drywall . . .” An “acoustics” company sounds like it has trade secrets; a “drywall” company doesn’t.

But let’s get back to the legal issues. Marek claimed that Enriquez’s email included confidential contact information for Marek’s customers and “proprietary notes” about the customers. Id. at *1. One of Marek’s customers was Muckleroy and Falls, id. at *1, which sounds like a business in a Frank Capra movie. Both Marek and JP Acoustics did work for Muckleroy and Falls after Enriquez left Marek. Id. at *4.

Marek claimed that Enriquez was using Marek’s confidential information to advance his business. Id. at *1. Marek sued Enriquez and JP Acoustics, claiming misappropriation of trade secrets, as well as breach of fiduciary duty, tortious interference with contract, and violation of the Computer Fraud and Abuse Act. Marek asked for an injunction to stop the defendants from doing business with any company that was a customer of Marek during the 12 months before Enriquez resigned. Id. at *2.

Marek claimed it spent years accumulating the customer information, and that it made diligent efforts to ensure the secrecy of its customer information, including restricted access to facilities, computer passwords, and disclosure to employees only on a “need to know” basis. Id. at *4.

The defendants responded that the customer information was readily available online or in the Yellow Pages. Id.

So was Marek entitled to a trade secrets injunction?

Let’s pause again to note that this is about as plain-vanilla a soft trade secrets case as you are going to find. You could have said to me “drywall manager leaves company, company files trade secrets suit,” and I could have guessed the essential facts (except maybe the name of the customer). So the outcome of the case may tell us something about how courts deal with typical customer list cases.

The federal district court judge said no, Marek was not entitled to an injunction.[1] First, the court said that the claims for breach of fiduciary duty and violation of the Computer Fraud and Abuse Act were based on conduct that occurred before termination of employment, any resulting damage was “readily quantifiable,” and therefore there was no threatened irreparable harm. Id. at *3. For the authoritative explanation of these concepts, see Injunction Junction, What’s Your Function?

Then the court turned to the claims of trade secrets misappropriation and tortious interference with contract. Illustrating Wolfe’s First Law, Marek claimed that its trade secrets were the customer information Enriquez emailed to himself.

But the court was not persuaded. It started by quoting the Trilogy Software case:

“[I]nformation that a firm compiles regarding its customers may enjoy trade secret status under Texas law.” Trilogy Software, Inc. v. Callidus Software, Inc., 143 S.W.3d 452, 466 (Tex. App.—Austin 2004, pet. denied) (citations omitted). “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.” Id. at 467. “Before any information can be a trade secret, there must be a substantial element of secrecy.” Id. (citation omitted). Secrecy requires that the information “is not generally known or readily ascertainable by independent investigation.” Id. (citations and quotation marks omitted). “It is the burden of the party claiming secrecy status to prove secrecy.” Id. (citations omitted).

If this sounds familiar, it might be because I discussed this case in my post When is a Customer List a Trade Secret?

Marek failed to persuade the court that the customer information was not “readily ascertainable.” The court cited several things missing from Marek’s case:

  • Marek did not provide the court with the email attachments containing the alleged trade secrets.
  • Marek did not describe the nature of the “proprietary notes” or why they should be considered proprietary information.
  • Marek did not offer specific facts to support its allegation that it “spent years accumulating” the customer contact information.

Id. at *4.

Maybe Marek should have seen it coming. The same judge had denied a TRO two months earlier in Computer Sciences Corp. v. Tata Consultancy Servs. Ltd., No. 3:19-cv-970-L, 2019 WL 2058772, at *3-4 (N.D. Tex. May 9, 2019), finding there was no evidence the emailed confidential software source code was actually shared with software developers.

But let’s not be too quick to fault Marek’s counsel. The deficiencies in Marek’s evidence seem obvious, but maybe the email attachments were not that helpful to Marek’s case. Perhaps the proprietary notes were not that proprietary. Perchance there were no more specific facts to be offered. Or maybe there was just not enough time to get the evidence needed.

And even if Marek had proven the customer information was a trade secret, there was another big hole in Marek’s evidence: proof of some nexus between the use of the alleged trade secrets and loss of sales to customers. (Picture Marek saying “Causation!” the way Jerry Seinfeld says “Newman!”)

The court said Marek did not allege that Defendants outbid Marek for any particular job or otherwise took Muckleroy and Falls business from Marek. Rather, both parties were servicing Muckleroy and Falls “to neither’s detriment and without direct competition.” In the absence of evidence that the defendants were injuring Marek’s business relationship with the customer, the court said, it could not find that Marek was substantially likely to suffer an irreparable injury due to the defendants’ contact with the customer. Id. at *4.

Injunction denied.

Nevertheless, the story had a happy ending. The parties later signed this Agreed Injunction that barred Enriquez and JP Acoustics from initiating new business with a list of specified customers.

And the Marek case provides lessons for both employees and employers in trade secrets cases.

Employees:

  • DON’T form an LLC for your future competing business any sooner than you really need to.
  • DON’T send company documents to personal devices or email accounts, even for valid reasons.
  • DON’T take customer lists when you leave. Is it really that hard to find the customers? (If so, the list might actually be a trade secret.)
  • If you take a customer list, DO show that the information in it is readily ascertainable.
  • If you do something you shouldn’t have before leaving, DO argue that it can be compensated with damages, so no injunction is warranted.
  • DO watch my video Dumb Things Employees Do Before Leaving a Company for similar tips in convenient audiovisual form.

Employers:

  • DO offer the misappropriated confidential documents as evidence, under seal if necessary.
  • DO specifically explain why the customer information is valuable and not readily ascertainable.
  • DO try to offer evidence that the employee has actually used the confidential information to take specific customer business from you (I know, this is often easier said than done).
  • DON’T expect to get an injunction merely because an employee has taken confidential company documents.
  • DO watch my video Smart Things Companies Can Do to Protect Confidential Information.

Finally, whether you’re an employee or employer, do get advice from a lawyer as early as possible, preferably one with experience handling departing employee disputes. That might help you avoid the common mistakes above. In the words of another John Goodman character, “Donny you’re out of your element!”

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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. Follow @zachwolfelaw on Instagram to keep up with his latest shenanigans.

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] To be precise, the court construed the motion for preliminary injunction as a motion for temporary restraining order, denied a TRO, and set a hearing on a preliminary injunction.

Does the Amended TCPA Still Apply to Departing Employee Lawsuits?

Does the Amended TCPA Still Apply to Departing Employee Lawsuits?

I know what you did last summer

They say that breaking up is like knocking over a coke machine. It’s just not going to happen on the first push. This is also true of my attempt to break up with the Texas Citizens Participation Act, or “TCPA.”

A quick recap: I fell in love with the TCPA when Texas courts started applying its broad definitions so broadly that you could file a motion to dismiss in just about any kind of lawsuit, as long as the claims had something to do with a “product or service in the marketplace.” That included departing employee lawsuits, the focus of my practice.

I’ll admit, it was a toxic relationship, one the Texas legislature probably never intended.

Then the backlash came. The Texas legislature, the Fifth Circuit Court of Appeals, and the Dallas Court of Appeals conspired to sabotage our relationship. See Turn Out the Lights, the Party’s Over: Texas Legislature Takes All the Fun Out of the TCPA.

The legislature dealt the cruelest blow. Last summer it amended the TCPA to carve out most claims based on non-competes and trade secrets. See Tex. Bus. & Com. Code § 27.010(a)(5).

Like a meddling parent, the legislature was determined to keep me and the TCPA apart. How am I supposed to file a TCPA motion to dismiss a departing employee lawsuit if the statute doesn’t apply to non-compete and trade secrets claims anymore? That’s my bread and butter.

Keep hope alive

But wait. There is hope. Breach of non-compete and misappropriation of trade secrets are not the only claims made in departing employee lawsuits. As I explained in my viral YouTube video What Are the Key Legal Issues in a Departing Employee Lawsuit?, breach of fiduciary duty is another common claim when an employee leaves a company to work for a competitor.

Does an employee really owe an employer a fiduciary duty, the highest common-law duty known to man? Well, sort of. For a brief explanation, see Fiduciary Duty Lite: What Employees Can and Can’t Do Before Leaving.

The typical theory in a departing employee lawsuit is that the employee, while still on the company’s payroll, schemed with others to compete with the company. If the employee crosses the line into actually competing with her employer, that can be a breach of the employee’s limited “fiduciary” duty to the employer.

There’s no exemption in the amended TCPA for claims of breach of fiduciary duty, and Texas courts have applied the statute to such claims. See, e.g., O’Hern v. Mughrabi, 579 S.W.3d 594, 603-4 (Tex. App.–Houston [14th Dist.] 2019, no pet. h.) (TCPA applied to suit making single claim of breach of fiduciary duty); Elite Auto Body LLC v. Autocraft Bodywerks, Inc., 520 S.W.3d 191, 194, 205 (Tex. App.–Austin 2017, pet. dism’d) (TCPA applied to claims against former employees including breach of fiduciary duty).

So if you’re on the defense side of a departing employee lawsuit, you may not be able to file a TCPA motion to dismiss the non-compete and trade secret claims, but you could still file a TCPA motion to dismiss the breach of fiduciary duty claim. And even if that motion is denied, you get an interlocutory appeal.

This is especially important when the employee doesn’t have a non-compete. Proving that the employer’s information was a trade secret can be difficult, so in cases without a non-compete, breach of fiduciary duty is sometimes the employer’s strongest theory.

Hey, I just met you

Still, my loyal Fivers know that carving out non-compete and trade secrets claims was not the only change the legislature made to the TCPA last summer. The legislature also changed the definition of “matter of public concern.”

The previous definition of “matter of public concern” was the match that lit the prairie fire that swept across Texas litigation. That definition covered communications about a product or service in the marketplace, which meant just about any kind of lawsuit.

But House Bill 2730 reigned in that broad definition, making these changes:

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Screen Shot 2019-11-03 at 2.48.46 PM.png

Is this new definition of “matter of public concern” broader or narrower?

Before, the definition included an issue related to a product or service in the marketplace. That prong of the definition covered a potentially wide range of lawsuits, but its language was fairly specific.

The new definition, in contrast, is vague to the point of being tautological. The statute now effectively defines “matter of public concern” to include “a subject of concern to the public.” Wow, thanks for that clarification, Texas legislature.

So does a claim for breach of a former employee’s breach of fiduciary fall under the new definition of matter of public concern?

And this is crazy

Here’s the argument that it applies. Let’s say a salesman decides he’s not happy with his job. He starts talking with some co-workers, or maybe with a competitor, about leaving the company and forming a new venture that will compete for the company’s customers. Then he starts talking to his customers about it. Maybe he even tells his customers to delay their orders until after he leaves.

Arguably, those communications are about competition in the salesman’s industry, which is a matter of interest to the community and a subject of concern to the public. So if the employer claims breach of fiduciary duty based on these communications, you could argue the TCPA applies.

The counter-argument says this is just too much. If “matter of public concern” is construed to include competition between two private companies, one could argue, then the TCPA would still apply to almost everything. That can’t be what the legislature intended.

That’s essentially what the Dallas Court of Appeals said about the previous version of the TCPA. In a series of decisions, the Dallas court reigned in the scope of the TCPA by holding that communications between private parties about doing business are not matters of public concern, despite the broad “product or service in the marketplace” language that was in the statute. The Fort Worth Court of Appeals took a similar view. See Metroplex Courts Push Back on Broad Application of TCPA.

It’s a safe bet those courts will take the same approach to the TCPA’s new definition of a matter of public concern. They are likely to reject the argument that an employee’s communications about competing with his private employer are a subject of concern to the public just because there is a general public interest in free competition.

But other courts may be more receptive to the argument. The Austin Court of Appeals and the Houston Court of Appeals took more of a “plain meaning” approach to the earlier version of the TCPA. That’s how the TCPA got applied to non-compete and trade secrets claims in the first place. See A SLAPP in the Face to Texas Trade Secrets Lawsuits.

So call me maybe

If you take a similar plain meaning approach to the new definition of matter of public concern, there is at least a reasonable argument that the definition applies to communications about competing with an employer. So, if an employer sues a former employee for breach of fiduciary duty based on the employee’s alleged scheme to compete with the employer, the employee should at least consider filing a motion to dismiss the claim under the TCPA.

I’ve prepared a sample motion that does just that.

*MASSIVE LAWYER DISCLAIMER: Every case is different, and this sample motion is just an idea for Texas litigators to consider; I’m not necessarily endorsing it, and non-lawyers should consult with qualified counsel about these issues.

Keep in mind, the plaintiff can defeat the TCPA motion by offering evidence that the employee owed a fiduciary duty, the employee breached the duty, and the breached caused damages.

But that can be a real hurdle for the employer. Whether the alleged conduct of the employee constitutes a breach may present a legal question for the judge. And even when there is evidence of a breach, it is sometimes difficult for the employer to show the breach caused actual compensable damages. (Another lurking issue is that the fiduciary duty claim may be preempted by the trade secrets statute, but I’ll save that for the “advanced” course.)

Bottom line: filing a TCPA motion to dismiss a breach of fiduciary duty claim in a departing employee lawsuit will sometimes be a good strategy for the defense.

Some will think it crazy to apply the TCPA to a claim against an employee for breach of fiduciary duty. But is it any crazier than the cases that applied the earlier version of the TCPA to departing employee litigation? As discussed above, the new definition of matter of public concern is arguably just as broad as the old definition.

Plus, this may shock you, but sometimes employers use contrived claims of breach of fiduciary duty to try to punish or bully employees who exercise their right to leave the company and compete freely. Isn’t that the kind of claim the TCPA is supposed to prevent?

If so, maybe I’m not so crazy to consider getting back together with the TCPA. The statute promised me it has changed its ways, so maybe I’ll give it one more chance before I finally tip over that coke machine.

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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. Follow @zachwolfelaw on Instagram to keep up with his latest shenanigans.

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.

 

Jurassic Non-Competes

Jurassic Non-Competes

Do Ancient Cases Hold the Secrets to Understanding Present-Day Texas Non-Compete Law?

“Non-compete abuse” is a hot topic. The press says some employers now require even rank-and-file employees to sign non-competes. The Jimmy Johns case was perhaps the low point. You’re going to make sandwich makers sign non-competes. Really? Are they going to run off with the secret bread-slicing techniques? Misappropriate goodwill from Jimmy Johns and take it to Quiznos?

Here’s another case I recently read about that just goes too far. The Patterson Institute, a small music school in Hillsboro, Texas, hired young Bill Crabb to teach piano, organ, violin, mandolin, and banjo, as well as music theory, harmony, and history. Crabb signed a 10-month employment contract, which included a non-compete barring him from teaching music in Hillsboro if he quit the job.

Then tension developed between Crabb and the Institute’s senior music teacher, Mary Rice. Crabb quit and opened a small music school of his own in Hillsboro. The Patterson Institute filed suit and obtained a temporary injunction, but the trial court dissolved the injunction after a trial.

The Court of Appeals reversed, holding that the statute prohibiting restraints of trade did not apply. The court reasoned that it would be inequitable for Crabb to teach at an independent school in Hillsboro, that the statute did not bar the restrictive covenant, and that the Institute was entitled to an injunction. The court cited Gates v. Hooper, in which the Texas Supreme Court held that a non-compete in the sale of a business was not an illegal restraint of trade.

But enforcing a non-compete against a small-town music teacher? This is just too much. The Texas legislature should do something about this kind of non-compete abuse.

Unfortunately, it’s too late for Mr. Crabb. You see, his case was decided in 1899. See Patterson v. Crabb, 51 S.W. 870, 871-72 (Tex. Civ. App. 1899).

But his case is a good reminder that non-competes have been around for a long time. By comparison, the Texas non-compete statute is relatively young. It just celebrated its 30th birthday in September.

I’ll confess that, even as a lawyer who has read a lot of Texas non-compete cases, I usually don’t pay attention to case law that predates the 1989 statute. But the statute was largely intended to codify Texas common law on non-competes (or at least parts of it). So, many of the issues found in older cases are still relevant.

Here’s a chronological sampling of some principles in older Texas non-compete cases that still apply today.

1. Texas courts generally favor non-competes in the sale of a business.

Gates v. Hooper, 39 S.W. 1079, 1080 (Tex. 1897), was the case cited in Patterson v. Crabb. It’s the oldest Texas non-compete case I have found so far. (If you find an older one please email me.) You can tell it’s an old case because the opinion is short but the paragraphs long.

This was the Gilded Age when monopolistic “trusts” were a major concern. But the court in Gates upheld a one-year non-compete in a contract for the sale of a mercantile business in Batesville. The court held that the non-compete was not a prohibited “trust” or “combination” because the transaction did not combine the capital, skill, or acts of the parties into any kind of “union, association, or co-operative action.” Id. at 1080-81.

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That was it. Nothing about reasonableness. But it set a precedent favoring non-competes in the sale of a business.

2. Non-competes are uniquely and primarily about protecting goodwill.

The two most common justifications for non-competes are (1) protecting a company’s goodwill and (2) protecting a company’s confidential information.

Reading between the lines, we can imagine both issues were present in Patterson v. Crabb. The opinion is pretty thin on reasoning, but we can assume the Patterson Institute established goodwill with its customers, i.e. its students. We can also assume that Mr. Crabb knew the students, knew the tuition they were paying, and could use that knowledge to set his own school’s tuition just low enough to “undercut” the Institute.

But there’s a fundamental difference between these two interests. There are multiple areas of law that protect an employer’s confidential information. See The Matrix: Making Sense of the Patchwork of Employee Confidentiality Duties.

In contrast, there is really only one legal mechanism to protect goodwill: a non-compete.

And a non-compete always has two fundamental problems. First, it hurts customers. If Mr. Crabb can’t teach music in Hillsboro, the students in Hillsboro may have only one place to go. Second, a non-compete can prevent someone from making a living doing the thing they do best. It doesn’t seem right to force Mr. Crabb to either move out of Hillsboro or change careers.

3. Non-competes should not restrain the right to earn a living.

These problems are not new. Over a hundred years ago, in Miller v. Chicago Portrait Co., 195 S.W. 619 (Tex. Civ. App.—San Antonio 1917, writ ref’d), Mr. Miller signed an employment contract with Chicago Portrait Company, which was in the business of enlarging photographs into portraits. The contract contained a one-year non-compete. Id. at 619.

The Court of Appeals reversed an injunction issued by the trial court. As to confidentiality, the court noted there was “no evidence of trade secrets connected with inducing people to have their photographs magnified into portraits and placed in expensive frames.” Id. at 620.

As to goodwill, the court distinguished between a contract for the purchase of a business and an employment contract, citing an employee’s interest in earning a living:

Courts will not favor contracts that would drive a man out of Texas to seek occupation in a business, with which he is perhaps better acquainted than any other, or put him in another business for which he is not trained or suited. This is a different case from the sale of a business induced by a contract not to engage in a similar business in a named locality in a specified time. The contract in this case is aimed at the right to obtain employment in a similar business. It is an attempt to restrain the right to earn a living.

Id. at 621.

So yes, there is a legitimate interest in protecting goodwill, but that interest must be weighed against an employee’s right to earn a living (and to stay in Texas), especially where no real trade secrets are involved.

Today, the Texas non-compete statute does not expressly refer to the employee’s interest in making a living, but that interest is embedded in the statute’s key concept: reasonableness.

4. Reasonableness is the key to non-compete law.

Given the competing interests at stake in any non-compete dispute, the fuzzy standard of “reasonableness” is critical.

The idea of measuring the enforceability of a non-compete by its reasonableness made an early appearance in Texas law in Randolph v. Graham, 254 S.W. 402 (Tex. App.—San Antonio 1923, writ ref’d). In that case, Dr. Randolph sold his medical practice to Dr. Graham, who agreed not to practice medicine within a 20-mile radius of Schertz, Texas. Id. at 402.

The Court of Appeals affirmed the trial court’s temporary restraining order enforcing the non-compete. The court first cited the policy in favor of enforcing non-competes tied to the sale of a business, reasoning that “professional men” or “skilled artisans” ought to be able to sell the goodwill of their businesses, and invoking “liberty and freedom of contract.” Id. at 402-3.

But the court implicitly recognized the limits of freedom to contract by then addressing the reasonableness of the restriction. The court cited cases from other jurisdictions holding that a contract in restraint of trade is unreasonable and void when it is unlimited in time and space. While the non-compete at issue was unlimited in time, it was limited to the Schertz area, and the court found that limitation sufficient to make the non-compete reasonable and enforceable. Id. at 403-4.

This would not be the last time that parties argued about whether the scope of a Texas non-compete was reasonable.

5. Reasonableness means a non-compete injunction should do no more than necessary to protect the goodwill the employee developed for the company.

By 1925, the essential elements of early Texas non-compete law came into focus, as illustrated by City Ice Delivery Co. v. Evans, 275 S.W. 87 (Tex. Civ. App.—Dallas 1925, no writ).

That case involved an employment contract between a driver and an ice delivery business in Dallas. The business divided its territory into districts, assigning each district to an employee. The contract prohibited the driver, Mr. Evans, from engaging in the ice business within the territory covered by his route, or within five squares of his route. Id. at 88-89.

By this time, the court said it was the “settled law” of Texas that a contract for the sale of a business may include a non-compete reasonably necessary to protect the purchaser’s interest in the goodwill of the business. Id. at 89.

But did the same principle apply to an employment contract? Looking to authorities outside Texas, the court found that non-competes in employment contracts should be governed by the same principles:

The test generally applied to determine the validity of such a covenant in a contract of employment depends upon whether or not restraint placed upon the employé after employment has ceased is necessary for the protection of the business or good will of the employer, and whether it imposes on the employé any greater restraint than is reasonably necessary to secure protection to the business of the employer or the good will thereof. If the covenant in question goes no farther than to accomplish this purpose, it is generally held to be valid.

Id. at 90. (NB: An “employé” is an employee who speaks French.)

In short, like a non-compete in the sale of a business, a non-compete in an employment contract is governed by the related principles of reasonableness and necessity to protect goodwill.

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Thus, the court said, the burden is on the employer to establish both the “necessity for” and the “reasonableness of” the non-compete. Applying this principle to the employer’s claim for an injunction, the court said that the evidence clearly established the necessity of the non-compete as to the immediate territory where Evans delivered ice to the company’s customers. Id.

But there was no such necessity for the five squares outside of his territory, the court reasoned, because the company had no goodwill outside of the employee’s territory that was due to the employee’s “personal contact” with the trade while in service of the employer. Id.

This critical principle is sometimes ignored but still applies today. An injunction should extend no further than necessary to protect the goodwill that the employee developed on behalf of the employer.

Seven years later, the Dallas Court of Appeals would cite City Ice Delivery and other cases and distill the essential requirements of Texas non-compete law as follows:

(1) Is the restraint placed upon the employee, after the employment had ceased, necessary for the protection of the business or good will of the employer?

(2) Does it impose upon the employee any greater restraint than is reasonably necessary to procure protection to the business of the employer or the good will thereof.

Martin v. Hawley, 50 S.W.2d 1105, 1108 (Tex. App.—Dallas 1932, no writ).

This language is strikingly similar to the language the legislature would use over 50 years later in the 1989 non-compete statute. The court also cited the general principle that “contracts restricting the liberty of employment are not viewed by the courts with favor.” Id. at 1108.

Thus, even back in 1932, we can clearly see the two competing considerations: protect the employer’s goodwill to the extent necessary, but without unduly restricting employee mobility. The dividing line is what is reasonably necessary to protect the employer’s goodwill.

6. Generally Texas courts will enforce an unreasonable non-compete to a reasonable extent.

While the basic reasonableness concept took shape in Texas cases as early as the 1930s, it was not entirely clear what a Texas court was to do if a non-compete was unreasonably broad.

This issue was implicit in City Ice Delivery, where the court enforced the non-compete only in part, to the extent of prohibiting competition in the driver’s immediate territory. Later the Texas Supreme Court addressed the issue more directly in Lewis v. Krueger, Hutchinson & Overton Clinic, 269 S.W.2d 798 (Tex. 1954).

In that case, young Dr. Lewis signed an employment contract with a clinic that barred him from practicing medicine in Lubbock County if his employment ceased. The trial court found the non-compete entirely unenforceable because it had no time limitation. The Court of Appeals disagreed but reduced the limitation to three years. Id. at 798-99.

Dr. Lewis argued the court could not make a new and different contract for the parties, but the Texas Supreme Court rejected this argument. Even though the non-compete could be interpreted as applying for life, “it would hardly be doing violence to the established principles to hold that the restriction is merely void or unenforceable with respect to that portion of the time beyond what the court considers reasonable.” Id. at 799-800.

This “blue pencil” rule allows the court to effectively rewrite the non-compete, and it still applies today. Enforcement of a non-compete is not all or nothing in Texas. Generally, if the non-compete is unreasonably broad, it can still be enforced, but only to a reasonable extent.

7. You can’t get damages for breach of an unreasonably broad non-compete.

But what about damages? Can the employer get damages for the employee’s breach of a non-compete that’s unenforceable as written?

The Texas Supreme Court addressed this issue in Weatherford Oil Tool Co. v. Campbell, 340 S.W.2d 950 (Tex. 1960). Citing Martin v. Hawley, the court said the non-compete as written was unreasonable because it had no territorial limitation. Then, citing Lewis, the court said an injunction could still be granted to restrain the employee from competing within a reasonable area. Id. at 952.

But the court said a claim for damages was not available prior to reformation. “We hold that an action for damages resulting from competition occurring before a reasonable territory and period have been prescribed by a court of competent jurisdiction must stand or fall on the contract as written.” Id. at 953. In other words, if the employer drafts a non-compete that is too broad, the employer can still seek an injunction, but it can’t get damages that occur before the court narrows the scope of the non-compete.

The Texas Supreme Court later clarified that the court’s power to reform the non-compete applies to both time and area. Justin Belt Co. v. Yost, 502 S.W.2d 681, 685 (Tex. 1974).

The Weatherford rule concerning damages was later codified in the 1989 statute. Five years later, Jimmy John’s started franchising. And the rest is history.

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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. Be sure to follow the Five Minute Law Facebook account, if anybody still uses Facebook.

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.