Employment Non-Competition and Trade Secrets: Lift-Outs, Garden Leave, Bad-Faith Actions, and White Hats
The terms "employee raiding" and "employee lift-outs" refer to the practice of one business hiring away a group of a competitor's employees. Business experts recognize lift-outs as both an efficient method of beefing up personnel and as a formidable weapon on the corporate battlefield. Consider the following examples of the damage inflicted by lift-outs:
When Conseco Capital Management lost its chief equity investment officer and multiple members of his department to one competitor, and 16 or so associates in the fixed-income management group to another, the company also lost a significant number of clients. Another company, the investment bank HSBC, was left with only a graduate trainee to take charge of analyzing media equities after its entire team of media analysts decamped for ABN AMRO.
Yet with the efficacy of lift-outs comes concomitant risk. As with many of the rugged tactics employed by corporate strategists, lift-outs entail a significant likelihood of litigation. When lift-outs involve employees under contract, the employer losing employees often possesses a cognizable claim for tortious interference with contract. In contrast, courts typically deem employee lift-outs involving at-will employees to be lawful. Under certain circumstances, however, an employer victimized by a lift-out of its at-will employees may possess a cause of action against its raiding competitor
Generally, an employer may assert a cause of action against a competitor for hiring away its at-will employees, but only if the competitor engaged in improper means to solicit the employees or solicited the employees for an improper purpose. Depending on the jurisdiction, potential theories of recovery for the lift-out of both contract and at-will employees include predatory hiring, unfair competition, tortious interference with contract, and tortious interference with a business relationship. With respect to at-will employees, these theories require a common element when applied to an employee lift-out: that the competitor acted in an unlawful manner.
In Diodes, Inc. v. Gustav H.D. Franzen, the California court of appeals summarized the general approach of courts to this type of action:
"Even though the relationship between an employer and his employee is an advantageous one, no actionable wrong is committed by a competitor who solicits his competitor's employees or who hires away one or more of his competitor's employees who are not under contract, so long as the inducement to leave is not accompanied by unlawful action …"
Unfair Competition and "Corporate Raiding"
In Boyce v. Smith-Edwards-Dunlap Co., a Pennsylvania appellate court confronted a claim of unfair competition where a competitor "systematically induced [employer's] employees to leave [employer] and come to work for [competitor]." The Boyce court noted that offering employment to another company's at-will employee is not actionable in and of itself.
"However, systematically inducing employees to leave their present employment is actionable when the purpose of such enticement is to cripple and destroy an integral part of a competitive business organization rather than to obtain the services of particularly gifted or skilled employees."
- Reading Radio, Inc. v. Fink –Sufficient evidence supported radio station's unfair competition claim against a competitor that hired away two of plaintiff's top sales representatives. The evidence demonstrated that after beginning employment with the defendant, the sales representatives solicited the former employer plaintiff's sales clients and employees with the knowledge and permission of the new employer defendant, and with knowledge of existing non-compete agreements.
- Medtronic Inc. v. Eli Lilly & Co. – Employer's claim against competitor of unfair competition based upon employee solicitation survived dismissal where the employer alleged that the competitor offered employees salaries designed not as reasonable compensation, but intended to destroy the employer's sales organization.
- E.D. Lacey Mills, Inc. v. Keith – Triable issue of fact remained as to whether competitor used wrongful means to solicit employer's employees and sales representatives where the competitor hired 17 of the employer's 21 sales representatives and 18 other employees. The employees stood as particularly crucial to the employer's manufacturing process. The competitor, which included former employees of the employer, left the employer and then immediately issued a telegram announcing the formation of the new company and sent the telegram to sales representatives affiliated with other competitors. Additionally, the competitor told certain sales representatives he believed a sufficient amount of the employer's business would be lost to the competitor/new company, and as a result the former employer might suffer financial difficulties and possibly would not survive.
"Garden Leave" Clauses
FLIR Systems, Inc. v. Parrish: The Cautionary Tale of a Bad Faith Trade Secrets Action
A recent case out of California's Second District Court of Appeal puts in sharp relief the dangers of bringing a trade secret action of questionable merit. In FLIR Systems, Inc. v. Parrish, the court upheld an award to defendants of a whopping $1,641,216.78 in attorneys' fees and costs for a trade secret action gone wrong. The court of appeal upheld the trial court's finding that the plaintiff filed and maintained the action in bad faith within the meaning of Section 3426.4 of the California Uniform Trade Secrets Act.
Section 3426.4 states, in pertinent part, as follows:
"If a claim of misappropriation is made in bad faith, a motion to terminate an injunction is made or resisted in bad faith, or willful and malicious misappropriation exists, the court may award reasonable attorney's fees and costs to the prevailing party. Recoverable costs hereunder shall include a reasonable sum to cover the services of expert witnesses, who are not regular employees of any party, actually incurred and reasonably necessary in either, or both, preparation for trial or arbitration, or during trial or arbitration, of the case by the prevailing party."
The defendants, Parish and Fitzgibbons, stood as officers and shareholders of Indigo, which manufactured and sold microbolometers, a device used in connection with infrared technology. Plaintiff FLIR manufactured and sold devices that utilize microbolometers: infrared cameras, night vision, and thermal imaging systems. In 2004, FLIR purchased Indigo. The defendants stayed on with Indigo until 2006, when they informed FLIR that they intended to leave Indigo and start a new company to mass produce bolometers. Fitzgibbons developed the business plan for the new company (to be called "Thermicon") years before FLIR purchased Indigo. The defendants offered FLIR an opportunity to take an ownership stake in Thermicon, contingent upon the defendants acquiring the necessary intellectual property and technology licenses, but FLIR rejected the defendants' offer.
The defendants left Indigo and proceeded with their plan to form Thermicon. They entered into negotiations with Raytheon Corp. to acquire the necessary licensing, technology, and manufacturing facilities. The defendants provided Raytheon with assurances that they would not misappropriate Indigo's trade secrets.
After learning of the negotiations between the defendants and Raytheon, FLIR sued the defendants for injunctive relief and damages. FLIR proceeded on a theory of "inevitable disclosure," asserting that the defendants' mass production of low-cost bolometers necessarily entailed the defendants' misappropriation of FLIR's trade secrets. FLIR's lawsuit proved fatal to the defendant's plans for Thermicon, as a spooked Raytheon informed the defendants that it would not go forward with negotiations. In turn, the defendants informed FLIR that they had abandoned their new business. FLIR nevertheless proceeded to bring its action for a permanent injunction to trial.
Unsurprisingly, the trial court ruled in favor of the defendants, finding no misappropriation or threatened misappropriation of trade secrets. The fact that the defendants failed to bring Thermicon to fruition proved critical to the court's analysis. As the court of appeals noted,
"It was uncontroverted that respondents received no funding for Thermicon, did not start a new business, had no employees or customers, did not lease a facility or develop technology, and did not design, produce, sell, or offer to sell infrared products."
In other words, Thermicon never developed into a full-fledged business. Yet FLIR proceeded with its action even after the defendants apprised FLIR of their intention to toss Thermicon on the scrap heap. Moreover, FLIR based its injunction on the theory of "inevitable disclosure," which, the trial court noted, California courts reject as a contravention of "a strong public policy of employee mobility that permits ex-employees to start new entrepreneurial endeavors."
In reviewing the trial court's award of $1,352,000 in attorneys' fees and $289,216.78 in costs, the court of appeal employed the two-part judicial gloss that California courts utilize in determining whether a claim of misappropriation meets the definition of bad faith under Section 3426.4 of the California Uniform Trade Secrets Act. First, the court considered the "objective speciousness of the claim." Second, the court looked at the plaintiff's "subjective bad faith in bringing or maintaining the action, i.e., [whether the plaintiff brought it] for an improper purpose."
As to the question of "objective speciousness", the court upheld the trial court's finding that the plaintiff's action qualified as such in that the plaintiff "suffered no economic harm and there was no misappropriation or threatened misappropriation of trade secrets." Notably, the court found support for "objective speciousness" in the testimony of FLIR's CEO, who testified that "'we can't tolerate a direct competitive threat by Bill [Parrish] and Tim [Fitzgibbons].'" The court appeared strongly influenced by what it termed "a preemptive strike ... for an anticompetitive purpose." The court then noted the plaintiff's reliance on the "inevitable disclosure" theory, which lacked support in California law. Finally, the court pointed to a most damning piece of testimony: the admission, by the president of one of FLIR's divisions, that he lacked an explanation as to why the lawsuit remained ongoing.
Turning to the second prong, the court marshaled a parade of evidence indicating the plaintiff's objective bad faith. First, the court noted the plaintiff's reliance on a faulty piece of evidence that Parrish had "threatened" a misappropriation—his download of company data onto a hard drive. However, the plaintiff learned of the download after seeking the injunction and the data contained on it was inaccessible. Second, the court debunked the plaintiff's contention that Parrish's objection to certain patent applications submitted by the plaintiff indicated that he would misappropriate trade secrets. Next, the court pointed to baseless and non-scientific expert testimony presented by the plaintiff. Finally, the court detailed the plaintiff's bad-faith settlement tactics, which included proposing certain settlement terms for "anticompetitive" purposes.
In reaching its affirmation of the trial court's award of attorneys' fees and costs, the FLIRcourt appeared particularly moved by the admissions of plaintiff's own CEO concerning FLIR's anti-competitive motivations. In this respect, the FLIR decision provides an expensive object lesson on when not to bring, or maintain, a trade secret (or non-compete) action. At least in California, courts conceive of actions to protect trade secrets as strictly defensive measures, not a hammer to hold over the heads of competitors. FLIR compounded the issue by pursuing its anticompetitive purpose even after any real threat of injury evaporated.
Wearing the "White Hat"
Case law continues to suggest no substitute exists for "wearing the white hat." One recent example offering support for this time-honored maxim: Glenn v. Dow Agrosciences, LLC. Here, the non-compete language appeared subject to a reasonable and enforceable interpretation. Yet, the facts revealed a defendant employee who repeatedly sought guidance from his current employer as to what he could and could not do, and who openly revealed his future employment plans in advance and appeared to have employer imprimatur on his plans. On such facts, the court appeared to go out of its way to find the restriction overbroad and unenforceable when the former employer unexpectedly sued. Unfortunately, the Indiana Supreme Court accepted transfer and then the case settled, so it possesses no value as precedent. Nonetheless, never fail to try and wear the white hat!