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Volume XIII, Number 34

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Protecting Your Business from Disloyal Employees

This is a true story (although the names have been changed). Bob Smith was employed by Acme Hospital & Health Care Services as an insurance sales account executive selling group health and life insurance products. Bob developed numerous customer accounts for Acme. Recognizing that its most valuable asset was its employees’ relationships with its customers, Acme required Smith to sign an agreement “not to compete, directly or indirectly, with any existing or future customer of the company.” Acme had protected itself from disloyal employees, right? Wrong.

After six years, Smith decided to break out on his own and solicited the business of, among others, 32 customers he had originally developed for Acme. In the ensuing litigation, the court found that the non-competition agreement was drafted too broadly and refused to enforce it. It also refused to re-write the contract—called “blue penciling”—to make it enforceable. Smith was free to take Acme’s customers.

Virtually every business has some sort of confidential information that it tries to protect from public disclosure. It may be a customer list, pricing information, strategic marketing plans, or even Coke’s “Secret Formula.” You would not post this information on the Internet, and you certainly would not share this information with your competitor. You, however, share this information with your employees every day. Most employees are free to leave your employment at any time. So, how do you avoid ending up like Acme? The answer is to properly use the “Twin Pillars” for protection of your confidential information.

The “Twin Pillars” of Protection

Non‑competition agreements and the Uniform Trade Secrets Act – the “Twin Pillars” of protection – provide a business with powerful weapons to protect its confidential information. A non‑competition agreement is a contract between a business and its employees that prohibits competition by the employee. It may be part of an employment agreement for a set period of time, or may be a stand‑alone agreement. The Uniform Trade Secret Act is a statute that prohibits misappropriation of trade secrets. The Act has been adopted in most states.

Under the Twin Pillars, injunctions are available. An injunction is a court order prohibiting a party from doing something, such as compete, accept employment with a competitor, or divulge certain information. In some circumstances, a business can obtain an emergency injunction, often called a temporary restraining order or a “TRO” on the same day as its request. Violation of an injunction is punishable as contempt of court. In addition, a business may recover quantifiable damages. In certain extreme cases, courts can award “exemplary,” or punitive damages, of twice the actual damages, as well as attorneys’ fees.

So what happened to Acme? How did it fail to protect itself?

Public Policies

Our society wishes to reward a business for building a better mousetrap. Therefore, courts protect the confidential information of businesses to encourage them to develop new information and processes. Courts, however, must balance this principle with other concerns.

Americans believe that a person should be free to leave his or her employment and to seek work elsewhere. To require an employee to choose between her current employment and starvation amounts to involuntary servitude. In addition, we generally believe in the free market. A business should not be permitted to restrain the market forces of competition through broad agreements not to compete. To do so would tip the balance too far in favor of the protection of a business’ information. As a result, courts attempt to balance these conflicting concerns. This balance is a matter of state law, so the specific nuances vary by state. Here, we examine Illinois law.

Non-Competition Agreements

Non‑competition agreements in employment have two basic requirements to be enforceable. First, the restriction on competition must be reasonable. This means that the restriction must be necessary to protect a legitimate business interest of the employer, not impose an undue hardship on the employee and not injure the public. Second, the non‑competition agreement must be supported by adequate consideration. The law of non-competition agreements varies by state, but (with only a few exceptions) the same principals largely hold, although they are sometimes differently formulated.

A. Is the Restriction on Competition Reasonable?

1. No Greater Than Necessary to Protect a “Legitimate Business Interest”

For decades, Illinois courts held that only two types of legitimate business interests, or “protectable interests,” existed in the employment context. They were either the protection of confidential information or the preservation of “near permanent” customer relationships. A recent Illinois Supreme Court case, however, clarified that in addition to these two interests, other legitimate business interests may exist.

In evaluating whether confidential information justifies a particular non‑competition agreement, courts will consider how easily the information may be duplicated from public sources, such as trade directories or even the telephone book, and the expenses associated with developing such information. Unfortunately, no precise formulas exist and whether something is sufficiently confidential and valuable to be a protectible interest is decided on a case specific basis.

It is important to remember that although courts will protect confidential information, employees have the right to use skills you may teach them. While this is a difficult distinction in practice, the concept is simple. Think of it like football: You are the head coach and you teach your players to tackle well. This is a skill. When a player is traded, he can take the tackling skill with him. Your play book, however, is confidential. Until you run your trick plays in a public game, you should be entitled to keep the plays secret.

A business seeking an injunction will have to show its confidential information to the court to provide that it is worthy of protection. In addition, it will probably have to share its information with, at minimum, the opposing lawyers. The court disclosure may be done “under seal,” which means, in confidence. Also, the disclosure in discovery should be done under a protective order, which like an injunction, is enforced by the court on pain of contempt. However, these safeguards may not be enough to make a business feel comfortable.

Coca Cola once faced this situation. Coca Cola bottlers sued Coca Cola Corporation over whether the syrup for Diet Coke was subject to the same contract terms as regular Coke. As part of discovery, the bottlers requested Coke’s “Secret Formula” and, of course, Coke refused. Upon hearing the dispute, the court found that the formula was relevant to the case and ordered the formula shared with the bottlers’ attorneys under a strict protective order. Coke refused even this intrusion, and was forced to accept a total defeat in the case. Of course, unlike Coca Cola, most businesses are willing to divulge their confidential information with the appropriate court‑mandated safeguards.

A second kind of protectable interest is a near-permanent customer relationship. As with confidential information, the existence of a near permanent customer relationship presents a balancing test. Courts will consider (1) the time it takes to acquire a customer, (2) amount of investment to acquire one, (3) the degree of difficulty in acquiring one, (4) the amount of personal contact needed, (5) extent of business’ knowledge of customer, (6) the length of time the customer has been associated with business, and (7) most importantly, the continuity of relationship. As a rule of thumb, a ten-year relationship is probably “near permanent.” A one-year relationship is probably not.

As the Illinois Supreme Court made clear in 2011 in Reliable Fire Equipment Co. v. Arredondo, other legitimate business interests may exist that would support the need for a non‑competition agreement. However, it declined to provide a list of such interests, instead instructing courts to look to “the totality of the circumstances of the individual case” to identify whether the interests justified a restriction on competition. While the Court almost certainly expanded the enforcement of non‑competition agreements, drafters of such agreements face great uncertainty as to whether a court will later find an interest to be legitimate. Until the case law is more fully developed concerning other legitimate business interests, one would be wise to continue to tie the need for non‑competition agreements back to the protection of confidential information or near-permanent customer relationships.

2. Don’t Get Greedy

The second element of whether a non‑competition agreement presents a reasonable restriction—and, thus, may be enforceable—is that it must not place an undue hardship on the employee. The public policy that a person should be free to seek work comes into play here. This generally means that a non‑competition agreement must be reasonable in scope, including duration, geography, and activity. This is where many businesses get into trouble. If a court believes that the business has attempted to overreach and prohibit more conduct than necessary to protect the business’ interests, then the court may refuse to enforce any of the agreement.

i) Duration

The duration of employment of a non‑competition agreement is often a tough issue. It depends heavily upon the industry, and such case-specific issues as the length of the sales cycle. The duration of a non‑competition agreement should end before the protected interest becomes stale. In general, an agreement with a duration of one year is usually fine, while three or more years tends to be overly broad.

ii) Geography

Traditionally, a non‑competition agreement must be limited to the location where the business operates. In more modern times, with the rise of Internet commerce and overnight shipping, geographical limitations have had less significance. Courts will usually enforce nationwide restrictions it the employer conducts business across the country. Nonetheless, an employee may use the lack of a geographical limitation to attack the enforceability of a non‑competition agreement. A good rule of thumb is to limit the restriction to locations where the employee has done business on the business’ behalf. Also, courts are more likely to enforce a nationwide restriction on competition if the activity being restricted is clearly and narrowly defined.

An alternative to a general restriction on competition is to prohibit an employee from soliciting a defined group of customers. For instance, an employee may agree not to solicit a certain list of customers, such as those with whom she did business while in her current employment. In such situations, geographical limitations are not necessary.

iii) Activity

The scope of the prohibited activity must also be reasonable. This element is inextricably tied to the interest the business seeks to protect. For instance, the employee of a business with proprietary information concerning commercial refrigeration systems should not have to agree to stay entirely out of the business of supplying restaurants and food vendors.

In the case of confidential customer lists, the protection should only extend to preventing the misuse of the lists. An employee may not be prohibited from contacting any potential customer regardless of whether the employer ever even knew of the potential customer. In fact, this is exactly where Acme ran into trouble. Bob’s contract prevented him from competing with any existing or future customer of Acme. The court held the restriction covered future customers whom Acme had yet to solicit. This was too broad. Despite the fact that Bob actually did have direct contact with the customers he developed, the court found that Acme’s attempt to overreach invalidated the entire agreement.

Not only does the reasonableness requirement mean that prohibition should be limited to that which is necessary to protect the business’ interests, but the language describing the prohibition should be objectively defined. Courts believe that employees should not have to guess at whether they may accept a new job. Thus, an employer should be careful to ensure that the description of the restriction is not vague.

Generally, a court will simply refuse to enforce an overly broad non‑competition agreement. An exception, however, exists that permits the court to re-write the agreement to contain a narrower restriction that it is willing to enforce. This is often called “blue penciling.” In Illinois, a court has discretion to blue pencil – it may decide to do it, but it is not required to do so. Several states, such as Virginia, do not permit blue penciling under their law. Thus, businesses tread on dangerous ground when they rely upon the charity of the court to save them from their own overreaching. Often, the court’s willingness to engage in blue penciling will depend upon whether it feels the employer tried to take advantage of the employee with less bargaining power versus merely having been imprecise in its drafting of the restriction.

3.  Not Injurious to the Public

The third element of whether a restriction on competition is reasonable is that it not injure the public. This is an opportunity for the court to consider the community at large. For example, in a small rural community, a court will be hesitant to bar one of the community’s only two doctors from practicing in the county. In a large city, however, this is unlikely to be a problem. In practice, disputes over the third element do not often play a central role in private party litigation.

B. Give the Employee Something of Value

In addition to presenting a reasonable restraint on competition, a non‑competition agreement must be supported by adequate consideration to be enforceable. This means the employee gets something of value to which she was not otherwise entitled in exchange for the non‑competition agreement. Many states, including Illinois, consider employment for a substantial period of time to be adequate consideration, even where that employment is “at will” such that either party can terminate the relationship. Likewise, many states also recognize hiring to be adequate consideration where the agreement is signed at the very start of employment and as a condition of employment. However, some states do not accept that continued at will employment can constitute adequate consideration. Furthermore, an Illinois appellate court recently created a bright line rule that the employment must continue for at least two years before it is adequate consideration. While it is not clear whether other Illinois courts will accept this rule, it has introduced some uncertainty. Bearing in mind that continued employment (or hiring) might not be found to be adequate consideration, employers often avoid the issue by tying new non‑competition agreements to discretionary raises, bonuses, or other perks.

C. Additional Safeguards

We have discussed the basic requirements for creating an enforceable non‑competition agreement. If you go through the effort of having an attorney write one for your employees, however, you should consider adding additional protections to the contract, in addition to the non‑competition agreement, that further define the employment relationship and protect your business. For example, a non‑disclosure (or confidentiality) agreement can contractually obligate an employee to keep your company’s confidential information secret. Unlike non‑competition agreements, confidentiality agreements can have an infinite duration.

Likewise, various non‑solicitation agreements may provide adequate—or additional—protection. These can prohibit an employee from soliciting business from a finite list of your customers with whom he dealt. They offer the added benefit of being easier to enforce against a disloyal employee than a non‑competition agreement. An anti‑raiding provision, which prohibits the hiring of fellow employees, is also often another valuable protection.

And, as mentioned before, you can include a provision that all disputes relating to or arising from the employment—not just ones about non‑competition—must be raised in arbitration. While arbitration can have some drawbacks, it has the distinct advantage of being a private proceeding, shielded from the public view.

Finally, with a mind towards the ultimate goal – deterrence – a business may consider including a fee shifting provision that requires the employee to pay the attorneys’ fees and costs associated with enforcing a non‑competition agreement. Although courts are often hesitant to enforce such provision, the risk of enforcement can provide a powerful disincentive to an employee considering whether to breach her non‑competition agreement.

Trade Secrets Act

The second of the Twin Pillars – the Uniform Trade Secrets Act – does not require an agreement. Application of the Act can be confusing, but it all boils down to a fairly simple rule: if a defecting employee knows your trade secret and you can show a real threat that the employee will either use your trade secret or divulge it to another business, you may obtain an injunction against the employee. You might also obtain an injunction against any competitor to which the employee plans to divulge (or has divulged) the trade secret, if the competitor is on notice of the employee’s wrongful conduct.

With this general structure in mind, if a business learns that its employee plans to jump ship with its trade secrets, it may wish to put the potential future employer on notice of the disloyal employee’s improper acquisition of the trade secrets. Of course, this should be done through legal counsel to reduce the risk of a lawsuit by the employee for interfering in her attempts to find employment.

So, what information is entitled to “trade secret” status? A trade secret is any information that “derives independent economic value … from not being generally known” and “is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.” One may imagine a broad range of information that meets the first part of this definition. The version enacted in Illinois even expressly includes confidential customer lists. In court, the fight tends to revolve around whether the information actually derives value from being secret and whether adequate steps have been taken to maintain the secrecy.

In general, there is little you can do now to make your secret information more valuable. For example, if the information can be readily replicated from publicly available sources then it does not qualify for protection since it does not derive value from being secret. Absent further development of your information into something useful that is not publicly known, it is not a trade secret.

However, you can undertake prophylactic measures now to ensure that the information is adequately protected, the second prong of the definition for trade secrets. Not only will this help protect you in court, it will also reduce the chances of an accidentaldisclosure. How one goes about protecting trade secrets is highly dependent on the particular circumstances of the business and its trade secret. Some of the more common steps for protecting such information are:

(1) Enter confidentiality and/or non‑competition agreements with employees;

(2) Distribute written policies regarding security and regular reminders;

(3) Secure your information – either with locks for paper, or passwords for electronic information;

(4) Place “Confidentiality” stamps on sensitive information;

(5) Maintain document control procedures – keep track of who sees your sensitive information;

(6)  Limit distribution of sensitive information to those who need to know;

(7) Implement a formal “document retention” policy (i.e., destroy documents according to schedule, but first consult an attorney); and

(8) Keep track of the measures you have taken to protect your trade secret (you do not want to consider this for the first time as your attorneys are preparing to ask the court for an emergencyinjunction).

An interesting situation develops when a high‑level employee departs for a competitor with knowledge of your trade secrets, but claims that he has no plans not use them or share them with his new employer and you cannot prove otherwise. Fortunately, a legal theory has developed, including in Illinois, called the “inevitable disclosure doctrine.” This theory recognizes that, even without any intentional wrongdoing, certain high‑level employees will inevitably use confidential information in their new employment. Although this can be a difficult theory to prove in court, it does provide a business with some protection where the business failed to obtain a non-competition agreement from its high-level employees and has no evidence that such employees will be disloyal.

Conclusion

The time to think about protecting your business’ information is before you have a problem. In fact, a business that prepares itself to defend its confidential information will likely never need to defend itself because of the deterrent effect of the Twin Pillars.

© 2023 Honigman Miller Schwartz and Cohn LLP National Law Review, Volume IV, Number 338
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About this Author

Ian H Fisher Honigman Chicago Offfice  business litigation, class action lawyer
Partner

Mr. Fisher focuses his practice on assisting clients with strategies to meet their business goals and, as necessary, serves as their commercial litigator. He has a broad range of clients from small entrepreneurs to Fortune 100 companies and is adept at choosing a strategy that is appropriate for the problem at hand. Mr. Fisher counsels clients in real estate, antitrust, business interference, trade secret misappropriation, noncompetition covenant, consumer fraud and employment discrimination disputes. He has substantial experience in class actions and multidistrict litigation...

312.701.9316
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