Loyal. adj. Faithful to a person, ideal, custom, cause, or duty;
of, relating to, or marked by loyalty…

The American Heritage Dictionary, 4th Ed.

“I’ll take fifty percent efficiency to get one hundred percent loyalty.”

Samuel Goldwyn (1882-1974)

I.  INTRODUCTION

What follows is an introduction to the issues raised by the law of employee duty of loyalty, and its relation to trade secrets and other proprietary business information. This area of the law often forms the basis for disputes arising between employers and their former employees. In particular, emphasis is placed upon those situations where ex-employees choose to compete in the same business with their former employers. It is this circumstance which seems to offer the greatest temptation for former employees to utilize wrongfully the information and knowledge gained in their prior positions, often to the detriment of their previous employer.

II.  REAL WORLD COMPETITION

What would you do if faced with one of the following situations?

A) The Exodus en Mass

The owner of a highly successful real estate brokerage business decides to take an extended European vacation with her husband of 30 years. The brokerage utilizes six full-time sales people, none of whom have signed a non-compete agreement.

While the owner is away she leaves the brokerage in the hands of the six sales people, most of who have been with the brokerage for several years. Sometime during the owner’s vacation of a lifetime, all of the salespeople submit their written resignations and leave them on the desk of the owner. When the owner returns, the office is silent and the resignation letters are on her desk.

It appears, too, that some of the company’s files have been left askew, and many of the salespersons’ rolodexes are missing. The owner then learns that all her former salespeople are now working literally across the street, at a competing brokerage. She is unable to confirm the status of many of the pending sales and leads of which she knew prior to her vacation.

B) The Flash-in-the-Pan Departure

The corporation is one of only a handful of companies located in the United States which manufacturers and markets sophisticated teleconferencing devices which generally sell for tens of thousands of dollars. Often larger corporate customers are willing to spend well over one hundred thousand dollars for state of the art teleconferencing systems and appurtenances which even fewer companies can provide. The competition for these sales is keen.

The corporation has employed a sales manager of outstanding reputation. He is highly paid and well worth the money. He knows the industry and the potential customers extremely well. As a manager who actively participates in large sales calls with junior salespersons, he is privy to some of the most sensitive information the corporation possesses, i.e., pricing structures, profit margins and mark-up information for various products.

After a few years of phenomenal performance, the sales manager, without warning, suddenly resigns and announces that he will be working for a major competitor in the same position. At the time of his resignation, there is pending a potentially major sale which the sales manager and a junior salesperson had been working for many months. Many hundreds of hours of design work, demonstrations, wining and dining, and much travel had gone into the sales proposal. The deal was very close to closing when the manager left the company.

A few days after the sales manager’s departure, the customer contact for the potential major sale spoke to the junior sales person and demanded a price reduction which was very close to the mark-up figure on the proposed sale of the equipment. The customer contact made clear that without the requested reduction, there would be no sale.

C) The Entrepreneur Within

A small environmental testing and consulting business employs only ten people. Because the company is very busy but small, each employee wears several hats. One such person, a Project Manager, sells consulting services and oversees actual testing, but lacks the necessary qualifications and license in order to satisfy state regulators. Thus, he cannot “sign off” on completed projects. This status is critical to the company and allows it to obtain high-end environmental consulting projects. This causes some friction between the project manager and the company president since the president feels he must step in too often to finish projects.

The president decides to hire a new person. The company pays several thousand dollars to send the new person to school to obtain her license. In the meantime, the new person is trained in all other aspects of the business by the unlicensed project manager. They become close friends through this work association.

Because the company is small, the unlicensed individual is also its informal “IT” manager. Each week he updates the company’s computer files which contain its client lists, vendor information and pricing schedules, as well as all its financial information, including the salaries of all the employees. He does this work at home using a laptop supplied by the company.

One day after work the Project Manager and the new person are having drinks. The new person has now received her license and is working out well. The Project Manager tells the new person he is planning on leaving to start his own environmental consulting business. He shows her a business plan and stationary, business cards, etc. that he has already made up. He tells her he needs her ability to sign off on projects and can offer her more money. She agrees to go with him. The next day they both submit their resignations.

NB. Each one of these scenarios is drawn from an actual case prosecuted by the author on behalf of the employer. The legal actions taken, as well as the outcomes of same, appear at Section XI, infra.

III.  PRINCIPLES GOVERNING EMPLOYEE DUTY OF LOYALTY

Historically, the public interest has favored free trade and the ability of employees to engage in same by moving about at will. See e.g., Nordenfeldt v. Maxim Nordenfelt Guns & Ammunition Co., [1894] A.C. 535 at 565 (“[t]he public have an interest in every person’s carrying on his trade freely: so has the individual. All interference with individual liberty of action in trading, and all restraints of trade themselves, if there is nothing more, are contrary to public policy and therefore void. That is the general rule”)

The at-will employee may plan to go into competition with his employer and may take active steps to do so while still employed. The at-will employee has no general duty to disclose such plans to his employer, either before or after he resigns. At-will employees may change employers freely:

Application of the rules protecting trade secrets in cases involving competition by former employees requires a careful balancing of interests. There is a strong public interest in preserving the freedom of employees to market their talents and experience in order to earn a livelihood. The mobility of employees also promotes competition through dissemination of useful skills and information.

Restatement of Unfair Competition § 42, comment b (1995).

Certain limits apply, however, to the conduct of at-will employees who wish to compete with their employers. Employees cannot appropriate their former employer’s trade secrets and other confidential business information. They may not solicit their employer’s customers while still working for the employer. An at-will employee also may not act for his own future interests at the expense of his employer by using his employer’s funds or other resources for personal gain, or otherwise engage in a course of conduct designed to hurt the employer. Consider Restatement of Unfair Competition § 42, comment b (1995):

During the duration of an employment relationship, an employee is subject to a duty of loyalty applicable to all conduct within the scope of the employment. See Restatement, Second, Agency § 387. The duty of loyalty encompasses a general duty not to compete with the employer in the subject matter of the employment … including a duty to refrain from using confidential information acquired through the employment in competition with the employer.

Before terminating employment, managerial personnel may not solicit the departure of employees – particular key employees – to work for a competitor. Doing so is a violation of management’s duty of loyalty to the corporation. Compare Restatement (Second) of Agency § 393, comment e (“[A] court may find that it is a breach of duty for a number of key officers or employees to leave their employment simultaneously …”)

“The employment relationship by its nature ordinarily justifies an inference that the employee consents to a duty of confidence with respect to any information acquired through the employment that the employee knows or has reason to know is confidential … The duty to refrain from unauthorized use or disclosure of confidential information continues after termination of the employment relationship.” Restatement of Unfair Competition § 42, comment c (1995).

IV.  TRADE SECRETS AND CONFIDENTIAL INFORMATION

In keeping with the historical emphasis on promoting market competition, an employee is free to carry away and use the general skill or knowledge acquired during the course of employment. He may not, however, compete with his former employer by using the trade secrets or other confidential business information of his former employer. The term “trade secret” has been defined variously as follows:

A trade secret may consist of any formula, pattern, device or compilation of information which is used in one’s business, and which gives him [or her] an opportunity to obtain an advantage over competitors who do not know or use it.

See Restatement of Torts § 757, comment b (1939). A more recent statement of the law in this area does away with the “used in one’s business” requirement, thereby providing a broader, more functional definition:

A trade secret can consist of a formula, pattern, compilation of data, computer program, device, method, technique, process, or other form or embodiment of economically valuable information. A trade secret can relate to technical matters such as the composition or design of a product, a method of manufacture, or the know-how necessary to perform a particular operation or service. A trade secret can also relate to other aspects of business operations such as pricing and marketing techniques or the identity and requirements of customers.

Restatement of Unfair Competition § 39, comment d (1995). The term “trade secret” is defined in the Massachusetts General Laws as “anything tangible or intangible or electronically kept or stored, which constitutes, represents, evidences, or records a secret scientific, technical, merchandising, production, or management information, design, process, procedure, formula, invention or improvement.” G. L. c. 266, § 30(4) (a statute imposing criminal liability for trade secret theft.)

Business information which does not rise to the level of a “trade secret” per se, yet which may be protected as proprietary, includes specific business plans, financials, contract bid amounts, plans for expansion, customer lists, customer routes and the like.

Some of the information at issue in the case scenarios in Section II, supra, for example, included the following: customer lists and leads; product pricing and profit margins on specific products; the status of specific bids and sales proposals; financial information and customer profiles and specific customer needs. The sine qua non of such proprietary information is secrecy. Restatement of Unfair Competition § 39, comment f (1995) (“the requirement of secrecy is satisfied if it would be difficult or costly for others who could exploit the information to acquire it without resort to the wrongful conduct ….”)¹

The following criteria have been used to determine whether business information qualifies as a trade secret or otherwise should be treated as confidential and proprietary:

1) the extent to which the information is known outside the particular business at issue;

2) the extent to which the information is known to employees and others within the company
itself;

3) the extent of the measures taken by the company to guard the secrecy of the information;

4) the value of the information to the company;

5) the amount of effort or money expended in developing the information;

6) the ease or difficulty with which the information could be properly acquired or duplicated by others.

The Restatement of Unfair Competition § 39 comment g offers the following on precautions

to maintain secrecy of confidential information:

Precautions to maintain secrecy may take many forms, including physical security designed to prevent unauthorized access, procedures intended to limit disclosure based upon the “need to know,” and measures that emphasize to recipients the confidential nature of the information such as nondisclosure agreements, signs, and restrictive legends.

“[T]he subject matter of a trade secret must be secret. Matters of public knowledge or of general knowledge in an industry cannot be appropriated by one as secret.” Restatement of Torts § 757, comment b. In particular circumstances, however, “routine data” belonging to a particular company may be considered confidential. For instance, information such as a company’s sales locations may appear public and non-confidential.

Perhaps the most enduring judicial statement on the protection of business information not rising to the level of a technical trade secret can be found in USM Corporation v. Marson Fastener Corporation, et. al., 379 Mass. 90, 104 (1979):

A plaintiff who may not claim trade secret protection either because it failed to take reasonable steps to to preserve its secrecy or because the information, while confidential, is only “business information,” may still be entitled to some relief against one who improperly procures such information. The law puts its imprimatur on fair dealing, good faith, and fundamental honesty. Courts condemn conduct which fails to reflect these minimum accepted moral values by penalizing such conduct whenever it occurs. Seismograph Serv. Corp. v. Offshore Raydist, Inc., 135 F. Supp. 342, 354-355 (E.D. La. 1955), modified on other grounds, 263 F.2d 5 (5th Cir. 1958) (“It is simply the difference between right and wrong, honesty and dishonesty, which is the touchstone in an issue of this kind.”)…See also Crocan Corp. v. Sheller-Globe Corp., 385 F. Supp. 251, 254-255 (N.D. Ill. 1974) (“improper means used to gain information is a separate basis of liability, regardless of whether the information constitutes a technical trade secret”).

See also Restatement of Torts § 759, comment b. (“Examples of [confidential information], other than trade secrets,…are: the state of one’s accounts, the amount of his bid for a contract, his sources of supply, his plans for expansion or retrenchment, and the like. There are no limits as to the type of information included except that it relate to the matters in his business. Generally, however, …the information must be of a secret or confidential character.”)

V.  EMPLOYMENT AGREEMENTS WITH RESTRICTIVE COVENANTS

Restrictive covenants in written employment contracts are judicially enforceable if the employer can demonstrate that:

1) the agreement is necessary to protect a legitimate business interest of the employer;

2) supported by consideration;

3) reasonable in scope;

4) is consistent with the public interest.

A recent Massachusetts Superior Court decision enforced a non-competition clause in a written employment agreement providing for a twenty-four month restriction on ex-employees’ would-be competing activities. See United Rug Auctioneers, Inc. v. Arsalen, et. al., Superior Court Civil Action No. 03-0347. The benefits of a written agreement are, inter alia, that it puts employees on notice as to which aspects of the business the employer considers proprietary, confidential or otherwise a part of the goodwill of the company. Moreover, a written employment agreement with restrictive covenants provides a valuable framework for a civil complaint should the need arise for same. For instance, such an agreement may stipulate that unauthorized disclosure of trade secrets and confidential information will result in irreparable harm to the company, an essential element for injunctive relief in duty of loyalty cases.

Legitimate business interests which may properly be the subject of restrictive covenants in written employment agreements include protection of trade secrets, confidential information, and business goodwill. Goodwill is defined as a business’s positive reputation with its customers or potential customers generated by repeat business with existing customers or by referrals to potential customers.Goodwill may also be shown by demonstrating particular expertise in a defined area, as well as significant advertising.

VI.  WHO NEEDS A RESTRICTIVE COVENANT?
THE “INEVITABLE DISCLOSURE” DOCTRINE

The absence of a written employment agreement with restrictive covenants may not be fatal to the cause of an employer trying to prohibit proprietary and confidential business information from being used by an ex-employee to compete unfairly. In some jurisdictions courts have fashioned restrictive employment agreements ex post facto where clear violations of employee duty of loyalty have been demonstrated.

An excellent example of such judicial intervention is found in DoubleClick v. Henderson, et. al., 1997 N.Y. Misc. Lexis 577.

DoubleClick was a new, fast-growing Internet advertising business. The company had two types of clients: 1) a network of 75 popular web sites with respect to which it had an agreement to sell advertising space on the sites, and 2) individual advertisers who had separate contracts with DoubleClick which allowed them to shown their ads on the web site network without having to negotiate access to each web site.

DoubleClick had developed proprietary methods of delivering ads to the web sites in its network, as well as systems which caused certain ads to “pop up” when specified search terms were used. The company also developed proprietary methods to gauge the effectiveness of its advertisements. The company maintained various sources of proprietary information such as sales and marketing strategies, customer requirements, financial projections, and a business plan which discussed long-term goals and strategies.

Two top managers with access to all of the above-described company information decided to leave DoubleClick and start their own competing business. They began preparations to do so while still employed at the company. When DoubleClick learned of their plans, it fired both managers and confiscated their laptops, where, it discovered a competing business plan and other strategic documents. It promptly went to court to enjoin the competing business. It should be noted that neither ex-manager had signed a confidentiality agreement or non-compete which pertained to their employment with DoubleClick.

DoubleClick asserted the following counts in its complaint against the ex-managers and their new competing venture: misappropriation of trade secrets, unfair competition, and breach of duty of loyalty. The court found that the two former executives had in fact misappropriated DoubleClick’s trade secrets. In particular, the court noted that one of the executives had on his laptop a document showing the company’s margins or “site share,” i.e., the percentage shares which it and a client web site split from advertising revenue. It appeared that the former executives intended to use this information to offer “better” deals to DoubleClick’s clients.

The court also found that “the centrality of [the executives] in DoubleClick’s operations makes it unlikely that they could eradicate” the trade secrets from their minds in the context of the competing venture. With regard to duty of loyalty issues, the court noted the following: the executives had used DoubleClick’s computers, e-mail and spread sheets to build their own competing business plan. The executives – while still employed by DoubleClick - had also met with a potential DoubleClick client, pitched the client for DoubleClick, and then, immediately thereafter, pitched the prospective DoubleClick client for their new venture.

In agreeing to fashion equitable relief in favor of DoubleClick, the court found the following preliminary facts which constituted liability for misappropriation of trade secrets, breach of duty of loyalty, and unfair competition:

[T]here is substantial evidence that defendants 1) used DoubleClick’s proprietary information to prepare for the launch of [the competing venture] and to position it to compete with DoubleClick, 2) worked on their plans for their new company during working hours at DoubleClick and used resources given to them by DoubleClick to do so, and 3) sought customers and financing for [the competing venture] without regard to their duties to their current employer. (DoubleClick, page 7.)

The court fashioned the following remedy which in effect amounted to a judicially imposed non-compete/non-disclosure agreement, although none existed between DoubleClick and the ex-managers prior to suit:

Defendants are enjoined, for a period of six months from  the date of this opinion, from launching any company, or taking employment with any company, which competes with DoubleClick, where defendants’ job description(s) or functions at said company or companies include providing any advice or information concerning any aspect of advertising on the Internet… …. Defendants are also enjoined, for a period of six months= from the date of this opinion, from providing any advice or information concerning any aspect of advertising on the Internet to any third parties who 1) work for defendants’employer(s), or 2) provide or promise to provide any of the defendants with valuable consideration for the advice or information, or 3) share or promise to share any financial interest with any of the defendants. (DoubleClick, page 8.)

The so-called inevitable disclosure doctrine in not recognized by all courts. Some common law jurisdictions, however, will grant injunctions to protect confidential and proprietary business information absent express agreements governing same.

The justification for doing so rests on a theory of implied contract arising from the employer/employee relationship

VII. WHO TO SUE: SHOULD YOU TARGET THE NEW EMPLOYER ALONG WITH THE EX-EMPLOYEE?

In employee duty of loyalty cases there may be claims against the new employer. The new employer may be held liable for misappropriation of trade secrets, as long as the new employer has notice of the ex-employee’s nefarious activities in this respect. The new employer may be liable for aiding and abetting breach of the ex-employee’s fiduciary duties to his ex-employer. An action may also lie for intentional interference with contractual or advantageous business relations.

There are practical considerations when targeting the new employer. For instance, a suit against the new employer may invite counterclaims (such as restraint of trade and abuse of process), as well as a harder-fought battle than desired. The new employer may bankroll the defense of the ex-employee. Moreover, it may be more difficult to limit or prevent the involvement of one’s own customers in the litigation, particularly where the new employer may have solicited them independent of and prior to hiring the ex-employee.

As word and rumors of the litigation spread among customers, some may be “turned off” by what they perceive to be overly aggressive business tactics designed to stifle competition, or simply “sour grapes.” Moreover, it may be easier to negotiate a compromise with the new employer concerning the status of the ex-employee and any confidential information he may possess if the new employer is not targeted directly as a defendant. Of course, because equity (in the form of injunctive relief) operates in personam, it may not be possible to obtain the full measure of relief and protection absent claims against the ex-employee’s new company or venture.

VIII.  A LIKELIHOOD OF SUCCESS ON THE MERITS:
THE “SILVER BULLET” OF INJUNCTIVE RELIEF

Injunctive relief is particularly appropriate in cases involving the protection of confidential and proprietary business information and customer goodwill:

Injunctive relief is often appropriate in trade secret cases to insure against additional harm to the trade secret owner from further unauthorized use of the trade secret and to deprive the defendant of additional benefits from its wrongful conduct. If the information has not become generally known, an injunction may also be appropriate to prevent destruction of the plaintiff’s rights in the trade secret through a public disclosure by the defendant.

See Restatement of Unfair Competition § 44(2) (Tent. Draft No. 4, 1993). See also DoubleClick, Inc. v. Henderson, et al., 1997 N.Y. Misc. LEXIS 577. (“[D]efendants’ exploitation of their intimate knowledge of DoubleClick’s proprietary information is impossible to quantify in dollar terms. Accordingly, an injunction is the appropriate remedy.”) The proponent of injunctive relief must demonstrate a likelihood of success on the merits of its substantive law claims; irreparable harm (i.e., inadequacy of monetary damages in light of the goodwill interests at stake); that the balance of harms favors plaintiff rather than defendant; and that the public interest will be served by granting the requested relief.

IX.  MONETARY DAMAGES FOR MISAPPROPRIATION

Damages for misappropriation of trade secrets and confidential information may be assessed as defendant’s profits realized from his tortious conduct; plaintiff’s lost profits; or a reasonable royalty. Multiple damages may also be awarded pursuant to statute. See e.g., G.L. c. 93, § 42 which provides in pertinent part:

Whoever embezzles, steals or unlawfully takes, carries away, conceals, or copies, or by fraud or by deception obtains, from any person or corporation, with intent to convert to his own use, any trade secret, regardless of value, shall be liable in tort to such person or corporation for all damages resulting therefrom. Whether or not the case is tried by a jury, the court in its discretion, may increase the damages up to double the amount found.

Despite the availability of money damages in duty of loyalty cases, injunctive relief nevertheless remains the quickest, most efficacious means of thwarting the machinations of would-be absconders of company proprietary information.

X. HOLDING THE BIG GUNS IN RESERVE: A LITIGATION PREFACE WHICH SOMETIMES WORKS

Sometimes all it takes is the right letter and a frank discussion with the ex-employee of the potential consequences of walking off with confidential and proprietary business information. A cease and desist letter may also be successful in dissuading a departed employee from utilizing confidential business information for the benefit of his new employer.

XI.  LITIGATION OUTCOMES OF THE “REAL WORLD COMPETITION” SCENARIOS DESCRIBED IN SECTION II

A) The Exodus en Mass

The five sales representatives had signed a “Broker-Salesperson Independent Contractor Contract” which provided in pertinent part:

The Salesperson shall not, after the termination of this contract, use to his own advantage, or to the advantage of any other person or corporation, any information gained for or from the files or business of the Broker.

The sales representatives also signed an acknowledgement sheet which stated that they had read and agreed to the contents of a company Procedures Manual which stipulated in part that all “listings and prospects which have been worked upon by [the broker] remain the whole and undisputed property of the Company at the time of separation.”

In this case the plaintiff moved very quickly against the five former sales representatives. Although none had signed a formal non-compete, the court granted, ex parte, a Temporary Restraining Order against all five former salespersons which commanded in part that they:

[D]esist and refrain from using, concealing, revealing, divulging, assigning or disseminating any document or any information concerning or relating to plaintiff’s business; and further from pursuing rentals, sales or other real estate services with any clients with whom you had any contact while associated with the plaintiff and/or with respect to which you became aware of while associated with the plaintiff….

(Emphasis added.) (See Appendix B for the entire Restraining Order text.) The court also ordered that the sales representatives return to the company “any books, records, or other documents given to or acquired by you from plaintiff and any documents containing information taken from any such documents….” Unfortunately for the salespeople, they had planned a large party to introduce their new endeavor, inviting primarily plaintiff’s clients and contacts as guests. In light of the above order, however, the party had to be cancelled. By its terms the restraining order expired in 10 days. When the court, after hearing, indicated its inclination to grant a preliminary injunction more or less mirroring the restraining order, the parties worked out a settlement agreement.

B) The Flash-in the-Pan Departure

While employed by the plaintiff company, the sales manager had signed an “Employee Proprietary Information and Inventions Agreement” which provided in part:

I agree to keep confidential and not disclose, or make any use of except for the benefit of the Company …any trade secrets or confidential information of the Company relating to products, processes, know-how, designs, formulas, test data, customer lists, business plans, marketing plans and strategies and pricing strategies….

Throughout his employment with the company, the sales manager was routinely provided with computerized customer lists and pricing information, including gross margin and distribution information. Distribution of this information was limited to a select few sales employees and company principals. At a hearing on Plaintiff’s motion for preliminary injunction, the court indicated it was inclined to grant the requested relief prohibiting the sales manager from calling on plaintiff’s customers or otherwise using the confidential sales information of the company. With this in mind, the parties worked out a stipulated injunction which entered with the court’s imprimatur.

C) The Entrepreneur Within

The departing project manager had not signed a non-compete/confidentiality agreement with the plaintiff company. Nevertheless, the plaintiff company sought and obtained an injunction prohibiting the ex-employee and his new company from taking affirmative steps to contact any of the former employers’ clients for a period of one year. Also, the defendants returned dozens of CD’s containing client lists and other proprietary information belonging to the plaintiff company.

XII. SUGGESTIONS FOR STAYING OUT OF TROUBLE

Make written employment agreements containing restrictive covenants a part of the employment relationship from the outset. Also, spell out the type of information considered to be confidential and proprietary by the employer. Limit employee access to sensitive information used in the operation of the business, and put all employees on notice that certain kinds of information will be imparted to employees only on a need-to-know basis. Make sure employees understand that company property – including intellectual property – must be returned to the employer prior to departure. In particular, the use and whereabouts of items like sales manuals, training manuals and other writings discussing business plans and company processes should be routinely monitored. Even “lower level” employees may need to sign non-disclosure agreements if they work in and around highly sensitive business information or machinery.