Got a New Job? Better Check That Non-Compete ClausePublished: March 19, 2001 in Knowledge@Wharton
Few would dispute the ability of the Internet to generate and spread information instantly and on a global basis. And few would deny that the Internet has helped to redefine such concepts as "workplace," "marketplace" and "intellectual property."
What is up for debate – and indeed has been the subject of recent court cases – is the Internet’s impact on an individual’s ability to change jobs without interference from a previous employer.
On the surface, it doesn’t sound like there should even be a conflict. Individuals who are not covered by an employment contract are generally governed by the "employment-at-will" doctrine, which presumes that the employee is employed for an indefinite period rather than for a fixed term, and that both employer and employee have the ability to end the employment relationship at any time and for any reason. While some activity on the part of an employer is prohibited (such as termination based on discrimination or the violation of other "public policy" as defined by state and federal law), the legal theory has also traditionally meant that an at-will employee can leave one employer for another without any barriers.
But recent court cases, driven in part by high-tech concerns, seem to be eating away at the concept of employee mobility, thereby giving employers the right to dictate what company an ex-employee may or may not join.
Some of the legal activity appears to be no more threatening than an application of traditional non-compete clauses that are recognized by most states. But other cases indicate that the courts are closing the noose around the practice of job-hopping and, in seeking to protect legitimate trade secrets, may hinder technological progress.
Consider the case of Ciena Corp., a Linthicum, Md.-based provider of intelligent optical networking systems. According to a recent Wall Street Journal article, Ciena won a court order last year enforcing the company’s standard employment contract that bars employees from working for a rival for a year after leaving. In this case the ruling forced a former Ciena manufacturing director to cease working for Chromatis Networks Inc., a manufacturer of optical networking and related products. In addition to losing his job, the former Ciena employee lost out on "millions of dollars in potential stock profits when Lucent Technologies Inc. bought Chromatis for $4.5 billion in May," according to the Journal.
Traditionally, these employment contracts, often referred to as non-compete agreements, were aimed at protecting an employer’s trade secrets or customer lists. So a salesperson or stock broker, for example, might be prohibited from soliciting former clients for a reasonable period of time, or a pharmacist-employee might be prohibited from opening his or her own practice in the same town as the ex-employer for a limited time. Courts would often honor a "covenant-not-to-compete" if it was reasonable in nature and did not prevent the former employee from making a living.
But the principles behind non-compete clauses get a bit more tangled when the issues concern the Internet, where there are no geographic limits and where trade secrets are made up of applications of thought instead of processes or tangible property.
"Contractual limitations have been common for a long time, but in today’s high-tech economy they’ve become more newsworthy," observes Wharton legal studies professor Richard Shell. "In today’s market the most valuable component of many high-tech companies is the human, or intellectual capital, which means a firm’s main asset can now simply walk out the door."
The problem, says Shell, is that the efforts of a company to protect that intellectual capital with a non-compete clause can unreasonably restrict a person’s mobility. "A covenant not to compete is only enforceable for a limited time, but it can still be a problem when you have companies like Microsoft, for example, that use the law to aggressively quiet competition in industries where there is not enough competition to begin with."
Non-compete agreements, which are common for high-tech companies as a condition of employment, can be tough. But at least the employee is aware of the restriction on subsequent employment. What happens, however, when an employee who never even signed a non-compete agreement is barred from joining a competitor?
That happens and it’s not infrequent, says Christopher Wells, a Seattle-based partner with Lane Powell Spears Lubersky LLP, a multi-specialty law firm. He notes that the doctrine is known as "inevitable disclosure" and was demonstrated in 1997 in a New York court case involving DoubleClick, Inc.
In the case, Kevin Ryan, president of Internet advertising company DoubleClick, Inc., discovered that two of his executives planned to leave. Fearing they would use confidential information about DoubleClick’s business to start a competing venture, the employees’ lap-top computers were confiscated and the company asked the New York State Court to issue an injunction preventing the two from working in the Internet advertising industry for six months.
The court granted the requested injunction based upon "evidence of actual misappropriation" of DoubleClick’s trade secrets. That part of the decision was not controversial. But in a move that was chilling for employees across the nation, the court also found that the actual misappropriation claim was "bolstered by the fact that there is a high probability of inevitable disclosure of trade secrets in this case."
Based upon these findings, and despite the fact that neither employee had a non-compete agreement or even a valid confidentiality agreement with DoubleClick, the court entered an order that prohibited the defendants from starting a competing business for at least six months.
"The inevitable disclosure doctrine seeks to prevent a former employee from working for a competitor under the theory that an individual cannot help but exploit knowledge from his previous employer and put it to work for a competitor," says Wells. "There’s no ‘Chinese wall’ to segregate information in your head."
He observes that courts are more likely to apply inevitable disclosure, or enforce a non-compete agreement, if the former employee takes a position that’s is similar to his or her previous job, particularly if the position pays considerably more than the old one even though the responsibilities are not very different.
"If an employee leaves company A where she was northeast regional sales manager and goes to company B as a regional sales manager in the southwest, a court might say she’s not subject to a non-compete covenant or the inevitable disclosure doctrine," says Wells. "She might also be safe if she works for a company that’s in a different kind of business. But if she’s in a similar line of work the court may be suspicious."
He said concerns over that kind of outcome probably fueled a recent decision by Redmond, Washington-based Crossgain Corp. to ax about 25% of its employees, including the start-up’s two founders and chief executive officer, in response to pressure from Microsoft. Crossgain develops Internet-based standards and tools for software developers and, according to a recent report in the Wall Street Journal, the terminated individuals were all ex-Microsoft employees who had previously signed non-compete agreements with the Redmond-based giant.
The inevitable disclosure doctrine is at the heart of a court case currently being argued by an attorney in a Philadelphia-based law firm in which Wharton legal studies lecturer Bob Borghese is a principal.
The firm is representing a seller of specialized medical products that hired two salespeople who formerly worked for a competitor. Alleging misappropriation of trade secrets, the former employer says the two ex-employees improperly left with customer lists and should be enjoined from contacting the customers.
"Even though there were no restrictive covenants preventing the employees from joining the new firm, the former employer is utilizing the doctrine of inevitable disclosure in its argument," says Borghese. "It’s like a warning shot aimed at all of the company’s competitors. While it may not dissuade employees from leaving their company, it can certainly give them, as well as a prospective employer, pause."
In this instance, notes Borghese, a key concern is whether the customer list really constituted a trade secret. "The ex-employer has rights, since it incurred the costs of developing the customer list," he says. "But the real question is whether the list was maintained as a trade secret."
In this case, at least, Borghese predicts that the former employer will not prevail because it failed to maintain adequate safeguards to protect the information as a trade secret. "The customer list was maintained on an open network where it was easily accessible," he says. "If a company wants to maintain the information as a trade secret, then it needs to properly safeguard the asset to maintain its secrecy."
Meanwhile, Wells says that courts are walking a tightrope as they weigh a company’s right to protect its trade secrets against an individual’s right to work. And he thinks the courts may be coming down too hard against the individual. "Courts are striving for balance, but there are other options," he says. "For example, a court could permit an ex-employee to work for a competing firm, but the new employer would pay monetary damages to the former employer."
Under the Uniform Trade Secrets Act, which has been adopted by most states, an injunction may "condition future use upon payment of a reasonable royalty for no longer than the period of time for which use could have been prohibited." So why don’t courts sack the inevitable disclosure doctrine and instead levy monetary sanctions?
Maybe because it’s easier to tell a person he or she can’t take on a new job than it is to gain enough of an understanding of a company’s business to equitably award monetary damages or a royalty - especially when the companies are involved in high-tech ventures where today’s cutting-edge solution can be rendered obsolete in a heartbeat.
Ian N. Feinberg, an attorney in the Palo Alto office of Gray Cary Ware & Freidenrich LLP, calls the doctrine of inevitable disclosure a "seductive" one that "permits the overburdened and non-technically trained judge to avoid the seemingly impossible task of understanding asserted technical trade secrets, or worse, determining which of them are actually secret and have been misappropriated or are threatened with misappropriation."
A court that applies the inevitable disclosure doctrine, he adds, can prevent an employee from "performing specified duties without having to identify precisely what trade secrets are threatened with disclosure by the performance of those duties. In addition, of course, it is much easier to monitor compliance with an injunction which prohibits specified work than an injunction which prohibits use or disclosure of specific trade secrets."
Interestingly enough, the roots of the inevitable disclosure doctrine did not spring from a high-tech court battle. Instead, the guiding case, PepsiCo v. Redmond (1995), involved a defendant, Redmond, who had worked for Pepsico for 10 years, rising through the ranks to become the general manager of the business segment covering California that generated annual revenues in excess of $500 million and provided 20% of Pepsi’s U.S. profits.
In the course of his employment the general manager had gained access to PepsiCo’s annual operating and three-year strategic plans containing financial goals and strategies for manufacturing, production, marketing, packaging and distribution. This included especially vital pricing models and marketing plans for particular beverages in various markets.
In 1994, Redmond left PepsiCo to join Quaker Oats (which at the time sold such products as Gatorade and Snapple) as chief operating officer. PepsiCo sued and won a preliminary injunction preventing Redmond from marketing Snapple and Gatorade for a specific period. The new position, PepsiCo claimed, required him to anticipate and respond to PepsiCo’s trade secret marketing plan, a plan which Redmond had helped create while at the company. The injunction was upheld on appeal.
While the court emphasized that the mere fact that a person assumes a similar position at a competitor does not make it "inevitable that he will use or disclose trade secret information," it went on to rule that "[a] plaintiff may prove a claim of trade secret misappropriation by demonstrating that the defendant’s new employment will inevitably lead him to rely on the plaintiff’s trade secrets." The court cited the "fierce competition" between PepsiCo and Quaker Oats, particularly in the "sports beverage" (Gatorade) and "new age beverage" (Snapple) product lines.
Could the court have ruled differently?
Wells says yes. He cites another case in which a limited injunction was crafted by a court in AllisChalmers Manufacturing Co. v. Continental Aviation & Engineering Corp. That court also found that it was impossible for a former developer of fuel injection pumps not to use the former employer’s trade secret information. However, in an attempt to maintain the employee’s "right to pursue his chosen vocation," the injunction was designed to be "as restricted as possible to protect the secrets involved without undue restraint."
"This goal was accomplished by permitting the engineer to perform any work except development of the particular type of engine pump he had been working on at AllisChalmers," says Wells. "It was a truly balanced opinion."
Feinberg argues that courts should be using scalpels, not clubs, when "the mere threat of an ‘inevitable disclosure’ injunction can result in a decision not to hire an employee of a competitor, chilling employee mobility," he says. "For the same reason, widespread application of the doctrine could adversely affect the creation of new companies by people who are disenchanted with their present employer or who think they have invented a better mousetrap."
So will America’s technology drive sputter, a victim of its own anti-theft devices? Perhaps not. Because even as the noose appears to tighten around employee rights in some states, it is being loosened in others, like California, where Feinberg says the courts "have historically recognized the fundamental right of an employee to earn a living and have denied injunctive relief that interfered with this right."
Quoting from a California Supreme Court decision, Continental Car-Na-Var Corp. v. Moseley, Feinberg notes the decision stated that "...equity will to the fullest extent protect the property rights of employers in their trade secrets and otherwise, but public policy and natural justice require also that" the right of people to follow any of the "common occupations" of life should be respected as well. Every individual, the opinion added, "possesses as a form of property, the right to pursue any calling, business or profession he may choose." That last phrase echoes a similar one made a long time ago concerning Life, Liberty, and the pursuit of Happiness.