Business Law

Some Observations on Restrictive Employment Agreements in the Information Age


by William H. Horton and Michael R. Turco

The information age has fundamentally changed the terms of the employment relationship between many employees and employers. As jobs have become more knowledge based, employers have spent large amounts of time and money training and retaining employees. In addition, employees have become more mobile, taking to a new employer those expensive skills. This article reviews some employers’ efforts to restrict post-termination competition in knowledge-based jobs and makes some observations on the judiciary’s response to those efforts.

THE CHANGE

Technology has made information and knowledge more accessible and valuable. Fifty years ago, computers were an academic curiosity. Large amounts of information were either unavailable or difficult to access, analyze, and distribute. Jobs were far less automated; many employees performed work now done by machines. Long-term employment and customer relationships were more common.

Much of this has changed. Large amounts of information are readily available to be analyzed at high speed by a laptop computer with inexpensive software. The results can be distributed worldwide almost instantly to any number of recipients over the Internet at a negligible cost. Employers have downsized, rightsized, merged, or spun off regularly. Job-hopping or a long résumé is sometimes a badge of honor rather than a fact to be minimized. An expensive training program or internship that provides valuable skills to an employee makes them attractive to a competitor. Sometimes those skills are difficult to distinguish from confidential information.

As a result, employers have increasingly demanded employment agreements that restrict employee mobility, such as confidentiality and noncompetition agreements. Employees, in keeping with Newton’s second law of motion, have resisted such attempts with equal and opposite force. Since the law generally is a lagging indicator responding to, rather than driving, changes in society or the economy, it has taken some time for these situations to ripen into disputes reviewed by the judiciary.

TRADE SECRETS

How has the information age affected the application of the law of trade secrets? The law itself has changed little, essentially prohibiting the use or disclosure of valuable, secret commercial information. Michigan adopted the Uniform Trade Secret Act in 1998,1 joining 41 other states. While some of the definitions, procedures, and remedies are revised, the act primarily codified existing trade secret law, including Michigan’s common law.

An analysis of the application of trade secret law in the information age suggests that employers are attempting to restrict the use of more general information and to prohibit disclosure before it occurs.

EarthWeb, Inc v Schlack2 and Doubleclick, Inc v Henderson3 are two Internet-related cases that apply the same law to similar facts in the same jurisdiction. They arrive at completely different results while applying the inevitable disclosure doctrine discussed below, which should require the highest level of proof for the plaintiff to prevail.

Trade secret law prohibits the improper acquisition or disclosure of protected secrets. However, if they are properly acquired, it is not unlawful to possess them. Injunctive relief is available when disclosure has actually occurred or is threatened.4 Actual disclosure is usually a question of the quality of the proofs: does the evidence show that the defendant actually disclosed the secrets. On the other hand, threatened disclosure is usually a question of whether the defendant’s past acts suggest the defendant will disclose in the future. Obviously, predicting the future is much less accurate and more difficult than determining a past act.

The inevitable disclosure doctrine is a third, more attenuated, theory to prohibit the future disclosure of trade secrets. According to the doctrine, a person may be enjoined from competing where the new position is very similar to the prior job, there has either been actual misappropriation of secrets or a lack of forthrightness about the new job, and the performance of the new job will inevitably require the use of confidential information from the prior job.5

One notable application of the doctrine involved William Redmond, the general manager for Pepsi Cola’s California operations. At the time, "sports drinks," such as Gatorade, were becoming popular. Quaker Oats, the maker of Gatorade, had lured away a Pepsi executive to run its Gatorade division. As is not unusual, this executive began courting his former co-employees from Pepsi, including Redmond. Quaker made Redmond an offer to join its Gatorade division and Redmond negotiated both with Pepsi and Quaker to obtain the best deal, overstating to Pepsi the offer made to him by Quaker.

Redmond eventually took the job with Quaker and Pepsi filed suit, alleging that Redmond knew the contents of and would inevitably use or disclose the contents of its "Strategic Plan." The Strategic Plan was an annual document discussing Pepsi’s financial goals, marketing and manufacturing strategies, and other business plans.

There was no allegation that Redmond had taken a copy of the plan. However, the district court, applying the Illinois version of the uniform act, held that there was a clear threat of misappropriation of secrets and enjoined Redmond from using or disclosing Pepsi’s trade secrets. It also enjoined him from taking his new job with Quaker for six months.

On appeal, the Seventh Circuit affirmed.6 In short, the court found the risk of inevitable disclosure too high:

PepsiCo believes that Quaker, unfairly armed with knowledge of [its business] plans, will be able to anticipate its distribution, packaging, pricing, and marketing moves. Redmond and Quaker even concede that Redmond might be faced with a decision that could be influenced by certain confidential information that he obtained while at PepsiCo. In other words, PepsiCo finds itself in the position of a coach, one of whose players has left, playbook in hand, to join the opposing team before the big game.7

Caution in general application of this case should be exercised. First, the case was a review of the district court’s conclusions following an evidentiary hearing on a motion for a preliminary injunction. As a result, the Seventh Circuit reviewed the case to determine only whether the district court had abused its discretion, a low standard. The court recognized this low-water mark and suggested that a different fact finder could have concluded differently than the district court:

The facts of the case do not ineluctably dictate the district court’s conclusion.****Nonetheless, the district court, after listening to the witnesses, determined otherwise. That conclusion was not an abuse of discretion.8

Second, some courts have held that the doctrine of inevitable disclosure does not exist in those states, like Michigan, where the uniform act has been enacted.9 They reason that the Legislature is presumed to know of the common law and did not include the doctrine in the codification. Instead, the uniform act prohibits only "actual or threatened misappropriation" and states nothing about inevitable disclosure.10

Third, successful application of the doctrine results in a drastic remedy since it judicially converts a trade secret agreement into a noncompetition agreement. Imagine Redmond’s surprise when he found himself not in a new, exciting position at a new company but on the sidelines for six months.

Despite these cautions, claiming inevitable disclosure seems to be the cry of the former employer when an important knowledge-based employee jumps ship to a competitor. Proper application should be especially judicious. Against this background lie the cases of Doubleclick and EarthWeb.

In Doubleclick, the plaintiff-company created and marketed banner advertisements that appear on the top of many websites. If the viewer is interested in the product being advertised, they double click on the banner and jump to the site containing information about the product. The defendants were former vice-presidents who decided to leave the company and open a competing business. When news of their plan leaked, the defendants were confronted. They confessed and were fired and their laptop computers were confiscated. The computers showed they had copied revenue projections, pricing, product strategies, and databases containing information about clients.

Without an evidentiary hearing but only on briefs, the New York court enjoined the defendants for six months from starting or working for any company that competed with their former employer. Among other things, the court held that information about the plaintiff’s pricing and customers were trade secrets and it was inevitable that the defendants would use that information in their new employment.

EarthWeb is in contrast. In this case, EarthWeb hosted an Internet website containing technical articles and links for information technology professionals. EarthWeb sued a former vice-president in charge of their website content after he left EarthWeb to join a start-up Internet division of another company offering similar, but not identical, services. The plaintiff alleged that the defendant would inevitably use or disclose its secrets regarding its strategies, business arrangements, and technical knowledge.11 The plaintiff did not have any evidence that the defendant had taken any documents or other tangible information with him.

The court in EarthWeb refused to issue an injunction. There was no evidence of actual or threatened misappropriation, the jobs were somewhat different and, because of the general nature of the alleged trade secrets, the court refused to apply the inevitable disclosure doctrine.

While the general legal principles stated in both Doubleclick and EarthWeb are virtually the same, the application of them to the facts are different.12 In Doubleclick, the apparent misappropriation related to pricing strategies and specific price agreements with various customers. The defendants argued that the price information was not secret because it was published by the plaintiff on its website. The plaintiff argued that each situation was "deal driven" and therefore custom and secret. In either case, the court seemed to miss the point—naked pricing information once disclosed to a customer is no longer secret.13 Customers are free to disclose such information and typically do so to competitors to obtain better rates. While having the pricing history of Doubleclick would certainly be helpful to compete with it, it is difficult to consider it a trade secret.

The court also found the defendants had copied substantial portions of the Doubleclick business plan in creating their own plan. While such evidence may show a proclivity to misappropriate secrets, most business plans are not in themselves secret. In this case, the business plan was more than a year old and had been "shown to venture capital firms" in an effort to raise money.14 Once disclosed to outsiders, it lost its secrecy.15 More important, it was at least a year old and probably had very little commercial value, especially considering the speed with which the development of advertising was evolving on the internet in the mid to late 1990s.

The Doubleclick court used these weak and old events of misappropriation to conclude that the defendants would inevitably disclose some undefined secret information in the future. It appears that the court overstepped an appropriate application of the doctrine and eliminated, at least temporarily, a competitor, rather than crafting an order that would protect trade secrets.16

On the other hand, EarthWeb appears to have charted a more precise and careful course through turbulent waters. The court prefaced its analysis by noting that "the inevitable disclosure doctrine treads an exceedingly narrow path through judicially disfavored territory. Absent evidence of actual misappropriation by an employee, the doctrine should be applied in only the rarest of cases."17

The court refused to apply the doctrine, finding that the similarity of the two employment positions was not high enough, the subject matter of the websites had a different focus, and the defendant’s prior employment had been at-will. The defendant testified that he would not have taken the job with plaintiff if he could not work in the industry in the future.

In that regard, the court was troubled by the imposition of a judicial noncompetition provision:

Another drawback to the doctrine is that courts are left without a frame of reference because there is no express non-compete agreement to test for reasonableness. Instead, the courts must grapple with a decidedly more nebulous standard of "inevitability." The absence of specific guideposts staked-out in writing will only spawn such litigation, especially as the Internet becomes a primary medium for ideas and commerce.18

Michigan courts would well serve its citizens by cautiously approaching application of the doctrine for knowledge-based jobs. Detailed knowledge of a specific formula, plan, or other specific information, coupled with a prior bad act and a high similarity in the former and current jobs, may justify application of the doctrine’s harsh remedy. On the other hand, knowledge of a more general nature, modest dissimilarity in the jobs, or a failure to maintain secrecy, does not justify a judicially-decreed noncompetition agreement. Other remedies may be appropriate.

Noncompetition Agreements

Michigan’s Legislature repealed the statute prohibiting most noncompetition agreements in 1986 and shortly thereafter enacted a provision authorizing courts to review these agreements for reasonableness; if they are overbroad, the statute authorizes enforcement to the extent they are reasonable.19 Such agreements will be enforced if they have a reasonable geographic scope, reasonable time period, and are drafted to protect a reasonably competitive business interest.20

Perhaps the most important consideration to change in the information age is the geographic scope and time periods. Since some skills and information may not qualify as a trade secret, using an agreement to prevent an employee from competing may be the most practical avenue. However, skills and information may have worldwide application.

As a result, some employers have imposed restrictions on competition anywhere on the globe. James L. Dam wrote in Lawyers Weekly:

In the past, an important way to establish the fairness and reasonableness of a noncompete agreement was to limit the agreement to a particular geographic area, such as the area within 50 miles of the employer.

But now, especially for the Internet companies, such a limit frequently won’t make sense, and attorneys are focusing on other ways to convince judges that the agreements should be enforced.21

Some courts that have reviewed such agreements have found something akin to an inverse relationship between geography and time: as the geographic scope of the agreement increases, the time period should decrease. The cases of EarthWeb22 and Heartland Securities Corp v Gerstenblatt23 illustrate this point.

In Heartland Securities, the court struck down a four-year, worldwide noncompetition agreement for an on-line stock trader. The court stated:

Courts may only enforce restrictive covenants that are reasonable in time and geographic limitations. None of the defendants’ agreements provide for any geographic limitations; the noncompete agreements theoretically cover the entire world. Other courts have held restrictive covenants with similar lack of geographic limitations to be unreasonable.

* * *

The duration of the restrictive covenant, especially when read with the limitless geographic scope of the covenant, is unreasonable.24

In EarthWeb, the court held that a one-year, worldwide noncompetition agreement was too long.

As a threshold matter, this Court finds that the one-year duration of EarthWeb’s restrictive covenant is too long given the dynamic nature of this industry, its lack of geographic borders, and [the employee’s] cutting-edge position with EarthWeb where his success depended on keeping abreast of daily changes in content on the Internet.25

These knowledge-based cases suggest that, absent unusual circumstances, broad noncompetition agreements are suspect if they are over a year long; no legitimate business interest is protected beyond that period. The four-year restriction in Heartland was unreasonable, as well as three-year and two-year agreements in other cases.26

Two other observations should be noted regarding these cases. First, the EarthWeb court, applying a New York statute similar to Michigan’s, found the noncompetition provision to be overbroad, but ruled that it had the authority to enforce it to its reasonable extent. However, in the exercise of its discretion, it refused to do so because the agreement was too overbroad.27 Such a refusal provides a useful prophylactic against the seemingly common practice of drafting such agreements as broad as possible then arguing that the court can simply make it reasonable. Michigan courts should take note.

Second, a factor to be considered by the court in determining reasonableness is whether a terminated employee is entitled to be paid during the noncompete period. In other words, if an employer is willing to pay a terminated employee during the prohibited period, it apparently has concluded that it has a legitimate business interest to protect that justifies the payment. A long, uncompensated noncompete is less likely to protect such an interest:

The Court finds further support for a strict construction of the employment agreement based on its rather onerous terms. The agreement provided that Schlack’s employment was at-will. While it contained a restrictive covenant, it made no provision for the payment of severance to Schlack in the event EarthWeb terminated his employment.28

Absent other circumstances, the best evidence that a former employer has a legitimate business interest to protect is either an agreement of short duration or an agreement of longer duration with some compensation for the former employee.

Training Reimbursement Agreements

As employers have found it necessary to spend large amounts of time and money training employees, they are expecting them to stay with the company long enough for it to recoup its costs. Michigan has an interesting twist on these agreements.

Most states treat such time agreements under the same rules applicable to noncompetition agreements. They must be reasonable and protect only a legitimate business interest. For example, in Matthews v City of Gulfport,29 the federal district court held that the plaintiff did not dispute that she had signed such an agreement and that it was reasonable, but that she disputed the amount. The court entered a judgment of liability on defendant’s counter-claim.30

In contrast, the court in Heartland Securities, when faced with an agreement to repay the astounding amount of $200,000 in alleged training costs for a stock trader, refused to do so. The court found the amount to be so unreasonable that it refused to enforce any portion of it:

This Court declines to exercise its discretion to "blue pencil" the provisions at issue in an effort to make them enforceable...As discussed above, Heartland has failed to show that the purpose of the restrictive covenant was to protect a legitimate business interest. Additionally, Heartland has failed to demonstrate that it did not overreach or use dominant bargaining power in reaching the agreements with defendants.31

Michigan courts have split on the issue until recently when the Supreme Court resolved the issue. An obscure Michigan statute makes it unlawful to pay a fee for a job.32 In Sands Appliance Services v Wilson,33 the defendant had received extensive training in repairing appliances, a field in which he had no prior experience. He agreed to repay some of those training costs if he left the company within three years. He left the company and refused to pay. The employer brought an action to recover $6,500 in training costs. The district court and circuit courts held that the statute barred the contract. However, the Court of Appeals reversed, holding that the statute was not intended to apply to these facts.34 The Supreme Court reversed.

One cannot argue with the decision of the Supreme Court in the face of the language of the statute. The statute prohibits, among other things, the giving of a bond by an employee as security to complete a specific period of employment.35 Application of the statute to a training reimbursement agreement based on a specific period of employment violated the plain language of the statute.

However, it certainly seems the statute is ripe for legislative revision or repeal. While the legislative history of the statute is absent, the plaintiff argued without success to the Court of Appeals that it was enacted in response to a practice in the Great Depression of selling jobs for a fee.36 Since then, circumstances have changed dramatically. Fortunately, unemployment levels have not approached those of the Depression since. The Legislature has also authorized a more restrictive practice by allowing noncompetition agreements. In addition, the Supreme Court has allowed agreements that compensate employers for the taking of customers by a former employee.37

If amended or repealed, training reimbursement agreements should be enforceable if rules similar to those applicable to noncompetition agreements are used. The amount of the reimbursement should be directly related to the cost of the training. The forgiveness period should be connected to the time it would reasonably take the employer to recover the training cost. While overbroad agreements could be restricted and enforced, agreements that overreach should not be enforced at all.

CONCLUSION

The information age has required some adjustment of the rules, but most of the old rules still apply. The change has been in the application of the old rules to new facts. A rule of reasonableness should be applied to restrictive employment agreements. However, the courts must carefully scrutinize the facts and circumstances of unfamiliar knowledge-based (and jargon-filled) businesses before applying those rules. n

Footnotes

1. MCLA 445.1901, et seq.

2. EarthWeb, Inc v Schlack, 71 F Supp 2d 299 (SD NY 1999), aff’d, 2000 US App Lexis 11446 (CA 2, May 18, 2000).

3. Doubleclick, Inc v Henderson, 1997 NY Misc Lexis 577 (1997).

4. MCLA 445.1903.

5. E.g., Pepsico, Inc v Redmond, 54 F3d 1262 (CA 7, 1995); Bayer Corp v Roche Molecular Systems, Inc, 72 F Supp 2d 1111 (ND Cal 1999).

6. Pepsico, Inc v Redmond, 54 F3d 1262 (CA 7, 1995).

7. Id. at 1270.

8. Id. at 1271.

9. E.g., Bayer Corp v Roche Molecular Systems, Inc, 72 F Supp 2d 1111 (ND Cal 1999).

10. The reasoning of these courts is suspect if the doctrine is simply considered a species of "threatened" disclosure.

11. 1171 F Supp 2d at 302.

12. The difficulty in reconciling these cases may be due in part to lack of access to detailed information about the cases. It is sometimes difficult to discern detailed facts from trade secret cases, since courts are understandably reluctant to recite them in their opinions. Most trade secret acts allow the record to be sealed, which was done in both of these cases.

13. A history of pricing generally does not contain enough information to qualify as a trade secret. Once disclosed to the customer, it has lost its secrecy. Economation, Inc v Automated Conveyor Systems, Inc, 694 F Supp 553, 555 (SD Ind 1988); Carbonic Fire Extinguishers, Inc v Heath, 190 Ill App 3d 948, 547 NE2d 675 (1989). However, a company’s pricing strategy or historical information that could predict future pricing strategy can be considered a trade secret. See, for example, Stampede Tool Warehouse, Inc v May, 651 NE2d 209, 216 (Ill App 1995).

14. 1997 NY Misc. Lexis at 4.

15. It is interesting to note that some courts have held that stolen information posted on a website is no longer secret to third parties regardless of the misappropriation because of the immediate and worldwide disclosure. Ford Motor Co v Robert Lane, 67 F Supp 2d 745, 753 (1999); Religious Technology Center v Arnaldo Pagliarina Lerma, 908 F Supp 1362, 1368-69 (Ed Va 1995).

16. For example, the court could have enjoined use or disclosure of the information, required the return of all documents, required periodic certification of compliance to the court, prohibited contact with a specific list of customers, or entered some other order that protected the information but allowed legitimate competition.

17. 71 F Supp 2d at 310.

18. Id. at 311.

19. MCLA 445.774.

20. E.g., Compton v Joseph Lepak, DDS, PC, 154 Mich App 360, 368 (1986).

21. James L. Dam, Lawyers Take New Approaches to Noncompetes, Lawyers Weekly USA, p 1 (July 20, 2000).

22. 71 F Supp 2d 299 (SD NY 1999).

23. 2000 US Dist Lexis 3496 (SD NY 2000).

24. Id. at 20-21 (citations omitted).

25. Id. at 313.

26. The judicial creation of noncompetition agreements in Redmond and Doubleclick were only six months in duration. Michigan courts would benefit from a specific analysis of the duration of a plaintiff’s legitimate business interest before applying what may be an unreasonable time period contained in an agreement.

27. 71 F Supp 2d at 313.

28. Id. at 311.

29. 72 F Supp 1328 (MD Fla 1999).

30. Id. at 1341.

31. Id. at 29.

32. MCLA 408.478(1).

33. 463 Mich 231 (2000).

34. 231 Mich App 405 (1998).

35. MCLA 408.478(1); See also: 1982 AACS, R 408.9011.

36. 231 Mich App at 411, 415.

37. Follmer, Rudzewicz Co v Kosco, 420 Mich 394 (1984).



William H. Horton is a shareholder and board member with Cox, Hodgman & Giarmarco, P.C.

Michael R. Turco is also a shareholder. Both specialize in commercial litigation.

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