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Trade Secrets Cases Shoving Aside Noncompetes Amid High Turnover

Oct. 19, 2021, 9:07 AM

A recent North Carolina state court ruling that ex-employees of an HVAC company could be liable for stealing trade secrets like customer lists—but not for calling those customers in violation of a covenant—was an outcome fitting an emerging trend.

Companies that feel exploited by former employees helping a rival increasingly turn to trade secrets claims for relief, as restrictive employee covenants fall out of favor. In recent months that has combined with a spike in pandemic-spurred employee movement to fuel a rise in trade secrets cases, attorneys say.

Noncompete and non-solicitation agreements that bar employees for a period from joining a competitor or trying to sell to their ex-employer’s existing or prospective customers have been scrutinized and often voided. Courts often deem the clauses overbroad and unenforceable.

The shifting emphasis toward trade secrets enforcement represents a way for companies to compensate for the narrowed scope of covenants as tools to protect company assets. While less able to restrain what ex-employees do, in the digital age employers have significant ability to know what they take.

Employees, meanwhile, need to realize many companies track what they access, download, or transmit, which will arise in discovery if the company alleges a bid to harvest proprietary information.

“If, when balancing the scale, there’s an issue that could be construed against the employer, it most likely will be in a noncompete context,” intellectual property attorney Hayden J. Silver III of Womble Bond Dickinson LLP in Raleigh, N.C. said. Trade secrets claims are “more important than ever given this judicial rigor applied to restrictive covenants.”

The North Carolina Business Court, which heard the HVAC company’s case, has seen trade secrets cases nearly double from calendar 2017 to 2020. Their share of all cases at the court grew from 10% to 25% in that period.

Federal data also suggests companies now rely less on noncompete agreements and more on trade secrets claims, Russell Beck, a trade secrets attorney at Beck Reed Riden LLP said. Noncompete lawsuits “leveled off” in the last 10 years, while in the last two decades trade secrets cases have quintupled, he said.

“When you don’t have noncompetes, you end up with a bit of a muddled mess, and companies will take additional measures they didn’t have to take before. And I don’t think that benefits anybody,” Beck said. “I think that does more harm to workers.”

The shift has companies increasingly looking for ways to detect and curb theft.

Departing employees, especially those leaving high-level or sales positions, can expect scrutiny if they download or transfer various types of information, business attorney Melissa N. Subjeck of Hodgson Russ LLP said. Activity on personal devices may turn up in discovery. Activity on company systems may be detected pre-suit by company-hired forensics consultants.

“You’re seeing the increasing importance of monitoring those systems, and of oversight and protection. Companies have their finger on the pulse. They are monitoring it. You can see the fingerprint on every document when they are accessed,” Subjeck said, adding that the right evidence can drive ex-employees to a quick settlement.

Covenant ‘Unreasonable’

Trade secrets increasingly have become a favored method for protecting intellectual property in general for decades, including at the expense of patents that must be novel and eventually expire. The relative ease of stealing large volumes of the expanding portfolio of intellectual property electronically creates heightened vulnerability, while increased turnover adds opportunities to exploit it.

“We’re seeing a ton of employee departures, especially high-level employee departures,” labor attorney T. Cullen Stafford of Wyrick Robbins Yates & Ponton LLC in Raleigh, N.C., said.

Stafford said companies used to rely more on restrictive covenants to go after high-level employees who depart to prevent rivals from pillaging knowledge and expertise they’ve spent years developing.

But courts have clamped down, he said. Agreements have “boxes to check” to be enforceable, and “squishy” rules give judges “a lot of ways” to invalidate ones they don’t like, Stafford said.

In the North Carolina case, the HVAC company, Mechanical Systems & Services Inc., sued its former employees in the North Carolina Business Court.

The NCBC, ruling in August on a motion to dismiss, deemed an MMS non-solicitation agreement unenforceable. It barred trying to sell to recent customers of MSS or affiliate, prospective customers to whom MSS or an affiliate proposed a sale, or anyone the employee had worked with before leaving.

The court called the non-solicitation agreement “facially unreasonable” for covering thousands of facilities with which the employee gained no knowledge or experience while at MSS.

But the court rejected the employees’ argument that the trade secrets claims were too vague. The complaint named customer lists, contract terms, pricing information, recruiting strategies, customer needs, sales proposals, and correspondence, which the court said was enough detail to survive dismissal.

MSS also adequately alleged an employee accessed trade secrets after deciding to join a competitor, kept them, and used them, the court said.

Discovering Secrets

State courts generally offer low pleading standards than federal courts, making them an attractive destination for trade secrets litigants. But some states, including North Carolina, have responded to surging complaints by tightening standards to bring them closer to federal thresholds, Stafford said.

The goal is to limit fishing expeditions to uncover merely hypothesized theft—or, theoretically, access the defendant’s own secrets—through discovery. To do so, courts require alleged trade secrets and their alleged theft to be described with enough specificity.

“It has gotten a lot harder in North Carolina to assert a trade secrets claim out of the gate, mainly because the business court has clamped down,” Stafford said.

Concern over “fishing expeditions” is overblown, with few real-world examples, trade secrets attorney James Pooley of James Pooley PLC said. He said the premise “doesn’t make a lot of sense” in ways, partly because “almost everything produced” in discovery is deemed attorney-eyes-only, so a plaintiff company won’t see it.

Heightened pleading standards represent a “powerful tool” for defendants to get potentially legitimate cases tossed, as it’s often inherently difficult to know precisely what secrets were stolen before discovery, Pooley said. Defendants can sway judges with “jargon-laced reasons” that allegedly stolen information doesn’t qualify as a trade secret or isn’t specific enough, he said.

“They fight like wet cats over it, and that can be a problem. And it’s a problem for judges,” Pooley said. “We have this loose talk of fishing expeditions, when in fact that’s exactly the discovery system we have.”

To contact the reporter on this story: Kyle Jahner in Washington at kjahner@bloomberglaw.com

To contact the editors responsible for this story: Renee Schoof at rschoof@bloombergindustry.com; Keith Perine at kperine@bloomberglaw.com

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