1. Enforcing Non-Competes and Protecting Trade Secrets. By: Charles H. Wilson Cozen O’Connor P.C.

2. PART 1: Introduction

3. Scenario You have a star employee who works for or starts a competing company and convinces the entire sales team to join him. They lure away most of your company’s clients. 3

4. Scenario A General Manager decides to help a competitor develop business, while still working for your company. She downloads all of your customer data onto a thumb drive and provides it to the competitor. She sends critical financial and marketing information to her personal email account before resigning. 4

5. PART 2: Elements of a Valid Covenant Not to Compete

6. A COVENANT NOT TO COMPETE IS… Contractual restrictionContractual restriction Limits or prevents an employee from competing during or after employmentLimits or prevents an employee from competing during or after employment Usually restricts an employee from working for a competitor for a certain period of time after termination of employmentUsually restricts an employee from working for a competitor for a certain period of time after termination of employment Used to protect customer relationships, confidential information, trade secrets and goodwillUsed to protect customer relationships, confidential information, trade secrets and goodwill Non-Solicitation agreements, or agreements to refrain from soliciting customers or employees during and after employment, are also frequently treated as a covenants not to compete in TexasNon-Solicitation agreements, or agreements to refrain from soliciting customers or employees during and after employment, are also frequently treated as a covenants not to compete in Texas Covenants Not to Compete are controlled by statute in TexasCovenants Not to Compete are controlled by statute in Texas 6

7. TEXAS BUSINESS & COMMERCE CODE Section 15.50(a): “A covenant not to compete is enforceable if it is… 1.ancillary to or part of an otherwise enforceable agreement at the time the agreement is made to the extent that it contains limitations as to time, geographical area, and scope of activity to be restrained that are reasonable; and, 2.does not impose a greater restraint than is necessary to protect the goodwill or other business interest of the promisee” 7

8. TEXAS BUSINESS & COMMERCE CODE Two Step Inquiry: 1.Is there an otherwise enforceable agreement; and, 2.Is the non-compete covenant part of or ancillary to that agreement. Marsh USA v. Cook, 354 S.W3d 764 (2011). 8

9. QUESTION What type of agreement will satisfy the “otherwise enforceable agreement” requirement? 9

10. Otherwise Enforceable Agreement The “otherwise enforceable agreement” requirement is satisfied when the covenant is “part of an agreement that contain[s] mutual non-illusory promises.” Marsh USA v. Cook 10

11. EXAMPLES Confidentiality/Non-Disclosure Agreement Employer promises to provide or provides confidential information in exchange for employee’s promise not to disclose such information.Employer promises to provide or provides confidential information in exchange for employee’s promise not to disclose such information. Employment Agreement for a Guaranteed Term Employment Agreement in which Termination can only be “For Cause” 11

12. EXAMPLES At-Will Employment Agreement Employer promises to provide specialized training, 14 days notice, and inventory upon terminationEmployer promises to provide specialized training, 14 days notice, and inventory upon termination Evan’s World Travel, Inc. v. AdamsEvan’s World Travel, Inc. v. Adams Stock Options In Return For Promise Not To Disclose or Solicit. 12

13. Marsh USA Inc. v. Cook In order for a covenant not to compete to be “ancillary to or part of an otherwise enforceable agreement” between an employer and an employee… the consideration given by the employer in the otherwise enforceable agreement must be reasonably related to an interest worthy of protection the consideration given by the employer in the otherwise enforceable agreement must be reasonably related to an interest worthy of protection 13

14. QUESTION Is a company required to provide an employee with the confidential information, trade secrets or specialized training at the time the agreement is entered into? 14

15. ALEX SHESHUNOFF MGMT. SERVS. V. JOHNSON The Supreme Court of Texas Held: NO, employers are only required to promise to give an employee confidential information, trade secrets or specialized training at the time the agreement is made; and,NO, employers are only required to promise to give an employee confidential information, trade secrets or specialized training at the time the agreement is made; and, the employer must actually provide the consideration during the employee’s employmentthe employer must actually provide the consideration during the employee’s employment 209 S.W.3d 644 (Tex. 2006) 15

16. QUESTION Is a company required to expressly promise to provide an employee with confidential information, trade secrets or specialized training in the future or can it be implied? 16

17. MANN FRANKFORT STEIN & LIPP ADVISORS, INC. V. FIELDINGS The Supreme Court of Texas Held: No need for an express promise by an employer to provide an employee with confidential information so long as the “nature of the work” required itNo need for an express promise by an employer to provide an employee with confidential information so long as the “nature of the work” required it Courts may imply a return promiseCourts may imply a return promise Expands SheshunoffExpands Sheshunoff 289 S.W.3d 844 (Tex. 2009) 17

18. QUESTION What type of activities can a company lawfully restrict an employee from engaging in after employment? 18

19. RESTRICTIONS Common to preclude employee from soliciting or doing business with clients he/she serviced during employmentCommon to preclude employee from soliciting or doing business with clients he/she serviced during employment Industry-wide exclusions may be unreasonableIndustry-wide exclusions may be unreasonable Restrictions that prohibit an employee from doing business with clients with whom they had no contact may be unreasonableRestrictions that prohibit an employee from doing business with clients with whom they had no contact may be unreasonable 19

20. QUESTION What is a reasonable time period for a covenant not to complete? 20

21. REASONABLE TIME Fact-specific inquiry (depending on industry, type of information involved, etc.)Fact-specific inquiry (depending on industry, type of information involved, etc.) Generally, 6 months to 1 year is well within rangeGenerally, 6 months to 1 year is well within range Anything over two years will be highly-scrutinizedAnything over two years will be highly-scrutinized Unlimited restriction on time is unenforceableUnlimited restriction on time is unenforceable May depend on the speed with which technology or other confidential information evolves in particular industry; What is “shelf life” of confidential information?May depend on the speed with which technology or other confidential information evolves in particular industry; What is “shelf life” of confidential information? 21

22. QUESTION What is a reasonable geographic area in which to restrain an employee from competing? 22

23. GEOGRAPHIC AREA Typically found reasonable if limited to the region within which the employee worked during employmentTypically found reasonable if limited to the region within which the employee worked during employment This issue may not be relevant due to today’s global business landscape; better practice is to restrict non- compete to customers employee servicedThis issue may not be relevant due to today’s global business landscape; better practice is to restrict non- compete to customers employee serviced 23

24. Non-Solicitation Agreement  Are Non-Solicits considered to be Non-Competes? Yes – Subject to same analysis under Texas law.  How do you include a geographic restriction on a non-solicitation agreement where the customers are not limited to one area? Texas law allows a description of customers, or a customer list, to substitute for a geographic restriction. 24

25. Enforcement Issues  What happens if the Judge modifies the scope of the agreement? The employer can only recover damages for a breach after modification.  If the agreement is found unenforceable, does the employee get fees? Texas law allows for the employee to recover fees if the employer knew at time of drafting that the restrictions were overly broad, and sought to enforce a greater restraint than necessary. 25

26. PART 3: “I Don’t Have A Non-Compete, Now What?”

27. Related Common Law Claims or Theories  Tortious Interference with Contract/Business Relationship or Expectancy –New employer induced employee to breach employment or non-disclosure agreement  Breach of Fiduciary Duty/Duty of Loyalty –employee is removing or transferring documents or actively competing while still employed  “Inevitable Disclosure” –Employee will be employed in similar position requiring him or her to use information

28. Texas Uniform Trade Secrets Act Definition of Trade Secret Includes a formula, drawing, pattern, compilation including a customer list, program, device, method, technique or process that: (1) Derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable by proper means by, other persons who can obtain economic value from its disclosure or use. (2) Is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.

29. Texas Uniform Trade Secrets Act Misappropriation (1) Acquisition knowing or having reason to know trade secret was acquired by improper means. (2) Disclosure or use (actual or threatened) of trade secret without express or implied consent. (3)“Improper means” includes theft, bribery misrepresentation, breach of a duty to maintain secrecy, to limit use, or to prohibit discovery, espionage through electronic of other means.

30. Texas Uniform Trade Secrets Act Damages (1) Actual loss (2) Unjust Enrichment (3)Reasonable Royalty

31. Examples of Trade Secrets –Financial goals and marketing strategies; –Computer software, hardware, and databases; –Cost and pricing information; –Customer lists and preferences; –Employee compensation information

32. PART 4: Protecting Trade Secrets

33. Protect Trade Secrets through Contract You can require any employee (even at-will) to execute a non disclosure agreement including a confidentiality provision: –List materials identified as trade secrets or confidential information and acknowledge that they are confidential. –Acknowledge that the information belongs to the employer and was developed through the employer’s lengthy and expensive efforts.

34. Protect Trade Secrets through Employment Contract –Establish guidelines regarding access and handling of the information. –The provision should be effective both during and after the employment relationship. –Do not include a time frame. Consider – would it ever be okay for an ex-Coke employee to divulge the secret formula?

35. Protect Trade Secrets Through Additional Measures Include confidentiality provisions in the employee handbook. Periodically distribute memoranda to employees to remind them of their obligations to maintain confidentiality

36. Protect Trade Secrets Through Internal Controls Include confidentiality provisions in contracts with third parties. Use passwords to protect company information. Monitor software that logs database access. Mark confidential documents with a warning that indicates the documents’ proprietary and confidential status. –Segregate confidential documents in locked storage cabinets or designate custodian to track the information. –Do not indiscriminately mark documents “confidential,” as that will undermine the validity of the designation. Maintain customer contacts in employer-owned media.

37. Take Action When Suspect Departing Employee of Wrongdoing If an employer suspects that one of its employees is using confidential information to set up business in competition with the employer’s business, it should move quickly to ensure it has effective IT and other relevant systems in place to track and record the employee’s actions.

38. Investigations Get/seal computers –Chain of custody Save/copy all back-up tapes Get employer’s records –Cell phone bills, expense reimbursements, agreements, handbooks

39. Investigations Determine what confidential information the employee had access to. Check the employee’s office. –Lock down –Missing files/documents –Shredder

40. Computer Forensics Look for the smoking gun Removable media –Flash drives –CD burning –Portable hard-drives/zip drives

41. Computer Forensics Use of email to send documents to home computer Lockbox or cloud storage Deletion – the black hole theory

42. Computer Forensics If feasible – do not search for anything on our own; it ruins chain of custody. Get an experienced expert.

43. Handling Resignations of Departing Employees In most cases, employees should be immediately relieved of any duties that would expose them to company information or customers. –This may necessitate immediate termination—but beware, because if a restrictive covenant is in place, the employee may be able to argue that the early termination should preclude its enforcement.

44. Handling Resignations cont’d Another option is to keep employees on the payroll while serving out the notice period, but relieve them of any meaningful job duties. Employers may want to consider offering severance packages in exchange for contractual nondisclosure provisions.

45. Conduct an Exit Interview Question the employee about his or her future plans Lying = Misrepresentation Remind exiting employees of their obligations with respect to the company’s confidential information. –Review terms of the employee’s non-compete agreements during the interview. Ask employee to sign acknowledgement that he or she is aware of his or her obligations.

46. Conduct an Exit Interview Encourage employees to ask questions they may have about their obligations concerning confidential information. Record employees’ questions and responses as part of the minutes of the meeting. Ask employee to verify that he or she is not keeping any company property or documents that contain confidential or proprietary business information.

47. Prevent Further Access to Company Information Disable former employees’ passwords and e-mail accounts. Require the return of keys or building pass- cards and notify security that the individual is not allowed on the premises. Require the return of any company-owned equipment; i.e., laptop, PDA, that may contain business information.

48. PART 5: Issues in Litigation

49. Remedies Injunction Actual Damages Disgorgement for Unjust Enrichment Exemplary Damages Punitive Damages Attorneys’ Fees, Costs and Expenses

50. Injunctive Relief Helpful Tips 1.Computer Analysis 2.Expedited Discovery 3.Move Swiftly 50

51. Expedited Discovery Request simultaneously with filing the lawsuit Demonstrate to the Court –Some connection between the expedited discovery and the avoidance of irreparable injury; and –Some evidence that the injury that will result without expedited discovery is greater than the defendant will suffer if the expedited relief is granted.

52. Expedited Discovery Request from ex-employee –Expedited depositions –Expedited document requests –Entry onto new employer’s premises –Access to computers and email –Court order prohibiting deletions/destruction Stop the bleeding theory

53. Damages Defendant’s Profits Plaintiff’s Lost Profits Economies of Scale Royalty

54. Preparing to Compete In Texas, employees can prepare to compete. Employees can generally set-up a business, but can’t tell customers or take affirmative steps to compete. Right to Compete vs. Breach of Fiduciary Duty – gray line.

55. Federal Liability The Computer Fraud and Abuse Act –Hacking into employer computer systems –Deleting data to “cover tracks” The Electronic Communications Privacy Act –Criminal Penalties

56. PART 5: Conclusion

57. Steps for Protecting Company 1.Agreements Non-Compete and Non-Solicitation Confidentiality and Non Disclosure 2.Policies Confidentiality Security of Trade Secrets IT Security 3.Systems and Processes Restrictions on Flash Drives and Other Copying Protocol for Resigning Employees Exit Interviews

58. Charles H. Wilson Office Managing Partner, Vice Chair cwilson@cozen.com (713) 750-3117 Contact Information