The Phelps case involved the not so uncommon fact pattern of a sale of a business with the owner (or in this case, putative owner) forming a new company to compete in the same space as the old company after the close of the transaction, with the parties left to argue about whether the conduct violated any sale agreement.   In the Phelps case, S.C. Phelps (SCP) was sold through an asset purchase agreement to plaintiff Phelps Staffing, LLC.  As part of the transaction, the sole shareholder of SCP, Ms. Sheila Phelps, agreed to sign on her behalf and on behalf of SCP, a non-compete agreement.  Ms. Phelps’ husband, Charles Phelps, who was not an owner of SCP but was instrumental in acquiring new customers, refused to sign a non-compete agreement.  Ms. Phelps was allegedly disassociating herself from the business, so the non-compete was not an issue.  Mr. Phelps, on the other hand, had allegedly started his own company C.T. Phelps, Inc. (CTP), and evidently was keeping the option open of competing in the future.  Mr. Phelps received half of the proceeds from the sale, but did not personally sign the asset sale agreement. 

According to the opinion, following the sale of the business, Mr. Phelps informed his wife that he intended to reenter the contract labor staffing business and would do so through his new company, CTP.   Mr. Phelps contacted former customers of SCP and solicited them to do business with his new company.  Mr. Phelps also allegedly “flipped” some of the contract workers to his new company from SCP.   Ms. Phelps provided some marginal assistance to her husband in acquiring and installing accounting software on new computers.  Several months later, plaintiff Phelps Staffing, LLC filed suit against Mr. and Mrs. Phelps, SCP and CTP for breach of the non-compete and confidentiality provisions, trade secret misappropriation and unfair competition, among other claims.  Following summary judgment and later a bench trial, the trial court found in favor of Mr. and Mrs. Phelps on the non-compete claims.  The plaintiff appealed the decision.

On appeal, plaintiff argued that Mr. Phelps, although not a signatory to the non-compete agreement, was nonetheless subject to it as he was the “true owner” of SCP.  In support of this argument, the plaintiff apparently did not cite to and rely upon North Carolina authority.  Instead, plaintiff relied on a Montana case, Bolz v. Myers, 651 P.2d 606 (Mont. 1982). 

In Bolz, the plaintiff there, Dale Bolz,  purchased a hearing aid center, which was negotiated between Bolz and defendant Mason Myers.  Myers wife and son executed the purchase agreement, while Mason Myers did not.  The purchase agreement contained a non-compete agreement and in that case, the Montana Supreme Court found it binding on Mason Myers based in large part on the fact that Mason Myers was asked by Bolz and gave oral assurance to him that he had no intention of competing against Bolz after the sale.  In Phelps, the plaintiff argued that Bolz was factually on point.  The North Carolina Court of Appeals disagreed, finding the absence of any such oral assurance by Charles Phelps to be dispositive of the issue.

While there are several interesting aspects to this case — not the least of which is the fact that somehow all of “financial and accounting data sets” of the prior business (SCP) were somehow installed on the new computer at CTP yet no liability was found against defendants for unfair competition – perhaps the most interesting is the question of whether the Court of Appeals would have accepted and applied Bolz had the facts been slightly different.  The Court of Appeals did not just reject the proposition out of hand.  The Court of Appeals, while noting the opinion was not controlling, agreed with the plaintiff that there were factual similarities between Bolz and the present case, but then found the lack of oral assurance to be a key fact that distinguished the present case from Bolz.  

Perhaps the door has been left open just a bit for such an application in the future.  But if such an argument were to be considered, it would face great hurdles.  First, the facts would likely have to approach some manifest injustice to the plaintiff, arising almost to fraudulent conduct in deceiving the plaintiff to proceed with a sale of the business without obtaining a non-compete from one of the key persons at the seller.  Second, the plaintiff would have to overcome the fact that non-competes are disfavored in the law of this State.  Finally, the plaintiff would have to overcome N.C. Gen. Stat. 75-4, requiring non-competes be in writing, signed by the party to be bound, for it to be legally enforceable.  For some reason, the Court of Appeals did not discuss this provision.  Whether a Bolz type case could find a foothold here in North Carolina would seem to be a long shot but time will tell.

At the trial court level, the defendants challenged the plaintiffs’ trade secret assertions.  The lower court, in ruling on a motion for summary judgment filed by the defendants, found that while the Plaintiff had shown the EU Model was unique, it had “failed to distinguish which aspects of its software, as a compilation, are publicly available or readily ascertainable and which are not.”  The district court granted the defendants’ motion and entered judgment in their favor.

On appeal, the Fourth Circuit reviewed district court’s decision as to the trade secret claim. The Fourth Circuit first noted that the Virginia statute recognizes “compilation of information” as being a trade secret, if not generally known or readily ascertainable by proper means, and specifically, that “computer source code as a compilation can qualify as a trade secret.” The Fourth Circuit then reviewed the evidence presented and concluded that the Plaintiff had presented sufficient evidence to establish the trade secret status of the “software compilation” for a jury to consider.  As observed by the Court:  “Although the EU Model uses certain mathematical formulas that are in the public domain, [Decision Insights] asserted that the combination and implementation of these formulas in [Decision Insights'] source code for the software constitutes a trade secret.”  The Fourth Circuit found sufficient evidence to support this trade secret claim and remanded the case to the District Court for further consideration of other issues, including whether the Plaintiff had met its burden to show that it had taken reasonable measures to protect the alleged trade secret, another element of a trade secret claim.

While interesting in a number of respects, the Fourth Circuit’s opinion reaffirms that “compilations of information,” even when some of that information may be in the public domain, can be a trade secret.  The North Carolina Court of Appeals has similarly found under the North Carolina Trade Secrets Protection Act that a compilation of business information can be a trade secret and protectable.  See Sunbelt Rentals, Inc. v. Head & Engquist Equipment LLC, 174 N.C. App. 49, 620 S.E.2d 222 (N.C. App. 2005). In that case, Sunbelt alleged that the Defendants, through an orchestrated raid of its business, created a competing company by misappropriating Sunbelt’s trade secrets consisting of a “compilation of business information.” Following a bench trial, the North Carolina Business Court entered judgment in Sunbelt’s favor on the trade secret claim, among others, which was affirmed on appeal:  “Defendants argue plaintiff’s ‘compilation of broad generalized categories of ever-changing business information’ does not qualify as a trade secret.  We disagree.”  Id.    

These cases are instructive. Trade secrets are not always the Coca Cola formula.  Trade secrets can include customer lists, pricing data and even compilations of valuable business information, which may be in the public domain in part, but taken as a whole, have value and are unique.  As demonstrated by the Sunbelt and Decision Insights opinions, it is the totality of the information that merits protection under the trade secrets statutes and each case must be evaluated on their facts to see if the elements of the trade secret claim are met.

While the fact that the conduct alleged — entering into a flat out prohibition against calling another competitor’s employees to hire them — gave rise to concern at the DOJ may not be terribly newsworthy, the DOJ’s analysis of the situation in its Competitive Impact Statement (attached) is.

First, some background is necessary. The DOJ contended that the defendants, at various times starting in 2005, agreed not to call each other’s employees for employment.  With the exception of Intel, each of the Do Not Call Defendants was alleged to have created internal “do not call lists” related to the competitor’s employees.  These alleged agreements precluded the cold calling of the competitor’s employees, regardless of geographic location or position.  The DOJ, looking at precedent in its complaint in U.S. v. Ass’n of Family Practice Residency Doctors, No. 96-575 CV-W-2, Complaint at 6 (challenging guidelines used for residency programs for senior medical students) and the illegal agreement found U.S. v. Cooperative Theaters of Ohio, Inc., 845 F.2d 1367 (6th Cir. 1988) (finding agreement not to solicit another’s customers a per se violation of Section 1), found support for its claims brought against the “Do Not Call” Defendants.  The DOJ viewed there to be no difference in treatment under Section 1 between customer restraints and employment restraints, or output or input markets:

“Antitrust analysis of downstream, customer-related restraints is equally applicable to upstream monopoly restraints on employment opportunities.”

For the DOJ, the restraints placed on the employees of the Do Not Call Defendants was great.  Even though these alleged agreements did not prohibit hiring of the other’s employees, the agreements interfered with the employee’s movement to another company and the pricing for those services.  Competition for hiring employees in the computer industry was impacted.  As the DOJ stated in its impact statement:

“Defendants’ concerted behavior both reduced their ability to compete for employees and disrupted the normal price-setting mechanisms that apply in the labor setting. These no cold call agreements . . . are facially anticompetitive because they eliminated a significant form of competition to attract high tech employees, and, overall, substantially diminished competition to the detriment of the affected employees who were likely deprived of competitively important information and access to better job opportunities.”

Perhaps the most interesting part of the DOJ’s action here is its analysis of what conduct is not prohibited as a per se violation when restricting employment opportunities.  The DOJ stated that certain limited exceptions exist to a per se analysis if the challenged agreement is “ancillary to a legitimate procompetitive collaboration“.  What is considered “ancillary” is a very short list:

“To be considered “ancillary” under established antitrust law, however, the restraint must be a necessary or intrinsic part of the procompetitive collaboration. Restraints that are broader than reasonably necessary to achieve the efficiencies from a business collaboration are not ancillary and are properly treated as per se unlawful.”

In other words, agreements not to hire that are narrowly drawn to protect the interests of a legitimate joint venture are not per se unlawful but would be reviewed under a rule of reason approach.  This is the only exception noted by the DOJ to its per se treatment.

In this “No Call List” matter, the DOJ contended that the agreement was not tied to a specific collaboration and was overbroad, applying to all geographies, job functions, product groups and time periods.  The DOJ concluded that these agreements were not “ancillary” to any collaboration, even though there was some indication that there were some joint venture collaborations between the parties.  Simply put, the DOJ sees the situation as black and white: if it is not “ancillary to a legitimate collaborative effort” — i.e. a joint venture — it is a per se violation of Section 1.

The implications of this DOJ action remain unclear. Would DOJ’s analysis have differed if the defendants had entered into this type of agreement to protect their trade secret information?  Would DOJ view agreements between competitors, that are part of settlement agreements but restrain the hiring of competitor’s employees to protect those secrets, as per se violations or subject to a rule of reason analysis.  Precedent would suggest that such agreements should be subject to a rule of reason analysis, Weisfied v. Sun Chemical Corp., 210 F.R.D. 136 (D. N.J. 2002), but the DOJ’s analysis is categorical and does not lend itself, at least on the face of it, to that interpretation.

For now, we will just have to put this discussion “on hold.”

In that case, Bimbo Bakeries USA, Inc. obtained an injunction against Chris Botticella, Bimbo’s former Vice President of Operations in California, to prevent him from working with Bimbo’s competitor, Interstates Brand Corporation (now Hostess Brands Inc.).  Bimbo contended that Botticella had downloaded confidential, trade secret information of Bimbo prior to his departure, which he continued to receive as an employee of Bimbo after he had received his offer from Hostess.  Bimbo also argued that an injunction was warranted given the sufficient likelihood that Botticella would disclose Bimbo’s trade secrets in his new position.  The district court agreed with Bimbo and granted the injunction.  On appeal, the Third Circuit affirmed. 

The Third Circuit opinion raises several interesting points.  First, in affirming the district court’s injunction, the Third Circuit made it clear that it was not basing its decision on the theory of “inevitable disclosure.”  Rather, the Third Circuit based its decision on the Pennsylvania trade secret statute’s proscription of threatened misappropriation. 

Second, the Third Circuit clarified that the standard for showing such threatened misappropriation.  Rejecting the argument that a showing was required of  ”virtual impossibility” of avoiding disclosure of the trade secrets, the Third Circuit concluded that a lesser standard, of showing a sufficient likelihood of disclosure, is all that is required. 

In clarifying the standard for proving threatened misappropriation (and in the process distinguishing prior contrary language of the Third Circuit in Victaulic Co. v.Tieman, 499 F.3d 227, 234 (3d Cir. 2007) as dicta), the Third Circuit found more than enough evidence in the record, to support Bimbo’s likelihood of success on the merits, including evidence of Botticella’s continued receipt of Bimbo confidential information after he had received his Hostess offer, his “copying Bimbo’s trade secret information from his work laptop onto external storage devices” and the substantial similarity of his positions at Hostess and Bimbo.  Interestingly, the Third Circuit also found that the district court was entitled to make an adverse inference against Botticella for failing to testify at the preliminary injunction hearing. 

As any good chef knows, a great dish is made up of not one but many great ingredients.  For the district court, and the Third Circuit, Bimbo introduced many pieces of probative evidence that made a compelling case that absent an injunction, Botticella was likely to misappropriate Bimbo’s trade secrets.  Bimbo’s case was not reliant only on claims of “inevitable disclosure.”

Armacell LLC manufactured foam insulation products and employed Jeffrey Bostic in its Research and Development Group as a Senior Research Scientist.  Armacell had developed and marketed a foam insulation that was based on ethylene propylene diene methylene (EPDM), which was superior to other pipe insulation in terms of its fire test ratings.  Armacell competed with K-Flex, which did not have an EPDM product prior to this dispute.  

In its complaint, Armacell alleged, among other things, that Bostic and K-Flex had misappropriated Armacell’s trade secrets for the EPDM insulation product.  Armacell alleged that Bostic resigned from Armacell to accept a position as a chemist at K-Flex and in the process, undertook ”a surreptitious campaign of disloyal actions,” copying  onto external hard drives thousands of competitively sensitive and confidential information of Armacell.    Armacell asserted that K-Flex, which did not have an EPDM product, had been struggling to compete with Armacell in the sale of two inch thick pipe insulation.  After Bostic was hired, however, K-Flex quickly had ready for testing a one-inch thick EPDM product, a product for which K-Flex had no commercial need but which could be reproduced to develop a two-inch EPDM sample.  Armacell alleged that this evidence was strong circumstantial evidence of misappropriation.

The North Carolina Business Court agreed with Armacell and issued a preliminary injunction against Bostic, K-Flex and its affiliated company.  On appeal, the Defendants challenged the injunction order, asserting that the Business Court erred in finding that Armacell had proven a likelihood of success on the merits of its trade secrets claim.  The Defendants contended that Armacell brought only “speculative claims” and “while the evidence demonstrated that Bostic took a significant amount of data from [Plaintiff's] computer system, [Plaintiff] did not show that [Defendants] had a specific opportunity to acquire [Armacell's EPDM formulation].”  The Defendants argued that the evidence was simply not sufficient. 

The Court of Appeals rejected the Defendants’ argument.  In affirming the granting of the injunction, the Court correctly observed that North Carolina’s Trade Secrets Protection Act only requires that the plaintiff make out a prima facie showing of misappropriation and the burden then shifts to the defendant to show that it obtained the subject information lawfully. 

Under the Act, a prima facie case is established by “the introduction of substantial evidence that the person against whom relief is sought both:

(1) Knows or should have known of the trade secret; and

(2) Has had a specific opportunity to acquire it for disclosure or use or ahs acquired, disclosed, or used it without the express or implied consent or authority of the owner.”  N.C. Gen. Stat. § 66-155. 

Once the prima facie showing is made, it is up to the defendant to rebut that evidence through the introduction of “substantial evidence that the person against whom relief is sought acquired the information comprising the trade secret by independent development, reverse engineering, or it was obtained from another person with a right to disclose the trade secret.” Id.

Although the defendants challenged the very nature of the burden shifting in the statute, the Court, consistent with precedent, reiterated the view that the statute in fact contemplates a shifting of the burden of proof.  Combs & Associates, Inc. v. Kennedy, 147 N.C. App. 362, 369, 555 S.E.2d 634, 639 (2001); Byrd’s Lawn & Landscaping v. Smith, 142 NC. App at 376, 542 S.E.2d at 693.  The reason for the burden shifting is simple:  the North Carolina statute reflects the practical reality that “[f]ew defendants leave the proverbial ’smoking gun’” when misappropriating a trade secret.  Lawsuits Between Business Competitors: Chapter 75-1.1 and Beyond, Eric D. Welsh, Mecklenburg County Bar Association Business Litigation Forum, February 17, 2006, p. 7.  Moreover, due to the frequent absence of direct evidence, a claim for misappropriation will often depend upon circumstantial evidence.  Medical Staffing Network, Inc. v. Ridgway, 194 N.C. App. 649, 658, 670 S.E.2d 321, 329 (2009); Byrd’s, 142 N.C.App. at 377, 542 S.E.2d at 693; Static Control Components, Inc. v. Darkprint Imaging, Inc., 200 F. Supp. 2d 541, 545 (M.D.N.C. 2002).    

In reviewing the record before it, the Court of Appeals found ample circumstantial evidence to support Armacell’s prima facie case of trade secret misappropriation.  The evidence showed that Bostic, as a Senior Research Scientist, had knowledge of Armacell’s EPDM technology and K-Flex, which had not developed an EPDM product prior to Bostic being hired by it, had, within a year after hiring Bostic, produced an EPDM sample.  Relying on Sunbelt Rentals, Inc. v. Head & Engquist Equip., L.L.C., 174 N.C.App. 49, 620 S.E.2d 222 (2005), the Court of Appeals found that this “before and after” evidence was ”sufficient circumstantial evidence to show Defendants’ opportunity to acquire the trade secrets as well as Defendants’ subsequent use thereof.”  

In Sunbelt, a case involving the theft of trade secrets and unfair competition resulting from a corporate raid, the North Carolina Business Court found as persuasive evidence of misappropriation the fact that the Defendants were able to quickly compete against Sunbelt even though they had not invested time to develop independently the requisite resources to do so.  As the Business Court stated:

In this instance it may be more important to look at what was not done and the business results.  There is no evidence of a unified pricing structure for Hi-Lift.  Many salespeople testified that they did not have prices when they began calling on customers.  There were no restrictions placed on the sales people concerning use of BPS information.  The sales people began calling on the same customers within days of leaving BPS and in some cases went after business that was based on special pricing arrangements.  Credit decisions had to be based upon knowledge obtained at BPS, as there is no evidence of the independent development of credit information for the customers called upon at the outset.  Indeed, there is little evidence of the independent development of information by Hi-Lift that one would expect in a normal greenfield operation. As previously noted, there was an advantage to Hi-Lift to get the new Hi-Lift branches open in the BPS markets before Sunbelt could close its transaction. The rapidity with which the old BPS customers were identified, called upon and converted to Hi-Lift, despite the lack of business information and guidance from Hi-Lift management, provides strong circumstantial evidence that at least some of BPS confidential information was used to solicit customers.  Sunbelt Rentals, Inc. v. Head & Engquist Equip., LLC, 2003 NCBC 4, 2003 WL 21017456 (N.C. Super. May 2, 2003). 

As in Sunbelt, the Defendants in Armacell obtained  a head start advantage as a result of Bostic’s alleged misappropriation and that advantage, from the Court’s perspective, was sufficient proof of misappropriation.   

The Defendants in Armacell attempted to rebut this prima facie showing, arguing that Armacell’s proof showed only that Bostic stole some of Armacell’s information but not the information related to the EPDM product.  Defendants’ curious argument, however, failed because they were unable to come forward with ample evidence to explain how it was that they had developed the EPDM product so quickly if not through Bostic’s efforts.  Here, it would appear that Armacell caught Bostic with his hand in the “trade secret cookie jar” — perhaps 7000 times — which was more than enough for the Court to conclude, at this stage, that Bostic not only had access to the information but, in light of the absence of a product before and then sudden introduction of a product after his hiring, had misappropriated that information. 

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*  Parker Poe represented Sunbelt Rentals, Inc. in the Head & Engquist Equipment litigation and Eric Welsh was a member of the trial team.

This article, titled “A Statistical Analysis of Trade Secret Litigation in Federal Courts,” is noted by the authors as being the first such statistical analysis conducted of trade secret cases in federal court. Several of the authors’ conclusions are of interest here.

First, the number of trade secret claims doubled from 1988 to 1995 and then doubled again from 1995 to 2004. The authors believe that trade secret cases in federal court will double again by 2017.

Second, trade secret theft cost companies as much as 300 billion dollars per year.

Third, in more than 85% of the cases, the trade secrets were misappropriated by employees or business partners, not third party computer hackers.

This article tends to highlight several facts known by attorneys who practice in this area: trade secret misappropriation can have a large financial impact on a company and to reduce the risk of misappropriation, attention should be paid closer to home. It is the employee that leaves his employment with files on a USB device or the business partner that was entrusted with confidential, proprietary information that then uses the information for its own financial gain that poses the most immediate risk. These frequent scenarios have been noted previously in this blog. See Nucor v. Bell, 2:06-cv-02972-DCN (D.S.C. 2008) (Post February 19, 2010)** and Raytheon Corp. v. Indigo Systems Corp., No. 4:07 cv-109 (E.D. Tx 2009) (Post March 17, 2010). While we periodically see the stunning event where someone from abroad has successfully hacked into a computer and wreaked havoc (see “Cyberattack on Google Said to Hit Password System,” John Markoff, New York Times, March 20, 2010), the risk faced daily by companies is for more pedestrian but certainly no less impactful to their business.

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* Published with permission of the authors.

** Parker Poe represented Nucor in this lawsuit.

Caputo filed a motion to dismiss, arguing that the non-compete was unenforceable as a matter of law and that ACS had failed to state a claim under both UDTPA and the North Carolina Trade Secrets Protection Act. In a decision rendered by the Magistrate Judge, and adopted by the District Court Judge, the Court found that the non-compete, although vague as to its geographic reach and potentially invalid, was “not per se unreasonable at the motion to dismiss stage.” The Court made this ruling even though it found that the non-compete, which had no geographic restriction but rather was client based, potentially would prohibit the solicitation of prospective customers throughout the United States in the building renovation business.

“If the Court defines ‘prospective’ as ‘expected, likely or future,’ then it is possible that the non-solicitation provision could be overly broad as applied to Caputo. But, the non-solicitation provision is not so unreasonable as to be declared unenforceable as a matter of law on a FRCP 12(b)(6) Motion to Dismiss.”

Apparently, the Court was willing to permit the parties to engage in discovery to determine the meaning of the solicitation provision so the Court could then determine if the provision was invalid. Although this case is ongoing, it will be interesting to see what evidence is produced to demonstrate a meeting of the minds on this point.

Although the discussion of the non-compete is interesting, the far more important discussion relates to the treatment of the UDTPA and trade secrets claims.

The Court curiously found that the complaint did not state a cause of action under the UDTPA. Citing the principle set forth in Broussard v. Meineke Discount Muffler Shops, Inc., 155 F.3d 331 (4th Cir. 1998) that an UDTPA claim cannot “piggyback” on a breach of contract claim, the Court found that the complaint did not allege “substantial aggravating circumstances” that are necessary to support a claim under UDTPA. The Court viewed the dispute as a breach of contract, noting ACS’ UDTPA claim was not “distinct from” the primary breach of the non-compete and confidentiality agreements. The Court’s holding here is somewhat surprising in that ACS’ claims also included a claim in tort for trade secret misappropriation, which the Court upheld. The Court’s decision also seems to run counter to other cases where UDTPA claims were brought, and upheld, in similar situations involving employee breaches of non-compete or confidentiality agreements. See e.g. Philips Electronics North America Corp. v. Hope, 2009 WL 1883921 (M.D.N.C. June 30, 2009); Static Control Components, Inc. v. Darkprint Imaging, Inc., 200 F. Supp.2d 541 (M.D.N.C. 2002). Moreover, trade secret misappropriation claims frequently become the basis for an UDTPA claim. See Sunbelt Rentals, Inc. v. Head & Engquist Equipment, LLC, 00-CVS-10358, North Carolina Business Court, July 10, 2002.

More interesting, though, is the Court’s statement that ACS’ UDTPA claim was defective because it was “wholly divorced from the context of consumer transactions.” The Court cited PCS Phosphate Co., Inc. v. Norfolk Southern Corp., 559 F.3d 212 (4th Cir. 2009) and Dalton v. Camp, 353 N.C. 647, 548 S.E.2d 704, 710 (2001) for the proposition that UDTPA was “intended to benefit consumers,” and then extrapolated the principle that an UDTPA claim must address “consumer transactions.” A closer look at Dalton shows that such is not the case. In fact, in Dalton, the North Carolina Supreme Court specifically noted that while UDTPA was intended to benefit consumers, “its protections extend to businesses in appropriate circumstances.” As noted previously, “[U]nfair trade practices involving only businesses affect consumers as well.” United Labs, Inc. v. Kuykendall, 322 N.C. 643, 665, 70 S.E.2d 375, 389 (1988). Other UDTPA claims have been brought in North Carolina against businesses. See e.g. Sara Lee Corp. v. Carter, 351 N.C. 27, 519 S.E.2d 308 (1999); Static Control Components, Inc., 200 F. Supp.2d at 550; Sunbelt Rentals, Inc. v. Head & Engquist Equipment LLC, 620 S.E.2d 222 (N.C. App. 2005).* One would certainly expect that even in ACS, the UDTPA claim would have some impact on consumers. Perhaps this is one of those situations where “you know it when you see it,” and the Complaint just did not show the predicate egregious facts. Whatever the situation, the ACS case gives some pause to the federal court’s willingness to hear an UDTPA claim in the context of an employer-employee dispute even when in the presence of a trade secret misappropriation claim.

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* Parker Poe was counsel to Sunbelt Rentals, Inc. in this lawsuit and Eric Welsh was part of the trial team.

In Raytheon Corp. v. Indigo Systems Corp., Case No. 4:07-cv-109, Raytheon filed a complaint on March 2, 2007 against Indigo, alleging claims of trade secret misappropriation surrounding Indigo’s commercialization of infrared imaging cameras. Raytheon, which had earlier developed and commercialized its own infrared imaging cameras, alleged that Indigo, which was formed by former Raytheon employees in 1996, had misappropriated Raytheon’s trade secrets on this technology through, in part, the hiring of over 75 Raytheon employees over the course of several years. According to the decision, Raytheon, concerned that Indigo might be engaged in improper conduct, wrote a formal letter to Indigo, raising its suspicions. In response, Indigo denied any wrongdoing. Based on reassurances from Indigo, Raytheon entered into an agreement with Indigo in July 1997 regarding the hiring of the former Raytheon employees. In that agreement, Indigo agreed to “require all future Indigo employees to refrain from using the intellectual property of former employers.” Following Raytheon’s entering into this agreement with Indigo, Raytheon continued a consulting relationship with Indigo until 2000, and the parties continued to work sporadically on some collaborative projects. Indigo signed confidentiality agreements with Raytheon in connection with these consulting services prior to 2000, all of which, according to the Court, were unrelated to the infrared technology.

In March 2004, Raytheon obtained an Indigo infrared imaging camera and disassembled that camera several months later. Raytheon apparently saw indications in the Indigo camera of the use of Raytheon’s trade secrets. After that discovery, Raytheon reviewed certain files of employees who had left for Indigo and identified a “correlation between the areas of expertise of those employees and the types of technology developed in the interim by Indigo.” Raytheon filed suit against Indigo on March 2, 2007.

Indigo denied any wrongdoing, and moved for judgment from the Court that the misappropriation claim was untimely anyway — barred by the three year statute of limitations. Under Texas law, the time period in which to bring suit for trade secret misappropriation begins once “the misappropriation is discovered or by the exercise of reasonable diligence should have been discovered” and Indigo argued that Raytheon had learned of sufficient facts regarding its claim long before March 2004. In response, Raytheon argued in essence that it’s claim was not barred because Indigo had stolen its trade secrets over the prior 12 years and concealed its conduct or provided assurances such that Raytheon could not discover the misappropriation earlier than March 2004.

The District Court rejected Raytheon’s position, finding a lack of diligence on Raytheon’s part in bringing its trade secret misappropriation claim. The District Court found that the facts were known to Raytheon that provided a reasonable basis for it to suspect that its trade secrets had been misappropriated.

While the Raytheon court’s decision may on first blush appear surprising — especially in light of the allegations that Raytheon was lulled into inaction by Indigo’s reassurances — the Court’s decision finds some explanation and support in two key areas. First, Indigo was a competitor of Raytheon in the infrared imaging camera market for years, a point which was not lost on Raytheon. Raytheon internally tracked Indigo as a competitor in this market for years before 2004 and had in fact lost business to Indigo, which Raytheon was aware of at the time. The Court obviously had difficulty squaring these facts with Raytheon’s claim that during this same period it was reassured by Indigo that it had not stolen Raytheon’s trade secrets and therefore perceived no need to take action. Second, Raytheon could not explain sufficiently to the Court why it did not take action against Indigo after 2000, when Raytheon stopped its consulting services with Indigo and “ceased reposing trust in Indigo,” but before March 2004, when “it developed suspicions it deemed worth investigation.” The Court found this latter point to be the “most damaging” to Raytheon’s argument.

“The termination of the parties’ consulting relationship, Indigo’s competitive successes in the military market — some of which came at Raytheon’s expense, the continued hiring of Raytheon personnel by Indigo and the ability to inspect its employee files were all well known by or readily available to Raytheon long before March of 2004. That combination would have ’cause[d] a reasonably prudent person to make inquiry, which, if pursued, would lead to discovery of the concealed cause of action.’”

Raytheon has indicated its intent to appeal the District Court’s decision and while the final chapter may not yet be written on this one, the decision does highlight the importance of being vigilant in protecting one’s trade secrets. As this decision makes abundantly clear, whether or not a claim is timely filed depends on the totality of the information available. Accordingly, when suspicions of misappropriation occur, thorough investigation is warranted and delay should be avoided. Not only does delay potentially jeopardize the timeliness of the filing, as evidenced by the Raytheon case, but just as important, every day that passes means that someone else is using or disclosing the trade secret, with its value potentially being compromised or lost. While a damage claim may ultimately compensate the wronged party, at least in part, a prolonged delay in bringing action can create impediments for obtaining an order from a court to prevent the continued use or misappropriation of the trade secret. Finally, a lack of diligence in detecting and remedying the misappropriation also can lead to questions regarding the strength of the assertion that the information allegedly stolen is a trade secret in the first place. Indeed, faced with unexplained delay, one can be left to question how information can be a “trade secret” if the aggrieved party did little to determine if the secret had been stolen, or, worse yet, did nothing to correct the wrong once reasonable suspicions occurred. The expression “snooze you lose”, once bantered about in childhood, resonates in this setting as well.

Although the principles of inevitable disclosure have existed for decades in trade secret cases, the “inevitable disclosure” doctrine itself finds its origin in the Seventh Circuit Court of Appeals opinion Pepsico, Inc. v. Redmond, 54 F.3d 1262 (7th Cir. 1995). Under that doctrine, a former employee can be enjoined by a court from taking on employment with a competitor of his former employer if such employment would necessarily require the disclosure or use of his former employer’s trade secrets to carry out the duties of the new position. “A plaintiff may prove a claim of trade secret misappropriation by demonstrating that defendant’s new employment will inevitably lead him to rely on the plaintiff’s trade secrets.” Pepsico, Inc. v. Redmond, 54 F.3d 1262, 1269. Since that significant decision, courts from around the country have been asked to consider the “inevitable disclosure” doctrine, and while two state appellate courts have rejected the doctrine (see Whyte v. Schlage Lock Co., 125 Cal. Rpt. 2d 277, 291 (Ct. App. 2002) and LeJeune v. Coin Acceptors, Inc, 849 A.2d 451, 471 (Md. 2004)), the majority of the courts to consider the doctrine have accepted it to some extent. See e.g. National Starch and Chemical Corp. v. Parker Chemical Corp., 219 N.J. Super. 158, 530 A.2d 31 (N.J. 1987) (applying New Jersey law); Cardinal Freight Carriers, Inc. v. J.B. Hunt Transportation Services, Inc., 987 S.W. 2d 642 (Ark. 1999) (applying Arkansas law); Air Prods. & Chem., Inc. v. Johnson, 442 A.2d 1114, 1120 (Pa. Super. Ct. 1982); Victaulic co. v. Tieman, 499 F.3d 227, 234 (3rd Cir. 2007). Although no state court in North Carolina has yet formally adopted the doctrine, a federal court has found the doctrine not to be inconsistent with North Carolina law and that it would be followed by a North Carolina court with respect to specifically defined trade secrets. See Merck & Co. v. Lyon, 941 F.Supp. 1443, 1460-62 (M.D.N.C. 1996) (granting in part injunction under inevitable disclosure doctrine, finding that North Carolina courts would enjoin threatened misappropriation based on their version of inevitable disclosure); see also Analog Devices, Inc. v. Michalski, 157 N.C.App. 4621, 579 S.E.2d 449 (2003) (finding it unnecessary to consider whether to adopt the doctrine of inevitable disclosure since it would not be applied in the broad fashion sought by the plaintiff).

In Bimbo Bakeries, the court applied the “inevitable disclosure” doctrine in entering a consent injunction against a former employee of Bimbo who allegedly possessed Bimbo’s trade secrets, including proprietary and confidential information concerning Bimbo’s strategies, formulas and process parameters for Bimbo’s products. The former Bimbo employee, who was one of five key executives of Bimbo’s western region operations, had accepted a similar position at Hostess Bakery. The former employee had not entered into a non-compete agreement with Bimbo but had signed a confidentiality agreement. Bimbo filed suit against the former employee for trade secret misappropriation and argued to the federal court that without an injunction, the former employee would inevitably use or disclose the trade secrets in his new position with a competitor. The court agreed and entered a consent injunction, preventing the former employee from assuming his new position with Hostess Bakery. The former Bimbo employee has filed a notice of appeal.

Several points are worth noting from the Bimbo Bakeries court’s decision. First, the court applied the “inevitable disclosure” doctrine but found that the threat of disclosure of a trade secret “need not amount to its inevitability.” Noting that Pennsylvania law provides the right to enjoin “threatened” not just “actual” misappropriation of a trade secret, the court found that a more flexible standard should be employed than “inevitability” in determining whether a substantial risk exists of disclosure or use of the trade secret. Applying the doctrine in that case, the court found “at least a substantial threat that Defendant will disclose Bimbo’s trade secrets in the course of his employment at Hostess.”

Second, while the court recited several bases for its finding of this “substantial threat” of disclosure, perhaps the most significant related to the former employee’s conduct and actions following his acceptance of an offer from Hostess. The court appeared to rely heavily on the fact that the former employee allegedly had not disclosed to Bimbo his plans to begin employment with Hostess while employed by Bimbo and receiving its trade secrets and had downloaded Bimbo Bakeries’ confidential information from his work laptop computer on to an external storage device prior to his departure from Bimbo. The court found this strong evidence which undermined his denials of future disclosure or use of the trade secrets. “Defendant’s handling of Bimbo’s trade secrets after accepting the Hostess position undermines his trustworthiness with regard to those trade secrets.” Bimbo Bakeries, Inc. v. Botticella, Civil Action No. 10-0194 at * 29. The court found that the evidence regarding the former employee’s conduct evidenced an intention on that former employee’s part to use Bimbo’s trade secrets at Hostess, and if the case was close, which it appeared not to be, for this court, convincingly tipped in favor of an injunction.

“Defendant’s knowledge of Bimbo’s trade secrets, combined with evidence of an intention to use them at Hostess, creates a realistic expectation that Defendant will draw on and will use his knowledge of Bimbo’s trade secrets in performing his job at Hostess. Based upon the totality of the evidence, we are satisfied that there is a substantial likelihood that Defendant will not be able to perform his duties at Hostess and will not perform those duties without disclosing, whether intentionally or inadvertently, Bimbo’s trade secrets.” Bimbo Bakeries, Inc. v. Botticella, Civil Action No. 10-0194 at * 29.

In trade secret cases, the actions of departing employees can be a key factor in a court’s determination of the risk of future disclosure or use. All the denials of use cannot overcome findings of deceptive conduct by the employee when leaving for a competitor. For example, in the Pepsico case, the Seventh Circuit noted that the ex-employee’s “lack of forthrightness on some occasions, and out and out lies on others, in the period between the time he accepted the position with [his new employer] and when he informed [his then employer] that he had accepted that position leads the court to conclude that [the defendant] could not be trusted to act with the necessary sensitivity and good faith under the circumstances in which the only practical verification that he was not using plaintiff’s secrets would be [the defendant’s] word to that effect”. PepsiCo, Inc. v. Redmond, 54 F.3d 1262, 1270.

Similarly, the United States District Court of South Carolina, in a “classic inevitable disclosure scenario”, relied on the fact that a departing employee had taken his former employer’s documents, and had acted in bad faith in spoliating evidence of his conduct, in enjoining that former employer from taking on duties in his new position with a competitor. Nucor Corp. v. Bell, 2:06-cv-02972-DCN (2008). As the court noted:

“There are also circumstances demonstrating defendants’ unwillingness or inability to safeguard Nucor’s purported trade secrets. Bell took Nucor documents after he knew he was going to work for SeverCorr and plaintiff has shown a possibility of succeeding to the extent its trade secrets claim relies on those events. Thus, plaintiff has some evidence that Bell already misappropriated its trade secrets. More importantly, the court has already concluded in connection with the motion for sanctions that Bell acted in bad faith by throwing away the SanDisk thumb-drive containing documents with Nucor’s potential trade secrets. . . . The presence of spoliation supports a finding that the circumstances as a whole warrant application of the inevitable disclosure doctrine.”

Based in part on the former employee’s bad faith conduct, the court, in a case of first impression in South Carolina, applied the inevitable disclosure doctrine and found that the former employer’s new employment would inevitably require him to disclose the purported trade secrets.

Time and time again in trade secret cases, the denials of actual or threatened misappropriation are belied by the conduct of the departing employee. The old adage rings true here: actions speak much louder than words.

Parker Poe Adams & Bernstein LLP was counsel to Nucor Corp. in the Bell matter, which marked the first time a court in South Carolina accepted the inevitable disclosure doctrine in a trade secret case after having found that the defendants spoliated evidence.

In the Milliken & Co. v. Morin case, Milliken had employed Morin as a research analyst. As part of his employment, Morin signed an employment agreement with Milliken, which contained an inventions assignment provision, a non-compete provision and a confidentiality provision. In his position with Milliken, Morin allegedly developed an idea to create a high modulus multifilament polypropylene fiber. Milliken apparently did not pursue the idea of developing this fiber. Morin subsequently resigned from Milliken, created his own company, and filed a patent for a high modulus multifilament polypropylene fiber. Upon learning of Morin’s conduct, Milliken brought suit against him, alleging claims for, among other things, breach of contract with respect to the confidentiality provision and violation of South Carolina’s Trade Secrets Act. At the close of Milliken’s case at trial, Morin moved for a directed verdict, arguing that the confidentiality agreement was unenforceable. The trial court denied the motion and Morin appealed the decision.

The central issue in Morin’s appeal, which is of interest here, was whether the confidentiality provision satisfied “the same strict scrutiny” applied to non-compete agreements under South Carolina law. The appellate court, citing Carolina Chem. Equip. Co. v. Muchkenfuss, 471 S.E.2d 721, 723 (Ct. App. 1996) for the proposition that “a covenant not to divulge trade secrets had the effect of a covenant not to compete, and thus, was subject to the same strict scrutiny,” analyzed Morin’s confidentiality provision under standards applicable to non-compete agreements, and determined that the provision “did not substantially restrict Morin’s competitive employment activities” and was enforceable. In arriving at this conclusion, the court noted that the provision did not “prohibit Morin from disclosing or using any and all information he learned working at Milliken, or using the general knowledge and skills he learned while working there.” The court also found the provision reasonable as to time period and territory.

The Milliken case raises several important questions. First, should the Milliken decision be read to stand for the proposition that all confidentiality agreements must meet the standards set for non-compete agreements to be enforceable? While not expressly addressing the issue, the court suggests that may be the case. In its analysis, the Milliken court quickly jumped to the Muckenfuss decision, stating “In Muckenfuss, the court determined a covenant not to divulge trade secrets had the effect of a covenant not to compete, and thus, was subject to the same strict scrutiny.” However, the Milliken court did not initially address whether the confidentiality provision had this effect as to Morin. The court did not consider the competitive effect of the confidentiality provision as an initial matter and simply proceeded to an analysis under the non-compete standards. There certainly is a healthy question as to whether Muckenfuss should be read for the proposition that all confidentiality agreements, regardless of reach or effect, must be analyzed under the standards set for non-compete agreements.

Second, if Muckenfuss and now Milliken are to be read broadly to reach all confidentiality agreements, then one is left to ask about what that means for the enforceability of confidentiality provisions that prohibit an employee from disclosing confidential information of his former employer in a non-competitive setting. For example, if a former employee disclosed confidential information on the internet out of spite or revenge, such disclosure would not be in a competitive environment. Yet, the enforceability of the confidentiality provision, and redress for the wrong, might still turn on whether it met the “strict scrutiny” afforded to non-compete agreements. If the provision lacked any territorial limitation, would it nevertheless be found enforceable and a tool for redress against such conduct? Applying a broad reading to Muckenfuss and Milliken could lead to the conclusion that even in such a situation the confidentiality agreement may be found invalid.

With the adage “better safe than sorry,” the uncertainties surrounding confidentiality agreements in South Carolina suggest the need to draft confidentiality agreements in a manner that is compliant with the standards set for non-compete agreements. Among other things, confidentiality agreements should be kept narrow to avoid a charge that it would prevent the employee from “using the general skills and knowledge he gained” at the former employer. Carolina Chemical Equipment Co., Inc. v. Muckenfuss, 471 S.E.2d 721, 724. In this case, the “horse” may actually be a zebra, even though it lacks the stripes, and should be handled accordingly.