Court Rejects Non-Compete Which Applied Following Employee "Termination" When the Employee Voluntarily Resigned

Earlier this month, the Franklin County Court of Appeals affirmed a judgment for physicians and a medical officer manager who were alleged to have violated post-employment restrictive covenants and misappropriated trade secrets.  Buckeye Wellness Consultants, L.L.C. v. Hall, 2022-Ohio-1602.   The Court agreed that the one-year terms of the employment agreements did not automatically renew when the contracts lacked language indicating automatic renewal and both physicians indicated that they wanted to renegotiate their contracts before they ultimately resigned between six and 16 months following the expiration of their agreements.   The non-solicitation clauses only applied during the term of the agreement and one for one year after termination of the agreements.   The clause had expired before one of the physicians had resigned.   While the court indicated that the clause could not be enforced against the other physician who had resigned only six months after his agreement expired, the Court also pointed out that the employer had failed to identify a single patient who had been inappropriately solicited and refused to find notification of a change of practice to constitute a solicitation.   The Court also agreed that one non-compete was unenforceable because the employee never worked in the restricted territory.  The Court also found that the other non-compete did not apply because the employee voluntarily resigned, his agreement implied a distinction between termination and (voluntary) separation, and the clause only applied “for one year “following termination of the Employee.”   Finally, the Court rejected the trade secret claim because the employer failed to produce any evidence that the defendants had inappropriately accessed the password protected trade secret lists or used them. 

According to the Court’s opinion, the defendants all worked at the same medical office before being hired by the plaintiff employer.  Each physician also practiced elsewhere.   The two defendant physicians entered into one-year employment agreements which contained restrictive covenants prohibiting competition and solicitation of patients.   One non-compete applied “so long as the Employee is employed by the Employer, and for a period of one (1) year following termination of the Employee.”  The other non-compete applied for one year “following termination by the Medical Doctor/Physician.”   Both non-solicitation clause applied only for one year following “after termination of this agreement.”  Interestingly, the agreements did not provide for automatic renewal.   Both physicians attempted to negotiate better terms after the first year and, when unsuccessful, submitted their resignations.  One resigned six months after his agreement expired and one 16 months after his agreement expired.   The office manager never signed an agreement or non-compete.   They ultimately formed a new practice and all patients were informed by the defendants and plaintiff of their move.  The employer then filed suit for breach of contract, tortious interference, theft of trade secrets, conversion, conspiracy, unjust enrichment, etc.  The trial court entered judgment for the defendant employees.

The most significant issue was when the one-year restrictive covenant periods commenced and expired.  As an initial matter, both clauses applied “during the term of the Agreement” and for “so long as the Employee is employed” by the employer.   Both non-solicitation clauses expired one year after termination of the agreements.   The employer argued that the term of the agreements and non-competes continued until termination of employment, but the Court disagreed.  Each clause indicated that “[t]he term of this Agreement shall commence on the Effective Date of this Agreement and shall continue for one (1) year(s) thereafter” and that the parties could revisit the physician’s compensation at the end of each contract year.  The agreements were silent as to the manner or duration of any renewal.  The employer asserted that renewal was implied, but the Court disagreed.   The language indicating that the agreement had a term of one -year was clear and unambiguous, particularly when renewal was never mentioned.   Generic references in other clauses of the agreement to potentially renewable terms was not a substitute for an explicit term discussing how long and when the contract would be renewed.  The reference to “year(s)” did not make the agreement ambiguous because it simply meant that the term “one” could have been made “five” while being negotiated.

The Court then addressed whether the restrictive covenants continued to apply after the agreements expired on their terms. 

The general rule of contracts under such a situation was " '[w]here a contract of employment for a definite time is made and the employee's services are continued after the expiration of the time, without objection, the inference is that the parties have assented to another contract for a term of the same length with the same salary and conditions of service, following the analogy of a similar rule in regard to leases.' . . . . The employee who continues working under the same terms and conditions after the employment agreement has expired becomes a hold-over employee.

However, the presumption that arises from an employee's continued employment is "rebuttable by proof that a new contract for the continued period has been entered into, or by facts and circumstances showing that the parties did not intend to continue upon the terms and conditions of the original contract."

In this case, at the expiration of the employment agreements, both physicians indicated their displeasure with their terms and conditions of employment and attempted to negotiate new agreements.    Among other things, one wanted to become a part-owner and the other wanted to work more days each week and spend more time with each patient and see more investment in EMR, etc.  “The evidence shows that the doctors did not intend to continue working under the terms and conditions of the original employment agreements, so a new one-year contract does not arise by implication of law.”  Accordingly, the terms of their prior written agreements no longer bound them and they became employed at will, entitling each of them to resign prior to completing another year of employment. 

The non-compete language was slightly different for each physician and their employment agreements expired at different times.   With respect to Dr. Santiago, the Court agreed that the non-solicitation covenant – which applied for 12 months after expiration of the employment agreement --  had expired by the time he had resigned 16 months after his employment agreement had expired.   The duration of the non-compete was ultimately irrelevant because he always worked outside the 5-mile restricted radius.   Both covenants applied so long as they were employed and were triggered by their terminations.   Although the Court thought that the language “termination by” the physician was ambiguous when Dr. Santiago had voluntarily resigned and the agreement did not define “termination,” the ambiguity was ultimately irrelevant.    In other words, the non-solicitation clause did not apply because it had expired before he resigned.  The non-compete duration was irrelevant because he had never worked inside the restricted territory.   

Dr. Hall’s situation was more complicated because he resigned only six months after his agreement had expired (before the non-solicitation clause expired) and the duration and territory of his non-compete were different:

During the term of this Agreement, including the renewals hereof, so long as the Employee is employed by the Employer, and for a period of one (1) year following termination of the Employee, Employee shall not . . . . Employee shall further not solicit any patient or employee of Employer for a period of one (1) year after the termination of this agreement.

Unlike Dr. Santiago’s agreement, Dr. Hall’s agreement contained a separate provision governing terminations which apparently did not explicitly apply to this dispute.  Also, unlike Dr. Santiago’s agreement, Dr. Hall’s agreement defined “employment separation” as "’the separation or termination of Employee's employment with the Company, regardless of the time, manner or cause of such separation or termination.’  . . . . ‘13(D) also refers to actions based on an employee's ‘termination or separation.’"  While “separation” was never mentioned in the non-compete clause, the definition of employment separation indicated that termination and separation were different terms with different meanings.  “The employment agreement clearly provided different meanings for the two terms, and they are not interchangeable.”  Because the non-compete only applied after employment if Dr. Hall were terminated, the Court concluded that it did not apply after employment if he voluntarily resigned.  

There was no discussion of the use of the terms in IRC 409A(a)(2)(A)(i) or 26 CFR § 1.409A-1 ("An employee separates from service with the employer if the employee dies, retires, or otherwise has a termination of employment with the employer.")

Oddly, the Court then converged the language of the non-compete clause with the language of the non-solicitation clause in rejecting the employer’s argument that the “termination” mentioned in the non-compete clause meant termination of their relationship, not the employee:  “the plain meaning limits termination to firing of the employee, which did not happen here. Hall was not subject to the covenant not to compete and solicit.”

The Court also rejected the claims that the defendants had misappropriated trade secrets (i.e., a password protected list of patient names and attorney referral sources).   The Court of Appeals found that the employer failed to produce any evidence that the lists were misappropriated, how or when the lists were obtained or how or when they were used.  Indeed, the employer could not identify a single patient who was supposedly misappropriated or solicited.  The Court concluded that it was mere speculation that the employer lost patients and the defendants gained patients based only on a misappropriation of password protected patient and referral source lists.

The Court rejected any argument that patients were improperly solicited when they were informed that the defendant physicians had changed medical practices:

Hall and Santiago, pursuant to their professional obligations, informed their patients that they were moving to a new location. Doctors have an obligation to their patients to ensure continuity of care and prevent a patient from being abandoned. These letters do not rise to the level of solicitation.

It is notable that there are a limited number medical providers who accept new workers' compensation patients, and so it is logical that patients will seek continuing care with a familiar provider, even when the provider moves. In addition, when you consider that Spanish speaking patients only have one or two medical providers who speak fluent Spanish, Santiago is in great demand by both patients and attorneys,  . .

Indeed, it appears that patients followed Dr. Santiago from his prior practice to the employer when he was hired and he was always busy with Spanish-speaking patients.

NOTICE: This summary is designed merely to inform and alert you of recent legal developments. It does not constitute legal advice and does not apply to any particular situation because different facts could lead to different results. Information here can change or be amended without notice. Readers should not act upon this information without legal advice. If you have any questions about anything you have read, you should consult with or retain an employment attorney.

Sixth Circuit: Trade Secret Defendants Outsmarted Themselves Out of a Statue of Limitations Defense and into a Trial

Earlier this month, the Sixth Circuit reversed summary judgment for the defendants in a theft of trade secrets case because they were too successful in arguing one of their substantive theories (that there had been no misappropriation) so as to undercut what had been a successful statute of limitations argument.   Kendall Holdings, Ltd v. Eden Cryogenics, LLC, No. 12-3258 (6^th Cir. 4-5-13).   The defendants argued – and the trial court agreed --  that the individual defendant’s retention of arguably trade secret materials in 1999 started the four-year statute of limitations on any claim for theft of trade secrets and, therefore, the claim was time-barred by the time it was brought in 2007.  However, the Court found that the former president’s acquiescence in the individual defendant’s possession meant that the possession did not constitute misappropriation and the clock did not start to run in 1999.  Therefore, it was only after the plaintiff learned that the defendants had begun improperly utilizing the materials in 2007 that the statute of limitations began. 

The facts of the case are fairly complicated. Each of the two individual defendants had at various times worked in differing capacities for the plaintiff’s predecessor company. In 1999, one of the individual defendants left employment with the plaintiff’s predecessor company while still in possession of arguably trade secret backup materials (which he and/or some of the other defendants may have helped develop). He then worked for a competitor until returning to work for the plaintiff company for a few months in 2004. He was never asked to return the trade secret materials of the plaintiff’s predecessor and did not arguably begin to use those materials to benefit the defendant company until 2006 -- 7 years after he last worked for the plaintiff’s predecessor and about 8 years before the lawsuit was filed. Meanwhile, the former president of the plaintiff’s predecessor (who was also an individual defendant employed by the defendant company) testified that he was aware that the other individual defendant still had the arguably trade secret materials in his possession in 1999 and never requested their return before he was fired by the plaintiff company in 2004 and before he formed the defendant company in 2006.

The  Court’s analysis was fairly straightforward:

Under OUTSA, a plaintiff may recover damages from a party that misappropriated the plaintiff’s trade secrets. Ohio Rev. Code § 1333.63(A). “Misappropriation” is defined in the statute as the “[a]cquisition of a trade secret of another by a person who knows or has reason to know that the trade secret was acquired by improper means”; or the disclosure or use of another’s trade secret without the other’s consent, if the discloser/user acquired it by improper means, in breach of a duty of secrecy, or with the knowledge that it was a trade secret and had been acquired by accident or mistake. Ohio Rev. Code §  1333.61(B). “Improper means” include “theft, bribery, misrepresentation, breach or inducement of a breach of a duty to maintain secrecy, or espionage through electronic or other means.” Ohio Rev. Code § 1333.61(A). An action must be brought “within four years after the misappropriation is discovered or by the exercise of reasonable diligence should have been discovered.” Ohio Rev. Code § 1333.66.

The Court noted that the statute of limitations generally does not begin to run until the plaintiff suffers an injury, and does not begin to run under the discovery rule until the plaintiff discovers or reasonably should have discovered that it has been injured.  The trial court concluded that the statute began to run when the plaintiff’s predecessor company knew – or reasonably should have known – that the individual defendant had “unlawfully acquired, disclosed, or used its trade secret information.”  The president of the plaintiff’s predecessor admitted that he knew the individual defendant had retained the trade secret information in 1999 and did not ask for their return even when the defendant went to work for a competitor of the plaintiff’s predecessor.   Therefore, the trial court had concluded that the plaintiff’s predecessor had knowledge of the misappropriation approximately eight years before the lawsuit was filed.

The Sixth Circuit rejected this analysis because there was disputed evidence that the individual defendant had properly acquired the trade secret information in 1999 (based on a convincing argument on the merits asserted by the defendants).   Indeed, the individual defendant convincingly argued that he had the plaintiff’s predecessor’s consent to retain the information in 1999.  As noted by the Sixth Circuit:

In other words, in an attempt to demonstrate that [the plaintiff’s] substantive claim of trade secret misappropriation lacked merit, defendants introduced evidence that fatally undermined their statute of limitations argument.

                . . ..  .

Had [the trial court] viewed the evidence in the light most favorable to [the plaintiff]– evidence introduced, ironically enough, by [its] adversary – no cause of action for misappropriation could have arisen in 1999 because evidence in the record supports a finding that [the individual defendant] did not acquire the shop drawings in breach of any duty or by other improper means.

Therefore, there was no undisputed issue of fact that the materials had been misappropriated more than four years before the lawsuit was filed since the defendant arguably had consent to retain them in 1999.  (Remember the statute of limitations is an affirmative defense for which the defendant bears the burden of proof).  Moreover, there was no undisputed issue of fact on the misappropriation claim because the plaintiff remarkably argued that the defendants conspired to take the information in 1999 with plans to use it six years later and that the defendants did not have permission to ever use the materials even if they arguably had permission in 1999 to retain them.   Thus, a plausible argument existed that the materials were not misappropriated until 2006 when the defendants first began to use them in competition against plaintiff.

All this being said, the parties must now go to trial on the issues instead of having them resolved on a motion.  There has been no finding on liability.

NOTICE: This summary is designed merely to inform and alert you of recent legal developments. It does not constitute legal advice and does not apply to any particular situation because different facts could lead to different results. Information here can change or be amended without notice. Readers should not act upon this information without legal advice. If you have any questions about anything you have read, you should consult with or retain an employment attorney.

Sixth Circuit Reinstates Trade Secret Claim By Lowering Evidentiary Burden for Small Companies.

Last week, the Sixth Circuit reinstated a trade secret claim by lowering the evidentiary burden for small companies who have to show the existence of a statutory trade secret. Niemi v. NHK Spring Co., 07-3536 (6th Cir. 9/19/08). In that case, the plaintiff father-son partnership created “machines and tools to manufacture stabilizer bars for automobiles,” and often conducted business on a handshake. Despite not having written confidentiality agreements, the Court held that a dispute of material fact existed as to whether the plaintiff had taken reasonable steps under the circumstances to protect the secrecy of its alleged trade secret and remanded the case to be decided by a jury.

The plaintiff signed a standard purchase order with the defendant which contained “a statement of standard terms and conditions providing that ‘no other or different terms or conditions shall apply to this order unless specifically agreed to in writing’” by the buyer. The plaintiff company did not insist on a written confidentiality agreement protecting the exclusivity of their designs or processes because he claimed that the defendant buyer assured him “that the new method ‘would remain confidential’ even before he disclosed it. and because plaintiff trusted the defendant-buyer for being “honorable people of integrity I’ve dealt with for thirty years.” A few years later, the plaintiff claimed that the defendant-buyer asked for a written exclusivity agreement (and promise not to share the design with other manufacturers) and he signed the agreement in exchange for a verbal assurance that he would continue to be the exclusive designer of the defendant company and would also receive the opportunity to bid on design work for the defendant’s parent company. A few years later, the plaintiff learned that a new engineering manager at the defendant company was using other designers (in violation of the verbal exclusivity agreement) and sharing details of the trade secret design (in violation of the verbal confidentiality agreement). When the dispute could not be resolved, the plaintiff brought suit for, among other things, violation of Ohio’s trade secret statute and promissory estoppel.

Under the Ohio statute, “trade secret” means “information, including the whole or any portion or phase of any scientific or technical information, design, process, procedure, formula, pattern, compilation, program, device, method, technique, or improvement, or any business information or plans, financial information, or listing of names, addresses, or telephone numbers, that satisfies both of the following: (1) It 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) It is the subject of efforts that are reasonable under the circumstances to maintain its secrecy” It is the second prong of the test which was at issue in the litigation.

While the district court did not believe that the plaintiff took reasonable efforts to protect the secrecy of its designs, the Sixth Circuit found there to be a disputed issue of fact on that issue. In particular, the plaintiff presented evidence that “he maintained complete control over his drawings and blueprints for the new manufacturing process in a secret, locked location in his house . . .. [and] did not disclose them to anyone other than his son and partner . . . , and agents of [defendant]—and to them only after receiving assurances of confidentiality.” Moreover, “[w]hen drawings were transported to and from [defendant’s] place of business in Toledo, they were always personally hand-delivered either by [plaintiff] or his son or by [defendant’s] personnel, who were required to sign for them. . . . No trade secret information was ever communicated by [plaintiff] via electronic media. . . . In addition, [plaintiff] was well aware of the security measures consistently employed by [defendant] at its facility.” The plaintiff also produced evidence “that he created standardized drawings of standardized manufacturing machine parts. This enabled [defendant] to order the fabrication of different tools by different manufacturing or ‘build’ shops without needing to disclose the complete set of prints to any one shop, thereby preserving the secrecy of the trade secret method.” Importantly for the Court, although the defendant attempted to minimize the importance of these facts, it did not present any evidence to refute or contradict them. When the defendant argued that plaintiff was careless in not marking the drawings “confidential,” the plaintiff explained that it was not necessary since no individual drawing alone disclosed the entire process. “Hence, this standardizing technique is said to represent a reasonable and effective effort to preserve secrecy even without labeling the individual drawings ‘confidential.’”

In addition, the plaintiff produced “deposition testimony detailing the conversation he had with [defendant’s manager] in 1993 or ‘94, when he remembers signing the exclusivity agreement and [the manager] reportedly assured him that [defendant] would continue to direct its design needs to him as long as he maintained the secrecy of his new method” In turn, the manager “testified that he is unaware of any such written agreement and he doesn’t recall agreeing that [plaintiff] would be [defendant’s] exclusive designer. However, [the manager] acknowledged that [plaintiff] had been [defendant’s] ‘primary, if not exclusive designer.’ Hence, although [the manager’s] testimony does not directly corroborate [plaintiff’s evidence] that there was an exclusivity agreement, his recollection of the parties’ relationship and course of dealing from 1991 to 1997 affords de facto corroboration.”

The plaintiff also produced expert testimony that “that it is customary in the automotive industry for small companies such [plaintiff] to rely on oral assurances of confidentiality regarding proprietary information when dealing with large automotive companies. . . . . Absent such evidence of customary practice in the industry, reliance on an oral promise could well be deemed not to represent a ‘reasonable effort’ to maintain secrecy.”

The plaintiff also argued that the Sixth Circuit should follow the Seventh Circuit opinion in Learning Curve Toys, Inc. v. PlayWood Toys, Inc., 342 F.3d 714 (7th Cir. 2003) applying Illinois’ version of the Uniform Trade Secrets Act (with an identical definition of trade secret). “Learning Curve teaches simply that whether efforts taken to maintain the secrecy of a trade secret are reasonable under the circumstances depends on the circumstances; that what is reasonable for a small company may be different from what is reasonable for a large company; and that the determination ordinarily represents a question for the jury. Id. at 724-25. The court observed that “only in an extreme case can what is a ‘reasonable’ precaution be determined as a matter of law, because the answer depends on a balancing of costs and benefits that will vary from case to case.” Id. at 725.” In that case, the “court upheld the jury’s verdict based on evidence of an oral confidentiality agreement, coupled with evidence that oral confidentiality agreements were customarily relied on. Id. at 725-26. The court readily acknowledged that PlayWood could and should have done more to protect its secret, but concluded the evidence was sufficient for the jury to determine that PlayWood, the smaller and less sophisticated of the parties, took reasonable precautions under the circumstances. Id.”

In short, the Court concluded that, “except where the evidentiary showing of reasonable efforts could not conceivably support a judgment in favor of the plaintiff, the reasonableness of the efforts is a question for the trier of fact. Because, depending on the credibility of the witnesses, it is conceivable, based on the present record, that a reasonable jury could find that [plaintiff’s] efforts to maintain the secrecy of his trade secret were reasonable, in light of his long term relationship with [defendant] and the relative sophistication of the parties, we conclude that the district court’s summary judgment ruling on the claim for misappropriation of trade secret was in error.”

The Court also found that the plaintiff’s promissory estoppel claim should survive summary judgment and be resolved by a jury.

Insomniacs can read the full decision at http://www.ca6.uscourts.gov/opinions.pdf/08a0349p-06.pdf.


NOTICE: This summary is designed merely to inform and alert you of recent legal developments. It does not constitute legal advice and does not apply to any particular situation because different facts could lead to different results. Information here can change or be amended without notice. Readers should not act upon this information without legal advice. If you have any questions about anything you have read, you should consult with or retain an employment attorney.