Franklin County Ohio Court of Appeals: Inevitable Disclosure Doctrine Is No Substitute for a Non-Compete Agreement.

Just before Christmas, the Franklin County Court of Appeals reversed a six-month injunction precluding an employee from working for the competitor of his former employer when he signed a confidentiality agreement, but was never requested and never signed a non-compete agreement. Hydrofarm, Inc. v. Ordendorff, 2008-Ohio-6819. The Court held that it was an abuse of the trial court’s discretion to enter the injunction because the employer failed to show by clear and convincing evidence that the employee’s working for a competitor – 18 months after he had left his prior job -- would necessarily or inevitably result in the disclosure of the trade secrets of his former employer. Accordingly, the Court held that this situation was distinguishable from other cases when an Ohio appellate court has precluded – in the absence of a non-compete agreement -- an employee from working for a competitor because it would inevitably result in the disclosure of trade secret information.

According to the Court’s opinion, the employee worked for the plaintiff employer for approximately 14 years in the area of sales. During his employment, the employee necessarily became aware of trade secrets, as well as confidential and proprietary information that belonged to the plaintiff employer. The parties executed a Separation Agreement on November 30, 2005 “which, among other things, prohibited [the employee] from disclosing confidential information, unless compelled by legal process, but did not require [the employee] to forego employment with any competitors . . . Approximately one and one-half years later, on May 14, 2007, [the employee] was hired by . . . a direct competitor of [the plaintiff employer], for a position that was substantially similar to his” last position with the plaintiff employer.

The plaintiff employer filed suit for compensatory damages and injunctive relief “[a]lleging, among other things, breach of contract; unfair competition; misappropriation of trade secrets, a violation of the Ohio Uniform Trade Secrets Act, R.C. 1333.61, et seq.; disclosure of confidential information without [the plaintiff employer’s] consent, a violation of R.C. 1333.81; breach of a confidential relationship; breach of fiduciary duty; and conversion.” The employee counterclaimed, “[a]lleging breach of contract; tortious interference with a business relationship; tortious interference with a contract; and malicious prosecution.” Over objections from both parties, the common pleas court accepted the magistrate’s recommendation that the employee be enjoined from working for any competitor for six months. Both parties appealed and the employer was initially required to post a $25,000 bond in the event that the employee prevailed on appeal. However, the trial court reconsidered, stayed in the injunction and required the employee to post a $10,000 bond in the event that the employer prevailed on appeal.

As noted by the Court, different courts have evaluated the inevitable disclosure doctrine differently. “The rule against inevitable disclosure "holds that a threat of harm warranting injunctive relief exists when an employee with specialized knowledge commences employment with a competitor." Berardi's Fresh Roast, Inc. v. PMD Ent., Inc., Cuyahoga App. No. 90822, 2008-Ohio-5470, at ¶27. ‘[T]his doctrine is applied when a former employer seeks `injunctive' relief when a former employee begins work with a competitor while the noncompetition clause has not expired.’ Id. (Emphasis added.) Cf. Dexxon Digital Storage, Inc. v. Haenszel, 161 Ohio App.3d 747, 2005-Ohio-3187, discretionary appeal and cross-appeal not allowed, 107 Ohio St.3d 1682, 2005-Ohio-6480 (applying the "inevitable disclosure" doctrine to enjoin a former employee in the absence of a noncompetition agreement).”

The Court found that the inevitable disclosure doctrine may rarely substitute for a non-compete agreement to preclude an employee from working for a competitor only in different circumstances. “Although in Dexxon, the Fifth District Court of Appeals applied the "inevitable disclosure" doctrine to enjoin a former employee in the absence of a noncompetition agreement, Dexxon is factually distinguishable because in Dexxon both entities were engaged in the highly technical business of large-scale electronic data storage. Moreover, Dexxon does not reveal what sort of trade secrets the former employee possessed, or how these former employees afforded the rival entity an irreparable competitive advantage over the plaintiff.”

“In cases in which courts have enforced the "inevitable disclosure" doctrine in absence of a noncompetition agreement, the former employee possessed timely, sensitive strategic and/or technical, or both, information that, if it was proved, posed a serious threat to his former employer's business, or a specific segment thereof. See PepsiCo, Inc. v. Redmond (C.A.7, 1995), 54 F.3d 1262; Barilla Am., Inc. v. Wright (S.D.Iowa, 2002), No. 4-02-CV-90267; Proctor & Gamble Co. v. Stoneham (2000), 140 Ohio App.3d 260. On the record before us, the present case is distinguishable from those cases.”

Ultimately, the Court held that the employer failed to support its burden of proving entitlement to injunctive relief under its legal theory about the inevitable disclosure doctrine. “When resolving a matter involving trade secrets, "[a] court must balance `* * * the conflicting rights of an employer to enjoy the use of secret processes and devices which were developed through his own initiative and investment and the right of employees to earn a livelihood by utilizing their personal skill, knowledge and experience.' . . . Neither this court nor the Supreme Court of Ohio has applied the "inevitable disclosure" doctrine in a case that did not involve an enforceable noncompetition agreement. An employee possessed of his former employer's trade secrets ‘[has] the right to take employment in a competitive business, and to use his knowledge (other than trade secrets) and experience, for the benefit of the new employer[.]’ . . . . Although Ohio passed its version of the Uniform Trade Secrets Act after B.F. Goodrich, see, generally, R.C. 1333.61 et seq., the Act did not so much alter the common law as codify it. Consistent with common law, Ohio's version of the Uniform Trade Secrets Act provides that threatened misappropriation of trade secrets may be enjoined. See R.C. 1333.62. If the General Assembly had intended to permit injunction of competition or employment under the Act, it easily could have so specified. Instead, it left the law substantially intact; that is, employers or employees are free to, and frequently do, enter into noncompetition agreements, while the state has an interest in promoting morality in business affairs and innovation.”

In this case, the Court found that the fact that the employee both possessed knowledge of trade secret and confidential information and held substantially similar jobs with the plaintiff employer and, 18 months later, its competitor was insufficient to justify precluding the employee from working for the competitor in the absence of a non-compete agreement. Rather, the plaintiff employer would be required “to demonstrate by clear and convincing evidence not only that [the employee] possesses [plaintiff employer’s] trade secrets, but, also, that [the employee] will inevitably disclose them to [the direct competitor], or will utilize those trade secrets in his competitive work on behalf of [the direct competitor], and that those trade secrets will enable [the competitor] to achieve a substantial competitive advantage over [the plaintiff employer]. In other words, [the plaintiff employer] must demonstrate that the danger of misappropriation in this case threatens irreparable harm. ‘Actual irreparable harm is usually not presumed, but instead must be proved.’ Levine, supra, paragraph four of the syllabus.”

“Although the Ohio Trade Secrets Act permits injunction of threatened misappropriation of trade secrets, the usual elements for an injunction must be proved by clear and convincing evidence, even where the plaintiff seeks to invoke the "inevitable disclosure" doctrine to enjoin a former employee's employment with a competitor.” In this case, the plaintiff employer’s “executive vice president, testified that the information involved includes [the plaintiff employer’s] price lists and sales goals, but these are created annually, and it is unclear how 2-year-old price lists and sales goal information would produce a competitive advantage for [the competitor]. [He] testified that defendant [employee] possesses production information related to [plaintiff employer’s] "private label" sales, but because defendant [employee] was a salesman and not involved in the actual production of such products, it appears that his knowledge was limited to pricing and marketing efforts. Such information is hardly static. “

The executive “also testified that [the employee] possessed consumer research analysis; that is, the results of customer polling conducted in advance of each trade show, which was used to determine the product selection and display for each particular show. According to [the executive], there are numerous trade shows in North America every year. Thus, it is difficult to imagine, and [the executive] did not explain, how two-year-old customer polling results for shows that have already occurred poses the threat of an unfair competitive advantage. [The executive] also testified that [the employee] possessed information about new product concepts. However, he also testified that it was [the employee] who would suggest new products based on his conversations at trade shows and with customers. This information seems more the product of [the employee’s] own 14 years of sales and marketing experience than technical information posing a threat of misappropriation.”

The executive “further testified that [the employee] possessed information about [the plaintiff employer’s] marketing and advertising strategies. More specifically, this meant sales leads, pricing information, decisions as to which trade shows to attend, and information about the way in which [the plaintiff employer’s] products would be displayed and marketed at each trade show. Again, the pricing, sales leads and trade show selection information is out-of-date, and product displays would have been visible to anyone attending the same trade shows attended by [the plaintiff employer]. Finally, the record contains no evidence that the employee has misappropriated or disclosed any of [the plaintiff employer’s] trade secrets or other confidential business information, or that he engaged in any nefarious activities or attempts to circumvent any of the parties' agreements. In fact, [the executive] testified that he has no reason to believe that [the employee] has shared any confidential information with [the competitor].

Insomniacs may read the full opinion at http://www.sconet.state.oh.us/rod/docs/pdf/10/2008/2008-ohio-6819.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.

Cuyahoga Court of Appeals Limits Unfair Competition and Inevitable Disclosure Claims to Duration of Non-Competition Agreement.

In October, the Cuyahoga Court of Appeals ruled on a dispute between coffee barons which arose out of the division of a coffee business in a divorce (in which the wife’s attorney ended up with the business) after the husband began a new coffee venture (at the urgings of his disinherited children) following the expiration of his non-compete agreement. Berardi's Fresh Roast, Inc. v. PMD Enterprises, Inc., 2008-Ohio-5470 (8th Dist. 10/23/08). The courts agreed with the husband that his preparations to begin his new coffee business did not violate the non-competition agreement and he was entitled to engage in fair competition with his former business by promoting his “better” and “less expensive” coffee. The court also ruled that the inevitable disclosure doctrine did not justify relief for the plaintiff company because the confidentiality obligation did not survive the expiration of the non-compete.

Like most businesses, the Company started in happier days when the Executive and his wife began with a small retail store in Cleveland and the Executive’s talent with coffee blends grew the business to a nationwide scope. Fourteen years later, the Executive sold his share in the Company to his wife in a divorce, agreed to a three-year non-competition agreement (containing a perpetual confidentiality clause) and accepted a deferred compensation arrangement. However, after the wife sold the business to her attorney (thus disinheriting their children), the Executive’s sons asked him to re-enter the coffee business, which the Executive agreed to do following the expiration of his non-compete agreement. In the meantime, he lined up the financing and suppliers for his new business, investigated prices and blends, purchased the necessary equipment and signed an office lease. The day after the non-compete agreement expired, the Executive opened his new coffee business and he hired three former employees (who then worked for the Company). One of the Company’s major grocer clients then began buying its coffee from the Executive based on his reputation, his lower price and the taste of his coffee. The Company then filed suit against the Executive, his new company and its former employees.

“In its complaint, [the Company] alleged tortious interference with business, breach of the noncompetition agreement, theft of trade secrets, deceptive trade practices, civil conspiracy, and destruction or conversion of [the Company’s] personal property. The Executive counterclaimed for failure to pay the remainder of his deferred compensation. The trial court granted summary judgment to the Executive on all claims and the Court of Appeals affirmed that judgment, except that it reversed summary judgment on the conspiracy and on one of the trade secret claims.

Trade Secrets Claim. The Company’s trade secrets consisted of the coffee blend formulas the Executive developed when he owned the Company. “The formulas consist of both the origin of the beans (i.e. Africa, Columbia, Brazil) and percentage used of each type of bean.” Although the Executive’s new company created a sales cheat sheet to indicate which of its blends most closely approximated the Company’s coffee blends, a comparison of the formulas showed that the Executive’s coffee blends used different beans and percentages than the Company’s blends – with one exception. In that case, the Executive admitted that the formulas were identical, although he used a different roasting method which changed the taste. In addition, the Executive claimed that the formula for that blend actually belonged – in whole or in part – to the client who helped develop the blend and was its exclusive buyer. The client supported this contention. However, because the Company pointed out that the client was not even aware of the blend’s formula and had asked for a copy of the formula only a few months before the Executive opened his new coffee business, there was a disputed issue of material fact as to whether the Executive misappropriated this particular trade secret formula.

The courts rejected the remaining trade secret claims involving the confidential client list because the Executive showed that he created his new client list (of names and telephone numbers) from researching the yellow pages, the internet and client referrals and making cold calls, etc. There was no evidence that the Executive’s new client list overlapped identically with the Company’s client list or contained other information unique to the Company’s clients (such as buying habits, prices, etc.).

Conspiracy. Because the court of appeals resurrected this trade secret claim, it felt compelled to resurrect the civil conspiracy claim based on the alleged misappropriation of trade secret. “The elements of civil conspiracy are: (1) a malicious combination of two or more persons, (2) resulting in injury to person or property, and (3) existence of an unlawful act independent of the conspiracy.” In that the Executive is alleged to have conspired with his new employees to misappropriate the single coffee blend, that claim would be sent to a jury to decide its merits.

Inevitable Disclosure. The Company argued that the doctrine of inevitable disclosure should bar the Executive from hiring its former employees since those employees possessed trade secret information and could use it to compete against the Company. The courts indicated that this doctrine is limited to when “a threat of harm warranting injunctive relief exists when an employee with specialized knowledge commences employment with a competitor.” Because those employees were apparently not subject to a non-compete agreement and the Executive’s non-compete agreement had expired, the courts held that the doctrine was inapplicable to this situation.

Unfair Competition. The court rejected the Company’s arguments that the Executive’s preparations in forming his new business constituted a violation of the non-compete and unfair competition because there was no evidence that he was competing, was soliciting customers, was hiring or recruiting employees or advertising before the expiration of the non-compete agreement. The fact that the Executive’s son mentioned his father’s future venture to a Company employee a few months before the business opened was irrelevant.

Similarly, the court rejected the Company’s arguments that the Executive and its former employees tortiously interfered with its contracts with its customers by persuading them to switch suppliers (i.e., to buy from the Executive instead of the Company). Under Ohio law, competitors are permitted to engage in fair competition without actual malice. There was no evidence that any of the customers breached any contracts with the Company when they switched coffee suppliers. Rather, their contracts were terminable at will. Moreover, “informing potential clients that its coffee tastes better and was less expensive, does not constitute ‘actual malice.’"

The courts also rejected for lack of evidence claims that the Executive was providing customers with “cheat sheets” indicating that his coffee was the same as the Company’s or was placing his coffee in grocery bins identified for the Company’s coffee.

Deferred Compensation. The Company argued that it was not required to make the remaining payments of deferred compensation to the Executive because he allegedly breached the non-compete agreement. However, as discussed above, the court rejected all arguments that he breached the non-compete agreement. In any event, the courts found this to be irrelevant because, pursuant to the contractual terms, the deferred compensation obligation was independent of the non-compete obligation. The compensation was due because of past services rendered, not because of the non-compete provision.

Insomniacs may read the full decision at http://www.sconet.state.oh.us/rod/docs/pdf/8/2008/2008-ohio-5470.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.