Turning Trade Secrets into Non-Compete Agreements

One of the more controversial issues in trade secret law today is the use of the so-called "inevitable disclosure" theory to prevent a former employee from working for a competitor in his or her area of expertise. Companies urging adoption of this theory argue that an injunction prohibiting such employment . not just disclosure of trade secrets . should issue merely upon a showing of three elements. First, that the former employer and the new employer are competitors, second, that the employee's new position is comparable to his prior position or is such that the trade secrets the employee obtained in his prior employment would have to be used in his new position, and third, that the new employer has not taken sufficient, demonstrable steps to prevent any misappropriation from occurring. As a practical matter, courts have provided little guidance regarding what constitutes "comparable employment" or identifying those situations where an employee will "have to use" confidential information in a new position, increasing the guesswork . and the risk . for workers seeking competitive employment.

Increasingly, the inevitable disclosure theory is being used to obtain the benefits of a non-compete agreement (i.e., prohibition against certain types of employment) without the stigma and strict scrutiny applied to such an agreement. Examples of recent cases involving the inevitable disclosure theory include Dow Chemical's successful effort to temporarily enjoin fourteen engineers and sales executives from working for rival General Electric; AMD's efforts to stop several of its engineers from joining Hyundai Electronics; Proctor & Gamble's effort to prevent its vice president for laundry and cleaning products from accepting a similar position with arch-rival Clorox; and a suit by Informix Software to enjoin thirteen former employees from working for its chief database software rival, Oracle Corporation. More generally, the inevitable disclosure theory has become increasingly common in negotiations with departing employees, and an important weapon in the arsenal of a company trying to prevent its former employees from joining a competitor.

The theory has caused particular concern among companies and employees in Silicon Valley and other similar areas containing large concentrations of highly skilled, mobile employees. Often employees in these areas obtain a large amount of technical knowledge in their positions. Such knowledge can be difficult to distinguish from legitimate trade secrets, particularly for those not skilled in the particular technology or field. Yet the diffusion of this technical knowledge has been recognized by scholars as an important factor in the economic success of Silicon Valley and other such areas.//1// If routinely applied by the courts, the inevitable disclosure theory could significantly impede the spread of general technical knowledge that occurs when employees leave one company for another and also inhibit the free flow of ideas that forms the backbone for economic growth.

A. Evolution of the Inevitable Disclosure Doctrine

The inevitable disclosure theory was most clearly enunciated in the early 1980s in two Fifth Circuit cases. //2// Yet the theory was not included in the Uniform Trade Secrets Act ("UTSA"), and declined in popularity as the UTSA was adopted by most states. For example, in one of the first inevitable disclosure cases decided under the UTSA, a district court in Minnesota denied plaintiff's motion for injunctive relief based upon inevitable disclosure, holding that "in the absence of a covenant not to compete or a finding of actual [disclosure] or an intent to disclose trade secrets, employees may pursue their chosen field of endeavor in direct competition with their prior employer."//3// The court further recognized the potential unfairness of the inevitable disclosure doctrine, stating that "a claim of trade secret misappropriation should not act as an ex post facto covenant not to compete."//4(

The inevitable disclosure doctrine resurfaced with the Seventh Circuit decision, Pepsico, Inc. v. Redmond, 54 F.3d 1262 (7th Cir. 1995).//5// In Pepsico, the Seventh Circuit affirmed a preliminary injunction preventing the defendant, a general manager of Pepsico's new age and sports drinks (i.e., non-cola drinks), from accepting a similar position with Quaker Oats' Gatorade division. The court held that Illinois' UTSA permits a plaintiff to "prove a claim of trade secret misappropriation by demonstrating that defendant's new employment will inevitably lead him to rely on plaintiff's trade secrets."//6// The court found that "unless Redmond possessed an uncanny ability to compartmentalize information, he would necessarily be making decisions about Gatorade and Snapple by relying on his knowledge of [Pepsico's] trade secrets."//7// The court coupled this finding with its disbelief, based on Redmond's and Quaker's lack of candor, that Redmond would keep his promise not to disclose Pepsico's secrets (and that Quaker would ensure that no Pepsico secrets were used). An essential element of the court's ruling was its finding that plaintiff had shown "proof of [defendants'] willingness to misuse" Pepsico's secrets.//8(

The two years of trade secret jurisprudence that have followed the Pepsico decision have shown that the case raises more questions that it answers. Pepsico and subsequent case law have failed to adequately define those instances where an employee will "necessarily be making decisions" based on confidential information obtained from his former employer as opposed to making decision based on his own general skills and knowledge. Further, although the Pepsico holding suggests that some element of bad faith or willful intent is necessary for a finding of inevitable disclosure, an express ruling to this effect was not made. Not surprisingly, some courts have considered the former employee's intent when applying the doctrine while others have not. By recognizing and understanding the uncertainty that surrounds the application of the inevitable disclosure doctrine, attorneys can better advise their clients who are seeking competitive employment in the short term and lobby for clearer guidelines from the courts and lawmakers in the long term.

B. Application of the Inevitable Disclosure Doctrine After Pepsico

Two recent decisions from district courts in North Carolina split on the applicability of Pepsico and the inevitable disclosure theory.//9// In FMC Corp. V. Cyprus Foote Mineral Co., 899 F. Supp. 1477 (W.D.N.C. 1995), the court denied a preliminary injunction motion based upon the plaintiff's claim that its former employee would "inevitably disclose" company trade secrets "knowingly or unknowingly." The FMC case is the more common type of trade secret case seen in Silicon Valley, as the individual defendant was an engineer with specialized technical skills, who left the leading technology company in his field after 14 years to join a competitor alleged to have inferior technology.//10// In denying plaintiff's motion for injunctive relief, the court recognized the danger of extending the inevitable disclosure doctrine to "unknowing" disclosures of trade secrets, noting that "if the doctrine is applied as urged by FMC, then no employee could ever work for its former employer's competitor on the theory that disclosure of confidential information is inevitable."//11(

The court rejected one of the most popular arguments by proponents of inevitable disclosure: that the individual's technical expertise gained at the prior employer is based on that employer's confidential information, as well as any confidential information of a prior employer. In sensitive situations, it may be advisable to bring in counsel to advise new employees of their confidentiality obligations and ensure that no misappropriation will occur. This is one area where the proverbial ounce of prevention is worth a pound of cure.

Document and Retain All Development Efforts. In states which have adopted the UTSA, an employer may defend itself against a claim of trade secret misappropriation by showing that its competitive information has been reverse engineered or independently derived. Therefore, it is important that employer's carefully document all attempts at independent development, especially when they decide to enter into a product area that they had not focused on before hiring a competitor's employees.

Intellectual property is often the lifeblood of a high technology company. Employees generally understand the importance of such information and usually do not want to risk their careers by disclosing valuable, proprietary information to a competitor and/or new employer. Establishing sound policies at the beginning -- and end -- of the employment relationship can result in a substantial lessening of the risk of dispute between the employer and the departing employee.

ENDNOTES

//1// Expert Report of Kenneth J. Arrow, submitted in I.B.M. v. Seagate Technology, Inc., Case No.: 3-91-CV-630 (D.C. Minn. 1994).

//2// See FMC Corp v. Varco International, Inc., 677 F.2d 500 (5th Cir. 1982); Union Carbide Corp. v. UGI Corp., 731 F.2d 1186 (5th Cir. 1984).

//3// IBM Corp. v. Seagate Technology, Inc., Civ. 3-91-0360, slip op. at 7 (D.Minn. April 21, 1992).

//4// Id.

//5// Shortly before the Seventh Circuit's holding in Pepsico, the First Circuit had rejected the inevitable disclosure doctrine in Campbell Soup Company v. Giles, 47 F.3d 467, 470 (1995), where the court held the defendant was "unlikely to use or disclose" plaintiff's secrets merely because he held a similar job with a competitor.

//6// Id., 54 F.3d at 1269.

//7// Id.

//8// Id. at 1270-71.

//9// North Carolina has incorporated portions of the Uniform Trade Secret Act into its law. Glaxo v. Novopharm Limited, 931 F.Supp. 1280, 1299 (E.D.N.C. 1996). Like the UTSA, the North Carolina statute provides that "actual or threatened misappropriation may be preliminarily enjoined." See N.C.Stat. Section 66-154.

//10// Id. at 1479-81.

//11// Id. at 1482.

//12// Id.

//13// Id. at 1483.

//14// Id. at 1481.

//15// Id. at 1447-49.

//16// Id. at 1449.

//17// Id. at 1457 (citing Pepsico, 54 F.3d at 1269).

//18// Id. at 1458.

//19// Id. at 1460.

//20// Id.

//21// See id. at 1462; 1464-65.

//22// Id. at 1462.

//23// Some commentators have included additional cases to the list of post-Pepsico cases which have applied the inevitable disclosure doctrine in favor of a former employer. See e.g., Neveux v. Webcraft Technologies, Inc., 921 F.Supp. 1568 (E.D.Mich. 1996); Branson Ultrasonic Corp. v. Stratman, 921 F.Supp. 909 (D.Conn. 1996); La Calhene, Inc. v. Spolyar, 938 F.Supp. 523 (W.D.Wis. 1996); Lumex, Inc. v. Highsmith, 919 F.Supp. 624 (E.D.N.Y. 1996); Ackerman v. Kimball International, 652 N.E.2d 507 (Ind. 1995). In each of these cases, however, the departing employee had executed a valid non-competition agreement.

//24// Id. at 1420.

//25// Id. at 1420.

//26// Id.

//27// Id. at 1435.

//28// Id.

//29// Id.

//30// Id. at 1436.

//31// The Uncle B's plaintiff also asserted that O'Rourke had breached a non-compete agreement. A signed copy of the agreement was never produced at the hearing and the parties' testimony conflicted regarding whether such an agreement had ever been entered into. Id. at 1417-18. It is unclear what portion, if any, of the court's analysis regarding "inevitable disclosure" was influenced by its awareness that a non-compete may have been signed.

//32// See 18 U.S.C. Section 1836.

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