Seven Deadly IP Sins in Employee Hiring

Employees are the lifeblood of every successful enterprise. Most companies, especially start-ups, hire employees from competitors. In general, it is perfectly legitimate to recruit and hire competitors' employees. Doing so, however, can lead to litigation by competitors, unless one can avoid the seven deadly intellectual property sins of employee recruiting.

1. Don't Automatically Ignore Noncompete Covenants

A competitor may seek to enforce against its former employees written covenants not to compete, which usually proscribe specified types of employment, over a specified geographic area and for a specified duration. Reasonably narrow non-compete covenants are typically upheld by courts around the country. A notable exception is California, where such covenants are generally void under Section 16600 of the Business and Professions Code, which provides that "every contract by which anyone is restrained from engaging in a lawful profession, trade or business of any kind is to that extent void."

However, before tearing up the noncompete agreement, remember that Sections 16601 and 16602 of the Business and Professions Code permit noncompete provisions to be enforced against a seller of a business, including a stockholder who sells all of his shares in a corporation, or a transferor of a partnership interest. In particular, these statutes provide that:

Any person who sells the goodwill of a business, or any shareholder of a corporation selling or otherwise disposing of all of his shares in said corporation, or any shareholder of a corporation which sells:

  1. all or substantially all of its operating assets together with the goodwill of the corporation,
  2. all or substantially all of the operating assets of a division or a subsidiary of the corporation together with the goodwill of such division or subsidiary, or
  3. all of the shares of any subsidiary, may agree with the buyer to refrain from carrying on a similar business within a specified county or countries, city or cities, or a part thereof, in which the business so sold, or that of said corporation, division, or subsidiary has been carried on, so long as the buyer, or any person deriving title to the goodwill or shares from him, carries on a like business therein.

For the purposes of this section, "subsidiary" shall mean any corporation, a majority of whose voting shares are owned by the selling corporation. Cal. Bus. and Prof. Code ' 16601.

Any partner may, upon or in anticipation of a dissolution of the partnership, agree that he will not carry on a similar business within a specified county or counties, city or cities, or a part thereof, where the partnership business has been transacted, sl long as any other member of the partnership, or any person deriving title to the business or its goodwill from any such other member of the partnership, carries on a like business therein. Cal. Bus. and Prof. Code ' 16602.

Accordingly, ensure that Sections 16601 and 16602 are inapplicable. If it appears that hiring and employee will violate a valid noncompete provision, the company and its prospective employee must decide whether to disclose her plans to her employer and also whether she should attempt to negotiate a termination of the noncompete provision. For instance, the termination could occur in exchange for a lump sum payment equivalent to some part, or all, of her salary over the duration of the noncompete provision.

2. Respect Nondisclosure Obligations

Keep in mind that, in general, employees are free to bring with them to a new job their knowledge, skills, "tools of the trade" and experience, cf. Rigging International Maintenance Co. v. Gwin, 128 Cal. App. 3d 594, 60607 (1982). However, the typical nondisclosure agreement between a company and an employee will contain a provision forbidding the employee to use or disclose his ex-employer's confidential trade secret information after the employee leaves the company. Trade secrets are items of confidential or secret information that confer a competitive advantage and are not generally known outside the company. The Uniform Trade Secret Act has been enacted in California and about forty other states. The California enactment defines a "trade secret" as information, including a formula, pattern, compilation, program, device, method, technique, or process, that:

  1. Derives independent economic value, actual or potential, from not being generally known to the public or other persons who can obtain economic value from its disclosure or use; and
  2. Is the subject of efforts that are reasonable under the circumstances to maintain secrecy. Cal. Civ. Code ' 3426.1(d).

A company's trade secrets can include information relating to its technology, products, business and marketing plans, customers, vendors, and employees. Such trade secrets can comprise secret combinations of otherwise public information, Imperial Chemical Indus. Ltd. v. National Distillers & Chemical Corp., 342 F.2d 737, 742 (2d Cir. 1965), and so-called "negative information," which is the secret "know-how", gleaned through trial and error, of the processes, materials and methods that work and those that don't, see Comment to Uniform Trade Secret Act, ' 1, 14 Uniform Laws Annotated (1980); Head Ski Co. v. Kam Ski Co., 158 F. Supp. 919, 92223 (D. Md. 1958). Accordingly, when in doubt, a company should not hire an employee for what he knows; rather hire him for what he can do. Consider also requiring as a condition of employment that new employees agree in writing not to use or disclose others' trade secrets, and to abide by their confidentiality obligations to former employers.

3. Just Say No to Souvenirs

Many companies' nondisclosure agreements and termination certifications require employees to return to the company all tangible confidential property of the company, such as floppy disks, laboratory notebooks, drawings, schematics, specifications, prototypes, customer lists and the like. It is therefore important to ensure that a prospective employee has returned to his former employer everything of confidential nature. What the employee may view as a personal diary, souvenir or "pride-of-authorship" document may be regarded by the former employer as a confidential technical notebook, prototype or blueprint.

Even worse, possession of a former employer's technical information can lead to criminal prosecution under Section 499c of the Penal Code, which makes it a felony to misappropriate "any scientific or technical information, design, process, procedure, formula, computer program or information stored in a computer." In recent years, start-ups and established public companies alike have been rudely interrupted by law enforcement officials executing ' 499c search warrants. To avoid the disruption and adverse publicity of a criminal investigation, insist that all employees bring nothing with them from their ex-employers.

4. Don't Presume that the Employee Owns Ideas

Beware of prospective employees who claim ownership of intellectual property that they conceived of or developed while employed by a competitor. Discuss the existence and scope of the competitor's patents and copyrights, which may confer title on the development to the company. Another potential land mine lurking in the typical nondisclosure agreement is the employee's inventions assignment provision. Such clauses usually provide that anything invented, developed or conceived by the employee on company time is the property of the company.

Under Labor Code Section 2870, the employee may claim ownership of ideas or inventions, but only if:

  1. the inventions are developed on the employee's own time (i.e., nights and weekends),
  2. without use of trade secrets or company supplies, equipment, facilities or property (such as copy machines, computers or telephones), and
  3. do not result from my work performed by the employee for the employer or relate to the company's business, or actual or demonstrably anticipated research or development.

The last element is often difficult to satisfy, since any company's "anticipated" R&D can cover quite a broad range of ideas.

5. Obey General Rules of Employee Hiring

Now, assume that the prospective employee is unfettered by a noncompete agreement, does not possess tangible property, promises not to use or disclose the former employer's trade secrets, and is not hell-bent on exploiting technology that is not hers. Are you out of the woods yet? Maybe, maybe not. Pay heed to some general rules of employee hiring.

First, think twice before hiring someone who displays no qualms about badmouthing his employer. The employer may feel bad enough about losing a valuable employee to you, the competition; disparagement or defamation can add insult to injury and trigger litigation.

Next, try to minimize participation of your competitors' ex-employees in the recruitment of employees from that company. Appearances count, to judges and juries, and to your competitors. Increased contacts by ex-employees also allow the competitor to argue that improper hiring practices are occurring. Consider using newspaper ads or a headhunter, seeking clearly specified skills, rather than more generalized and direct initial contact with competitors' employees. Once candidates have been identified, avoid utilizing their ex-colleagues in the recruitment process. These limitations apply to all former employees of the competitor, but especially to those former employees bound by nonsolicitation clauses forbidding solicitation or recruitment of their erstwhile colleagues. Such clauses have been upheld by California courts, e.g., Loral Corp. v. Moyes, 174 Cal. App. 3d 268, 279-80 (1985).

Third, discourage ex-employees of a competitor from recruiting based on their knowledge of that company's trade secrets, especially those relating to employee information, which includes confidential information about particular employees' specific job duties and research results, their salary, bonus and stock information, and job performance reviews.

6. Don't Get Greedy

Avoid a disabling, "en masse" raid on a competitor's workforce, which can expose you to claims of unfair competition. A raid can not only comprise a large number of employees, but can also constitute, in the eyes of a competitor, the hiring of only a few key employees from a small and critical group. If you desire to hire several employees at once from a competitor, consider the competitor's possible response and its reaction to any previous group departures. You can then structure the recruitment and hiring process to minimize disruption to the competitor while satisfying your hiring needs. This may mean hiring everyone at once, or it may require a more gradual, one-at-a-time approach.

Similarly, discourage candidates who are still employed at a competitor from organizing a group exodus to you from that competitor. Conduct of this nature could constitute a breach of fiduciary duty by the candidate, and subject you to claims of unfair competition or inducing breach of fiduciary duty. Such a fate befell the Matthew Bender publishing company in an action brought by its competitor BancroftWhitney, in BancroftWhitney Co. v. Glen, 64 Cal. 2d 327 (1966). While president of BancroftWhitney, Mr. Glen orchestrated the formation of a western division for Matthew Bender, by actively encouraging nearly 20 other officers, directors, senior editors and other BancroftWhitney employees to a accompany him to Matthew Bender. The California Supreme Court held that Glen breached his fiduciary duty and that Matthew Bender was liable as well.

The undisputed evidence shows a consistent course of conduct by him designed to obtain for a competitor those of plaintiff's employees whom the competitor could afford to employ and would find useful. 64 Cal. 2d at 347, 348.

Similarly, in Motorola, Inc. v. Fairchild Camera and Instrument Corp., 366 F. Supp. 1173 (D. Ariz. 1973), Motorola accused its officer and director Dr. Lester Hogan of enticing seven other senior Motorola officers and managers to join him at Fairchild Semiconductor. However, the District Court held that Fairchild's hiring of Hogan and the others was perfectly okay:

The evidence does not lead the Court to believe or find that there was any conspiracy by Fairchild Camera, Sherman Fairchild, Walter Burke and Dr. Hogan, or any of them, to injure Motorola by enticing away its employees. Each of the seven other employee defendants (Dwork, Blanchette, Scalise, Procassini, Lehner, Hinkelman and Corrigan) resigned from Motorola for his own individual reason; each independently applied for employment at Fairchild and negotiated his own financial deal. Some went because of friendship with Dr. Hogan and a desire to continue to work with him personally, some for the challenge of a new job. There is no evidence of any conspiracy involving these seven men or collusion for the purpose of injuring Motorola. Each knew that there was a competent and adequate replacement for his position at Motorola, and the subsequent performance of their replacements adequately bears them out. 366 F. Supp. at 1178.

7. Beware of Inevitable Disclosure

Even if none of the above issues exists, hiring a competitor's employees, can still trigger litigation on the basis of the inevitable disclosure doctrine. This theory permits a cause of action for trade secret misappropriation to be alleged even in the absence of any actual misappropriation based solely on the employee's exposure to trade secrets and the claimed likelihood of disclosure due to similar or identical responsibilities at the new job. In Pepsico, Inc. v. Redmond, 54 F.3d 1262 (7th Cir. 1995), the Seventh Circuit Court of Appeals applied the inevitable disclosure doctrine in affirming a district court preliminary injunction barring a former Pepsico marketing executive from holding a similar position at the Gatorade division of Pepsi's competitor Quaker Oats. The Seventh Court recited the Illinois Uniform Trade Secret Act's provision for injunctions against "actual or threatened misappropriation" of a trade secret (emphasis added; see also Cal. Civ. Code ' 3426.2(a)) and noted:

The question of threatened or inevitable misappropriation in the case lies at the heart of a basic tension in trade secret law.

Admittedly, PepsiCo has not brought a traditional trade secret case, in which a former employee has knowledge of a special manufacturing process or customer list and can give a competitor an unfair advantage by transferring the technology or customers to that competitor.

PepsiCo has not contended that Quaker has stolen the All Sport formula or its list of distributors. Rather PepsiCo has asserted that Redmond cannot help but rely on PCNA trade secrets as he helps plot Gatorade and Snapple's new course, and that these secrets will enable Quaker to achieve a substantial advantage by knowing exactly how PCNA will price, distribute, and market its sports drinks and new age drinks and being able to respond strategically.

Thus, when we couple the demonstrated inevitability that Redmond would rely on PCNA trade secrets in his new job at Quaker with the district court's reluctance to believe that Redmond would refrain from disclosing these secrets in his new position (or that Quaker would ensure Redmond did not disclose them), we conclude that the district court correctly decided that PepsiCo demonstrated a likelihood of success on its statutory claim of trade secret misappropriation. 54 F.3d at 1268, 1270-71 (emphasis added).

Employer should build a solid defense to such a claim, by ensuring that new employees can perform their job duties without resorting to use or disclosure of ex-employers' trade secrets, and should consider requiring them to document their activities, whether they be product design and development or sales and marketing efforts, in order to prove lack of reliance on competitors' trade secrets.

Conclusion

Review the nondisclosure and noncompete agreements of prospective employees to determine the existence and scope of contractual clauses that define your competitors' confidential information, or limit the candidates' ability to seek competitive employment, claim ownership of inventions, or solicit employees or customers. Consider also asking high-profile candidates, whose departure is sure to cause upset competitors, to obtain multiple offers, or even to resign first before receiving an offer.

Finally, recognize that diligent good faith and preparation may not prevent a dispute from arising. Hiring from competitors can spark emotional reactions. The competitor's management may feel surprised, betrayed, deceived, vulnerable, and vindictive. A natural response is to fight back, especially where intellectual property issues accompany the loss of human capital.