IL ND Considers Conflicts of Laws and Inevitable Disclosure Doctrine in Employee Non-Solicitation and Trade Secrets Spat

When some  high-level General Electric employees defected to a Chicago rival, GE sued for trade secrets theft and for violations of employee non-solicitation and confidentiality agreements.

Partially granting and partially denying the employee defendants’ motions, the District Court in General Electric Company v. Uptake Technologies, Inc., 2019 WL 2601351 (N.D.Ill. 2019) provides a thorough choice-of-law analysis and discusses the trade secrets case inevitable disclosure doctrine.

Non-Solicitation Agreement: What State’s Law Applies – New York or California?

The first choice-of-law question involved GE’s non-solicitation agreement (the NSA). GE argued that New York law applied since that was what the NSA specified. For their part, the defendants argued that California law controlled the NSA since that is where they were based when they worked for GE and because California law voids employment restrictive covenants.

In Illinois (a federal court exercising supplemental jurisdiction over state-law claims applies the choice-of-law rules of the forum state – here, Illinois), a choice-of-law provision governs unless (1) the chosen forum has no substantial relationship to the parties or the transaction, or (2) application of the chosen law is contrary to a fundamental public policy of a state with a materially greater interest in the issue in dispute.

A party challenging a contractual choice-of-law provision bears the burden of demonstrating a difference in two states’ laws – a conflict – and that the conflict will make a different in the outcome of the lawsuit.

Under New York law, a restrictive covenant in an employment agreement is reasonable if it is no greater than required to protect a legitimate interest of an employer, does not impose an undue hardship on the employee and is not injurious to the public. New York court also consider the temporal and geographic reach of restrictions.

The court found that the NSA’s were enforceable under New York law. It noted that GE was a global company, the one-year term was reasonable and the restriction was narrowly-tailored to high-level employees.

By contrast, California Code Section 16600 voids any contract “by which anyone is restrained from engaging in a lawful profession, trade or business of any kind.” The Court found the NSA was likely void under California law, but it wasn’t a cut-and-dried issue since there is a clear split in California case authorities: some courts enforce non-solicitation agreements; others don’t.

This schism in the California courts signaled an unclear California policy which led the Court to ultimately conclude that applying New York law did not clearly impinge on a fundamental California public policy. [*6]

The Court then found that GE sufficiently alleged the required elements of a breach of contract claim against the defendants and denied the defendants’ motion. (The court did grant the motion filed by the lone employee whose NSA specified California law would govern.)

GE’s Trade Secrets Claim – What Law Governs?

Illinois’s choice-of-law rule for trade secret misappropriation focuses on where the misappropriation occurred or where the defendant benefitted from the misappropriation.

Since Uptake’s (the individual defendants’ corporate employer) principal place of business is in Illinois and the defendants allegedly pilfered GE’s trade secrets there, Illinois law governed GE’s trade secrets claim.

Illinois recognizes the “inevitable disclosure doctrine” which allows a trade secrets plaintiff to show misappropriation by showing a defendant’s new employment “will inevitably lead him to rely on the plaintiff’s trade secrets.”

The plaintiff must allege more than that an erstwhile employee’s general skills and knowledge will be used to benefit a new employer. Instead, the plaintiff must focus on protecting “particularized plans or processes” a defendant was privy to which are unknown to industry competitors and could give the new employer an unfair advantage over the plaintiff. [*9][citing to PepsiCo v. Redmond, 54 F.3d 1262 (7th Cir. 1995).

In evaluating whether disclosure is inevitable, the Court considers (1) the level of competition between former and current employer, (2) whether employee’s new position is similar to former position, and (3) actions new employer has taken to protect against the new employee’s use or disclosure of former employer’s trade secrets.

Since GE alleged that Uptake is a competitor in the data analytics market for industrial machinery and the defendants’ Uptake positions are similar to their former GE ones, the Court found GE sufficiently pled an ITSA claim under the inevitable disclosure doctrine.

Afterwords:

This case illustrates in sharp relief how convoluted and important choice-of-law questions are when different employment agreement sections apply different states’ laws.

The case also provides a useful summary of the key considerations litigators should hone in on when alleging (or defending) trade secrets misappropriation claims based on the inevitable disclosure doctrine.

Subcontractor’s Failure to Get Certified Mail ‘Green Cards’ into Evidence = Draconian Trial Loss in Lien Spat

The Second District appeals court recently affirmed a harsh result against a subcontractor who failed to properly serve a Section 24 notice in accordance with the strictures of the Illinois Mechanics Lien Act.

The earth-moving subcontractor recorded a lien against a nascent Starbucks in Chicago’s western suburbs seeking payment for various change orders. It sent its lien notice to the property’s lender by certified mail but not to the property owner.

After a bench trial, the trial judge reluctantly found for the property owner defendants and held that the subcontractor’s lien notice failed to follow the Act.  The subcontractor appealed.

Affirming judgment for the property owner, the Court first emphasized the oft-cited rule that since rights created by the Act are statutory, the statutory technical and procedural requirements are strictly construed. The burden of proving that each requirement of the Act has been satisfied is on the party seeking to enforce its lien – here, the subcontractor.  But where there is no dispute that an owner actually received notice, courts will overlook technical defects.

Section 24 of the Act requires a subcontractor to serve notice of its intent to lien by certified mail or personal delivery to the record owner and lender (if known)within 90 days after completing the work on the property. 770 ILCS 60/24(a).

An exception to this notice requirement is where a general contractor’s sworn statement provides the owner notice of the subcontractor’s work and unpaid amount.

While courts will uphold a lien notice sent only to an owner (and not to the lender) since there is no concern of the owner being prejudiced or having to pay twice, the reverse isn’t true. Citing to half-century-old case law, the Court held that since notice to an owner is the ‘very substance of the basis on which a mechanic’s lien may be predicated,’, the Court refused to excuse the subcontractor’s failure to serve the owner with its lien notice even though the lender was given proper statutory notice.

And while the plaintiff attached some certified mail green (return) card copies to its written response to Defendant’s directed verdict motion at trial, the plaintiff never authenticated the cards or offered them in evidence at trial. As a result, the appeals court refused to consider the green cards as part of the appellate record. (An appeals court cannot consider documents that were not admitted into evidence at trial.)

In addition, the plaintiff’s trial testimony was conflicting. The Plaintiff’s owner’s testimony conflicted with a 2014 affidavit of mailing prepared by one of Plaintiff’s employees.  This evidentiary dissonance failed to show the owner’s actual notice of the plaintiff’s lien notice.  As a result, the trial court found that the plaintiff failed to carry its burden of proving that it complied with its Act lien notice rules.

The court then rejected the subcontractor’s argument that the owner had actual notice of its work since it saw the plaintiff performing grading work on the property and the plaintiff sent regular invoices to the owner’s agent.  However, under Illinois law, the mere presence of or owner’s knowledge that a contractor on a job is not a valid substitute for the required statutory notice.

The court also nixed the subcontractor’s claim that the owner had actual notice of the subcontractor’s work based on the sworn statements submitted to the owner from the general contractor. While courts have upheld an otherwise deficient subcontractor lien notice where sworn statements in the record plainly show the subcontractor’s identity and amounts owed.  Here, there were no sworn statements in the record. A trial witness may only testify to matters on which he/she has personal knowledge. Ill. R. Evid. 602. Since the plaintiff didn’t call to testify the owner’s construction manager – the only one who supposedly received the GC’s sworn statements (that identified plaintiff) –  there was no competent evidence that the owner received and reviewed any sworn statements that referenced the plaintiff’s work and amounts owed.

Afterwords:

This case shows how unforgiving statutory notice requirements can be in the mechanics lien context.

In hindsight, the subcontractor plaintiff should have introduced certified mail receipts into evidence.

Failing that, it should have called the owner’s construction manager as an adverse agent to lock in testimony that the general contractor furnished the owner with sworn statements and those statements sufficiently identified the subcontractor plaintiff.

Cal. Court Validates Reverse-Piercing; Creditor Can Add LLC to Prior Judgment Against Member

I previously featured (here) a 2018 4th Circuit decision that discussed reverse veil-piercing under Delaware law.  In 2017, a California court provided its own trenchant analysis of reverse veil-piercing and how that remedy relates to a charging order against an LLC member’s distributional interest.

The judgment creditor plaintiff in Curci Investments, LLC v. Baldwin, 14 Cal.App.5th 214 (2017) won a $7.2M judgment against a prominent real estate developer. In post-judgment discovery, the creditor learned the developer was sheltering his assets in an LLC; an entity through which he also loaned over $40M to family members and partnerships in the years leading up to the judgment.

The trial court denied the creditor’s motion to “reverse pierce” and hold the LLC responsible for the judgment.  The court reasoned that reverse-piercing was not a recognized remedy in California. The creditor appealed.

First, the court noted, under California law, a judgment creditor can move to modify a judgment to add additional judgment debtors. See Cal. CCP 187.

The court then stressed that an LLC’s legal separation from its members may be disregarded where the LLC is utilized to “perpetrate a fraud, circumvent a statute, or accomplish some other wrongful or inequitable purpose.”

In such circumstances, the acts of the LLC will be imputed to the individual members or managers who dominate the LLC. Under this alter-ego doctrine, individuals or other entities cannot abuse the corporate form to commit a fraud or elude creditors.

The appeals court broke with the trial judge and held that California recognizes “outside reverse veil piercing.” This applies where a third-party creditor tries to satisfy an individual’s debt by attaching assets of an entity controlled by that individual.

The reasons typically given by courts that decline to reverse pierce are discouraging creditor’s from bypassing standard judgment collection protocols, the protection of innocent shareholders and preventing the use of equitable remedies where legal theories or remedies are available.

Here, however, those policy concerns weren’t present.

First, the court noted that unlike in the corporate debtor context – where a creditor can step into a shareholder’s shoes and obtain shares, the right to vote and to dividends – a creditor’s rights against an LLC member are limited.

With an LLC, a plaintiff can only get a charging order against the LLC member’s distributional interest. The member remains an LLC member and keeps all of his/her rights to manage and control the LLC.

And since the individual defendant in Curci retained complete control to decide if and when LLC distributions would be made, the charging order was an illusory remedy.

This last point was blinding in light of the evidence that the defendant caused the LLC to distribute nearly $180M in the six years leading up to the judgment and no distributions had been made in the five years after the judgment.

The Court further distinguished the charging order remedy from reverse piercing in that the former only affixes to an LLC member’s distributional interest while the latter remedy reaches the LLC’s assets; not the individual member’s. [7]

Second, there was no possibility that an innocent shareholder would be harmed. This was because the judgment debtor owned a 99% interest in the LLC. (The 1% holder was the debtor’s wife who, under California community property laws, was also liable for the debt owed to the plaintiff.)

Lastly, there was no concern of the plaintiff using reverse-piercing to circumvent legal remedies like conversion or a fraudulent transfer suit. The court found that burdening the creditor with showing the absence of a legal remedy would sufficiently protect against indiscriminate reverse piercing.

Afterwords:

While Curci presents an extreme example of an individual using the corporate form to elude a money judgment, the case illustrates the clear proposition that if an individual judgment debtor is using a business entity to shield him/herself from a judgment, the court will reverse pierce and hold the sheltering business jointly responsible with the individual for a money judgment.

The case should be required reading for any creditor’s rights practitioners; especially on the West Coast.