Archives for May 2014

IT Recruiting Firm’s Non-Compete and Trade Secrets Claims Against Former Employees Fail – ND IL (Part I of II)

In Instant Technology, LLC v. DeFazio, 2014 WL 1759184, the Northern District of Illinois examines Illinois non-compete law, trade secrets rules and a slew of business torts in the context of a heated battle between rival recruiting firms and some of their key employees.  This article distills the case’s key restrictive covenant principles.  Part II of the post will summarize the court’s ruling on the plaintiff’s trade secrets, tortious interference, and civil conspiracy claims.

The plaintiff staffing firm sued several former employees and their current employer – a rival recruiter – for violating restrictive covenants contained in their employment contracts and for disclosing the plaintiff’s trade secrets in connection with their current position with the competing firm.  Plaintiff sued when it found out that the defendants had contacted some of plaintiff’s clients and job placement candidates in violation of their non-compete and non-solicitation provisions.  After a several-day bench trial and hearing testimony from almost 20 witnesses, the Court ruled in the defendants’ favor on all of the plaintiff’s claims.

Illinois Non-Compete Rules

The Court found that the defendants’ non-compete provisions were unenforceable because they lacked consideration and because the plaintiff couldn’t establish a legitimate business interest to be protected by the non-competes.  Under Illinois law, when assessing a restrictive covenant (here, a “non-compete”), the court looks to whether (1) the covenant is ancillary to a valid contract, and (2) whether it’s supported by consideration.  Consideration to support a non-compete is lacking if an employee can be fired the minute after he signs it and will only have adequate consideration only if, after signing the covenant, the employee remains employed for a substantial period of time – defined as two years or more of continued employment. See Fifield v. Premier Dealer Services, Inc. 2013 IL App (1st) 120327.

Aside from requiring at least two years of continuous employment, a valid non-compete has to be “reasonable.”  The reasonableness of a non-compete turns on whether it (1) is no greater than necessary to protect a legitimate business interest of the employer; (2) the non-compete doesn’t impose an undue hardship on the employee; and (3) it’s not injurious to the public. 

A legitimate business interest will usually exist where (a) the employee has access to the employer’s confidential trade information; and (b) the employee is tampering with the employer’s established customer relationships.  Other factors a court considers when determining whether an employer has a legitimate business interest include (i) the “near-permanence” of customer relationships; (ii) whether the employee’s acquired the employer’s confidential information; and (iii) the non-compete’s time and space restrictions.

Near-permanency (of customer relationships) depends on the nature of the business involved.   Businesses that engender customer loyalty and that offer specialized, unique services have a better chance of establishing a near-permanent client relationship than do companies whose services are more generic and disposable.   An industry marked by high turnover or one in which customers uses many vendors – like the recruiting business (or a large corporation that uses regional law firms) – will not meet the near-permanence criterion.

Under these guideposts, the Court invalidated the former employees’ non-competes.  First, several of the employees didn’t work the requisite two years to support the non-competes: they lacked consideration.  In finding the non-competes substantively unreasonable, the Court noted that the staffing industry is mercurial and subject to “massive turnover.”  The recruiting industry also uses elemental (read: not secret) sales techniques like cold calls to make sales and identify potential prospects.

And while maintaining workforce stability can be a legitimate business interest (as the plaintiff argued), where an industry is subject to rampant turnover – with frequent employee departures and terminations – the workforce stability argument fails.  The Court held that enforcing the defendants’ non-competes wasn’t likely to enhance the plaintiff’s workforce stability given the high turnover in the recruiting business and its basic, non-specialized sales techniques (cold-calling, e.g.).

Afterwords: Instant Technology is significant and instructive for its expansive analysis of Illinois non-compete principles, its validation of the two-year employment rule announced in Fifield (see http://paulporvaznik.com/fifield-case-two-years-of-continous-employment-sufficient-consideration-to-enforce-employee-restrictive-covenants/1261) and its discussion of the legitimate business interest non-compete clause prong.  The case illustrates that with a business that is historically subject to high turnover and that utilizes direct selling techniques, it will be hard for an employer to establish near-permanence with its customers ad, by extension, difficult to show a legitimate and protectable business interest.

 

Illinois Court Gives Agency Law Tutorial In Commercial Lease Fight

Three agency law issues that I regularly encounter in commercial litigation practice are (1) authority, (2) ratification and (3) a contract that doesn’t identify a valid entity.

The authority question posed is whether an individual – typically a company employee or independent contractor – can bind the company by the individual’s conduct.

Ratification applies where a corporate principal accepts the benefits of an agent’s unauthorized conduct.

The third, “unclear party” issue arises where a contract is signed by an individual on behalf of an unsueable entity such as a street address (i.e. “Tenant: 15 S. Wacker Drive”) or a generic business name with no “Inc.”, “Ltd.” or “LLC” designation.

Cove Management v. AFLAC, Inc. 2013 IL.App (1st) 120884, features all of these in a commercial lease dispute involving a large insurance company.

The lease designated the company as “tenant” but was signed by an independent  (non employee) sales agent.  After a lease default, the plaintiff landlord sued the company to recover rent damages.

The trial court dismissed the suit, buying the company’s argument that the agent who signed the lease wasn’t authorized to sign on the company’s behalf.  The landlord appealed.

Held: Affirmed.

Rules/Reasoning:

Even though the agent used business cards, envelopes and stationery submitted that bore the company colors and logo, it wasn’t enough to saddle the company with lease liability.

The Court rejected this argument as it laid out the operative Illinois agency rules:

An agent’s authority to bind a principal can be actual or apparent;

Actual authority can be express or implied;

Express authority is authority explicitly granted to the an agent by the principal, while implied authority is proven circumstantially based on the nature of the agent’s position;

Apparent authority is authority imposed by law – regardless of whether there is actual (express or implied) authority – based on a principal holding out an agent as having authority to bind the principal;

– Apparent authority must be based on words or conduct of the principal; not of the agent;

– If there is no showing of detrimental reliance by a third party on the agent’s authority; there can be no finding of apparent authority;

– A third party dealing with an agent has a duty to inquire into an agent’s supposed authority and can’t blindly rely on an agent’s claim that he has authority to enter contracts on behalf of his corporate principal;

Ratification applies where a principal learns of an unauthorized action (taken by a supposed agent) but retains the benefits of the transaction;

– Ratification requires the principal- with full knowledge of an agent’s unauthorized act – to manifest the intention to accept the benefits of the unauthorized act or to acquiesce in the transaction

¶¶ 9-14.

The Court found that there was no actual authority since the agent’s independent contractor agreement specifically provided that the agent could not sign contracts for the company.

There was also no apparent authority since plaintiff pointed to no conduct by the company that clothed the agent with authority to execute leases in the company’s name.

All of plaintiff’s apparent authority arguments were based on conduct of the agent; not the company.

The Court also found the lessor failed to show the company ratified the agent’s conduct.  All rent payments that were made came from the agent and there was  no evidence the company even knew the lease existed before suit was filed.

The corporate lack of lease knowledge also doomed the lessor’s alternative unjust enrichment/quantum meruit counts.  Since the company didn’t know about the lease, the plaintiff couldn’t show it conferred a benefit on the insurance company based on the sales agent renting the office space.  (¶¶ 34-35). (Quantum meruit requires plaintiff to prove that the defendant benefitted from plaintiff’s services.)

Take-aways: This case demonstrates the paramount importance of precision in lease drafting.  The insurance company defendant probably should have vetted all independent agent leases to ensure that the leases don’t designate the company as tenant.

Procedurally, the case shows how important it is to file counter-affidavits in response to a section 2-619 or summary judgment motion.  Since the landlord didn’t file a counter-affidavit in response to the company’s own affidavit, the Court had to accept the company’s version of events as true.  This spelled defeat for the landlord.

Rollin’ In My Six-Fo: Dr. Dre’s Claim to ‘Chronic’ Royalties From Death Row Bankruptcy Estate Rejected

ChronicIt was part of my black 1993 Eagle Talon’s cassette player’s (and later my 2005 Chevy Cobalt’s CD player’s) rotation for well over a decade.

It also introduced me to a new and dangerous vocabulary.  Growing up in the somewhat sheltered confines of Wichita,  I’d never heard of nor seen a “Gat” a “tech 9 tronic”, a “Six-Fo”, “hollow points”, a “swap meet” or a “Desert Eagle”.  I’d never visited the “LBC”, made a “187” call, imbibed a “Remy Martin and Soda Pop” concoction and never ingested “Indo-nesia” (cough). 

‘It’, of course, is The Chronic, Dr. Dre’s (a/k/a Andre Young) 1992 Gangster Rap masterpiece that is rightly viewed as a watershed in the annals of hip-hop.

Dropping in the wake of the Rodney King tumult, Chronic’s musical, social and cultural influence can’t be overstated – especially for those of us in our early 20s in the early 90s.

Widely regarded as “the album that brought hardcore hip-hop to the Suburbs”, the Chronic put future hip-hop deities Snoop Dog, (the late) Nate Dogg and Warren G on the hardcore rap map as well as lesser-known acts Daz, Bushwick Bill, Kurupt, RBX and Lady of Rage.  More importantly, Chronic ushered in a new sensibility of incendiary rap complete with blisteringly graphic portrayals of the drugs, nihilism, violence, desperation and unadulterated Rage of the South Central (L.A.) cityscape – the setting for the album’s rabbit-punch lyrics and hypnotic, Parliament-infused grooves.

It’s for these reasons that I find post-worthy the recent California bankruptcy decision in In re Death Row Records, Inc. (May 9, 2014).  In Death Row, the U.S. Bankruptcy Court for the Central District of California (where else?) denied the hip-hop impresario Andre Young’s (“Dr. Dre” or “Dre”) administrative expense claim of over $3M in producer and artist royalties related to Chronic on-line sales.

Dre’s administrative claim was premised on several written and verbal agreements between him, Death Row Records (DRR) and Interscope – a key Chronic distributor – going back more than two decades. 

The agreements gave Dre artist, publishing and producer royalties totaling over 20% of the record’s total sales.  The agreements were silent on Internet sales of the record since digital music didn’t yet exist.                                                                         

Several years of acrimonious litigation ensued when DRR bought and sold the Chronic’s digital rights to another music company without Dre’s consent.

After DRR filed for bankruptcy protection, Dre filed an adversary claim and a separate state court suit alleging illegal digital distribution of The Chronic.  

Dre’s bankruptcy claim sought about 18 years worth of Chronic royalties from Internet sales, totaling over $3M.  The Trustee moved to dismiss Dre’s claim.

Held: motion granted.  Dre’s claim fails. 

Q: Why?

A: An administrative expense claimant (like Dre) must establish that (1) he entered into a transaction with or gave consideration to the debtor; and (2) that he conferred a substantial benefit on the estate.  Death Row, p. 10.

The bankruptcy court found Dre’s claim defective under Federal notice pleading rules.  Dre failed to allege the terms of any contract with DRR that entitled DRE to payments and he failed to sufficiently plead measurable money damages he suffered from the lost royalties.

The Bankruptcy Court also dismissed Dre’s royalties claim under res judicata and statute of limitations principles.  The court found that the court’s previous litigation of Dre’s adversary claim and state court action (which was partially successful) were conclusive on the issues raised in Dre’s administrative claim.                                                                                                                                                              

The Court also dismissed Dre’s claims on statute of limitations grounds.  Dre didn’t file his administrative expense claim until 2013 – long after the limitations periods expired for breach of contract under California law (4 years written; two for oral).

Afterwords: Despite the case’s dizzyingly convoluted facts and procedural history, its issues are pretty basic.  The case demonstrates how important it is under Federal pleading rules for an administrative expense claimant to sufficiently allege contractual specifics and to show that he did in fact benefit the bankruptcy estate.  Death Row also shows the gravity of a claimant offering damages evidence that has an adequate foundation and isn’t based on speculation.  Finally, Death Row signals that claim preclusion and issue preclusion apply with equal force in bankruptcy administrative expense proceedings.