High-Tech Sports Equipment Plaintiff Alleges Viable Fraud Claim Against Electronic Sensor Supplier (Newspin v. Arrow – Part II)

In Newspin Sports, LLC v. Arrow Electronics, Inc., 2018 WL 6295272, the Seventh Circuit affirmed the dismissal of plaintiff’s negligent misrepresentation claims but upheld its fraud claims.

Under New York law (the contract had a NY choice-of-law provision), a plaintiff alleging negligent misrepresentation must establish (1) a special, privity-like relationship that imposes a duty on the defendant to impart accurate information to the plaintiff, (2) information that was factually inaccurate, and (3) plaintiff’s reasonable reliance on the information.

New York’s economic loss rule softens the negligent misrepresentation theory, however. This rule prevents a plaintiff from recovering economic losses under a tort theory. Since the plaintiff’s alleged negligence damages – money it lost from the flawed electronic components – mirrored its breach of contract damages, the negligent misrepresentation claim was barred by the economic loss rule. [*10]

Plaintiff’s fraud claims fared better.  In New York, a fraud claim will not lie for a simple breach of contract.  That is, where the only “fraud” alleged is a defendant’s broken promise or lack of sincerity in making a promise, the fraud claim merely duplicates the breach of contract one.

To allege a fraud claim separate from a breach of contract, a plaintiff must establish (1) a legal duty separate from the duty to perform under a contract, or (2) demonstrate a misrepresentation collateral or extraneous to the contract, or (3) special damages caused by the misrepresentation that are not recoverable as contract damages. [*11] [32]-[33].

Applying these principles, the Court noted that the plaintiff alleged the defendant made present-tense factual representations concerning its experience, skill set and that its components met plaintiff’s specifications.  Taken together, these statements – if true – sufficiently pled a legal duty separate from the parties’ contractual relationship to state a colorable fraud claim.

The Court also rejected the defendant’s argument that the plaintiff’s fraud claims were subject to the UCC’s four-year limitations period governing sales of goods contracts.  Since the plaintiff’s fraud count differed from its breach of contract claim, Illinois’s five-year statute of limitations for common law fraud governed.  See 735 ILCS 5/13-205,  As a result, plaintiff’s 2017 filing date occurred within the five-year time limit and the fraud claim was timely. [*12] [35].

Afterwords:

The economic loss rule will bar a negligent misrepresentation claim where a plaintiff’s pleaded damages simply restate its breach of contract damages;

A fraud claim can survive a pleadings motion to dismiss so long as the predicate allegations go beyond the subject matter of the contract governing the parties’ relationship.

Photo Album Inventor’s Trade Secrets Case Survives Summary Judgment – IL ND

The Northern District recently discussed the reach of the apparent agency doctrine along with trade secret abandonment in a spat over a photo album device.

The plaintiff in Puroon, Inc. v. Midwest Photographic Resource Center, Inc., 2018 WL 5776334 (N.D.Ill. 2018), invented the Memory Book, a “convertible photo frame, album and scrapbook” whose key features included embedded magnet technology (to keep pictures in place) and an interchangeable outside view.

The plaintiff sued the defendant photo-album seller when plaintiff learned the defendant was selling a product similar to the Memory Book. Defendant opposed the suit, claiming it independently created the analogous album product.  Both sides moved for summary judgment motion on multiple claims.

Apparent Agency

The salient agency issue on plaintiff’s breach of contract claim was whether a third-party who performed manufacturing services for the defendant and to whom the plaintiff sent some photo book samples was the defendant’s apparent agent If so, defendant was potentially liable on plaintiff’s breach of contract claim which asserted defendant went back on its promise to build Memory Book prototypes.

In Illinois, a statement by a purported agent alone cannot create apparent authority. Instead, for apparent authority to apply, the court looks to statements or actions of the alleged principal, not the agent. Once a litigant establishes that an agent has authority to bind a principal, the agents’ statements are admissible as an agent’s statement made within the scope of the agency. See Fed. R. Evid. 801(d)(2)(D)(a statement is not hearsay if offered against opposing party and made by party’s agent or employee on a matter within the scope of that relationship while it existed.) [*5]

Here, there was record evidence that a high-ranking employee of defendant referred to both defendant and the manufacturer as “we” in emails. The court viewed this as creating the impression in a reasonable juror that the manufacturer was an agent of defendant.

Because of this fact question – was the manufacturer the defendant’s agent? – both parties’ summary judgment motions were denied on plaintiff’s breach of contract claim.

Trade Secret Misappropriation

The bulk of the opinion focuses on whether the plaintiff sufficiently established that its Memory Book device qualified for trade secret protection and whether there was enough misappropriation evidence to survive summary judgment. The Court answered (a muted) “yes” on both counts.

The court refused to attach trade secret protection to the Memory Book’s embedded magnets feature; the Court noted that magnets had been used extensively in other photo container products.

The Court did, however, afford trade secret protection to plaintiff’s manufacturing specifications.  It found the ‘specs’ secret enough to give plaintiff a competitive advantage.  The Court also noted that plaintiff supplied the specs to defendant only after it signed an NDA.  This was enough for the plaintiff to take its trade secrets claim to a jury and survive summary judgment.

Trade Secret Abandonment

The Court rejected defendant’s argument that plaintiff abandoned its trade secrets by sending samples to retailers and presenting Memory Book at trade shows.

It stated that the trade show attendees could not have identified the Memory Book’s manufacturing specifications merely by looking at the device or handling a sample. The court also credited plaintiff’s evidence that the album retailers weren’t provided with the Memory Book’s specs. The court opined that “reasonable steps for a two or three person shop may be different from reasonable steps for a larger company” and concluded that “[g]iven the fact that [Plaintiff] is a small, one-person company, a reasonable jury could find that [its]  efforts . . . were adequate to protect the Memory Book’s secrets.”

Afterwords:

Corporate entities should not too closely align themselves with third party independent contractors if they wish to avoid contractual liability on an agency theory;

Inventors should make liberal use of NDAs when sending prototypes to vendors, partners or retailers;

A smaller company can likely get away with less strenuous efforts to protect trade secrets than its bigger company counterparts.  The larger and more sophisticated the company, the more sedulous its efforts must be to protect its confidential data.

Fed. Court ‘Blue Pencils’ Telecom Employer’s Overbroad Nonsolicitation Term – IL ND

In Call One, Inc. v. Anzine, 2018 WL 2735089 (N.D.Ill. 2018), the Northern District of Illinois provides a useful gloss on Illinois restrictive covenant law in the context of a trade secrets action filed by a call center employer against a long-time employee.

The defendant worked for the plaintiff as a sales representative for 15 years. About a decade into her employment tenure, the defendant signed a non-compete agreement which, among other things, prevented her from soliciting plaintiff’s “prospective customers” for a 12-month post-employment period.

After talks for defendant to become an independent distributor of the plaintiff broke down and defendant quit her job, plaintiff sued when it learned defendant altered a Customer Report and e-mailed it to her personal email account. The defendant countersued for a declaration that the non-solicitation clause was overbroad.

Granting summary judgment for the ex-employee on her counterclaim, the Northern District judge set forth applicable Illinois law on restrictive covenants.

  • Restrictive covenants are scrutinized carefully since they are restraints of trade. The key inquiry is whether a given restriction is reasonable and necessary to protect a legitimate business interest of the employer.
  • A post-employment restrictive covenant is reasonable only where (1) it is no greater than necessary for the protection of a legitimate business interest of an employer, (2) does not impose an undue hardship on the employee, and (3) is not injurious to the public.
  • When determining whether an employer has met the legitimate business interest test – prong (1) above – the court considers whether an employer enjoys near-permanent relationships with its customers, whether the employee acquired confidential information during her employment and time and place restrictions contained in the subject covenant.
  • Courts are reluctant to prohibit former employee’s from servicing customers they never had contact with while working for an employer.

Applying these factors, the court found that the non-solicitation term excessive. It specifically viewed the restriction broader than necessary to protect Plaintiff’s ongoing client relationships.

According to the court, to prevent defendant from soliciting anyone who was ever a customer of plaintiff over the past 15 years was facially overbroad and not necessary to protect plaintiff’s current customer relationships. Another reason the court found the non-solicitation provision too expansive was it prevented defendant from contacting plaintiff’s clients with whom she never had any direct contact and didn’t even know about.

The agreement also contained a severability or “blue pencil” provision. Such a provision allows a court to modify an overbroad restrictive covenant in some settings.

Here, because the 12-month non-solicitation provision was chronologically reasonable in scope, the Court reformed the covenant to only prevent defendant from contacting any entity (a) who was a current and prospective customer of plaintiff as of defendant’s January 2018 termination date and (b) for which defendant had responsibility at the time of her separation.

The Court also granted summary judgment for the defendant on plaintiff’s claim premised on the Defend Trade Secrets Act of 2016, the statute that gives a trade secrets plaintiff access to Federal courts. To prove a Federal trade secrets act claim, the plaintiff must establish (a) the existence of a trade secret, and (b) misappropriation.

Misappropriation includes unauthorized disclosure of a trade secret by a person who used improper means to acquire knowledge of the trade secret and unauthorized disclosure of a trade secret by a person who knew or had reason to know that knowledge of the trade secret was “acquired under circumstances giving rise to a duty to maintain the secrecy of the trade secret.” 18 U.S.C. ss. 1839(5)(B)(i)-(ii).

Plaintiff failed to adduce evidence that defendant owed a duty to protect the confidentiality of the Customer Report when it was never labelled as confidential.  As a result, no reasonable jury could find defendant acquired the Report through improper means by breaching a duty to maintain its secrecy.

Afterwords:

An employer suing a former employee for violating a restrictive covenant must demonstrate the existence of near-permanent customer relationships or confidential information. As long as the time and space limitation is objectively reasonable, a court can edit and contract the scope of a post-employment restriction.

Where an employer cannot demonstrate that an employee had a duty to maintain the secrecy of the information the employer is trying to protect, it likely can’t establish Federal trade secrets misappropriation.

The plaintiff’s elaborate information security policies worked against it here. By failing to label the subject Report as confidential (which was required per the employee handbook), the Court refused to find the Report sufficiently confidential to impose a duty on the defendant to keep it secret.