Tag: Trade Secrets

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.

 

Non-Shareholder of ‘Belly Up’ Bakery Can Be Personally Liable on Piercing Claim – IL Court Rules

I’ve seen no hard data to support this but it seems that piercing the corporate veil – as a concept – has seeped into the cultural lexicon and consciousness.  I say this because many people – lawyers and nonlawyers alike – appear to have at least a nodding acquaintance with piercing.  Over and over I hear some variation of:  “Oh, that company’s out of business you say?  Just do that piercing thing.”  (Sigh) If only it were that easy.

Yet, for its perceived prominence in legal and business circles, veil-piercing’s mechanics and elements remain largely shrouded in mystery.  Piercing breeds misinformation and a flurry of questions: is piercing a remedy or a cause of action?  Whom should you sue? Do you sue the officers, directors, employees, shareholders? All of them?  Can you pierce in post-judgment enforcement proceedings?  Or do you have to file a new lawsuit once you find out a company is out of business?  The cases are inconsistent and unclear on these important veil-piercing questions.  See http://paulporvaznik.com/piercing-the-corporate-veil-in-illinois/71 (discussion of piercing generally).

The First District recently answered some of these questions in Buckley v. Abuzir, 2014 IL App (1st) 130469, a trade secrets-cum-veil-piercing case involving rival Chicago-land bakeries.  The plaintiff sued a corporate defendant (a competing bakery) alleging it hired away plaintiff’s top employee and stole plaintiff’s customers and secret recipes.  The court entered a default judgment of over $400,000 against the corporate defendant on the plaintiff’s trade secrets claim.  When collection efforts failed because the corporation was defunct, plaintiff filed a piercing claim against the individual that funded and controlled the judgment corporate debtor.

The trial court granted defendant’s motion to dismiss under Code Section 2-615 on the basis that plaintiff failed to allege sufficient facts to make out a piercing case and because the individual defendant wasn’t a shareholder, director or officer of the corporate debtor.  Plaintiff appealed.

Held: Reversed.  Plaintiff sufficiently pled grounds for piercing under fact-pleading rules and a veil-piercing claim can be brought against a nonshareholder.

Rules/Reasoning:

In reversing the trial court’s dismissal order, the First District aligned itself with multiple jurisdictions which allow a piercing remedy against nonshareholders of a defunct corporation.  The Court’s analysis was informed by the salient piercing principles:

Corporate Formation and The Basic Nature of Veil-Piercing

– A corporation is a separate entity from its constituent shareholders, directors and officers and the whole purpose of incorporating is to shield shareholders from unlimited personal liability;

– Veil-piercing applies where a corporation is dominated by an individual or entity to such an extent that the “separate identity” doesn’t exist and it’s a sham to continue to recognize a separation between company and the controlling agent;

– piercing the corporate veil is not a cause of action; instead, it is a means of imposing liability on an underlying cause of action (here, the underlying cause of action was the trade secrets claim plaintiff initially filed against the competing bakery concern);

– BUT, a plaintiff may bring a separate piercing action to pierce the corporate veil for a judgment previously entered against a corporation;

– Veil-piercing applies almost exclusively in disputes involving close corporations (think Mom and Pop businesses) or one-man corporations.

Buckley, ¶¶ 7-9, 12.

Veil-Piercing’s Elements

The Court also stated and applied Illinois’ familiar veil-piercing elements:

– Illinois courts will pierce the corporate veil where (1) there is such a unity of interest and ownership that the separate personalities of the corporation and the component dominant parties doesn’t exist and (2) adhering to the concept of separation between corporate entity and dominant agent would promote injustice or inequitable circumstances;

-the unity of interest element (number (1) above)) alone involves a multi-factored analysis of whether there is evidence of (i) inadequate capitalization; (ii, iii) a failure to issue stock, failure to observe corporate formalities; (iv)-(vi) nonpayment of dividends, insolvency of the corporate debtor, non-functioning corporate officers, (vii)-(xi), absence of corporate records, commingling of funds, diversion of corporate assets to shareholders instead of creditor’s, no arm’s-length dealings with related entities; and whether the corporation is a façade or front from the dominant shareholders.

Application:

The Complaint, while sparse and conclusory, alleged enough facts to satisfy the two overarching piercing elements.  On the unity of interest piercing element, the First District exhaustively (an understatement) canvassed over 20 states’ piercing decisions that permit a piercing plaintiff to bind a nonshareholder to a failed corporation’s judgment debt.  The First District aligned itself with those jurisdiction that allow piercing against individuals who aren’t officers, directors, shareholder or employees of a corporation.  All that’s required is that the defendant be an “equitable” or de facto owner.  If the individual controls a company “behind the scenes” and makes the key funding, hiring and firing decisions, then that individual’s personal assets can be reached via a piercing claim.

The plaintiff’s complaint allegations met the main unity of interest criteria: he hired, fired, funded and managed the corporation that plaintiff sued in the underlying trade secrets case.  The “officers” of that corporation had little or nothing to do with the day-to-day operations of the corporation.  The plaintiff also alleged that the corporation issued no stock and had no shareholders.  If this was true, then defendant not being a shareholder is an illusory defense: there are no shareholders.  (¶¶ 15-33).

The Court also sustained plaintiff’s promotion-of-injustice element allegations.  While the plaintiff’s unadorned allegations were conclusory, they still contained just enough facts to state a piercing claim under Illinois pleading rules.  Plaintiff alleged that the defendant hired away plaintiff’s key employee to gain access to secret recipes and data to unfairly compete with and siphon business from the plaintiff.  These allegations were enough (but not by much) to plead that refusing to pierce would result in unfairness to the plaintiff.  (¶¶ 34-41).

Take-aways: Even though the ultimate ruling is simply a reversal of a Section 2-615 pleadings motion to dismiss, the case’s importance lies in its endorsement of using piercing to reach assets of individuals who aren’t corporate officers, shareholders or employees yet in reality, control and fund the corporate entity.  It’s important to recognize though that the Court didn’t rule on the merits of the plaintiff’s claim.  All that is settled is that a plaintiff can allege facts against an “equitable owner”/nonshareholder of a corporation that can lead to personal liability for that nonshareholder.

Illinois Consumer Fraud Act Applies To ‘Biz to Biz’ Insurance Dispute Says Fed. Court

In GoHealth, LLC v. Zoom Health, Inc., 2013 WL 6183024, the Northern District provides a detailed summary of the necessary Illinois pleading elements of some signature business torts in a diversity contract dispute involving the sale of insurance products.

Plaintiff and defendants entered into a written agreement where plaintiff would sell insurance product leads to defendants for a fee.  The defendants would in turn use the leads in peddling insurance products to its own customers.  The relationship soured and each side filed claims against each other.  Defendant’s counterclaims sounded in consumer fraud and common law fraud. Each side moved to dismiss.

The Court struck defendants’ fraud and negligent misrepresentation claims and upheld its consumer fraud and trade secrets counts.

Fraud Claim and Negligent Misrepresentation Claims

The Court dismissed the defendants’ common law fraud  and negligent misrepresentation claims.  An Illinois fraud plaintiff must allege a (i) knowingly false statement, (ii) intended to induce reliance in the plaintiff, (iii) reliance by the plaintiff and (iv) damages resulting from the reliance.

Negligent misrepresentation has the same elements as fraud except the plaintiff must allege a negligent or reckless (instead of intentional) false statement.  Federal specificity-in-pleading rules under Rule 9(b) don’t apply to a negligent misrepresentation claim. *9-10.

Defendants’ fraud count asserted that plaintiff falsely inflated defendants commission and renewal rates and misstated some sales projections.

The Court found that these two statements non-actionable as they involved future events (e.g. future sales and commissions projections).  Statements of future intent, opinions or of financial projections don’t equal fraud under the law.

The Court also rejected defendants’ argument that plaintiff was in business of providing information for the guidance of others in their business dealings – a key exception to the economic loss rule (this rule posits that you can’t recover in tort where a contract governs the parties’ relationship.)

The Court held that plaintiff was contractually obligated to provide sales leads and nothing else.  It wasn’t hired to provide sales projections or renewal forecasts – the bases for defendants’ fraud and negligent misrepresentation claims.  Any information provided by plaintiff in connection with the leads was peripheral to the contract’s core purpose.  *11.

Consumer Fraud Claims – Allowed

The court sustained defendants’ consumer fraud counterclaim. 815 ILCS 505/1 (the “Act”).  The consumer fraud count was based on plaintiff furnishing over 40,000 bogus and recycled sales leads to defendant instead of fresh leads.

Allowing the claim, the Court broadly construed the Act to encompass business-to-business relationships: “the protections of the Act are not limited to consumers”, but applies broadly to “persons”, including businesses. *12.

The court found the defendant was a “consumer” of plaintiff’s sales leads which constituted intangible property under the Act. (The Act applies to intangible property.)

The defendants’ claim that plaintiff supplied a high volume of duplicate leads also stated a deceptive act under the Act.   *12.

Afterword:

This case is post-worthy for its application of the consumer fraud statute to a purely business-to-business setting and its discussion of what constitutes “information” in the context of a negligent misrepresentation claim that will beat an economic loss rule challenge.