Recently in Court of Chancery Category

January 16, 2014

Young Conaway Publishes Bloomberg BNA Series on Noncompetes

bloomberg.pngPartners Scott Holt, Barry Willoughby, and William Bowser recently co-authored Bloomberg BNA's Corporate Practice Series on Noncompetition Agreements. The publication provides an in-depth review of the use and enforcement of noncompetition agreements, including practical tips for prosecuting and defending noncompete cases.

The publication is available through the Bloomberg BNA web site

March 16, 2012

Settlement Discussions Not An Excuse for Delayed TRO Application To Enforce Noncompete

One of the most critical points in the enforcement of a noncompete is when a company first learns that a former employee may be engaging in unfair competition.  Indeed, the steps taken by the company in the first few days can often determine whether it will be successful in limiting the amount of harm done.

In many case, the company will act quickly and seek emergency injunctive relief to stop imminent irreparable harm to its business.  In other cases, the company may try to resolve the dispute with the competitor by engaging in settlement discussions at the outset.  The benefit of the latter strategy, of course, is that a business resolution is often preferable to the expense and uncertainty of litigation. 

But companies that chose the settlement route need to be aware that the passage of time can compromise their ability to get relief from a court should discussions break down, particularly if it needs an emergency injunction.  In a recent Chancery Court hearing on an application for a temporary restraining order, the court was quick to point out plaintiff’s apparent four month delay after learning of the defendants activities before seeking the TRO.  The plaintiff responded that the delay was due in part to its efforts to work out a standstill agreement with the defendants.  As noted in the transcript excerpt below, the court was not sympathetic to this argument:

You can't have a problem in November and come running in here [in March], you know, two days after you file your papers, and say all of a sudden you need a TRO. We don't operate like that. 

And the fact that you tried to … negotiate a standstill, that's great, but if you think that your rights are really being harmed to the extent that you say they are, you have to go on a parallel path to get some judicial relief. You haven't moved fast enough, and I'm not giving you a TRO.

Prompt action is the keystone for any company needing to enforce a noncompete agreement.  Even if those efforts involve an attempt to settle the matter, the company is well advised not to delay seeking emergency judicial relief that may be necessary to prevent ongoing irreparable harm.  By dual tracking enforcement efforts with settlement talks, companies can not only avoid prejudicing their legal rights, but can use the specter of an impending injunction hearing to foster an even quicker resolution of the dispute.

February 17, 2012

Protecting Trade Secrets In Delaware

Employers frequently confront the problem of theft or misappropriation of trade secrets and confidential, proprietary information by departing employees. While employers have an arsenal of legal weapons at their disposal to protect their most valuable business assets, it is critical that they take proactive steps to protect against the disclosure of important business information and prevent unfair competition. From a practical standpoint, failure to implement basic security measures makes it easier for an unethical employee or competitor to misappropriate confidential business information. From a legal perspective, absent efforts to preserve the secrecy of such information and avoid unfair competition, a court is unlikely to respond favorably to an employer request for relief.Delaware

Trade Secret Protection

Delaware, like most states, has enacted the "Uniform Trade Secrets Act" providing employers with legal protection for trade secret information even in the absence of contractual agreements with employees. While many people may believe that "trade secret" status is only afforded to scientific data such as the formula for Coke, in reality, trade secret protection is available for a much broader array of information. The statutory definition for a trade secret is "information" that "derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable by proper means, by other persons who can obtain economic value from its disclosure or use." To be protected by the statute, the information must be "the subject of efforts that are reasonable under the circumstances to maintain its secrecy."

Trade secret protection is available to business information other than scientific data such as formulas and chemical compounds. The Uniform Trade Secrets Act specifically extends protection to a "compilation," "program," "method," "technique," or "process" that has independent economic value to a company arising from its secrecy.

Customer lists may be subject to trade secret protection if the employer expended substantial resources and time in developing information that is not generally known to the public or competitors. Further, even if the customer list itself is not trade secret, information the employer compiled as part of its marketing efforts may be protected. For example, the courts have found that a "rankings report" kept by company sales representatives concerning the amount of sales to clients and ranking the company's customers by sales volume is sensitive financial information that may be subject to trade secret protection. Likewise, while an idea such as linking a savings program to an affinity group may not be a trade secret, the means by which such a program is implemented may be.

Even if business information does not meet the definition of a "trade secret," it still may be confidential, proprietary information subject to other legal protections.

Computer Fraud Act

Employers have a potentially powerful weapon to combat improper access and misappropriation of electronic data and information stored on a computer. We are all familiar with cases in which an unethical employee downloads company electronic information to a thumb drive for later use and/or sends such information via email to his or her personal computer in preparation for leaving employment and competing with their employer. The federal Computer Fraud and Abuse Act ("CFAA") may be used to hold employees liable both civilly and criminally for such misconduct. Although the CFAA was originally passed to target computer "hackers", not disloyal employees, some courts have applied the statute to employee misconduct. The CFAA also has criminal provisions. For example, former news anchor, Larry Mendete, plead guilty under the CFAA to intentionally accessing the private email account of his former co-anchor, Alycia Lane.

Delaware has a state counterpart to the CFAA.  The Misuse of Computer System Information Statute, 11 Del. C. § 935 et seq., makes it a crime to knowingly access a computer system without authorization. The statute prohibits not only the unauthorized copy and disclosure of electronic data, but the knowing deletion of data from a computer system.  The statute also has a civil component to this law which allows an aggrieved party to bring an action in the Delaware Court of Chancery for injunctive relief, restitution, treble damages, and attorneys' fees.  For more information see our earlier blog post on this statute.

Common Law Claims

There are many other legal claims that the company may assert to protect its business assets if an employee improperly uses or discloses its confidential, proprietary, or trade secret information. Employees who are given access to such information may be treated as fiduciaries with a duty of loyalty to protect it from disclosure during their employment. A competitor who knowingly participates in improper disclosure may be charged with "aiding or abetting" a breach of fiduciary duty or illegally participating in a civil conspiracy. In addition, a competitor who unfairly competes through the acquisition and intended use of such information may be sued for tortious inference with contract or business relations.

Contractual Protections

Aside from statutory and common law protections, there are contractual safeguards available to help employers stop the inappropriate disclosure of the business information and prevent unfair competition. At a minimum, all employers should consider requiring key employees who have access to confidential, proprietary, and trade secret information to sign Confidentiality and Non-Disclosure Agreements. A company may legally require employees who have access to confidential, proprietary information to sign such an agreement. If drafted properly, such agreements have "teeth" when enforcement action is necessary. Confidentiality agreements may provide not only for emergency injunctive relief, but also for an award of damages from the improper disclosure of company information. Importantly, in appropriate circumstances, Delaware courts will enforce a provision in a confidentiality agreement providing that an individual who violates its terms is subject to paying the company's attorneys' fees and costs in bringing enforcement action.

For certain classes of employees, employers should consider broader contractual protections beyond a simple confidentiality agreement. Employees in sales and marketing or high-level management positions may be in a position to seriously damage the company's business if they leave to work for a competitor. A non-competition agreement or restrictive covenant is valid and enforceable in Delaware so long as the agreement is not overly broad and is necessary to protect the company's legitimate economic interests.

Delaware courts will generally enforce a non-competition agreement that is reasonable in geographic and temporal scope. The non-competition agreement must contain a geographic restriction tied to the areas where the company does business and where the employee works to establish that the Company has a legitimate business interest in restricting competition in those locations. Delaware courts, like most courts throughout the United States, also require that the restriction against competition have a reasonable time limit. Typically, a Delaware court will find a two-year restriction to be reasonable.

Since enforcement of a non-competition agreement prohibits an employee from working in a specified field in competition with his or her former employer, courts are careful to balance the equities. The court will consider the employer's reasonable business needs versus the impact of the enforcement of such agreements on an individual's ability to earn a livelihood. Upon a showing of a need for such relief, however, courts will enforce non-competition agreements and may even issue an order prohibiting a former employee from working for a competitor.

An alternative to a non-competition agreement is a "non-solicitation" agreement. Non-solicitation agreements are narrower than non-competition agreements. A non-solicitation agreement restricts a former employee from soliciting a company's clients or customers. Like a non-competition agreement, a non-solicitation agreement must include a reasonable time limit. Instead of a geographic limitation, however, a non-solicitation agreement may restrict an employee from solicitation or business dealings with certain customers such as those with whom the employee had direct contact or about whom the employee received confidential information. Non-solicitation clauses may also include potential customers or prospects. Of course, as with other contractual provisions, careful drafting is necessary to ensure the enforceability of such contractual restraints.

In appropriate cases, employers may include confidentiality, non-competition, and non-solicitation clauses in the same agreement. As a rule of thumb, the need for such protections and the likelihood of successful enforcement increases with the amount of access an employee has to valuable business information and his or her level in the organization. In addition, employee misconduct, such as misappropriation of a customer list or other sensitive information, increases the likelihood that a court will award relief to the employer.

Posted by Barry M. Willoughby
February 16, 2012

Overbroad Forum Selection Clause Dooms Effort to Enforce Noncompete

Many businesses include Delaware choice-of-law and forum-selection clauses in their contracts to take advantage of Delaware law and the Court of Chancery’s strong reputation for reliable and well-balanced decision-making. However, in order to take advantage of Delaware’s judicial system, the forum selection clause must be drafted so that it confers personal jurisdiction over all of the parties. In a recent ruling, the Court of Chancery struck down a plaintiff’s attempt to enforce a noncompete agreement in Delaware because of a poorly worded forum selection clause.

In the case of Georgia-Pacific Consumer Products LP v. Jadczak, C.A. 6695-VCL, the plaintiff brought suit in Delaware to enjoin its former employee from working for a competitor in violation of his employment agreement. In addition to various restrictive covenants, the defendant’s employment agreement included the following personal jurisdiction provision:

Employee consents to and waives any objection to personal jurisdiction and venue in any federal and state courts having jurisdiction in any dispute arising out of the terms of this agreement.

Defense counsel moved to dismiss the case for lack of personal jurisdiction, arguing that the clause was over broad. They emphasized that the employee worked in Georgia when employed by Georgia-Pacific, and later accepted a job with a competitor in Kentucky. By contrast, the clause would allow him to be sued anywhere in the United States. In response, plaintiff’s counsel argued that Georgia-Pacific is a national company whose financial interests could be impacted in any state.

After lengthy arguments, the Court granted the motion to dismiss, providing three reasons for its decision. First, the Court noted that while parties may contractually accept the jurisdiction of Delaware’s courts, any such agreement must be clear and express. The Court found the language used by Georgia-Pacific to be ambiguous in its second use of the term “jurisdiction,” and therefore concluded that it did not meet the standard of a clear and express agreement.

Second, the Court found the provision to be so broad as to be unreasonable. Indeed, the Court noted that the language is not even limited to the United States, but could include any country that has a system of state and federal courts. The Court concluded that “a provision this general gives the employee insufficient notice of where the employee could be sued.”

Finally, the Court relied on issues of comity. In other words, the Court was hesitant to impose its will where other states had a much stronger interest in the outcome of the case. Noting that “Delaware does not have a significant interest in this dispute,” the Court instead deferred to the “paramount interests” of Georgia and Kentucky. Vice Chancellor Laster opined that “it risks giving offense to other states and it risks overstepping Delaware’s role in our federal system for Delaware to take ownership of this type of dispute involving an employee.”

This decision reinforces the need for companies to have well-drafted venue selection provisions, particularly if they wish to have their noncompete agreement enforced in Delaware. For Delaware choice of venue provisions, companies should also consider taking advantage of Delaware’s choice of law / venue statute, 6 Del. C. § 2708, which provides that the parties “shall conclusively be presumed to be a significant, material and reasonable relationship with this State and [the agreement] shall be enforced whether or not there are other relationships with this State.”

February 9, 2012

Court of Chancery Continues To Question Blue Pencil Rule

The Delaware Court of Chancery has once again indicated a reluctance to invoke the Blue Pencil Rule to reform overly broad restrictive covenants. Approximately 10 months ago, in his opinion in Delaware Elevator, Inc. v. Williams, Vice Chancellor Laster expressed his unwillingness to reform overbroad covenants, noting that “doing so puts the employer in a no-lose situation.” We discussed the opinion on this blog, urging drafters to exercise caution when drafting non-competition agreements and to give serious consideration to surrounding business circumstances when drafting. More recently, on December 21, 2011, during oral argument in Chesapeake Insurance Advisors, Inc. v. Williams Insurance Agency, Inc., et al., Vice Chancellor Noble echoed Vice Chancellor Laster’s position, quoting directly from Delaware Elevator.

In Chesapeake, the plaintiff-former employer sought to enforce a non-competition and non-solicitation agreement against several former employees, including the company’s former President. Oral argument was held to address the plaintiff’s dual motions for expedited proceedings and a temporary restraining order. In order to succeed on its motion for a temporary restraining order, plaintiff had to demonstrate, among other things, a colorable claim to relief. In order to demonstrate a colorable claim, the plaintiff had to present evidence that the underlying covenants are enforceable under Delaware law. Valid covenants must include reasonable temporal, geographic, and subject-matter restrictions.

Of significance here is the non-solicitation restriction, which prohibits the plaintiff’s former President from soliciting any of the plaintiff’s customers for 36 months following the termination of his employment. Delaware law has long recognized a presumption of reasonableness for restrictions extending no more than 24 months. Consequently, the plaintiff had an up-hill battle to convince the Court of the reasonableness of a 36-month restriction.

In an effort to cover his bases, the plaintiff’s counsel noted that in the absence of evidence justifying a 36-month restriction, the Court could always reform the covenant under the Blue Pencil Rule to limit the temporal restriction to a reasonable time period. Relying upon Vice Chancellor Laster’s decision, the Court stated that it would not “use the blue pencil to say ‘let’s make it 12 months or 18 months or 24 months.’ It’s not there. It’s gone.” Plaintiff’s counsel pointed out that the contract at issue had been fully negotiable, and that both parties had been represented by counsel. The Court was undeterred. While the Court recognized that “there is something of a divergence of opinion on that topic” between the Court of Chancery and the Delaware Supreme Court, it nonetheless indicated its intent to interpret the contract as written without modification.

Like the dicta in Delaware Elevator, the Court’s discussion in Chesapeake Insurance is not precedential. However, it provides a stronger indication (if one were needed) that the Court has little patience for needlessly broad restrictive covenants. Moreover, the relative bargaining positions of the parties is of little significance to the Court. Consequently, drafters should heed the Court’s warnings, and carefully consider the attendant business circumstances when drafting restrictive covenants. Among the issues to consider are: (1) the employee’s relative position within the company; (2) the extent of the employee’s business-related contacts; (3) the employee’s establishment within the field of business and the surrounding community; and (4) the realistic possibility of relocating or working outside of the geographical scope of the restrictive covenant. As an employee’s position within the company and access to customers and trade secrets increases, so does the employer’s ability to restrict his ability to compete and solicit current and prospective customers.

October 5, 2011

Chancery Court Decision Provides Insight Into Drafting Enforceable Forum Selection Clauses

The Delaware Court of Chancery is nationally respected for its consistent and conscientious decisions in cases involving complex business issues. As a result, many legal practitioners recommend that contracting parties include a forum selection clause requiring that any disputes arising from a given contract be heard by a court of competent jurisdiction in the State of Delaware, including the Court of Chancery. A recent case in the Delaware Court of Chancery provides insight into the effective enforcement of a forum-selection clause.Delaware

In the daintily-named case of ASDC Holdings, LLC v. The Richard J. Malouf 2008 All Smiles Grantor Retained Annuity Trust, two parties entered into an agreement regarding the sale of equity in a Texas business. The agreement contained both an arbitration and a Delaware forum-selection clause which provided that any actions “with respect to any claim or cause of action arising under or relating to this Agreement” must be brought in a Delaware state or federal court with jurisdiction.

After the deal was executed, both parties became unhappy and sought legal relief: Plaintiff initiated an arbitration proceeding, and Defendant brought suit in a Texas court. Plaintiff thereafter filed papers in the Delaware Court of Chancery, seeking a preliminary injunction to prohibit the Texas action from moving forward in violation of the forum-selection clause.

The first question before the Court was whether it had jurisdiction to grant a preliminary injunction. The Court of Chancery is a court of limited jurisdiction—it does not have jurisdiction where there is an adequate remedy at law for the damages alleged. Defendant asserted that Plaintiff had an adequate remedy at law because it could assert the forum selection clause as an affirmative defense in the Texas action. Rejecting this argument, the Court held that where the underlying forum-selection clause is valid and broad enough to arguably reach the underlying claims, litigating the applicability of the forum-selection clause in another state deprives the parties of the benefit bargained for and does not constitute an adequate remedy at law.

Having established that it had jurisdiction, the Court moved on to address the Plaintiffs’ Motion for Preliminary Injunction. In order to obtain a Preliminary Injunction, the moving party must show (1) a reasonable probability of success on the merits, (2) an imminent threat of irreparable injury, and (3) that the balance of the equities favors the issuance of the requested relief. Defendant raised several arguments as to Plaintiff’s probability of success. First, it argued that several defendants in the Texas action are not signatories of the contract at issue, and therefore may not invoke the forum selection clause. The Court noted that, as wholly-owned subsidiaries, officers, and directors of the contract signatory, the third-party defendants are closely related to the signatories and may invoke the clause. Regarding the remainder of Defendant’s contentions, the Court concluded that the forum-selection clause was broad enough to give rise to a colorable argument that all of the claims raised in the Texas action fall within the scope of the clause.

As to the second element of Plaintiff’s claim, the Court held that proceeding on a claim in an unwarranted forum constitutes irreparable harm. Finally, the Court concluded that the balance of the equities favored Plaintiff, although the Court did not elaborate.

The Court’s opinion raised two key points to drafting a forum selection clause that may be successfully enforced through a Motion for Preliminary Injunction. First, the forum selection clause at issue must be valid. This means that the clause must permit claims to be brought in the appropriate Delaware Court.  A clause requiring that any claim be brought in the Court of Chancery, regardless of whether the Court has subject matter jurisdiction, may not be enforceable. 

Second, the clause should be drafted as broadly as possible, to ensure that any claims raised in a foreign jurisdiction will be governed by the clause, and subject to dismissal under the forum-selection clause. If the causes of action are not arguably within the ambit of the forum-selection clause, the party seeking to enforce it may not be entitled to a preliminary injunction. The language used by the parties in this case—governing “any claim or cause of action arising under or relating to this Agreement”—was found to be sufficiently broad enough to cover the claims at issue.

September 27, 2011

Court Denies Preliminary Injunction Based on Insufficient Record

While the Court of Chancery will frequently enjoin parties from engaging in unfair competitive activities, the standard for obtaining preliminary injunctive relief remains high.  It is important for parties seeking injunctive relief to be able to provide the court with specific, admissible evidence of unfair competitive activities.  Generalized allegations normally will be insufficient to allow the court to grant relief. Take for example a recent case involving the purchaser of a company’s assets who sought to enforce a noncompete against one of the company’s former employees.

In that case, Geovesi Holdings, Ltd. purchased certain assets of Earthwater Global, LLC as part of a court-ordered liquidation. The purchased assets include “all employment, non-disclosure agreements and  confidentiality agreements entered into by [EW Global].”  Following the sale, Geovesi filed suit in Chancery Court against one of EW Global’s former employees, Robert Bisson, to enforce noncompete and non-solicitation covenants in his employment agreement.  There also was pending litigation between Bisson and Geovesi in Virginia and an arbitration proceeding.

As evidence of Bisson’s competitive activities, Geovesi relied exclusively on allegations in Bisson’s Virginia pleadings that he competed with Geovesi.  The Court noted that while these generalized allegations are admissible evidence of competition, they did not provide a sufficient evidentiary foundation to support injunctive relief.

The Court also found that Geovesi’s allegations that Bisson wrongfully solicited its employees was too general to support injunctive relief.  As evidence, Geovesi had pointed to names mentioned on Bisson’s website and made generalized allegations about other solicitation efforts.  Bisson, on the other hand, responded with an affidavit explaining the names listed on his website and denying any prohibited solicitations.  The Court found that on the present record it could not predict with any degree of confidence how this issue would be resolved at trial, making it inappropriate to issue injunctive relief.

Genovesi Holdings Ltd v. Bisson, 6780-VCL, (Del. Ch. 9/19/2011).

March 28, 2011

Court of Chancery Indicates It May Strike - Not Reform—Overly Broad Non-Compete Clause

When enforcing covenants not to compete, Delaware has long been viewed as a “reformation” state – meaning that when faced with an overbroad covenant, Delaware law allows the court to reduce the scope of the covenant and enforce it to the extent that the court deems reasonable. This view has developed among the lower courts in a number of decisions, but has never been fully addressed by the Delaware Supreme Court.chancerylogo60

However, as we noted in an earlier article, it is important to make certain the restrictive covenant you draft is reasonable both in its scope and duration. Employers should not count on a court to "reform" a poorly drafted restrictive covenant that is overly broad or vague. A recent case from the Court of Chancery demonstrates why.

In the case of Delaware Elevator, Inc. v. John Williams, No. 5596-VCL (Del. Ch. March 16, 2011), the plaintiff-employer sued its former employee alleging a violation of the employee’s non-competition agreement. Because the employee admitted that he had engaged in conduct that violated the terms of the non-competition agreement, the only question before the Court was whether the non-competition agreement was overly broad, and therefore unenforceable.

The non-competition agreement at issue had both a non-competition and a non-solicitation provision, each of which restricted the employee’s conduct for 3 years after he left his employment. The non-competition provision prohibited the employee from competing with the employer within 100 miles of its Newark, Delaware office. Under the non-solicitation provision, the employee was prohibited from soliciting any customer who had been a current or prospective client of the employer during the last 6 months of the employee’s employment.

The employee resigned his position with the employer in 2010. Shortly thereafter, the employer discovered that he was competing within 100 miles of the Newark Office, and that he was using a customer list that he developed while he was employed by the employer. When the employee refused to cease and desist, the employer brought suit, seeking to enjoin his violation of the agreement.

The non-competition agreement included a Maryland choice-of-law provision, so the Court’s analysis was conducted under Maryland law. After determining that the 3-year, 100-mile restriction was overly broad, the Court was faced with the question of whether to strike or reform the provision. The Court concluded that Maryland law required reformation under the blue pencil rule. However, the Court declared that it would have handled the question differently under Delaware law.

The Court stated that reformation of overly broad contracts puts an employer in a no-lose situation. If the agreement will be enforced to some lesser extent even if overly broad, an employer has no incentive to draft a reasonable provision in the first place. The Court also noted that for every employee who challenged the provision, others would choose not to, thereby harming consumers and interfering with labor and product markets.

The Court was further troubled by the disparity in bargaining power between low and mid-level employees and their employer. Where such employees are involved, the Court noted, there is no real choice as to whether to sign the non-competition agreement. Moreover, even if there were a choice, most employees do not have the savvy or access to legal advice to bargain effectively. As a result, the Court noted that Delaware law might require that an unreasonable restrictive covenant be struck in its entirety.

While the Court’s statements regarding Delaware law are dicta, they provide a strong indication that overly broad restrictive covenants might not be enforced in any manner by the Delaware Court of Chancery. As a result, employers should exercise caution when drafting non-competition agreements. These agreements should consider, among other things, (1) the employee’s relative position within the company, (2) the extent of the employee’s business-related contacts, (3) the employee’s establishment within the field of business and the surrounding community, and (4) the realistic possibility of relocating or working outside of the geographical scope of the restrictive covenant. As an employee’s position within the company and access to customers and trade secrets increases, so does the employer’s ability to restrict his competition and solicitation of current and prospective customers.

By Scott Holt and Lauren Moak

March 8, 2011

Injunction Carve-Out Provision Preserves Status Quo Pending Arbitration

While we are all familiar with the use of preliminary injunctions in aid of litigation, they also have a place in alternative dispute resolution. In Chartis Warranty Guard, Inc. v. National Electronics Warranty, LLC, the Delaware Court of Chancery issued a preliminary injunction pending the outcome of contractually mandated arbitration. The inclusion of a clause allowing issuance of a preliminary injunction prior to binding arbitration is a wise move if a contract includes non-competition or confidentiality provisions, the violation of which would lead to irreparable harm.

In Chartis Warranty, the plaintiff was a joint venture formed between the defendant, National Electronics Warranty, LLC (“NEW”) and Chartis Insurance. The purpose of the joint venture was to provide retailers with consumer warranty programs. Pursuant to the contracts governing the parties’ responsibilities, NEW received a designated fee for administering the retailer warrant programs, and Chartis received all profits earned above the fee owed to NEW.

In the course of its administration, NEW gathered a variety of data relating to the consumer warranty programs. Some of this information was publicly available, and some was sensitive. Among the move sensitive information was loss ratios, profitability, and earnings curves, which would be valuable to Chartis’s competitors. In the process of reorganizing certain programs, NEW provided this sensitive information to some of plaintiff’s competitors, leading to a dispute about whether the data was subject to various confidentiality provisions contained in the contracts governing the parties’ relationship. NEW maintained that it owned the data, and was permitted to disclose it—Chartis disagreed, asserting that it maintained exclusive ownership over the relevant information.

Both parties agreed that any dispute regarding the terms of the contract were subject to binding arbitration. However, the contract also permitted the parties to seek a preliminary injunction pending arbitration. Consequently, the plaintiff filed suit seeking an injunction to protect its interests in the allegedly confidential information that it claimed the defendant was disclosing to its competitors.

Under Delaware law, a preliminary injunction is appropriate it the moving party can demonstrate (1) a reasonable probability of success on the merits; (2) that they will suffer irreparable injury if the injunction does not issue; and (3) that the balance of the equities favors issuance of an injunction. In this case the Court, applying New York law as required by the contract, found that the plaintiff was likely to succeed on its arbitration claims because the terms of the confidentiality provision, indicating that the plaintiff owned “all books and records,” was broad enough to include the disputed data. In so finding, the Court rejected NEW’s argument that, at most, the plaintiff had a non-exclusive ownership interest. In the absence of any information limiting the plaintiff’s ownership right, the Court declined to find such a limit. The Court also concluded that the disputed data might constitute trade secrets.

Regarding irreparable harm, the Court reached two conclusions. First, it determined that the harm done to the plaintiff by NEW’s previous disclosure of the disputed data could be reduced to monetary damages, and therefore was likely reparable. However, the Court noted that NEW had expressed an intent to continue disclosing the disputed data. This on-going disclosure, the Court concluded, was irreparable because continuing harm to the plaintiff’s competitive position is much more difficult to quantify. Consequently, the Court found that the plaintiff had demonstrated a likelihood of irreparable injury.

Finally the Court concluded that the balance of the equities favored the plaintiff, considering the difficulty in quantifying the damage to plaintiff, and the short-term nature of the injunctive relief, which will terminate upon completion of the arbitration proceedings.

Delaware law clearly recognizes a business’s interest in the protection of its client contacts, confidential information, and good will. Consequently, where these types of information are at issue in a contract with an arbitration provision, including a clause allowing for a preliminary injunction is a good way to protect your interests.

Chartis Warranty Guard, Inc. v. National Electronics Warranty, LLC, No. 5764-VCP (Del. Ch. Jan. 28, 2011).

September 28, 2010

Chancery Court Stays Effort Of Company to Haul Ex-Employee Into Delaware

Vice Chancellor Chandler recently stayed, sua sponte, an action commenced in Delaware's Court of Chancery by a company seeking a declaratory judgment against a former employee.  The decision reiterates the importance of bargaining for consent to the jurisdiction of Delaware's Court of Chancery in any contract. 

Online Resources Corp. sought a declaration regarding the meaning of a severance agreement with a former employee.  The employee, however, commenced an action against Online Resources Corp. in a Virginia trial court, alleging that the company breached the agreement and wrongfully terminated him.  Online Resources Corp. sought to have the Virginia action dismissed because of the pending Delaware Court of Chancery Action, and because the claims raised by the employee in his Virginia action arose from the same facts and circumstances as those set forth in the company's Delaware Court of Chancery action.

The subject of Vice Chancellor Chandler's opinion was whether the employee's motion to dismiss the company's Delaware action should be granted.  After fully briefing the issue for the Virginia court, that court rejected Online Resources Corp. arguments and sua sponte stayed the case indefinitely in favor of allowing the case to proceed in Virginia. 

The Court cited several important key factors in support of its decision.  First, it found there were no important or novel issues of Delaware corporate law raised in Online Resources Corp.'s action.  Second, based upon the Virginia court's decision, there is no question that Online Resources Corp. would be required to defend the wrongful termination action in Virginia.  Finally, because the Virginia action was still pending, the Court found that Online Resources Corp. could bring its declaratory judgment claims in the Virginia litigation.  As a result, the Court stayed Online Resources Corp.'s Delaware action, citing the interests of comity and judicial economy.

Vice Chancellor Chandler did, however, agree to consider lifting the stay if Online Resources Corp. is unable to assert as a counterclaim in the Virginia action its claims involving the severance agreement or if the Virginia action is not prosecuted diligently by the employee.

The lesson from this short opinion is that, as we have previously posted, to the extent a party wants to ensure that it can sue a nonresident in Delaware based on a contract, it should bargain for consent to jurisdiction in Delaware's courts in the contract. This includes including Delaware’s statutory choice of law and venue provision in employment and severance agreements.

By Maribeth Minella

July 16, 2010

Civil Conspiracy May Open the Door For Jurisdiction Over Non-Resident Defendants

Much of the non-compete litigation occurs in Delaware because the parties (usually the former employee and his/her former employer) have consented to the jurisdiction of Delaware courts in the underlying contract. But in many of these cases, obtaining personal jurisdiction over third parties such as the former employee’s new employer may pose difficulties. If there’s evidence of a conspiracy between the defendants, however, one consideration is using the Conspiracy Theory to establish personal jurisdiction over the non-resident defendant.

When determining if it has personal jurisdiction over a non-resident defendant, a Delaware court conducts a two-part analysis. First, it considers whether the defendant’s conduct satisfies the state’s long-arm statute. Second, it considers whether the exercise of personal jurisdiction would violate the Fourteenth Amendment’s due process clause. The Conspiracy Theory is used to satisfy the long-arm statute when one defendant has engaged in conduct within the State that satisfies the long-arm statute, but the other defendant has not. In other words, the Conspiracy Theory is used to impute one defendant’s conduct to the other, thereby obtaining jurisdiction over both.

The standard for establishing personal jurisdiction using this theory not easy. A plaintiff must demonstrate that: (1) a conspiracy existed; (2) the defendant was a member of that conspiracy; (3) a substantial act or substantial effect in furtherance of the conspiracy occurred in the forum state; (4) the defendant knew or had reason to know of the act in the forum state or that acts outside the forum state would have an effect in the forum state; and (5) the act in, or effect on, the forum state was a direct and foreseeable result of the conduct in furtherance of the conspiracy.

This method of establishing jurisdiction was recently asserted in the case of LeCroy Corp. v. Hallberg, 2009 Del. Ch. LEXIS 178. In that case, Hallberg left his employment with LeCroy to work for a competitor, in violation of the non-competition provisions of his employment contract with LeCroy. The competitor was incorporated in Delaware, so the courts had jurisdiction over it, but the Hallberg had never lived or worked in Delaware. In order to obtain jurisdiction over Hallberg, the employer tried to establish a conspiracy between Hallberg and his new employer, in order to impute the employer’s tortious conduct in Delaware to Hallberg.

In this case, the tortious conduct on which LeCroy’s claim of conspiracy was based was the competitor’s decision to dissolve a predecessor business established in Colorado, and reincorporate the business in Delaware in order to hide the competitor’s connection with several of LeCroy’s former employees, all of whom were subject to non-competition agreements. However, the Court found that LeCroy failed to prove conspiracy because it could not demonstrate element (4), above. The Court held that Hallberg was hired after the competitor reincorporated in Delaware, thus there was no reason to assume that Hallberg knew of the reincorporation in Delaware. Based on its holding, the Court ordered that Hallberg be dismissed as a defendant for lack of personal jurisdiction.

As the Halberg case suggests, obtaining jurisdiction over a non-resident defendant using the Conspiracy Theory has its challenges. It is narrowly construed and will require more exacting factual allegations to withstand a motion to dismiss. Still, the theory can be a viable alternative for establishing personal jurisdiction where the facts suggest a conspiracy between the defendants, and where one or more defendants lacks contacts with Delaware.

July 9, 2010

Court of Chancery Explains E-Discovery Obligations of Litigants

Electronic discovery plays a central role in litigation where parties claim violations of trade secrets and breaches of noncompete agreements. Electronic discovery and forensic investigations often reveals extremely damaging evidence against the former employee, including acts such as downloading or e-mailing valuable company information.

The sheer number of emails that must be collected and reviewed can be an overwhelming task. VeriSign (the exclusive registry for .com and .net domains) estimates that there are approximately 2.25 billion email queries per day, and that is only a fraction of the number of emails sent each day.

When litigation commences, a question may arise as to whose responsibility it is to ensure all emails and other forms of electronic documents have been preserved and collected. Delaware's Court of Chancery has, not surprisingly, had several occasions to set forth how the Court intends to have litigants handle electronic discovery.

Most recently, in Roffe v. Eagle Rock Energy, GP, L.P., et al., C.A. No. 5258-VCL (telephone conference on discovery dispute held April 8, 2010), Vice Chancellor Laster specifically stated, "[Y]ou do not rely on a defendant to search their own e-mail system...There needs to be a lawyer who goes and makes sure the collection is done properly."

Vice Chancellor Laster's point is well-taken. Too often litigants discover that their opponent failed to collect potentially relevant electronically stored information (ESI), only to find out that the data has since been damaged, or worse, destroyed.

Another frequent circumstance is the producing party represents that they have turned over all relevant, non-privileged documents, only to find out that when their client harvested ESI it only searched a limited number of sources and neglected to search accessible archive locations or off-site servers. When these circumstances arise, the neglectful party is vulnerable to sanctions, such as fines, paying an opponent's attorneys' fees, and in some cases, an instruction that an adverse inference should be drawn against them.

In that same discovery teleconference, Vice Chancellor Laster also pointed out that any party involved in electronic discovery must investigate whether any auto-delete settings are operational. His comments suggested that if auto-delete settings were operational and impairing relevant documents, a forensic evaluation to make sure evidence was not lost would be appropriate.

In short, Delaware's Court of Chancery will not permit "lackadaisical" e-discovery. Therefore, any party involved in litigation should prepare a thoughtful and sound approach to working with electronically stored information.

June 14, 2010

Contract Language Key to Obtaining Jurisdiction Over Non-Residents

Any party wishing to litigate a dispute in Delaware involving a non-resident defendant must establish that the court has personal jurisdiction. If jurisdiction is challenged, the court will apply a two part analysis in determining whether there is basis for personal jurisdiction. First, the Court considers whether there is a basis for jurisdiction under Delaware's long-arm statute, 10 Del. C. § 3104. Next, the court must determine whether there are minimum contacts sufficient to satisfy the Due Process Clause of the Fourteenth Amendment.

For enforcement actions against non-residents with non-compete agreements, the personal jurisdiction requirement is usually met when the agreement contains a provision consenting to the jurisdiction of the Delaware courts. It is important to ensure that the language of the agreement unambiguously confers exclusive jurisdiction to the courts of Delaware in order to avoid a battle over venue. A case from the Court of Chancery illustrates why.

In Mobile Diagnostic Group Holdings, LLC v. Suer, 972 A.2d 799 (Del. Ch. 2009), the Court of Chancery dismissed an action to enforce a noncompete agreement after finding it had no personal jurisdiction over the defendant, a resident of California. In that case, the plaintiffs had negotiated a non-competition provision with one of its sales executives as part of a purchase agreement.

Continue reading "Contract Language Key to Obtaining Jurisdiction Over Non-Residents" »

June 11, 2010

Employees Exiting with Trade Secrets May Open the Door for Civil Conspiracy Claim

A mass exodus of employees from a company often results in the employees joining a competitor or starting up a competing business. Often the employees do not leave empty handed, and involve a concerted effort to use the company's confidential or proprietary information to obtain an unfair competitive advantage. Such acts may give rise to a common law claim of civil conspiracy.

To be successful on a civil conspiracy claim, a plaintiff must usuallys show that two or more persons engaged in an unlawful act done in furtherance of the conspiracy and some form of actual damages. The court will require that there be some underlying wrongful act, such as a tort or a statutory violation. In Delaware, a breach of contract is not an underlying wrong that can give rise to a civil conspiracy claim.

One of the advantages of a civil conspiracy claim is it provides recourse against parties who may not have participated in the initial wrongful act, but nonetheless participated in the conspiracy. This is significant since each conspirator is jointly and severally liable for the acts of co-conspirators committed in furtherance of the conspiracy.

Civil conspiracy claims have led to the award of injunctive relief in the Court of Chancery. Most recently, in Zrii, LLC v. Wellness Acquisition Group, Inc., the Court of Chancery awarded a preliminary injunction against various individuals after finding a their former employer had a reasonable likelihood of success in proving the existence of an unlawful act in furtherance of the alleged conspiracy.

Continue reading "Employees Exiting with Trade Secrets May Open the Door for Civil Conspiracy Claim" »

May 26, 2010

Delaware's Court of Equity

chancerylogo60.gifIn Delaware, covenants not to compete are usually enforced in a court of equity, the Court of Chancery. The Delaware Court of Chancery is the nation's principal forum for the resolution of corporate governance disputes. For consecutive years, the Delaware court system has been ranked by the U.S. Chamber of Commerce as the best in the nation.

No doubt this accolade is attributable, in part, to the five presiding jurists of the Chancery Court who are known for their highly sophisticated understanding of corporate matters and ability to handle complex litigation. There are no jury trials in Chancery Court. All matters are heard by the Chancellor or one of the four Vice Chancellors and are usually performed on an expedited basis.

The Court of Chancery's equitable powers enable it to resolve the matters before it in ways a court of law might not. For instance, the Court of Chancery has the ability to reform, or "blue pencil," what might otherwise be overly broad noncompete agreement.

The Court of Chancery also may award monetary damages under the so-called "clean up doctrine." This doctrine allows the Court which has acquired jurisdiction in a case to decide both equitable and legal questions provided that the legal questions are incidental to the equitable ones.