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Restrictive Covenants, Trade Secrets, and Fiduciary Duty Claims: Protecting Business Interests When An Employee Leaves - Part III

3. Remedies - An agent's breach of fiduciary duty will enable the principal to obtain the following compensation:

a. An accounting of the agent's profits from the breach.

b. Compensatory damages.

c. Punitive damages.

d. Repayment of compensation paid to the disloyal agent beginning on the date of the agent's breach.

D. Tort Liability

1. Intentional interference with existing or prospective contractual relations

a. Elements of cause of action

(1) The elements of an intentional interference claim are:

(a) the existence of an actual or prospective contract;

(b) the defendants' purpose or intent to harm the plaintiff by preventing completion of the contract;

(c) improper conduct (i.e., absence of privilege) on the part of defendants; and

(d) harm resulting from the defendants' actions.

(2) One who, without a privilege to do so, induces or purposely causes a third party (not the party's employer) not to (a) perform a contract with another or (b) enter into or continue a business relation with another, is liable to the other for the harm caused thereby. Restatement (Second) of Torts (1979), § 766; Adler, Barish, Daniels, Levin & Creskoff v. Epstein, 482 Pa. 416, 393 A.2d 1175, 1182 (1978).

(3) The tort of intentional interference can arise where a new employer or key employee encourages employees or customers to leave a business. See, e.g., National Risk Management, Inc. v. Bramwell, 819 F. Supp. 417, 433 (E.D. Pa. 1993); Morgan's Home Equipment Corp. v. Martucci, 390 Pa. 618, 633, 634, 136 A.2d 838, 847 (1957) .

(4) Absence of privilege (i.e., an improper purpose) may be inferred from an employee's breach of a duty of loyalty to an employer. See Adler, Barish, Daniels, Levin & Creskoff v. Epstein, supra, 393 A.2d at 1184-1185.

b. Intentional interference issues in inducing employees to leave employer

(1) Offering employment to another employer's at-will employee is not actionable by itself (Morgan's Home Equipment Corp. v. Martucci, 390 Pa. 618, 136 A.2d 838 (1957)).

(2) The systematic inducement of employees to leave their present employment and work with another is unlawful when the purpose is to cripple and destroy an integral part of a competitive business or organization, rather than to obtain the services of particularly gifted or skilled employees (Morgan's Home Equipment Corp. v. Martucci, 390 Pa. at 633-634, 136 A.2d at 847).

(3) It is actionable to induce employees for the purpose of having the employees commit wrongs, such as disclosing a former employer's trade secrets or enticing away a former employer's customers (Morgan's Home Equipment Corp. v. Martucci, supra; Albee Homes, Inc. v. Caddie Homes, Inc., 417 Pa. 177, 207 A.2d 768 (1965)).

c. Remedies

An employer may obtain both damages and equitable relief in an action for tortious interference with contractual relations. See Joseph D. Shein, P.C. v. Myers, 394 Pa. Super. 549, 576 A.2d 985, 988 (1990), appeal denied, 533 Pa. 600, 617 A.2d 1274 (1991).

2. Conversion, under Pennsylvania law, is the deprivation of another's right to property, or use or possession of property, or other interference with property without the owner's consent, and without legal justification. In Prudential Insurance Co. of America v. Stella, 994 F. Supp. 308, 323 (E.D. Pa. 1998), the Court held that a departing employee's removal of, and failure to return, client files and documents and computer equipment constituted conversion.

a. A claim for unfair competition arises under the Federal Lanham Act, when an ex-employee passes off goods and services as those of the ex-employer by virtue of substantial similarity, leading to confusion on the part of potential customers. See Prudential Insurance Co. of America v. Stella, 994 F. Supp. 308, 322 (E.D. Pa. 1998).

b. More broadly, ex-employers sometimes sue for unfair competition for employee piracy of the sort discussed in Section II, D, 1, c., or to backstop other claims for appropriation of customers or trade secrets.

4. Unjust enrichment - Unjust enrichment claims are generally an alternate means of stating a trade secret, fiduciary duty, or conversion claim. Homenexus, Inc. v. Directweb, Inc., 1999 WL 959823 (E.D. Pa. 1999). In Pennsylvania, to sustain a claim for unjust enrichment, a plaintiff must show:

a. a benefit conferred upon one party by another;

b. appreciation of the benefit by the recipient; and

c. retention of the benefit under circumstances that would be unjust. The remedy for unjust enrichment is the imposition of a constructive trust on the benefit to the defendant.

5. Conspiracy - A claim for conspiracy is an ancillary tort claim when a departing employee acts improperly. Under Pennsylvania law, a "conspiracy" is a combination of two or more persons acting with a common purpose to do an unlawful act by unlawful means for an unlawful purpose, an overt act done in pursuant of the common purpose, and actual legal damage (Homenexus, Inc. v. Directweb, Inc., 1999 WL 959823 (E.D. Pa. 1999)).

a. Proof of malice is an essential part of a cause of action for conspiracy. The New L&N Sales and Marketing, Inc. v. Menaged, 1998 WL 575270, *6 (E.D. Pa. 1998).

b. Lawful competition does not constitute a conspiracy. See Agra Enterprises, Inc. v. Brunozzi, 302 Pa. Super. 166, 448 A.2d 579 (1982).

c. A corporate entity cannot conspire with its own agents (Patient Transfer Systems, Inc. v. Patient Handling Solutions, Inc., 1999 WL 54568 (E.D. Pa. 1999)).

III. LITIGATION TO ENFORCE RESTRICTIONS

A. Proceedings for Temporary or Special Injunction

1. F.R.C.P. 65(b) authorizes the entry of a temporary restraining order upon motion if it clearly appears from specific facts shown by affidavit or verified complaint that immediate and irreparable harm will result to the applicant before the adverse party can be heard in opposition, and the applicant's attorney certifies to the court in writing the efforts that have been made to give proper notice.

2. Pa. R.C.P. 1531(a) authorizes entry of a special injunction without notice or hearing if it appears to the satisfaction of the court that immediate and irreparable injury will be sustained before notice can be given or a hearing held. Pa. R.C.P. 1531(d) automatically dissolves any injunction granted without notice unless a hearing on the continuance of the injunction is held within five (5) days after the granting of the injunction, or within such other time as the parties agree or the court may direct.

NOTE: The Pennsylvania Rules do not recognize a pleading titled "temporary restraining order," only a pleading entitled "special injunction." Use of the term "temporary restraining order" in Pennsylvania courts may lead to confusion with "preliminary injunction," with adverse consequences for the plaintiff's attorney if the request for injunction is denied.

B. Proceedings for Preliminary Injunction

1. General criteria for preliminary injunction

a. State court - A preliminary injunction may be granted if:

(1) the rights of the plaintiff are clear (i.e., plaintiff has a strong likelihood of success on the merits);

(2) an injunction is necessary to prevent irreparable harm which cannot be compensated by damages;

(3) greater injury would result by refusing the injunction than by granting it; and

(4) the preliminary injunction properly restores the parties to the status that existed immediately prior to the alleged wrongful conduct. (Albee Homes, Inc. v. Caddie Homes, Inc., 417 Pa. 177, 207 A.2d 768 (1965)).

NOTE: Pennsylvania courts treat a special or preliminary injunction as a drastic remedy, tantamount to a judgment and execution before trial; therefore, courts will grant injunctions sparingly, and only in the strongest cases. See Herman v. Dixon, 393 Pa. 33, 36, 141 A.2d 576, 577 (1958).

b. Federal court - Under F.R.C.P. 65, the showings required for a preliminary injunction and for a temporary restraining order are essentially identical. The moving party must demonstrate:

(1) a likelihood of success on the merits;

(2) the probability of irreparable harm if the relief is not granted;

(3) granting the relief will not result in greater harm to another party; and

(4) granting the relief is consistent with the public interest (Merrill, Lynch, Pierce, Fenner and Smith, Inc. v. Napolitano, 85 F. Supp.2d 491(E.D. Pa.); BABN Technologies Corp. v. Bruno, 1998 WL 720171, *3 (E.D. Pa. 1998)).

2. Showing a likelihood of success on the merits

a. Restrictive covenant cases - A plaintiff seeking a preliminary injunction must show the following as a prima facie case:

(1) The defendant agreed to a restrictive covenant.

(2) The covenant is enforceable (making the showing of each factor set forth in I, E, above, "Requirements for an Enforceable Restrictive Covenant").

NOTE: The plaintiff does not have the burden to prove that the restrictive covenant is reasonable; it is the defendant's burden to prove that the restrictions are not reasonable. See Jacobson & Co. v. International Environment Corp., 427 Pa. 439, 235 A.2d 612 (1967). Nevertheless, it is essential for the plaintiff, in showing probability of success on the merits, to show that courts have enforced a covenant like the plaintiff's restrictive covenant as reasonable in duration and geographic area.

(3) The defendant is violating the covenant.

See, e.g., John G. Bryant Company, Inc. v. Sling Testing and Repair, Inc., 471 Pa. 1, 369 A.2d 1164 (1977); Davis and Warde, Inc. v. Tripodi, 420 Pa. Super. 450, 616 A.2d 1384 (1992).

b. Trade secret cases - A plaintiff seeking a preliminary injunction must show:

(1) The information taken constitutes a trade secret.

(2) The information is of value to the employer and important in the conduct of the employer's business.

(3) By reason of discovery or ownership, the employer had the right to the use and enjoyment of the secret.

(4) The secret was communicated to the employee while employed in a position of trust and confidence under such circumstances as to make it inequitable and unjust for the employee to disclose it to others, or to make use of it to the prejudice of the employer (Felmlee v. Lockett, 466 Pa. 1, 351 A.2d 273, 277 (1976); Sweetzel, Inc. v. Hawk Hill Cookies, Inc., 1995 WL 550585 (E.D. Pa. 1995)). Compare In re Allegheny Health, Education and Research Foundation, ____B.R. ____, 1999 WL 1051211, *8 (Bankr. E. D. Pa. 1999) (no protectible interest where employer knew of patient list and failed to protect list).

(5) The trade secret has been misappropriated by being used or disclosed in breach of a confidence, with knowledge of the breach of confidence, and to the detriment of the employer (Rohm and Haas Co. v. Adco Chemical Co., 689 F.2d 424 (3d. Cir. 1982); see also College Watercolor Group, Inc. v. William H. Newbauer, Inc., 468 Pa. 103, 360 A.2d 200 (1976) (use of misrepresentation to gain access to competitor's plant)).

3. Showing irreparable harm

a. Irreparable harm must be pleaded and shown; it is not sufficient to stipulate in a contract that the ex-employer will suffer irreparable harm. See Dice v. Clinicorp., Inc., 887 F. Supp. 803, 810 (W.D. Pa. 1995). Nor is a mere showing that a defendant is working for a competitor sufficient. See Rollins Protective Services Co. v. Shaffer, 383 Pa. Super. 598, 557 A.2d 413 (1989).

b. Interference with client or customer relations or use of trade secrets constitutes irreparable harm, since such action is not ascertainable and not capable of full compensation for money damages. See John G. Bryant Company, Inc. v. Sling Testing and Repair, Inc., 471 Pa. 1, 8-9, 369 A.2d 1164-1167-8, (1977), quoting Blake, "Employee Agreements Not to Compete", 73 Harv. L. Rev. 625-653-54 (1960); Ogontz Controls Co. v. Pirkle, 346 Pa. Super. 253, 499 A.2d 593 (1985).

4. Possible defenses

a. Restrictive covenant cases

(1) failure to sign contract

(2) lack of consideration for the restriction

(3) expiration of the covenant

(4) duress in signing covenant

NOTE: If defendant was represented by an attorney, the duress defense will not apply. See Worldwide Auditing Services, Inc. v. Richter, 402 Pa. Super. 584, 587 A.2d 772, 777 (1991).

(5) unreasonableness in temporal or geographical scope (See, e.g., National Business Services, Inc. v. Wright, 2 F. Supp. 2d 701, 707 (E.D. Pa. 1998)).

(6) unclean hands. In Salomon, Smith, Barney, Inc. v. Vockel, 2000 WL 558580 (E.D. Pa. 2000), the United States District Court for the Eastern District of Pennsylvania refused to enforce a restrictive covenant against a departing stockbroker because of the brokerage firm's own "unclean hands" in having earlier obtained many customers from the broker's previous employer. The Court found that the plaintiff brokerage firm had once encouraged the stockbroker to engage in the same kind of unconscionable conduct that the brokerage firm now sought to restrain.

(7) a material breach or failure of consideration (e.g., through failure to pay employee) (See, e.g., Bilec v. Auburn & Associates, Inc. Pension Trust, 403 Pa. Super. 176, 588 A.2d 538 (1991); Durham Life Insurance Co. v. Evans, 1997 WL 535187 (E.D. Pa. 1997) aff'd, 166 F.3d 139 (3d Cir. 1999); Ritz v. Music, Inc., 189 Pa. Super. 106, 150 A.2d 160 (1959); Philadelphia Ear, Nose and Throat Surgical Associates, P.C. v. Roth, PICS 2000-0445-22-00 (C.C.P. Philadelphia Co. 2000)).

(8) laches or waiver, through plaintiff's failure to pursue or develop business (Bilec v. Auburn & Associates, Inc. Pension Trust, supra).

(9) unreasonableness of enforcement after employee discharge for poor performance

(See, e.g., Insulation Corp. of America v. Brobston, 446 Pa. Super. 520, 667 A.2d 729 (1995)), or other involuntary discharge through no fault of employee (All-Pak, Inc. v. Johnston, 694 A.2d 347 (Pa. Super. 1997)).

(10) harm to the defendant through interference with the right to earn a living. Courts are not sympathetic to this defense where an ex-employee has violated a reasonable restriction. See Merrill, Lynch, Pierce, Fenner and Smith, Inc. v. Napolitano, 85 F. Supp.2d 491 (E.D. Pa. 2000).

b. Trade secret cases

(1) The trade secret does not exist (e.g., it originated from public sources or is generally known in the business).

(2) The ex-employer does not have the right to the secrets.

(3) The trade secret was not communicated or kept in confidence (see, e.g., In re Allegheny Health, Education and Research Foundation, ____B.R. ____, 1999 WL 1051211, *8 (Bankr. E. D. Pa.)).

(4) The defendant is merely using its own general knowledge, not specific confidential information.

(5) any equitable defenses regarding harm, similar to the defenses against restrictive covenant claims.

5. Expedited Discovery - Neither Federal nor Pennsylvania Rules permit expedited discovery; however, federal courts have granted expedited discovery in preliminary injunction proceedings for breaches of restrictive covenants or trade secret theft. See, e.g., Educational Commission, Foreign Medical School Graduates v. Repik, 1999 WL 317052 (E.D. Pa.).

6. Bond - Bond is mandatory under both Federal and Pennsylvania Rules. See F.R.C.P. 65(c); Pa. R.C.P. 1531(b). Absent a provision for bond, an order granting a special or preliminary injunction in Pennsylvania is void, but the defect is curable by amending the order to provide for bond, and obtaining the bond (Downs v. Smythe, 701 A.2d 591 (Pa. Super. 1997)).

C. Damages

1. Compensatory damages - Under Pennsylvania law, compensatory damages need to be computed with reasonable certainty (Scobell, Inc. v. Schade, 455 Pa. Super. 414, 688 A.2d 715, 718-19 (1997)). In restrictive covenant cases, damages are often difficult to ascertain (Records Center, Inc. v. Comprehensive Management, Inc., 363 Pa. Super. 79, 525 A.2d 433 (1987)).

Among the elements recognized as possible damages in restrictive covenant, trade secret, and unfair competition cases are the following:

(a) lost profits (Scobell, Inc. v. Schade, supra;

(b) lost orders (Certified Laboratories of Texas, Inc. v. Rubinson, supra (holding damages obtainable but proof deficient));

(c) lost goodwill (Certified Laboratories of Texas, Inc. v. Rubinson, supra (holding damages obtainable but proof deficient));

(d) lost client revenues (Joseph D. Shein, P.C. v. Myers, 394 Pa. Super. 549, 576 A.2d 985 (1990));

(e) development costs for trade secrets (Computer Print Systems, Inc. v. Lewis, 281 Pa. Super. 240, 422 A.2d 148 (1980));

(f) loss of property converted (Sweetzel, Inc. v. Hawk Hill Cookies, Inc., 1996 WL 434012 (E.D. Pa.).

2. Punitive damages - See generally, Joseph D. Shein, P.C. v. Myers, supra; Certified Laboratories of Texas, Inc. v. Rubinson, supra; Sweetzel, Inc. v. Hawk Hill Cookies, Inc., supra.

3. Liquidated damages may be awarded in a restrictive covenant case. See DeMuth v. Miller, 438 Pa. Super. 437, 652 A.2d 891 (1995); Geisinger Clinic v. DiCuccio, 414 Pa. Super. 85, 606 A.2d 509 (1992). The existence of a liquidated damages provision does not preclude injunctive relief (Bettinger v. Carl Berke Association, Inc., 455 Pa. 100, 314 A.2d 296 (1974)).

4. Attorney's fees are awardable in restrictive covenant litigation. See Certified Laboratories of Texas, Inc. v. Rubinson, 303 F. Supp. 1014 (E.D. Pa. 1969). A contractual provision for attorney's fees was upheld in Maaco Enterprises v. Bremner, 1998 WL 669936 (E.D. Pa. 1998).

D. Counterclaims

1. Injunction against enforcement of restrictions - See Campbell Soup Co. v. Desatnick, 58 F. Supp.2d 477 (D. N.J. 1999) (ex-employee failed in attempt to preliminarily enjoin enforcement of non-compete).

2. Declaratory judgment of non-liability - See Homenexus, Inc. v. Directweb, Inc., 1999 WL 959823 (E.D. Pa. 1999). The former employee or new employer may also bring a pre-emptive action seeking a declaratory judgment of non-liability. See Hillard v. Medtronic, Inc., 910 F. Supp. 173 (M.D. Pa. 1995), in which the ex-employer then filed for injunctive relief.3. Tort claims

a. Defamation

(1) The former employer's publication of a press release on the ex-employee's violation of a restrictive covenant led to a defamation claim that withstood a motion to dismiss in Unisource Worldwide, Inc. v. Heller, 1999 WL 374180 (E.D. Pa. 1999).

(2) An employer's letter to a succeeding employer stating the intent to act to protect a restrictive covenant is privileged in an action for defamation (Gresh v. Potter McCune Co., 235 Pa. Super. 537, 344 A.2d 540 (1975)).

b. Intentional interference with contractual relations

(1) An accurate statement of a restrictive covenant is privileged (Gresh v. Potter McCune Co., supra).

(2) Employers who overstated restrictions on an ex-employee, causing a new employer to fire the employee, have incurred substantial liability for punitive damages for intentional interference with contractual relations in Collincini v. Honeywell, Inc., 411 Pa. Super. 166, 601 A.2d 292 (1991); and Ruffing v. 84 Lumber Co., 410 Pa. Super. 459, 600 A.2d 545 (1991).

c. Unfair competition

d. Commercial disparagement - This action is available only to attack the quality of an entity's goods or products, not an individual's character. See, e.g., Unisource Worldwide, Inc. v. Heller, supra.

e. Abuse of process - This action depends not on the issuance of process, but on some perverse, coercive, or improper use of the process (Homenexus, Inc. v. Directweb, Inc., 1999 WL 959823 (E.D. Pa. 1999)).

f. Wrongful institution of civil proceedings - Under 42 Pa. C.S. § 8351(a)(2), this action depends upon a favorable termination of the underlying action, and cannot be brought as a counterclaim.

E. Special Litigation Issues

1. Ethical considerations - Rule 1.7 limits an attorney's ability to represent clients with differing interests. Rule 1.7 may preclude representation of the former employee and new employer by the same counsel, making it necessary to obtain separate counsel for corporate and individual defendants. Defense counsel may need to enter into a joint defense agreement in order to allow joint defense work without waiving applicable privileges.

2. Insurance coverage - Coverage for "advertising injury" does not extend to trade secret claims. See Frog, Switch & Manufacturing Co., Inc. v. Travelers Insurance Company, 20 F. Supp.2d 798 (M.D. Pa. 1998), aff'd, 193 F.3d 742 (3d Cir. 1999).

3. Bankruptcy non-dischargeability - An individual's liability for misappropriation of trade secrets is not dischargeable in bankruptcy (In Re Harland, 235 B.R. 769 Bankr. (E.D. Pa. 1999)).

4. Settlement - Under Pennsylvania law, discontinuance of an action under a settlement agreement does not deprive the court of jurisdiction to enforce the agreement (Advanced Management Research, Inc. v. Emanuel, 439 Pa. 385, 266 A.2d 673 (1970)).