Case Report: Marsh USA Inc. and Marsh & McLennan Companies, Inc. v. Rex Cook

Introduction

In the matter of Marsh USA Inc. and Marsh & McLennan Companies, Inc. v. Rex Cook, docket number 09-0558, an dispute existed about how to apply the language of Section 15.50(a) of the Texas Business and Commerce Code, also known as the Covenants Not to Compete Act (the “Act”). The pertinent part of the section states that “a covenant not to compete is enforceable if it is ancillary to or part of an otherwise enforceable agreement at the time the agreement is made.” In interpreting the “ancillary to or part of an otherwise enforceable agreement” part of the Act, the Supreme Court of Texas had previously concluded that consideration given by the employer in the agreement must "give rise" to or create the interest in restraining competition, and that the covenant must be designed to enforce the employee's return promise. The parties in this matter, however, disagreed on whether the consideration must be paid or promised before the employee must restrain his behavior and whether the stock options given to Defendant Rex Cook (“Cook”) are proper consideration that can “give rise” to an employer’s interest in restraining competition.

Factual Background

Cook was considered a valuable employee during his term with Plaintiff Marsh USA, Inc. (“Marsh”), a company that provides insurance and consulting services countrywide. Marsh strongly believed that the customer contacts and relations developed by its employees constituted trade secrets within the insurance industry and sought to protect its developed goodwill through non-solicitation agreements. After Cook had cultivated significant customer relationships, Marsh approached him with a non-solicitation agreement to prevent him from luring customers to a rival insurance company for a period of two years following Cook's termination of employment with the company. As consideration for the agreement, Marsh offered Cook three thousand shares of stock of the company priced at their 1996 level that Cook could exercise when he consented to the agreement. After signing the agreement and exercising the stock options on February 3, 2005, Cook resigned from Marsh on November 15, 2007 and went to work for a rival insurance company. Marsh alleged that Cook breached the non-solicitation agreement by soliciting and servicing clients and prospective clients of Marsh within the two-year window prohibited by the non-solicitation agreement.

Procedural History

Marsh sued Cook in the 68th Judicial District Court of Dallas County for breach of contract and breach of fiduciary duty. Cook filed a motion for partial summary judgment claiming that the non-solicitation agreement was unenforceable and the trial court granted his motion. The trial court concluded that the “give rise” requirement of the Act may be met only if the consideration given by the company creates the interest in restraining competition, and that this will occur only where the interest in restraining competition did not exist before the consideration was given. Marsh appealed to the Fifth District Court of Appeals in Texas, but the Court agreed with the trial court’s reasoning in concluding that Marsh’s interest in restraining Cook from competing did not change or arise at the time that it transferred stock to Cook. Subsequently, on July 10, 2009, Marsh filed a Petition for Review before the Supreme Court of Texas; the Court accepted the case in April 2010.

Analysis

The Supreme Court of Texas set forth a test for interpreting the meaning of the “ancillary to or part of” requirement of the Act in Light v. Centel Cellular Co. of Texas, 883 S.W.2d 642 (Tex. 1994). The Supreme Court of Texas concluded in that case that consideration offered to bind an employee to a non-competition agreement must "give rise" to or create the employer's interest in restraining competition and that the covenant must be designed to enforce the employee's return promise. Marsh argued in its Petition for Review and subsequent briefs that the Court diverged from this test in a later case, Alex Sheshunoff Management Servs., L.P. v. Johnson, 209 S.W.3d 644 (Tex. 2006). Marsh asserted that Sheshunoff established that the “ancillary to or part of” requirement of the Act does not mean that the agreement must be immediately enforceable at the time it is made. Marsh also contended that the Sheshunoff opinion eliminated the “timing requirement” in Light that prevents employers from protecting goodwill or confidential information if either exists before the employer provides consideration for a non-competition agreement. Additionally, Marsh reasoned that applying the logic of Light could severely handicap the ability of businesses in Texas to protect unforeseen goodwill that their employees might develop. As such, Marsh believed that Cook was appropriately bound to the non-solicitation agreement because the stock options provided him an incentive to grow the amount and quality of the customer relationships for the company.

Cook disagreed with several elements of Marsh’s arguments in his Response and subsequent briefs, in particular Marsh’s emphasis on the reasoning of Sheshunoff and the application of the Light test. Cook argued that the Light test was appropriately and consistently applied not only by the trial and appeals courts in this matter, but also in the Sheshunoff opinion that Marsh cites. Cook argued that Marsh mischaracterized the “timing requirement” of Light, because under Texas Law, the consideration itself must be what "gives rise" to that interest. Therefore, in order for the consideration to have given rise to the interest, the employer's consideration has to exist before the employer's interest in restraining competition arises. Additionally, Cook argued that mere “financial benefits” do not give rise to an interest worthy of protection by a covenant not to compete and equates the stock options to a simple financial benefit, as Marsh could have theoretically paid the difference in price between the 1996 stock options and the company’s current price on the open market to try and unfairly bind Cook to a non-solicitation agreement.

Court’s Decision and Conclusion

Both Marsh and Cook presented compelling interpretations of the Act, but the Court ultimately agreed with Marsh. The Court eliminated the “give rise” requirement and held that consideration need only be “reasonably related to an interest worthy of protection, such as trade secrets, confidential information or goodwill.” In doing so, the court significantly loosened standards for Texas entities seeking to enforce non-competition agreements. The court noted that Marsh cleared the threshold for enforceability, as the stock options, the value of which is clearly tied to the long-term success of the company, were reasonably related to the company’s interest in its former employee not working for a competitor and in maintaining industry goodwill.

Case Report: 2FA Technology, LLC v. Oracle Corporation

On December 29, 2010, 2FA Technology, LLC (2FA), a Texas–based developer in the software security industry, unleashed an eleven-count complaint on its former licensee, security software supplier Passlogix, Inc., alleging conspiracy and corporate theft. The business relationship between the two parties had soured years ago. A related action filed in December of 2008 by Passlogix (now part of Oracle Corporation) against 2FA, charging breach of obligations and tortuous conduct is pending on the same judge’s docket in the Southern District of New York. , is. Passlogix, Inc. v. 2FA Technology, LLC, et al., Docket No. 08-cv-10986 (S.D.N.Y. Dec. 18, 2008) (Hon. Barbara S. Jones, J). In the 2008 suit, 2FA counterclaimed for breach of contract, breach of the covenant of good faith and fair dealing, unfair competition, misappropriation, and interference with business relations. Theft of trade secrets constitutes the pith of 2FA’s recent complaint, grounded in New York common law, and its counterclaims in the first suit are replete with the same allegations.

Relevant Facts
In 2006, Passlogix and 2FA entered into an agreement under which 2FA granted Passlogix a limited license of certain proprietary software, contingent on a non-compete mandate. 2FA, relying on this license agreement and the accompanying confidentiality provisions, provided Passlogix with “its most important and protected asset”— a source code, which supposedly embodied trade secrets.

The licensing agreement went south and was eventually terminated but not before Passlogix, according to 2FA, compromised the confidentiality of its source code. Passlogix allegedly failed to exercise the same degree of care to avoid the unauthorized disclosure that it would employ with respect to its own confidential proprietary information. In July 2006, a Passlogix engineer allegedly emailed the source code to a number of internal Passlogix personnel. This incident spiraled into mass internal emailing and the collection of “nearly 100,000 pages and hundreds of thousands of lines of source code.” 2FA further charges Passlogix with development of a credential management system and certain software enhancements that allegedly “included trade secrets taken from 2FA without 2FA’s permission…while having complete, unobstructed access to 2FA’s source code.” Theft of 2FA’s trade secrets purportedly escalated with a “code walkthrough” in September of 2007, during which Passlogix engineers and developers “siphoned as much intellectual property, know-how, knowledge of intricate workings of 2FA’s source code, and other proprietary information as they could.”

2FA Technology's Complaint
2FA’s resulting complaint involves allegations grounded in contract, as well as misappropriation, unfair competition, conversion, trespass to chattels, unjust enrichment, civil conspiracy, and aiding and abetting, among other things. 2FA also named as a defendant Oracle Corporation, the colossal, California–based enterprise software company in most of its causes of action.. Additionally, Oracle is the subject of a Criminal Possession of Stolen Property in the First Degree charge under New York Penal Law. Before November 1, 2010, when Oracle acquired Passlogix as a wholly owned subsidiary, the two companies were partners. After January 1, 2011, Oracle Corp. merged Passlogix, formerly with Oracle Systems Corp., and on the docket dated March 4, 2011 is a motion to substitute Oracle Systems Corp. for Passlogix. 2FA alleges that Oracle sold and continues to sell “rebranded Passlogix software” with the knowledge that it “contain[s] 2FA’s misappropriated trade secrets.” In that same vein, when Oracle acquired the majority interest in Passlogix, it “knew or should have known, that a portion of the property it was acquiring was stolen from 2FA.”

Interestingly, Oracle joins the suit fresh off a $1.3 billion jury verdict in its favor in a software piracy and corporate theft of trade secrets suit it brought against SAP, a German business management software company, for the actions of its subsidiary, TomorrowNow. Presently, 2FA seeks injunctive relief, restitution and disgorgement, damages of more than $10,000,000,000 and punitive damages.

This case is stagnant at the moment. On January 31, 2011, the defendants filed a motion to stay the proceedings pending the outcome of a partial summary judgment motion filed by Passlogix in the 2008 case. The summary judgment motion seeks dismissal in the entirety of each of 2FA’s counterclaims, which could spell doom for the pending similar claims in this action. 2FA filed a memorandum in opposition to the motion to stay on March 17, 2011 but the motion to stay was granted on April 6, 2011.

Case Report: Fruit of the Loom Inc. et al. v. Bishop

On January 21, 2011, Judge Myron Thompson of the District Court for the Middle District of Alabama, Northern Division denied Fruit of Loom, Inc. (Fruit of the Loom) and Russell Brands LLC’s (Russell) motion for a preliminary injunction. Fruit of the Loom, Inc. v. Bishop, 10-cv-1058, 2011 U.S. Dist. LEXIS 5963 (Jan. 21, 2011) ( ). Although a denial of a preliminary injunction is typically considered outcome determinative, often resulting either in settlement or withdrawal of the complaint, the plaintiffs in this case persisted.

Fruit of the Loom and Russell sued to enforce a Trade Secrets and Non-Competition Agreement (Agreement) executed by the defendant, Lonnie Bishop. Fruit of the Loom and Russell identified a variety of technologies and information that they allege is protected by the Agreement: 1) a proprietary method of sorting product to be shipped to Walmart; 2) knowledge of how Russell conducts business with Walmart and Target; 3) long range planning strategies to improve customer service to retailers; 4) proprietary preappointments process; 5) a sorting system developed to ship products to Target; 6) a “print and apply” system; 7) technology that allows storing of product without placement on wooden pallets; 8) a process to ship product to JoAnn’s that minimize the opportunity for shipping errors; and 9) confidential business strategies, plans, initiatives and non-public financial statements.

The Agreement contained a choice of law provision designating that the Agreement would be construed under Kentucky law. However, as discussed below, the validity and enforcement of the Agreement has been raised by the defendant. Consequently, the trade secrets identified in the Agreement may be analyzed under Alabama law if the Agreement were to be found invalid per se or invalid as applied to Bishop.. However, as both states have adopted the Uniform Trade Secret Act similar findings as to whether items are trade secrets would be expected.

Relevant Facts
An employee of Russell since 1993, Bishop was promoted to manager of a distribution center in Montgomery, Alabama in January 2007. Since his promotion, Bishop partook in the Management Incentive Plan (MIP). MIP is a bonus program through which participating employees receive a portion of the company’s profit, payable as a percentage of the employee’s salary, as long as the employee is still employed on December 31 of that year. Memorandum Brief in Opposition to Plaintiff’s Motion for Preliminary Injunction at 3, Fruit of the Loom, Inc. v. Bishop, 10-cv-1058, 2011 U.S. Dist. LEXIS 5963 (Jan. 21, 2011). Bishop received payments through the MIP program in 2007 and 2009, not in 2008. In 2010, in response to losing key employees in recent years, Russell and Fruit of the Loom required the execution of the Trade Secrets and Non-Competition Agreement to participate in MIP. Bishop was presented with the Agreement on May 28, 2010 and executed the Agreement on July 12, 2010. Bishop alleges that he spoke with his supervisors prior to executing the Agreement and that one of his supervisors represented to him that the Agreement would not be enforced by a court and did not apply to employees in Bishop’s position. In November 2010, Bishop left Russell and was hired as a manager of a distribution center for Gildan Activeware, Inc. Fruit of Loom and Russell believe that Bishop’s employment at Gildan is in violation of the Agreement and in particular, the non-compete clause.

The Enforceability of the Agreement
While Judge Thompson presumed the enforceability of the Agreement when considering the request for the preliminary injunction, Bishop defended that the Agreement was unenforceable because the restrictions contained in the Agreement are “unreasonable, impose greater restraints and restrictions than are necessary, are not appropriately limited in scope, time, and/or place, and impose an undue hardship and burden on [the defendant.]” Bishop additionally claimed that the Agreement is void or unenforceable due to 1) lack of consideration; 2) fraudulent misrepresentation concerning the subject matter and scope of the Agreement; or 3) that Bishop executed the Agreement under duress.

To determine whether a non-compete agreement is reasonable, courts generally consider the scope of time, activity and space relative to the protectable interests of the employer and sometimes the effect or fairness on the employee. Fruit of the Loom and Russell, while briefing the District Court in support of their motion for preliminary injunction, argued that the Agreement would be valid under Kentucky law. Kentucky courts have reliably held one-year restrictive covenant reasonable; allowed nationwide restrictions when an employer’s business was national; found continued employment to be sufficient consideration; and generally understood that such covenants are a valuable business tool.

Bishop disputed, however, that Kentucky law routinely held non-compete agreements valid. He contended that Kentucky and Alabama law on restrictive covenants were ‘analogous’ and, under Alabama law, most restrictive covenants were void. However, Bishop’s analysis of restrictive covenants was considered in relation to what law should govern the Agreement and not solely the specific enforceability of the Agreement. The detail and focus employed by the plaintiff may well explain Judge Thompson’s apparent presumption of enforceability, as Bishop had initially raised the issue of enforceability but ultimately failed to thoroughly analyze the case law when briefing the Court.

The Holding
When contemplating the request for a preliminary injunction, Judge Thompson had to consider the language of the Agreement. The non-compete clause provided that for twelve months after termination of employment with Russell, Bishop would not work or provide services for a “[c]ompetitor in an area, position or capacity in which [he] gained particular knowledge or experience during [his employment], involving the sale, design, or manufacture of [c]ompetitive [p]roducts...” The question before Judge Thompson was limited to whether Bishop’s role at each employer involved the sale of “competitive products.” The Court concluded that a reasonable juror would find that Bishop’s role at the rival companies did not involve “sales” as Bishop worked only in the distribution area. Judge Thompson also failed to find actual and imminent irreparable injury to Fruit of the Loom and Russell that could not be remedied by monetary damages. Additionally, he found that a balance of equities favored Bishop, noting a concern that a preliminary injunction would place significant hardship on Bishop and that there was no evidence that the lack of a preliminary injunction would harm the public interest. Fruit of the Loom, Inc. v. Bishop, 10-cv-1058, 2011 U.S. Dist. LEXIS 5963 (Jan. 21, 2011).

As noted above, the denial of a preliminary injunction would typically be a death blow and the case came to a close on May 12, 2011 when the parties stipulated to dismiss the case with prejudice.

Case Report: Gene Codes Forensics, Inc., v. The City of New York

On March 1, 2010, Gene Codes Forensics Inc. (GCF) filed a complaint against the City of New York Office of Chief Medical Examiner (OCME) for breach of contract and misappropriation of trade secrets used to develop GCF software that facilitated the identification of the September 11, 2001 (9/11) victims at Ground Zero. GCF is a firm that develops and licenses forensic software capable of analyzing DNA for human identification purposes. The Southern District of New York (SDNY) has diversity jurisdiction over this action and the court is considering the defendant’s summary judgment motion.

Relevant Facts
As detailed in the GCF’s complaint, the deceased victims of the 9/11 attack were very difficult to identify because no technology was then available to perform such a complex forensic analysis. The complaint provides that OCME asked GCF to develop unique software that could both provide accurate identification of the victims and organize the DNA data of the victims and of the fragmented remains located at Ground Zero.

GCF suspended existing software research and went to work in developing a new system of DNA matching technology, the Mass-Fatality Identification System (M-FISys). GCF believes that M-FISys was highly innovative because, unlike the previous DNA identification system used by OCME, M-FISys could perform mass screening of data. GCF had also previously developed a DNA analysis program for OCME before M-FISys known as “Sequencher.”

On March 1, 2002, GCF and OCME entered into a formal agreement for a term of three years beginning on September 12, 2001. Under the agreement, GCF must develop DNA identification software with specifications as required by OCME. Section VI(G) of the agreement, “Trade Secrets and Proprietary Information,” also provides that both parties must maintain each other’s confidential information using the same stringent methods the parties would use to protect their own confidential information (which is defined as all information marked confidential). The section further permits the parties to disclose confidential information to their affiliates as long as the disclosing party ensures that the affiliates would maintain confidentiality.

According to GCF, all copies of the M-FISys software were labeled as confidential. Additionally, GCF contends that the M-FISys database schema was never published, disclosed or demonstrated for public use and it was never distributed in the public domain. Section VII(D) of the agreement also provides that all software developed by GCF is the exclusive intellectual property of GCF. The section only grants OCME a non-exclusive license to use the software for non-commercial purposes. Under the agreement, OCME could not license the M-FISys software to any other persons or agencies.

In 2009, OCME employees allegedly “participated in printing out the confidential database schema” and worked with FBI software engineers to extract GCF’s trade secrets to enhance the functionality of FBI software, CODIS 6.0. GCF filed suit on March 1, 2010 seeking relief under New York law for breach of contract, misappropriation of trade secrets, unfair competition and unjust enrichment. OCME denied GCF’s allegations and filed a counterclaim for breach of contract against GCF.

Under New York law a trade secret consists of “any formula, pattern, device or compilation of information that is used in one’s business, and that gives the owner an opportunity to obtain an advantage over competitors who do not know or use it.” To recover under the law of New York, GCF must demonstrate that: “(i) it possessed a trade secret and (ii) that the defendant used that trade secret in breach of an agreement, a confidential relationship, or duty, or as a result of discovery by improper means.” GCF alleges that its trade secrets are: 1) the internal algorithms and program interfaces of the Sequencher program and the program itself; 2) the unique DNA matching algorithms in M-FISys; 3) the unique technique of collapsing data within the M-FISys program; and 4) the database schema for organization of large amounts of data. GCF adds that it has taken the proper measures to protect these trade secrets with “the use of non-compete and confidentiality agreements, password protection to its servers and databases, and confidentiality agreements with third parties.” Additionally, New York law has recognized computer programs and computer printouts as trade secrets. (See Kaufman v. IBM Corp., 97 A.D.2d 925 and Integrated Cash Mgmt. Servs., Inc. v. Digital Transactions, Inc., 920 F.2d 171 ). GCF also argues that New York City used GCF’s trade secrets in breach of their agreement.

Defendant’s Summary Judgment Motion
The City of New York (the City) filed a motion for summary judgment on August 30, 2010 to dismiss GCF’s entire complaint. In the memorandum of law in support of the motion, the City admits that OCME employees printed spreadsheets of the M-FISys database, but such action was necessary so as to migrate data from M-FISys to CODIS 6.0. GCF, however, points out easier methods of migrating data, arguing that OCME’s reason is merely pretext. The City further contends that the M-FISys’ database schema was not marked as confidential and therefore it cannot constitute a trade secret.Additionally, even if such schema could constitute a trade secret, GCF could not show that OCME used this trade secret “in breach of an agreement, a confidential relationship, or duty, or as a result of discovery by improper means.” (See Integrated Cash Mgmt. Servs., Inc. v. Digital Transactions, Inc., 920 F.2d 171).

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