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Time Limits and NDA/Confidentiality Agreements

Friday, June 8th, 2012

It is common for companies to share confidential information with a third party in order to achieve an operational objective, where the third party may be a prospective joint venturer, an acquirer, an investor or even a client.  Prior to disclosing such confidential information, however, these same companies usually require the execution of a confidentiality/non-disclosure agreement by the other party.

This blog has previously discussed issues surrounding confidentiality/non-disclosure agreements.  Today’s topic however is specific: the time limits, if any, that should be considered in such agreements.

Most companies if given a choice would prefer to include in their  NDA/confidentiality agreements a perpetual term, which essentially means that the confidential information can never be disclosed by the third party except in limited circumstances.  Often times however, this desire is diluted in the course of negotiations, leading to a final agreement containing just a limited time for confidentiality, ie, for example, 2, 5 or even 10 years. 

Unbeknownst to such parties, agreeing to this watered-down time limit may lead to substantial future risks with regard to confidential information.  An example is the California case of Silicon Image, Inc. v. Analogk Semiconductor, Inc.   In furtherance of its goal to protect its confidential information, Silicon Image took numerous prudent steps to protect its trade secrets, including: i) requiring its own employees, customers and business partners to sign confidentiality agreements; ii) maintaining a key card access system and by requiring visitors to sign in to protect its trade secrets; iii) protecting computer systems through network security and access control; iv) labeling confidential proprietary information and watermarking all information disclosed outside the company with the name of the individual receiving the information; and, v) providing training sessions to employees on its trade secret protection program.

Yet in spite of its strict adherence to the protection of its confidential information, Silicon Image decided to limit the term of its confidentiality agreements to a set number of years, instead of a perpetual term, due to the fact that that’s what other high-tech companies were doing, and due to the fact that many partners, investors and other third parties pushed back and refused to execute non-disclosure agreements containing a perpetual duration of confidentiality.

Despite its best practices described above, Silicon allowed itself to frequently enter into confidentiality agreements with terms of 2 to 4 years, which proved to be a serious error when the time came for Silicon to seek a preliminary injunction in California Court against a competitor it alleged misappropriated its confidential information.

In denying Silicon’s request for a preliminary injunction, the Court analyzed whether Silicon Image made reasonable efforts to protect its confidential information.  One of the key factors the Court focused on was whether or not the non-disclosure agreements between Silicon Image and its customers and distributors provided adequate protection.  Unfortunately for Silicon, the Court concluded that reasonable steps to protect trade secrets were not shown by Silicon, pointing particularly to the time limits included in its confidentiality agreements.

The Court held that “one who claims that he has a trade secret must exercise eternal vigilance,” requiring all persons to whom a trade secret becomes known to acknowledge and promise to respect the secrecy in a written agreement.  A time limit contained in an NDA demonstrated to the Court that Silicon’s own expectations of maintaining its trade secrets were time limited and, thus, a failure to demonstrate “eternal vigilance” over its trade secrets. 

As a result, Silicon lost a serious case in its attempt to protect its confidential information.  The moral of this story is a simple one.  Companies who include time limits in their confidentiality agreements do so at their peril.  In order to avoid the Silicon Image outcome, it is prudent to stand firm and refuse to include a set time limit for the receiving party’s obligations to maintain the confidential information.  The best practices are for the trade secret owner to insist that the obligation to maintain confidentiality survive as long as the information disclosed qualifies as a trade secret under the requirements of applicable law.

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Enforcement of Non-Compete Not Dependent on Solicitation of Former Clients or Use of Confidential Information

Monday, April 12th, 2010

In TEKsystems, Inc. v. Bolton, (2010), the Maryland Federal District Court recently reinforced Maryland law on the point that the enforcement of a covenant not to compete is not dependent on whether the competing former employee solicits his former employer’s clients or uses its confidential information, but rather on whether or not the scope of the restrictive covenant is reasonable. The only factors that will determine whether the non-compete is valid are its temporal and geographical limits, the employer’s legitimate business interests, the employee’s unique and specialized skills, any undue hardship on the employee, and the public interest served by enforcing the restrictive covenant.

The non-compete found in the former employee’s employment agreement contained standard language prohibiting the former employee from engaging “in the business of recruiting or providing on a temporary or permanent basis technical service personnel, industrial personnel, or office support personnel” for a period of 18 months after termination of employment, and within a geographical limitation of a 50-mile radius of the employee’s former office. Both the period of time of 18 months and the geographical scope of 50 miles have been held as reasonable on numerous occasions by Maryland courts.
The Court also found that the employer had legitimate business interests in enforcing the covenant, the employee possessed unique and specialized skills, and the employee would not suffer undue hardship by enforcing the covenant. The enforcement of the non-compete was upheld against the former employee.

To read a comprehensive blog of all of the issues address by the Court in this case, visit the blog of the Business Law Section of the Maryland State Bar Association at http://marylandbusinesslawdevelopments.blogspot.com/search/label/Injunctive%20Relief.

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Employment Agreement or Independent Contractor Agreement?

Thursday, January 21st, 2010

When looking to hire new personnel, my small business clients often ask me to draft the contract between the business and the new hire. It is oftentimes not until this point that the business has examined whether the new hire is an independent contractor or employee. An agreement used for an employee will be different in many key respects than an agreement drafted for use with an independent contractor. With that in mind, the following is a summary of the key differences between an employee and an independent contractor.

Much of this information has been taken from the IRS website at www.irs.gov, which contains a wealth of information on the subject and which I highly recommend every business reads when facing this issue. Just recently, the IRS published IRS Summertime Tax Tip 2009-20, which is summarized below.

-Hiring a worker as an independent contractor instead of as an employee will generally lessen the amount of taxes a business pays, because when a worker is an employee, employers must pay state and federal unemployment tax, social security tax and workers compensation/disability premiums to a State Insurance Fund. When a worker is an independent contractor, the business is not required to withhold these taxes or make these payments. That responsibility falls on the worker.

-The IRS uses three characteristics to determine the relationship between businesses and workers: Behavioral Control, Financial Control, and the Type of Relationship.

-Behavioral Control looks at whether the business has a right to direct or control how the work is done. The more control a business can exert over the work to be performed, the more likely the worker is an employee. Conversely, the more freedom and discretion the worker has in performing the work, the more likely the worker is an independent contractor. Do not confuse this with the business’s ability to control the result of the work done, a business is always permitted to exert control over results, and such control has no bearing on the contractor/employee discussion. Rather, the IRS examines the means by which the worker does the work.

-Financial Control looks at whether the business has the right to direct or control the financial and business aspects of the worker’s job. In other words, if the worker is on an employer’s payroll and receives a steady paycheck, the likelihood increases that the worker will be deemed an employee.

-The Type of Relationship factor relates to how the workers and the business owner perceive their relationship. It should be noted that the IRS will make its determination using substance over form, meaning that while it is interested in how the relationship between the parties is perceived by the parties, the IRS will make its determination ultimately regardless of how the parties paper their relationship.

In addition to the above points, the IRS has made clear in earlier publications that the following factors will also play a role in its determination:

-Who supplies the equipment, material, tools, workstations, and other items in order for the worker to perform the job. The more materials that the business supplies, the more likely the worker is an employee.

-Who controls the worker’s hours of employment.

Many times the characterization of the relationship between a worker and a business will be easy to determine. Sometimes, however, the line between employee and independent contractor will be blurred. It is in such a situation that the above factors must be analyzed carefully so that at the outset, a well written agreement hat accurately captures the parties’ relationship can be drafted and executed by the parties.

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A Non-Compete Can Be Enforced Even When Lacking Geographic Limitation

Tuesday, December 8th, 2009

Maryland law is well settled that a non-compete must be reasonable in geographic scope and duration in order to be held enforceable. However, Maryland courts will enforce a covenant not-to-compete that does not contain a geographic limitation in certain narrow and limited circumstances. The U. S. District Court for the District of Maryland stated in Intelus v. Barton and Medplus, Inc., 7 F. Supp. 2d 635 (1998) that every non-compete must be examined to determine reasonableness based on the specific facts at hand, even non-competes that fail to contain a finite geographic limitation. The Intelus court stated:

“Competition unlimited by geography can be expected where the nature of the business concerns computer software and the ability to process information. . . Because of the broad nature of the market in which Intelus operates, a restrictive covenant limited to a narrow geographic area would render the restriction meaningless.”

In determining the reasonableness of a non-compete that does not contain a geographic limitation, Maryland courts will consider the nature of the industry and the national and perhaps global nature of the competition. In Intelus, the court concluded that the restriction was reasonably related and limited to Intelus’s need to protect its good will and client base, and therefore upheld the enforceability of the non-compete.

In Hekimian Labs, a Florida federal court, interpreting Maryland law, found that where “testimony indicated that competition within the business of remote access testing is such that the whole world is its stage” and “that there are only about 20 companies that compete in this business, and they do so on a worldwide basis,” then “to confine the restrictive covenant to a specified geographical area would render the Agreement meaningless.”

The Florida Court concluded that if the agreement did contain a geographical restriction, the offending party would only need to move outside of this restricted area and the damage to the harmed party would be the same. Because of the national and international scope of the competition between the parties, the absence of a specified geographic limitation was reasonably necessary for the protection of the party attempting to enforce the non-compete, and the covenant was upheld.

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Maryland Courts May Grant Injunctive Relief Even when an Arbitration Clause Exists

Tuesday, December 8th, 2009

Maryland law permits a party to request injunctive relief from a Maryland federal or state court even when a contract states that all disputes must be referred to arbitration. The Court of Appeals of Maryland held in Brendsel v. Winchester Construction Company, Inc., 898 A.2d 472 (2006) that:

“[A]n interlocutory mechanics’ lien is in the nature of a provisional remedy, not much different than an interlocutory injunction or attachment sought to maintain the status quo so that the arbitration proceeding can have meaning and relevance, and the predominant view throughout the country is that the availability of such remedies by a court is permitted by the Federal and Uniform Arbitration Acts and is not inconsistent with the right to enforce an arbitration agreement.”

In its ruling, the Maryland Court of Appeals focused on the need for courts to have the ability to preserve the status quo by granting injunctive relief while a dispute is sent to arbitration. Without this ability, the Court held, a ruling by an arbitrator could very well be immaterial, as the damage done to a party could by that time be irreparable.

The Maryland Court of Appeals’ holding finds support from the Fourth Circuit in Merril Lynch et al. v. Bradley and Collins, 756 F.2d 1048 (1985):

“Accordingly, we hold that where a dispute is subject to mandatory arbitration under the Federal Arbitration Act, a district court has the discretion to grant a preliminary injunction to preserve the status quo pending the arbitration of the parties’ dispute if the enjoined conduct would render that process a “hollow formality.” The arbitration process would be a hollow formality where “the arbitral award when rendered could not return the parties substantially to the status quo ante.” Lever Brothers, 554 F.2d at 123.”

Therefore, Maryland courts are permitted to intercede and grant injunctive relief in spite of an arbitration clause where the absence of such relief would cause the arbitration to be nothing more than a “hollow formality.”
This power exists even when a contractual provision states that the parties must refer all disputes to arbitration.

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Maryland Case on the Definition of “Solicit” in a Non-Solicitation Agreement

Thursday, October 29th, 2009

Mona Electric v. Truland, 193 F. Supp. 2d 874 (2002), as well as the appeal of that case, provide support for the position that a terminated employee who executed a non-solicitation provision when hired, but which did not contain an accompanying non-compete covenant, will not be in violation of the non-solicitation agreement if the clients and customers of the employee’s former place of business, and not the employee himself, initiate contact with the former employee for the purpose of conducting business. The District Court for the Eastern District of Virginia held:

“there is no evidence that Gerardi violated the Agreement by “soliciting” Mona’s customers. Truland hired Gerardi as a Service Account Manager. Gerardi’s responsibilities in this new position include preparing estimates and working in the field. A part of Gerardi’s position at Truland is handling customer solicitation calls. In the electrical contracting field, customers often solicit bids from the electrical contractors. Plaintiff has not presented any evidence that Gerardi has initiated calls to customers during his employment at Truland. Rather, the evidence is that Gerardi responded to customer calls to Truland for bids. Gerardi’s acts of responding to customers who solicited him for bids clearly do not violate the Agreement. Gerardi did not sign an agreement that prohibited him from competing with Mona, he signed an agreement that precisely prohibited his “solicitation” of Plaintiff’s customers. Plaintiff asserts that the Agreement prevents Gerardi from submitting estimates to customers who call him to request bids. This would turn the non-solicitation agreement into a non-competition agreement, and under the unambiguous terms of terms of the Agreement, only solicitation of Mona’s customer’s is prohibited. Thus, were the Court to find the Agreement valid, no evidence has been presented in this case that Gerardi violated the terms of the Agreement, and summary judgment should be granted for the Defendant.” Mona Electric v. Truland, 193 F. Supp. 2d 874 (2002).

On appeal, the Fourth Circuit Court of Appeals, applying Maryland law, upheld the lower court’s findings:

“Despite Mona’s assertion to the contrary, the district court held and we agree that the plain meaning of “solicit” requires the initiation of contact. (J.A. at 135.) Therefore, in order to violate the nonsolicitation agreement, Gerardi must initiate contact with Mona’s customers. Mona argues that Gerardi solicited when he submitted estimates to Mona’s customers. However, this does not fall within the plain meaning of “solicit.” If Mona intended to prevent Gerardi from conducting business with its customers it could have easily stated that in the agreement. Taking the facts in the light most favorable to Mona, there is no evidence that Gerardi solicited Mona’s customers. Therefore, summary judgment was proper and the district court is affirmed.” Mona Electric v. Truland, 56 Fed. Appx. 108 (2003). [On appeal]

Conclusion

The Mona case and its appeal give substantial support to the position that: 1) if an employee executed only a non-solicitation agreement and not a covenant not-to-compete; and 2) because Maryland courts will interpret “solicitation” as requiring some action on the employee’s behalf to initiate contact, then by itself, the employer would fail in its attempt to prevent the former employee from doing business with the business’ clients and customers, PROVIDED that the business cannot show that the employee actively solicited those customers. The employee is barred from soliciting, ie. from taking any action to initiate contact in order to gain business. Courts will strictly construe this requirement and delve into the actual conduct of the employee in order to determine whether the employee actually “solicited” customers.

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What are the differences between a “non-compete agreement,” “non-disclosure agreement,” and “non-solicitation agreement”?

Thursday, June 18th, 2009

Need an Attorney to help your Maryland or DC business? Contact Raymond McKenzie at 301-330-6790 or ray@mckenzie-legal.com

Business clients often confuse the above terms, each of which protect business owners from a different type of harm. I will summarize the three types of agreements below.

Non-compete agreement

A covenant not-to-compete is an agreement whereby a party agrees not to compete against another party: 1) in a specific line of business; 2) for a definite period of time; 3) in a limited geographic area.

A non-compete agreement is usually found as part of a broader contract, such as an employment agreement or franchise agreement, and will take effect upon termination of the contract.

Maryland courts allow a covenant not-to-compete to be enforced provided it is “reasonable” in the activity it restricts, as well as in its geographic scope and duration. A typical non-compete looks something like the following:

Employee hereby agrees that for a period of one year following the date of termination of this Agreement for any reason, Employee shall be prohibited from acting, directly or indirectly, as an owner, manager, operator, consultant or employee of any business or business activity that is in the business of providing services similar to or competitive with Company.

Non-disclosure agreement

A non-disclosure, or confidentiality, agreement (“NDA”), is an agreement whereby a party pledges not to disclose the confidential and proprietary information of another party. NDA’s are commonly used to protect confidential information not generally made available to the public such as trade secrets, customer lists, business and marketing plans and strategy, and financial information, so that such information does not fall into the hands of competitors or even the public at large. NDA’s can be found in many employment and independent contractor agreements, as well as agreements where businesses are performing due diligence on one another prior to some type of relationship commencing.

Unlike the situation where covenants not-to-compete must be reasonable in all areas, non-disclosure agreements will be enforced by Maryland courts unless the person or company that is alleged to have violated the NDA is able to show that it learned of the confidential information from an independent, outside source. Whatsmore, an NDA need not contain any geographic or time restrictions in order to be valid and enforceable.

A typical NDA will look like this:

Employee acknowledges that Company may, in the course of Employee’s employment, provide Employee access to Company’s trade secrets, customer lists, business and marketing plans, financial information, and other confidential information related to the business of Company, including access to Company’s Employment Manual (the “Manual”). Employee agrees to retain all such information as confidential and may not use such confidential information on his or her own behalf or disclose such confidential information to any third party during or at any time after the term of Employee’s employment.

Non-solicitation agreement

A non-solicitation agreement is an agreement whereby a party pledges not to solicit the clients and customers of another party. Non-solicitation agreements are generally found in employment and independent contractor agreements, as well as vendor arrangements where one party is granted access to the clients list of another party.

Like an NDA, a non-solicitation agreement need not contain any geographic or time restrictions in order to be valid and enforceable in Maryland. A common form of non-solicitation agreement follows:

Employee hereby agrees that for a period of one year following the date of termination of this Agreement for any reason, Employee shall be prohibited from soliciting business from, or performing services for, or inducing or attempting to induce, any customer or client of Company, its subsidiaries or affiliates, to cease doing business with Company, or in any way interfering with the relationship between Company and any customer or client of Company.

Many business contracts will contain one or more of the above agreements. It is therefore important to be able to distinguish among them, and draft contracts that are specific to your business needs.

Need an Attorney to help your Maryland or DC business? Contact Raymond McKenzie at 301-330-6790 or ray@mckenzie-legal.com

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