Thursday
Apr292010

Non-Competes: It Can't Just be About the Money

At a Dallas Bar Association conference last fall, Michael Maslanka gave an excellent presentation on Texas Non-Compete Law.  His presentation was informative, topical, and entertaining.  He was also very gracious in speaking with various conference attendees afterwards.  As part of his presentation, he highlighted a legal point about non-competes that is generally misconstrued when he noted that non-compete provisions cannot be supported with monetary consideration.  While it is generally known that non-compete provisions require separate consideration to be enforceable, it is less well known that non-compete provisions also require a specific type of consideration to render the provision enforceable.  In general, Texas courts have required the consideration to be an interest in something worthy of limiting competition and enjoining an individual from making a living.  So, while Texas courts will allow a company to enforce a non-compete provision when the consideration is providing access to trade secrets or other confidential information, it will not enforce non-compete provisions when the consideration is monetary.  Monetary consideration is not a worthy enough interest to prohibit competition and to limit someone from making a living.  To illustrate this proposition, the Dallas Court of Appeals recently held that consideration consisting of stock options was insufficient to support an enforceable non-compete provision.  See Marsh USA v. Rex Cook, 287 S.W.3d 378 (Tex.App.--Dallas 2009) ("Financial benefits...do not give rise to an interest worthy of protection.").

As a practical matter, this rule requiring a specific type of consideration may present problems for some employers who want their employees to execute a non-compete after that employee already has access to the employer’s trade secrets and other confidential information.  For instance, when new owners purchase a company and want to implement non-compete agreements to protect their investment, they might have some trouble getting the newly acquired employees to lawfully enter non-compete agreements if the employees’ positions do not require access to new trade secrets or other new confidential information.  In resolving this issue, an attorney must remember that money will not solve the legal problem.

Thursday
Apr292010

Understanding the Limits of Electronic Discovery

Similar to real estate, where the three most important things are location, location, location, the most important thing for business litigation is email, email, email.  If you get to the other side’s email, you will increase your likelihood of success expediently.  Given the importance of email, it is critical that every business litigator review a recent case styled In re Weekly Homes.   In this case, the Court has held that a trial court abused its discretion when it ordered the employees of a non-party to turn over their personal hard drives because the Court found that it was too drastic for a trial court to "give the expert carte blanche authorization to sort through the responding party's electronic storage device."   According to the Supreme Court, the electronic requests had to be more specific and there had to be a reasonable likelihood that the information sought would be recovered.  In particular, the Court noted that the original requests for electronic information did not specifically request "deleted emails."  In rendering this decision, the Texas Supreme Court provided a detailed analysis about Rule 196.4, analyzing an assortment of federal cases, and a summary of "the proper procedure under Rule 196.4."  In outlining the limits of electronic discovery, this case demonstrates the importance of issuing electronic discovery that is tailored to what you need.  In doing this, you might need to take an early deposition of the other side’s IT person to fully understand the landscape of their electronic information.  This is a must read for business litigators.  

Wednesday
Dec232009

Honest Service Doctrine Going Down Again?

A few weeks ago, the so-called Honest Services Doctrine had another rough day before the United States Supreme Court, making it likely that the doctrine may be overturned for the second time in 25 years.  And this time, the doctrine may be found to be unconstitutional, which would make it less likely that Congress could revive it in its current form.  This is significant given how malleable the concept of “honest services” was for federal prosecutors who sought to utilize this doctrine to significantly expand the jurisdictional reach of the mail and wire fraud statutes.  (Transcript for Black Case; Transcript for Weyhrauch Case)

For those unfamiliar with the Honest Services Doctrine, it is a doctrine that derived from the federal government’s application of the mail fraud statute to combat political corruption.  In essence, the federal government successfully convicted politicians who took bribes or kickbacks by arguing that the bribe or kickback deprived the politician’s constituents of his or her honest services, which constituted mail fraud when the political used the mail as part of the scheme.  (The doctrine also applied to wire fraud cases.)  At first, this fraud theory hinged on the fact that, because politicians were considered fiduciaries to the public, their failure to disclose the bribe or kickback amounted to fraud by omission.  Because it was a fraud theory based on a fiduciary’s failure to disclose, one court noted, in dicta, that a disclosure of the bribe or kickback would likely negate a prosecution under this theory.  See United States v. Sawyer, 85 F.3d 713, 725 (1st Cir. 1996) (“Ostensibly, a person could offer an illegal bribe to a public official and not be concerned with its secrecy.  Thus, the evidence presented [for mail fraud] must permit a finding that [the defendant]. . . also intended to deceive the public about that conduct.”). 

Over the years, the federal government began extending the reach of this doctrine to cover items beyond bribery and kickbacks.  In some instances, the federal government convicted private employees who deprived their private employers of their honest services.  In other instances, the government sought convictions of private individuals who were involved in the public corruption cases even though the private individual did not, unlike the politician, owe a fiduciary duty to disclose anything to the public. 

But the real expansion of the doctrine began when the federal government extended the doctrine to cover situations where an individual merely failed to disclose a conflict of interest.  Thus, even in cases where a public official was not influenced by the conflict of interest, the mere failure to publicly disclose the conflict could constitute a federal felony as a fraud of omission.  Because many state legislatures have part-time legislatures where the public official has a full time job as a teacher, lawyer, doctor, etc., the potential reach of the Honest Services Doctrine was significant given the potential number of conflicts of interest.  For instance, an attorney from a large, national law firm could have a significant number of potential conflicts that would make it difficult to fully disclose, especially if the lawyer was prohibited from disclosure under the state’s professional conduct rules. 

To highlight the potential abuse associated with this expansion of the Honest Services Doctrine, Judge Harrington, a former federal judge and federal prosecutor in Massachusetts, argued that this expansion amounted to the federal government turning state misdemeanor violations into federal felonies:

This Court re-emphasizes the threat to liberty and reputation of individuals which occurs when federal prosecutors selectively transform state ethics violations,. . .typically enforced by the imposition of civil penalties, into serious federal felonies.  The government should be wary of the broad language and elastic interpretation of the federal criminal fraud statute, and refuse to engage in the innovative prosecutorial process of 'federalization' of state laws.

In 1986, the United States Supreme Court found that the Honest Services Doctrine was an improper extension of the mail fraud statute because this statute was not applicable to the intangible right of the citizenry to good government.  McNally v. United States, 483 U.S. 350 (1987).  Shortly after McNally was issued, Congress passed a federal statute that attempted to reinstate the Honest Services Doctrine.  18 U.S.C. § 1346.  Under 18 U.S.C. § 1346, the text read, “For the purposes of this chapter [18 USCS §§ 1341 et seq.], the term ‘scheme or artifice to defraud’ includes a scheme or artifice to deprive another of the intangible right of honest services.”  In applying this statute, federal courts generally defined the term “deprive another of the intangible right of honest services” in accord with the case law preceding McNally

Despite Congress’ attempt to revive the Honest Services Doctrine, the United States Supreme Court is again analyzing the legitimacy of the doctrine and may find that the doctrine, as delineated in the § 1346, is an unconstitutionally vague criminal statute.  While the government argues that the doctrine is not unconstitutional vague because federal courts have generally limited the doctrine to bribery, kickback, and concealed conflict of interest cases, nothing in the statute supports that limitation.  And nothing in the statute prohibits a federal prosecutor from using the generic term “honest services” to apply to something beyond those general limitations.  The following exchange between Justice Scalia and the government attorney highlights the constitutional issue:

JUSTICE SCALIA: There is no such thing as a vague law, so long as this Court says, oh, what the law -- it is absolutely unclear what the law means, so long as this Court says, oh, we think the law means --what do you want to pick -- bribery, then -- then it's okay. Right?

MR. DREEBEN: Justice Scalia --

JUSTICE SCALIA: Is that the system we have, that Congress can say, nobody shall do any bad things?

MR. DREEBEN: That's not what --

JUSTICE SCALIA: And it comes to this Court, and this Court says, bad things means bribery. And that law is a valid law, right?

MR. DREEBEN: That's not what this law says, and that's not what this Court has done in response to other criminal law.

JUSTICE SCALIA: What is it -- what is it that you are arguing for, that -- that a law that is, on its face, inherently vague can, somehow, be rendered valid to the citizens by a decision of this Court?

MR. DREEBEN: But that is common. This Court takes common law terms of art, such as fraud, and it reads into them elements that are not on their face on the basis of the common law. Take, for example, 18 U.S.C. 1111, which is the federal murder statute. It uses the phrase "malice aforethought."

 *   *   *

JUSTICE SCALIA: Well, you say it was a body of law. It wasn't about a body of law. We said it was wrong [in McNally]. So Congress is not here referring to some established common law crimes at all. It's referring to a mistaken series of decisions by the courts of appeals.

MR. DREEBEN: Well, I can't --

JUSTICE SCALIA: And that's quite different from -- from harking back to a common law term, such as fraud.

A review of the transcripts makes it seem that the Honest Services Doctrine is in trouble.  But the cases before the Supreme Court have not technically challenged the constitutionality of the doctrine, making it possible that the Supreme Court’s holding will limit the doctrine without rendering it unconstitutional.  Yet, Justice Scalia noted that it did not make sense to address the specific issues before the Supreme Court if the statute was unconstitutionally vague.  So, even if the doctrine holds on to fight another day, it will only be a matter of time before it is killed off.

Saturday
Oct312009

Why did the DOJ amend its guidelines on corporate cooperation? 

In a written summary of a recent seminar on white collar defense, Peter Hardy, a guest blogger for the White Collar Crime Prof Blog, included the following statement concerning the federal government’s decision to amend the so-called Thompson Memo, the federal memorandum that had delineated the federal government’s guidelines on corporate cooperation:

The DOJ has changed what it has said about what constitutes cooperation by a corporation.  Knowing or feeling that it has all the power, DOJ has imposed great demands upon corporations and its employees, and threatened the corporation with its own destruction.  (emphasis added). 

It is tough to ascertain what Mr. Hardy means in the highlighted section.  Is Mr. Hardy implying that the DOJ changed its policy on corporate cooperation because it wanted to level the playing field given its knowledge of its own power?  If so, he is wrong.  The DOJ leveled the playing field (i.e. it modified the Thompson Memo) after Judge Kaplan, a federal judge sitting in the District Court for the Southern District of New York, dismissed the indictments against a number of former KMPG employees who were indicted for allegedly setting up illegal tax shelters and, in the process, castigated the actions of at least two Assistant United States Attorneys for the Southern District of New York.  This was an unprecedented decision and a great blow to the federal government. 

According to Judge Kaplan, the federal government had violated the defendant’s right to counsel under the Sixth Amendment when it utilized the Thompson Memo to pressure KPMG into cutting off its payment of legal funds to these former employees.  After the Second Circuit affirmed Kaplan’s decision, the federal government had to change something, so it modified some aspects of the government’s ability to encourage a company to “cooperate.”  In addition to the Kaplan decision, some members of Congress had started to introduce legislation that would limit the government’s ability to force corporations to cooperate when it was targeting some of the corporation’s employees.  It was the ripple effect of the Kaplan bomb shell that forced the federal government to reconsider its cooperation guidelines; it had nothing to do with the DOJ’s concern about its own power. 

Tuesday
Oct062009

Trade Secret Privilege

In In re Union Pacific, --S.W.3d – (Tex. 2009), the Texas Supreme Court has held that a trial court abused its discretion when it ordered the production of confidential “rate structures,” which include formulas to determine shipping rates charged to customers, because the plaintiff could not demonstrate “with specificity exactly how the lack of information will impair the presentation of the case on the merits to the point that an unjust result is a real, rather than a merely possible, threat.”  (View the Legal Briefs: Union Pacific's Writ of Mandamus, the plaintiff's Response Brief, and Union Pacific's Reply Brief

This case arose from a train crash allegedly caused by Union Pacific when one of its trains crashed into another train after it failed to stop at a signal, causing a fire and the release of a toxic chlorine gas.  After the crash, a local resident filed a negligence and gross negligence action against Union Pacific, claiming injuries related to the release of the toxic gases.  The plaintiff’s negligence theory relied upon, among other things, an argument that “Union Pacific should have positioned the chlorine car farther toward the rear of the train and that the hazardous material should not have been placed next to steel cars.”  Union Pacific contested this theory by claiming that it did not have a duty to place the hazardous materials toward the rear of the train and that “placing hazmat cares in the back of the train would be cost-prohibitive.”  To rebut this argument, the plaintiff sought the production of Union Pacific’s “rate structures” to show that Union Pacific charged a higher price for the transportation of hazmat material, which would, according to the plaintiff, demonstrate that Union Pacific recognized a higher duty associated with transporting hazmat material. 

After the trial court denied Union Pacific’s motion to quash the document request and the San Antonio Court of Appeals denied Union Pacific’s mandamus petition, the Texas Supreme Court reversed the trial court for abuse of discretion, holding that the plaintiff failed to establish a specific need sufficient to pierce the trade secret privilege.  In essence, the Court found that the plaintiff failed to show “why she needs the specific rate structures to advance [her] negligence theory.”  (emphasis in original)  The Court also noted the irreparable harm to Union Pacific’s ability to compete with competitors, adopting Union Pacific’s argument that disclosure would “‘provide competitors with an advantage in predicting Union Pacific pricing and undercut Union Pacific efforts to market and conduct its business with its customers in a competitive fashion.’”