August 23, 2019

Tenth Circuit: Despite Probability of Ongoing Harm, Business Failed to Show Former Employee’s Solicitation Violated Business Agreement

The Tenth Circuit Court of Appeals issued its opinion in DTC Energy Group, Inc. v. Hirschfeld on Friday, December 28, 2018.

The district court denied plaintiff DTC Energy Group’s motion for preliminary injunctive relief. On appeal, the Tenth Circuit Court of Appeals affirmed.

DTC is a staffing and consulting firm, and has sued two of its former employees—Adam Hirschfeld and Joseph Galban—as well as a competing firm, Ally Consulting, LLC, for using DTC’s trade secrets to divert business from DTC to Ally.

Hirschfeld worked for DTC as a business development manager, and had signed an employment agreement that included confidentiality, non-solicitation, and non-interference provisions.  The confidentiality provision prohibited Hirschfeld from using DTC’s confidential information for his own benefit or the benefit of another company. The non-solicitation and non-interference provisions prohibited Hirschfeld from encouraging DTC’s current customers to take their business to a competitor and from recruiting DTC’s employees to work for a competitor, for the duration of his employment with DTC and for a period of 1-year thereafter, unless he resigned due to a change in ownership.

While employed by DTC, Hirschfeld used DTC’s resources to win business for Ally, allegedly in violation of his duty of loyalty to DTC and his employment agreement. Hirschfeld resigned from DTC in May 2017, citing a change in ownership. Upon his resignation, Hirschfeld took a flash drive containing DTC’s confidential information, and also kept his laptop logged into DTC’s Dropbox account so he could continue accessing DTC’s confidential information after his departure. The day after leaving DTC, Hirschfeld began working at Ally as its director of business development.

In September 2017, DTC filed its amended complaint and moved for preliminary injunction based on its claims for breach of contract, breach of duty of loyalty, misappropriation of trade secrets in violation of the federal Defend Trade Secrets Act and Colorado’s Uniform Trade Secrets Act, and unfair competition. The district court denied the motion, finding the duty of loyalty owed by defendants to DTC and the non-solicitation clause of Hirschfeld’s employment agreement had expired, and that DTC was unable to show a significant risk of future misappropriation of trade secrets and unfair competition. The district court reasoned that because a majority of the conduct at issue had occurred before DTC moved for a preliminary injunction, the resulting harm to DTC was therefore identifiable and could be remedied by an award of damages.

On appeal, DTC argued that the district court’s finding that DTC had established a significant risk of irreparable harm based on defendants’ past misconduct was erroneous because it failed to take into consideration the harm DTC continues to suffer as a result of defendants’ past misconduct—specifically the harm to DTC’s goodwill and competitive market position.

In its review of the district court’s decision, the Tenth Circuit focused on the showing of irreparable injury in the absence of the issuance of a preliminary injunction. The district court had found that DTC had shown a probability of irreparable harm from Hirschfeld’s ongoing breach of his employment agreement, but not with respect to DTC’s other claims.

DTC’s trade secret claims did not establish a probability of irreparable harm because there was no evidence in the record that defendants retained access to DTC’s confidential information or trade secrets. While the federal Defend Trade Secrets Act and Colorado’s Uniform Trade Secrets Act authorize preliminary injunctive relief to prevent actual or threated misappropriation of a trade secret, the Tenth Circuit concluded that DTC had not offered sufficient evidence that defendants currently possessed DTC’s trade secrets or would be likely to regain access to DTC’s trade secrets.

DTC’s unfair competition claim did not establish a probability of future irreparable harm because DTC had offered no evidence that Ally continues to appropriate DTC’s name or resources to solicit business, nor was there any evidence demonstrating ongoing confusion within the industry as to the relation between the two companies.

DTC’s breach of duty of loyalty claim also did not give rise to a future of irreparable harm. Because DTC identified the 12 contracts that Hirschfeld diverted from DTC to Ally and had previously hired experts to value the company during the change of ownership, the Court of Appeals reasoned that both the prior loss of DTC’s customers and consultants and the general decline of DTC’s value of a business could be quantified in money damages.

While DTC had shown a probability of future irreparable harm from Hirschfeld’s ongoing solicitation of DTC’s customers and consultants, the district court still denied injunctive relief as DTC had not shown a likelihood of success on the merits of the claim. The district court found that Hirschfeld was not bound by his employment’s non-solicitation provision as the change in ownership clause provision had been triggered.

On appeal, DTC argued that the prior breach doctrine prevented Hirschfeld from relying on the change in ownership clause, stating that Hirschfeld could not claim the benefit of the contract’s change in ownership clause after he had already violated the contract by improperly diverting business to Ally prior to his resignation. The Tenth Circuit agreed with the district court’s finding that the prior breach doctrine was inapplicable, as this was not an instance where DTC was defending against a demand specific performance, and the text of the employment agreement itself did not prevent Hirschfeld from relying on the provision in instances of prior breach. The Circuit went on to say that Hirschfeld’s present solicitation of DTC’s customers and consultants would not support issuing a preliminary injunction because the injunction would exceed the 1-year durational scope of the non-solicitation (the agreement’s provisions had expired prior to the time of the appeal).

In his concurrence, Judge McHugh wrote that in some circumstances an injunction can supported by the irreparable harm caused by defendants’ legal actions that would not have been possible but for their past breaches, as courts will sometimes enjoin future legal conduct because it was made possible by prior illegal conduct and will cause irreparable harm to the plaintiff. However, DTC had not pointed to any evidence of future irreparable harm stemming from defendants’ past misconduct (e.g., evidentiary support that DTC’s goodwill and competitive market position continues to be harmed) in the record that should have been considered by the district court, therefore the district court’s denial should be affirmed.

Tenth Circuit: District Court has Wide Discretion to Impose Special Conditions of Supervised Release

The Tenth Circuit Court of Appeals issued its opinion in United States v. Bowers on Friday, February 10, 2017.

Donald Bowers was charged and convicted on two counts of civil contempt in violation of 18 U.S.C § 401(3) for willfully and repeatedly violating a permanent injunction against him stemming from a civil trade secret misappropriation suit. Bowers was sentenced to fifteen months’ incarceration and, following his release, a thirty-six month period of supervised release, during which he would make monthly payments of the remaining amount he owed to the plaintiff in the underlying civil suit. Bowers appealed, claiming that the court erred by imposing payments to the plaintiff in the civil case as part of his supervised release, denying his motion for disclosure of the criminal referral, and sentencing him for a period that exceeded six months.

The underlying civil case did not actually include Bowers himself, but his son Lonny Bowers (Lonny) and the officers of WideBand, who were sued by ClearOne Communications, Inc. for misappropriation of trade secrets. Bowers became involved when he entered into an agreement with the defendants in the case to purchase WideBand’s assets in exchange for money to pay their legal fees. The court issued a temporary restraining order and preliminary injunction to stop the transfer of assets to Bowers.

In the civil case against WideBand, the jury returned a verdict against the defendants that included compensatory damages against all the defendants, and punitive damages against two of the WideBand officers (not including Lonny). The day after the verdict in the WideBand case, Bowers filed a statement to perfect a security interest in all of WideBand’s assets. When the court ordered Bowers to appear to show why he was not in contempt for violating the existing temporary restraining order, he failed to appear, and the court determined that he was also subject to the existing restraining order as he acted in concert with the defendants in the WideBand case.

After Bowers failed to appear in multiple contempt hearings and again violated the permanent injunction by setting up and operating DialHD, Inc., a company that used the assets of WideBand, the court issued a memorandum decision and civil contempt order against Bowers for violating the permanent injunction, and directed Bowers to self-surrender for incarceration and pay ClearOne’s reasonable attorney fees and costs. Bowers failed to purge himself of the contempt charge, and the court issued a bench warrant for his arrest. The court rejected both of Bowers’ appeals from the civil cases.

The district court entered a civil judgment against Bowers in an amount of $57,188.61 in attorney fees for violating the permanent injunction, an amount of $22,743.88 to pay ClearOne’s costs and fees from the original ClearOne civil case, and $8,648 in appellate attorney fees in connection with his first appeal in the civil case. In relation to the contempt cases against Bowers, the district court judge who presided over the civil case sent a memo regarding the referral of criminal contempt charges for Bowers to the United States Attorney for the District of Utah, outlining the details of the civil case. A federal grand jury returned an indictment against Bowers for willfully disobeying the permanent injunction and civil contempt order, both in violation of 18 U.S.C. § 401(3). A jury found Bowers guilty on both counts.

Bowers was sentenced to fifteen months’ imprisonment, followed by a term of three years supervised release, during which he would make monthly payments to ClearOne. On appeal, Bowers argued that the district court abused its discretion by ordering him to make monthly payments to ClearOne, denying his motion to compel the government to disclose the criminal referral, and argued that his sentence is illegal because 18 U.S.C. § 402 limits sentences like those Bowers committed to no more than six months.

As to his first contention regarding the imposition of payments as a condition of his supervised release, the court stated that district court has broad discretion to impose special conditions of supervised release, stating that the conditions must only (1) be reasonably related to the nature and history of the defendant’s offense, the deterrence of criminal conduct, the protection of the public from the defendant’s crimes, or the defendant’s educational and other correctional needs; (2) involve no deprivation of liberty than is reasonably necessary; and (3) be consistent with pertinent policy statements issued by the Sentencing Commission. The court rejected Bowers’ argument, stating that the special condition in this case satisfies all of the requisite elements.

Bowers’ second argument on appeal, that the district court erred in denying his motion to discover the criminal referral, was also rejected by the court, as the information in the referral did not contain oral or written statements or other evidence that would render it discoverable under Fed. R. Civ. P. 16. Finally, the court also rejected Bowers’ argument that a sentence of fifteen months for his crimes was illegal under § 402, as he did not raise it at the district court level and therefore waived his right to assert the argument at the appellate level. The court added, however, that even if Bowers had not waived the argument, he still would not be entitled to relief because he was not charged under §402, but under § 401, which does not impose a maximum punishment.

The Tenth Circuit affirmed the judgment of the district court.

Colorado Court of Appeals: Essential Element of Abuse of Process Claim is Improper Use of Courts

The Colorado Court of Appeals issued its opinion in Active Release Techniques, LLC v. Xtomic, LLC on Thursday, February 9, 2017.

Active Release Techniques (ART) is a provider of training, seminars, and business support software for chiropractors and other health care providers. ART contracted with Xtomic to manage ART’s IT services and provide support. When one of ART’s employees started a new business, Select Seminar Services, LLC (S3), with a co-owner of Xtomic, ART petitioned for a temporary restraining order and preliminary injunction. It also initiated the current litigation, asserting claims for misappropriation of trade secrets. Xtomic responded by asserting numerous counterclaims, including a claim for abuse of process. A jury ultimately decided all claims in Xtomic’s favor.

ART appealed, arguing the trial court erred by denying its motion for a directed verdict on Xtomic’s abuse of process claim. The court of appeals noted that “a valid abuse of process claim must allege ‘(1) an ulterior purpose for the use of a judicial proceeding; (2) willful action in the use of that process which is not proper in the regular course of the proceedings, i.e., use of a legal proceeding in an improper manner; and (3) resulting damage.'” In this case, ART moved for a directed verdict on the abuse of process claim at the close of evidence on the counterclaims. Xtomic argued that ART knew from the outset that it had no legitimate claims against Xtomic and the overly aggressive manner in which it pursued its claims against Xtomic was evidence of ART’s ulterior motive to use the lawsuit as a means to harass Xtomic and run it out of business. In denying ART’s motion for directed verdict, the court relied on ART’s pretrial settlement with Xtomic, ART’s reputation for filing lawsuits to control the behavior of former 5 associates and business partners, and the nature and number of preservation letters that ART sent to numerous individuals.

The court of appeals disagreed with the trial court that the settlement could be evidence of ART’s willful misuse of judicial process, because settlement does not imply that the originally filed suit was improper. The court also disregarded the evidence of ART’s other lawsuits, finding that it was only proper to focus on the instant case. Finally, the court found that the preservation letters were not directly related to any litigation but rather were issued in response to ART’s concern that Xtomic was destroying emails.

The court of appeals denied Xtomic’s motion for appellate attorney fees, since it was not the prevailing party. The court reversed the trial court’s denial of ART’s motion for directed verdict and remanded.

Colorado Supreme Court: Insurer Failed to Show Documents in Question Contained Trade Secrets

The Colorado Supreme Court issued its opinion in In re Rumnock v. Anschutz on Monday, December 5, 2016.

Pretrial Procedure—Protective Orders—Trade Secrets—Commercial Information.

The Colorado Supreme Court discharged its rule to show cause and affirmed the trial court’s partial denial of defendant American Family Mutual Insurance Company’s request for a protective order to restrict plaintiff’s use of alleged trade secrets. The court held that American Family failed to meet its burden to show that the documents were in fact trade secrets or other confidential commercial information.

Summary provided courtesy of The Colorado Lawyer.

Colorado Court of Appeals: Design of Manufacturing Part Was Not a Secret, Therefore No Misappropriation Occurred

The Colorado Court of Appeals issued its opinion in Hawg Tools, LLC v. Newsco International Energy Services, Inc. on Thursday, December 1, 2016.

Design—Trade Secret—Conversion—Defense—Waiver—Standing—Breach of Contract.

Hawg Tools, LLC (Hawg) rents mud motors to oil and gas drilling companies. Newsco International Energy Services, Inc. (Newsco) uses mud motors to provide drilling services. Gallagher owned Hawg. Before he formed this company, he operated a similar business called New Venture. In 2008 Gallagher asked a machinist to manufacture sealed bearing packs for use in New Venture’s mud motors. The machinist arranged for a designer, defendant Ficken, to design the sealed bearing packs for the machinist as a favor. The designer assigned his rights in the design to the machinist, who assigned them to Gallagher for compensation. Gallagher later assigned the rights to Hawg. The designer later designed a sealing bearing pack for Newsco. After determining that the Newsco design was similar to the Hawg design, Gallagher filed this lawsuit alleging (1) misappropriation of a trade secret concerning the design of a sealed bearing pack, (2) conversion of a trade secret, and (3) breach of contract. The trial court entered judgment in favor of plaintiff. The trial court denied defendants motions for directed verdict and judgment notwithstanding the verdict.

On appeal, defendants contended that the trial court erred when it denied their motions for directed verdict and judgment notwithstanding the verdict on Hawg’s claim for misappropriation of a trade secret. C.R.S. § 7-74-102(4) defines a trade secret as “the whole or any portion . . . of any . . . design . . . which is secret and of value.” To determine whether a trade secret exists, the fact finder considers (among other thing) the extent to which the information is known outside the business. Here, Hawg did not establish that its design, in whole or in part, was substantially different from designs that were publicly available at the time of its creation. The court of appeals concluded that (1) the record does not support a conclusion that the Hawg design was secret and (2) the record does not contain sufficient evidence to support the trial court’s decision to deny defendants’ motions for a directed verdict and for judgment notwithstanding the verdict.

Defendants also contended that the trial court erred when it denied their motion for judgment notwithstanding the verdict on Hawg’s conversion claim, asserting that the Uniform Trade Secrets Act preempts claims for conversion of trade secrets. This was a preemption defense based on choice of law, which defendants waived because they raised it for the first time in their motion for judgment notwithstanding the verdict.

Ficken appealed the judgment against him on Hawg’s breach of contract claim, contending that the trial court erred when it rejected his assertion that Hawg lacks standing to bring suit against him for breach of contract based on his violation of a confidentiality agreement. Here, the designer and the machinist entered into an assignment agreement with Gallagher. Later, Gallagher fully assigned his rights under this agreement to Hawg. Therefore, Hawg had standing to bring suit for breach of that agreement.

The judgment on Hawg’s claim for misappropriation of a trade secret was reversed and the case was remanded for the trial court to enter judgment in favor of defendants on that claim and to vacate the award of damages on that claim. The judgment on Hawg’s claims for conversion and breach of contract were affirmed.

Summary provided courtesy of The Colorado Lawyer.

Tenth Circuit: $2.92 Million Jury Award in Utah Trade Secret Case Affirmed

The Tenth Circuit Court of Appeals published its opinion in Storagecraft Technology Corporation v. Kirby on Tuesday, March 11, 2014.

James Kirby said the jury’s award against him was too much. True, he helped start and served as a director of StorageCraft, a computer software company. True, after a falling out with his colleagues he stole the computer source code on which the company’s products depended. True, he shared the source code with NetJapan, a rival company that quickly produced a competing software product much like StorageCraft’s. But he said the jury’s $2.92 million trade secret misappropriation award was still too much. Too much, Mr. Kirby said, because he never used the secret for his own personal profit. And too much because StorageCraft never sought to prove at trial that NetJapan made commercial use of its trade secret. Maybe he was angry about how his former colleagues had treated him, maybe he disclosed the trade secret to a rival out of vengeance. But without firmer proof that someone profited from his misdeed, Mr. Kirby insisted the jury’s verdict should be overturned.

The trouble was, Utah law doesn’t distinguish between a misappropriator’s motives. When someone steals a trade secret and discloses it to a competitor, he effectively assumes for himself an unrestricted license in the trade secret. And that bears its costs. After all, what value does a trade secret hold when it’s no longer a secret from the trade? The misappropriator may act with a wish to line his pockets or satisfy a vendetta or for some other purpose still. All the same, Utah’s trade secret statute holds him to account for the full value of the license he arrogated to himself. Just as the district court held.

Utah’s trade secret statute, Utah’s Uniform Trade Secrets Act, Utah Code Ann. § 13-24-4(1), the law governing Mr. Kirby’s case, expressly allows a reasonable royalty measure of damages when the misappropriator uses or discloses the trade secret. And no one disputed that Mr. Kirby did at least that — disclosed the secret to NetJapan. Nothing in the state’s trade secret statute categorically restricts the availability of reasonable royalty damages to cases in which the misappropriator used a trade secret commercially rather than disclosed it to others.

Mr. Kirby still argued the jury’s award was unreasonable based on the facts. The court stated it is important when setting a reasonable royalty award to account for the scope of the license the defendant assumed for himself, to aim at a price that reflects the particular use of the trade secret made by the defendant. While a defendant in Utah can’t avoid reasonable royalty damages because he disclosed the trade secret to others without anyone making commercial use of it, the amount of reasonable royalty damages he must pay depends on what he did with the secret — what uses he made of it. Even acknowledging all this, however, did nothing to help Mr. Kirby. His problem lied in the record. The evidence at trial showed that Mr. Kirby took StorageCraft’s trade secret and intentionally disclosed it to NetJapan, aware that NetJapan was an able competitor, and aware that NetJapan could well use the secret to compete with StorageCraft.

Judgment AFFIRMED.