Protecting Trade Secrets: The Inevitable Disclosure Doctrine

In New York, the modern line of inevitable disclosure cases was set in motion with Lumex, Inc. v. Highsmith, 919 F. Supp. 624 (E.D.N.Y. 1996), in which the court applied the doctrine of inevitable disclosure to bolster its decision to enforce a non-competition agreement. Lumex manufactured and sold Cybex fitness equipment. Its Cybex marketing manager, Gregory Highsmith, was subject to a “technical information and non-competition agreement.” When Highsmith resigned from Lumex to join competitor Life Fitness, which distributed similar equipment under a different trade name, Lumex sought a preliminary injunction on the grounds that Highsmith was subject to the non-compete and possessed confidential and trade secret information that “would be impossible for [him] not to divulge” to his new company. The court agreed that disclosure was likely inevitable, noting that as a member of Lumex's strategic planning committee “Highsmith was privy to the top secret Cybex product, business and financial information. He cannot eradicate these trade secrets … from his mind.” The decision also noted that the companies, more than mere competitors, were part of a “copy-cat industry,” which gave a selling advantage to whoever was “first to market.” Thus, despite the good-faith intentions of Highsmith and Life Fitness not to exploit Lumex's trade secrets – and the absence of evidence of actual misappropriation of trade secrets – the court enforced the restrictive covenant and granted an order restraining Highsmith from working for Life Fitness for 6 months.

A state court decision the following year, Doubleclick, Inc. v. Henderson, No. 116914/97, 1997 WL 731413 (Sup. Ct. N.Y. Co., Nov. 7, 1997), set a high water mark for the doctrine of inevitable disclosure in New York. Doubleclick, once a leader in the Internet advertising business, sought to enjoin two former executives — who had not executed non-competition agreements — from launching their own competitive business or taking employment with or consulting to any competitor company where their functions would include providing advice or information concerning any aspect of advertising on the Internet. Doubleclick alleged that the former executives: 1) had access to trade secrets regarding the company's pricing, future projects, strategies and client information; 2) misappropriated them by incorporating the trade secrets into their own business plan, and, in one instance, e-mailing trade secrets to an industry consultant with ties to Doubleclick's competitors; 3) breached their duty of loyalty by establishing their competitive venture and soliciting clients on company time; and 4) exploited the trade secrets to compete unfairly with their former employer. The court found evidence of misappropriation, but was unable to resolve on the record presented whether the misappropriated information was secret enough to warrant legal protection. Despite the absence of a restrictive covenant, the court granted a 6-month injunction and “bolstered”[its] decision by the “high probability of 'inevitable disclosure' of trade secrets.”

The tide ebbed 2 years later in EarthWeb, Inc. v. Schlack, 71 F. Supp. 2d 299 (S.D.N.Y. 1999). EarthWeb, a provider of on-line products to information technology (“IT”) professionals sought to enjoin its former Vice President of Worldwide (Web site) Content, Mark Schlack, from working for a provider of IT print-based information, alleging misappropriation of trade secrets and breach of a contract containing a confidentiality provision and a non-compete that did not unambiguously apply to his new employment. The court found no misappropriation, mendacity, or breach of fiduciary duty by Schlack. The court criticized EarthWeb for attempting an “end-run around the [inapplicable non-competition] agreement by asserting the doctrine of inevitable disclosure as an independent basis for relief.” In analyzing inevitable disclosure precedent, the court criticized courts that had “enjoined employees from working for competitors in the absence of an express non-compete agreement.” The court held that in “cases that do not involve the actual theft of trade secrets, the court is essentially asked to bind the employee to an implied-in-fact restrictive covenant based on a finding of inevitable disclosure. This runs counter to New York's strong public policy against such agreements and circumvents the strict judicial scrutiny they have traditionally required.” In denying the injunction, the court stated that absent evidence of misappropriation, the doctrine of inevitable disclosure “should be applied in only the rarest of cases.” The court set forth the following factors to consider in weighing the appropriateness of invoking the doctrine: 1) the employers in question are direct competitors providing the same or similar services; 2) the employee's new position is nearly identical to his or her old one; 3) the confidential information is highly valuable; and 4) other case specific factors, such as the nature of the industry and its trade secrets.

Despite the court's precatory language in Earthweb, last summer a lower court in New York changed tack when it issued an 11-month injunction based on the inevitable disclosure doctrine in the absence of either a restrictive covenant or actual misappropriation of trade secrets. Marietta Corp. v. Fairhurst, No. 37265, 2002-0229-M, 2002 WL 31056732 (Sup. Ct. Cortland Co., Aug. 23, 2002). The plaintiff in Marietta was a supplier of guest amenities to international large hotel chains. The defendants were Marietta's former Senior Vice President for Sales and Marketing, Thomas Fairhurst, and his new employer, Pacific Direct Incorporated (“Pacific”), which supplied high-end packaging and branded guest products to four- and five-star hotels. Fairhurst had been a member of Marietta's senior management team with responsibilities that included, inter alia, setting pricing policies, developing strategic worldwide sales and marketing plans, monitoring competitors, developing contacts with suppliers, and attending high level meetings regarding business plans, costs, and product development. Fairhurst's initial employment contract with Marietta, which expired in 1999, included a confidentiality provision as well as an express 1-year covenant not to compete; both provisions barred him from either breach or “threatened breach.” After negotiations in 1999, in place of a new employment contract, Fairhurst signed only a separate nondurational confidentiality agreement, with no express restriction on post-termination competitive employment. In May 2002, Marietta terminated Fairhurst's employment. The next month he accepted the position of President of U.S. Operations at Pacific.

Marietta promptly sought to enjoin Fairhurst from continued employment with Pacific on the ground he would inevitably use Marietta's confidential information and trade secrets, “consciously or unconsciously,” in carrying out the similar duties of his new position. Pacific countered that Marietta, which twice refused to compensate Fairhurst in exchange for an express non-competition clause, “should not now be able to 'transform' the confidentiality agreement into a covenant not to compete, and in so doing, obtain the benefit it desired, but was unwilling to pay for.”

Referring to EarthWeb, the court remarked that inevitable disclosure “has been limited to those situations where a relatively high-level employee has accepted employment with a direct competitor, in a position similar to that previously held, and with the opportunity and need to make decisions that directly relate to the subject matter of confidential information obtained in the course of the former job.” It concluded that “[u]nder those circumstances, it has been found that the employee cannot be expected to ignore or forget what he or she has learned from a direct competitor, when making decisions with respect to which such information could provide a distinct advantage for the new employer.” The lower court granted Marietta's motion for a preliminary injunction. In so deciding, despite the absence of a non-competition agreement (indeed, despite the employee's rejection of one) or evidence of intentional use or disclosure of Marietta's confidential information, and brushing aside the significant fact that Marietta had fired Fairhurst, the lower court extended the doctrine of inevitable disclosure well beyond the high water mark it had reached in Doubleclick.

Back to the Future

In January 2003, a unanimous panel of the Third Department reversed the lower court's decision in Marietta, and rendered a decision in line with EarthWeb. Marietta Corp. v. Fairhurst, 2002 WL 31898398 (3d Dep't, Jan. 2, 2003). Criticizing the lower court's decision, the court commented that despite the lack of evidence of misappropriation or disclosure, the lower court built from the concept of a threatened disclosure of trade secrets and “utilized a doctrine, not yet adopted by the state courts, of inevitable disclosure” to reason that Fairhurst was extremely likely to use Marietta's trade secrets and hence to conclude that Marietta met its burden of showing irreparable harm necessary for the issuance of a preliminary injunction.

Adopting the reasoning in EarthWeb, the court observed that irreparable harm is established only when a trade secret is misappropriated and when an employee is bound by an implied restrictive covenant. “[W]here there is no actual theft of a trade secret, the court, in applying the doctrine of inevitable disclosure, is 'asked to bind the employee to an implied-in-fact restrictive covenant' not to compete. As no restrictive covenant was in existence here and our well entrenched state public policy considerations disfavor such agreements, the doctrine of inevitable disclosure is disfavored as well, 'absent evidence of actual misappropriation by an employee'” (quoting EarthWeb).

Further critiquing the lower court's reasoning, the court stated: “While we agree that Fairhurst was privy to confidential information, there exists a valid and enforceable confidentiality agreement which clearly anticipated that he may change his employment during its duration after acquiring plaintiff's confidential information. Upon the record presented, we fail to find evidence of a breach of such agreement or that the confidential information also constituted a trade secret … Hence, in our view, Supreme Court adopted an overly expansive definition of “trade secret” so as to encompass nearly all confidential business documents … We find plaintiff's claims to be self-serving, entirely conjectural and insufficient to support the theory that Fairhurst had used or threatened to use a “trade secret.” Absent any wrongdoing which would constitute a breach under the confidentiality agreement, mere knowledge of the intricacies of a business is simply not enough … We find a clear abuse of discretion in the granting of the motion” (citations omitted).

Until the lower court's decision in Marietta, courts in New York had limited the application of the doctrine of inevitable disclosure to two circumstances: 1) to bolster the enforceability of a restrictive covenant, or 2) as an evidentiary “assist” in cases involving actual misappropriation of trade secrets. It would, therefore, be highly unlikely that high-level executive who was fired by his employer — which had tried, but failed, to obtain an agreement with the executive not to compete after the termination of employment – could be prevented from working for a competitor, even in the same position, in the absence of actual misappropriation of trade secrets. The tides have, once again, turned, returning the doctrine of inevitable disclosure to its former place.

When a former executive accepts a position with a competitor, how does the original company protect its trade secrets? One method is to invoke the doctrine of inevitable disclosure, which prohibits a former executive from competing when he or she cannot help but disclose or use the former employer's trade secrets to do so. Divulging these secrets, of course, would be in violation of the executive's continuing fiduciary duty to his or her former employer. Disclosure may be considered “inevitable” when the former executive accepts a nearly identical position with a direct competitor of the former employer, and will be called upon to use the former employer's trade secrets.

In some cases, the doctrine has been used to support a claim for injunctive relief predicated on an enforceable non-competition agreement. In others, it has been used to bolster a claim for injunctive relief based on misappropriation of trade secrets. Decisions by courts in New York reflect both approaches. A January 2003 decision by the Third Department in Marietta Corp. v. Fairhurst, 2002 WL 31898398 (3d Dep't, Jan. 2, 2003), reversed a trial court's decision that, had it stood, would have represented a sea change in the law, because the trial court issued an injunction based on the inevitable disclosure doctrine in the absence of either a non-compete or evidence of actual misappropriation of trade secrets.

Background

In New York, the modern line of inevitable disclosure cases was set in motion with Lumex, Inc. v. Highsmith , 919 F. Supp. 624 (E.D.N.Y. 1996), in which the court applied the doctrine of inevitable disclosure to bolster its decision to enforce a non-competition agreement. Lumex manufactured and sold Cybex fitness equipment. Its Cybex marketing manager, Gregory Highsmith, was subject to a “technical information and non-competition agreement.” When Highsmith resigned from Lumex to join competitor Life Fitness, which distributed similar equipment under a different trade name, Lumex sought a preliminary injunction on the grounds that Highsmith was subject to the non-compete and possessed confidential and trade secret information that “would be impossible for [him] not to divulge” to his new company. The court agreed that disclosure was likely inevitable, noting that as a member of Lumex's strategic planning committee “Highsmith was privy to the top secret Cybex product, business and financial information. He cannot eradicate these trade secrets … from his mind.” The decision also noted that the companies, more than mere competitors, were part of a “copy-cat industry,” which gave a selling advantage to whoever was “first to market.” Thus, despite the good-faith intentions of Highsmith and Life Fitness not to exploit Lumex's trade secrets – and the absence of evidence of actual misappropriation of trade secrets – the court enforced the restrictive covenant and granted an order restraining Highsmith from working for Life Fitness for 6 months.

A state court decision the following year, Doubleclick, Inc. v. Henderson, No. 116914/97, 1997 WL 731413 (Sup. Ct. N.Y. Co., Nov. 7, 1997), set a high water mark for the doctrine of inevitable disclosure in New York. Doubleclick, once a leader in the Internet advertising business, sought to enjoin two former executives — who had not executed non-competition agreements — from launching their own competitive business or taking employment with or consulting to any competitor company where their functions would include providing advice or information concerning any aspect of advertising on the Internet. Doubleclick alleged that the former executives: 1) had access to trade secrets regarding the company's pricing, future projects, strategies and client information; 2) misappropriated them by incorporating the trade secrets into their own business plan, and, in one instance, e-mailing trade secrets to an industry consultant with ties to Doubleclick's competitors; 3) breached their duty of loyalty by establishing their competitive venture and soliciting clients on company time; and 4) exploited the trade secrets to compete unfairly with their former employer. The court found evidence of misappropriation, but was unable to resolve on the record presented whether the misappropriated information was secret enough to warrant legal protection. Despite the absence of a restrictive covenant, the court granted a 6-month injunction and “bolstered”[its] decision by the “high probability of 'inevitable disclosure' of trade secrets.”

The tide ebbed 2 years later in EarthWeb, Inc. v. Schlack , 71 F. Supp. 2d 299 (S.D.N.Y. 1999). EarthWeb, a provider of on-line products to information technology (“IT”) professionals sought to enjoin its former Vice President of Worldwide (Web site) Content, Mark Schlack, from working for a provider of IT print-based information, alleging misappropriation of trade secrets and breach of a contract containing a confidentiality provision and a non-compete that did not unambiguously apply to his new employment. The court found no misappropriation, mendacity, or breach of fiduciary duty by Schlack. The court criticized EarthWeb for attempting an “end-run around the [inapplicable non-competition] agreement by asserting the doctrine of inevitable disclosure as an independent basis for relief.” In analyzing inevitable disclosure precedent, the court criticized courts that had “enjoined employees from working for competitors in the absence of an express non-compete agreement.” The court held that in “cases that do not involve the actual theft of trade secrets, the court is essentially asked to bind the employee to an implied-in-fact restrictive covenant based on a finding of inevitable disclosure. This runs counter to New York's strong public policy against such agreements and circumvents the strict judicial scrutiny they have traditionally required.” In denying the injunction, the court stated that absent evidence of misappropriation, the doctrine of inevitable disclosure “should be applied in only the rarest of cases.” The court set forth the following factors to consider in weighing the appropriateness of invoking the doctrine: 1) the employers in question are direct competitors providing the same or similar services; 2) the employee's new position is nearly identical to his or her old one; 3) the confidential information is highly valuable; and 4) other case specific factors, such as the nature of the industry and its trade secrets.

Despite the court's precatory language in Earthweb, last summer a lower court in New York changed tack when it issued an 11-month injunction based on the inevitable disclosure doctrine in the absence of either a restrictive covenant or actual misappropriation of trade secrets. Marietta Corp. v. Fairhurst, No. 37265, 2002-0229-M, 2002 WL 31056732 (Sup. Ct. Cortland Co., Aug. 23, 2002). The plaintiff in Marietta was a supplier of guest amenities to international large hotel chains. The defendants were Marietta's former Senior Vice President for Sales and Marketing, Thomas Fairhurst, and his new employer, Pacific Direct Incorporated (“Pacific”), which supplied high-end packaging and branded guest products to four- and five-star hotels. Fairhurst had been a member of Marietta's senior management team with responsibilities that included, inter alia, setting pricing policies, developing strategic worldwide sales and marketing plans, monitoring competitors, developing contacts with suppliers, and attending high level meetings regarding business plans, costs, and product development. Fairhurst's initial employment contract with Marietta, which expired in 1999, included a confidentiality provision as well as an express 1-year covenant not to compete; both provisions barred him from either breach or “threatened breach.” After negotiations in 1999, in place of a new employment contract, Fairhurst signed only a separate nondurational confidentiality agreement, with no express restriction on post-termination competitive employment. In May 2002, Marietta terminated Fairhurst's employment. The next month he accepted the position of President of U.S. Operations at Pacific.

Marietta promptly sought to enjoin Fairhurst from continued employment with Pacific on the ground he would inevitably use Marietta's confidential information and trade secrets, “consciously or unconsciously,” in carrying out the similar duties of his new position. Pacific countered that Marietta, which twice refused to compensate Fairhurst in exchange for an express non-competition clause, “should not now be able to 'transform' the confidentiality agreement into a covenant not to compete, and in so doing, obtain the benefit it desired, but was unwilling to pay for.”

Referring to EarthWeb, the court remarked that inevitable disclosure “has been limited to those situations where a relatively high-level employee has accepted employment with a direct competitor, in a position similar to that previously held, and with the opportunity and need to make decisions that directly relate to the subject matter of confidential information obtained in the course of the former job.” It concluded that “[u]nder those circumstances, it has been found that the employee cannot be expected to ignore or forget what he or she has learned from a direct competitor, when making decisions with respect to which such information could provide a distinct advantage for the new employer.” The lower court granted Marietta's motion for a preliminary injunction. In so deciding, despite the absence of a non-competition agreement (indeed, despite the employee's rejection of one) or evidence of intentional use or disclosure of Marietta's confidential information, and brushing aside the significant fact that Marietta had fired Fairhurst, the lower court extended the doctrine of inevitable disclosure well beyond the high water mark it had reached in Doubleclick.

Back to the Future

In January 2003, a unanimous panel of the Third Department reversed the lower court's decision in Marietta, and rendered a decision in line with EarthWeb. Marietta Corp. v. Fairhurst, 2002 WL 31898398 (3d Dep't, Jan. 2, 2003). Criticizing the lower court's decision, the court commented that despite the lack of evidence of misappropriation or disclosure, the lower court built from the concept of a threatened disclosure of trade secrets and “utilized a doctrine, not yet adopted by the state courts, of inevitable disclosure” to reason that Fairhurst was extremely likely to use Marietta's trade secrets and hence to conclude that Marietta met its burden of showing irreparable harm necessary for the issuance of a preliminary injunction.

Adopting the reasoning in EarthWeb, the court observed that irreparable harm is established only when a trade secret is misappropriated and when an employee is bound by an implied restrictive covenant. “[W]here there is no actual theft of a trade secret, the court, in applying the doctrine of inevitable disclosure, is 'asked to bind the employee to an implied-in-fact restrictive covenant' not to compete. As no restrictive covenant was in existence here and our well entrenched state public policy considerations disfavor such agreements, the doctrine of inevitable disclosure is disfavored as well, 'absent evidence of actual misappropriation by an employee'” (quoting EarthWeb).

Further critiquing the lower court's reasoning, the court stated: “While we agree that Fairhurst was privy to confidential information, there exists a valid and enforceable confidentiality agreement which clearly anticipated that he may change his employment during its duration after acquiring plaintiff's confidential information. Upon the record presented, we fail to find evidence of a breach of such agreement or that the confidential information also constituted a trade secret … Hence, in our view, Supreme Court adopted an overly expansive definition of “trade secret” so as to encompass nearly all confidential business documents … We find plaintiff's claims to be self-serving, entirely conjectural and insufficient to support the theory that Fairhurst had used or threatened to use a “trade secret.” Absent any wrongdoing which would constitute a breach under the confidentiality agreement, mere knowledge of the intricacies of a business is simply not enough … We find a clear abuse of discretion in the granting of the motion” (citations omitted).

Until the lower court's decision in Marietta, courts in New York had limited the application of the doctrine of inevitable disclosure to two circumstances: 1) to bolster the enforceability of a restrictive covenant, or 2) as an evidentiary “assist” in cases involving actual misappropriation of trade secrets. It would, therefore, be highly unlikely that high-level executive who was fired by his employer — which had tried, but failed, to obtain an agreement with the executive not to compete after the termination of employment – could be prevented from working for a competitor, even in the same position, in the absence of actual misappropriation of trade secrets. The tides have, once again, turned, returning the doctrine of inevitable disclosure to its former place.