Pitfalls of Poaching Employees After A Deal Craters; Luring talent from a suitor, or losing employees, after deal talks crumble presents risks for both companies

For most companies, their intangible assets – trade secrets and corporate know-how – are what give them an edge over their competitors. In an acquisition, they are often among the most coveted assets. So, any firm that enters into deal discussions with a potential suitor – particularly a rival – faces a dilemma: Reveal too little to your suitor, and the likelihood of reaching an agreement diminishes; divulge too much, and you open yourself to loss of competitive information if the deal talks cease. If a prospective deal partner is a competitor – or could be if it poached some of your top employees – keep in mind the consequences of including employees and revealing sensitive, competitive information in deal talks, which might not pan out. After meeting each other’s key employees, the parties to the aborted deal may contemplate cherry-picking talent from the other side, hoping to gain expertise, customer contacts, and perhaps even a few trade secrets. At the same time, some employees who were involved in the deal talks may be wondering whether working for the other company might provide better career opportunities. The price of opportunity is vulnerability, and the downside of disclosure is that it opens you up to the possibility that employees who decide to leave the company after deal negotiations fail will take with them expertise and trade secrets. Conversely, luring employees away from your competitor invites the risk that a trade secret theft or corporate raiding lawsuit will be brought against you. In either case, you could wind up being the plaintiff or the defendant in such a suit. These all-too-common scenarios present risks for all concerned. As companies negotiate deals, they should keep in mind: * Challenges imposed by the right of at-will employees to change jobs; * Employee solicitation limits on competitors; * Customer and co-worker solicitation limits on departing employees; and * Actions for minimizing the risks of a talent raid It’s also wise to know the ropes in asserting and defending corporate raiding, trade secret theft, and unfair competition claims, which are discussed below. Two conflicting legal principles frame this discussion, creating a legal tug-of-war. One, involving freedom of association, recognizes employees’ right to accept jobs of their choice. The second tenet holds that former employees should not be permitted to use misappropriated confidential or trade secret information to compete unfairly for their ex-employer’s customers and remaining employees. In California, as in many other states, most employees are “at-will,” meaning that they can leave whenever they want, and that their employer can likewise terminate them at will. At-will employees can seek employment with any company, including a competitor to their ex-employer. By the same token, an employer has the right to preserve its customer and employee relationships against unfair competition and to maintain the confidentiality of its trade secrets from misappropriation by ex-employees and rival companies. As recognized by the California Supreme Court: “Equity will to the fullest extent protect the property rights of employers in their trade secrets and otherwise, but public policy and natural justice require that equity should also be solicitous for the right inherent in all people, not fettered by negative covenants upon their part to the contrary, to follow any of the common occupations of life.” In the 2004 case of Reeves v. Hanlon, the California Supreme Court resolved the tension between these two competing principles. Reeves involved an employer – a law firm – whose workers were solicited away by a former employee. The departing employees took with them confidential and proprietary information, solicited their former employer’s clients, destroyed electronic data, left no exit memos to describe the projects they have been working on before they left, and issued misleading press releases to their former employer’s clients suggesting that the firm was going out of business. In effect, they crippled their former firm from competing with them for clients. Although the Supreme Court recognized the general right of at-will employees to change jobs, it also held that the right to work for an employer of one’s choice does not permit departing employees (or a third party who solicits them) to commit so-called “independent wrongful acts,” which include actions “proscribed by some constitutional, statutory, regulatory, common law, or other determinable standard.” In Reeves, those “independent wrongful acts” included tortious interference with the firm’s prospective business advantage (soliciting the firm’s at-will employees and clients using confidential and trade secret information) as well as alleged theft of the firm’s trade secrets. The question remains, however, whether a departing at-will employee may solicit his or her former employer’s customers, and the answer depends on how the solicitation occurs. Many, if not most, key employees, especially marketing staff responsible for developing and retaining customer business, expect their business contacts to follow them to their next place of employment. Employees typically refer to customers as “their” customers,” not “the company’s” customers. Although most of these employees might recognize that they cannot actively solicit customers for a competitor before they leave, some, nonetheless, will do so to try to solidify their position before starting a new job. Others will solicit former customers as soon as they join a competitor, believing that doing so is fair game. In so doing, they may well (consciously or not) be using confidential or trade secret information about those customers, which is protected from use or disclosure by the departing employee. What are customer solicitation limits on employees who switch employers, especially in the context of using trade secret information in doing so? According to the California Supreme Court, departing employees can “announce a change of employment, even to clients on a protected trade secret client list…because such conduct is basic to an individual’s right to engage in fair competition.” If the customer decides to move its business based on an announcement and nothing more, the Reeves Court would clearly approve. If, on the other hand, the former employee utilizes his or her confidential or trade secret information to solicit business, for example by offering to undercut prices or terms offered by the former employer, those “independent wrongful acts” would expose the ex-employee – and his or her new employer – to legal claims for injunctive relief and damages. Hiring employees from a rival always creates the potential for claims of corporate raiding and misappropriation of trade secrets. The following recommendations may ameliorate that risk for companies that hire defecting employees: Avoid hiring large groups of employees Mass defections may appear to a judge or jury as conspiratorial and orchestrated. If more than one employee is changing jobs, consider hiring them in phases, not as part of a mass recruitment. Bar new employees from transferring confidential information New hires should be counseled before they change jobs to not take any confidential or trade secret information from their former employer, especially via a home computer. Employees who change jobs should return all confidential data to their company before leaving and should retain no copies of the information. Instruct employees not to destroy data upon leaving his or her former employer Departing employees should not destroy any information, in order to avoid the appearance that they are trying to cripple or harm their previous employer or trying to compete unfairly for their former customers’ business. Recommend preparation of an exit memorandum Before leaving, employees should prepare a detailed exit memo that outlines the status of each project they were handling and what needs to be done to serve customers. Impose a marketing blackout period The hiring company should consider imposing a blackout period during which time new hires cannot reach out to their former customers, even if those customers approach them to do business. Prepare a joint announcement of the new job Departing employees should offer to work jointly with their former employer to prepare a public announcement, such as a press release, about their new job. Preserve electronic and hard copy data The new employer should preserve data to avoid claims that it destroyed evidence of unfair competition, which a competitor could use to prove corporate raiding. Think before you write Remind the people who are recruiting an employee not to characterize his or her hiring potential in e-mails or other correspondence in such a way that makes the hiring appear to be for the purpose of harming the competitor or encouraging the competitor’s customers to follow the employee. It’s prudent for a company that hires employees from a competitor to take precautions, although doing so does not prevent the rival company from bringing a lawsuit. If a suit is filed, the following actions may help defending your organization against claims of trade secret theft or corporate raiding. The Uniform Trade Secrets Act (UTSA), enacted in most jurisdictions in the country, mandates that a trade secret misappropriation plaintiff must first identify its allegedly stolen trade secrets with “reasonable particularity” before it can conduct any discovery in the lawsuit. This is one of the first battles fought in defending against claims of trade secret theft, and it offers an early opportunity to educate the court about the weaknesses in the plaintiff’s case and the strengths in yours. To defeat a trade secret theft claim, argue that the alleged trade secrets are “generally known to the public” – i.e., not secret – that the plaintiff failed to use “efforts that are reasonable under the circumstances to maintain” the secrecy of its trade secrets, and that customer lists are not trade secrets, especially if customer information is publicly accessible. Ask the court to order that the plaintiff post a large bond to support any order of injunctive relief. If the plaintiff is granted an injunction but cannot obtain a bond from a corporate surety, the injunction will not go into effect, meaning that the plaintiff may have won a pyrrhic battle and lost the injunction war. To the extent that the defecting employees are named parties in the litigation, raise employee rights, but be sensitive to the need to hire separate counsel for them. Representing the company and defecting employees may involve conflicting interests and, in some circumstances, risks waiving the attorney client privilege. Under the UTSA, trade secret misappropriation claims brought in bad faith entitle a defendant to recover its attorneys’ fees and costs. Other Side of the Coin Consider another scenario: Your company ended talks with a prospective merger partner – a competitor. Some of your top producers told you during the deal discussions that they would have a better platform to do business following a merger of the two companies. You’re concerned that they may leave to join the competitor, taking your customers and trade secrets with them. What can you do to protect your business? Before your company becomes the target of employee or customer poaching, consider the following: 1. Develop and maintain policies and procedures that preserve the confidentiality of company information. Have employees acknowledge in writing that confidential company information is a valuable asset of the company, that it is their job to maintain its confidentiality, and that they will comply with the company’s confidentiality policy. 2. For key employees, consider nondisclosure agreements and limited non-competition agreements (note, some states disallow non-competition agreements, so consult legal counsel before requiring your employees to sign them). 3. Consider a “garden leave” policy under which exiting employees are paid during a “waiting period” after their formal employment ends. (Note that some states may not permit a “garden leave” limitation on at-will employees’ right to change jobs, so consult counsel before including such a requirement.) This tactic is often used to prevent departing employees from working for a rival firm for a period of time, and it may inhibit the employees, who are still on your payroll, from soliciting customers during that time. This may also give the employer time to shore up relations with the customers of employees who are leaving. 4. Be sure your IT department is prepared to act on short notice to preserve departing employees’ e-mails, voice mails, and hard drives as well as security camera tapes and other electronic data that may be needed to prove trade secret theft and/or unfair competition. If your company faces employee defections to a competitor, act immediately. If you sit on your rights, you risk suffering significant financial harm in the interim and losing your opportunity to obtain injunctive relief, which can be the key to winning a corporate raiding and trade secret theft case. With the help of legal counsel, your company should immediately begin to collect facts and declarations that demonstrate independent wrongful acts, trade secret theft, and/or unfair competition in order to protect and pursue your legal rights. Send cease-and-desist letters to the former employees and their new companies. Start collecting data for your damages claim, realizing that your damages may be negatively impacted by the injunctive orders you seek. Once your organization has decided to file a lawsuit, preparing for and managing the suit are crucial and may have a significant impact on the outcome. With counsel, review what legal theories you can sue under, the burden of proof you will be required to meet, and the goals to be attained by bringing the lawsuit. In analyzing what legal theories to pursue, do not be so outraged at the conduct of your competitor or your ex-employees as to limit your legal claims to those based in intentional misconduct. Negligence-based legal theories potentially trigger insurance coverage; intentional misconduct claims do not, and insurance coverage may be a potent tool in obtaining a significant recovery. Potential claims include misappropriation of trade secrets, interference with prospective business advantage, interference with an at-will employment contract, unfair competition, breach of fiduciary duty (corporate officers are fiduciaries), conspiracy, constructive fraud, injunctive relief, constructive trust, unjust enrichment, breach of contract (to the extent that there is a contract involved), and conversion (if property is taken/destroyed). Early Action Is Critical Immediate recommended action includes seeking an ex parte temporary restraining order as soon as possible, before the competitor and its new employees have time to get their stories straight or gather facts. Also, consider seeking an ex parte electronic discovery preservation order that applies to company computers, home computers, and PDAs to prevent the routine destruction of crucial e-mails that may make your case. Other early actions will include obtaining a protective order to preserve trade secret confidentiality and an ex parte order for expedited discovery, so that you can meet your burden of proof at the preliminary injunction hearing. If granted, a preliminary injunction often signals the end of these cases, because an appeal from a preliminary injunction often takes longer to prosecute than getting to trial. Once enjoined from soliciting your customers, the departing employees’ value to your competitor will diminish dramatically. Your company should also consider lining up competent and experienced e-discovery consultants, and perhaps consider using an experienced e-discovery referee. Though many state courts are not yet bound by formal e-discovery rules, federal court rules went into effect last December. You should be prepared to respond to e-discovery requests in both state and federal court via your internal IT department and in cooperation with outside e-discovery consultants and counsel. Immediately seek information from your competitor’s computers, backup tapes, all e-mails going back to the theoretical beginning of employment discussions with your ex-employees, the defendants’ home computers, PDAs, and other electronic storage media. ISPs routinely destroy home e-mail information, even if the user does nothing to delete old data, so you need to act early to preserve this information. No lawsuit is filed lightly, and the business impact is a major consideration in making that decision. What damages is a company that alleges trade secret theft or corporate raiding entitled to if it prevails? Among the damages that may be claimed are: * Lost profits * Decreased enterprise value * Value of “stolen” business * Unjust enrichment * Out-of-pocket costs * Costs of recruiting replacement employees * Equipment costs, for any stolen or destroyed property In some cases, punitive damages may also be available. However, it is rare in a business-versus-business case for either side to obtain an award of punitive damages. For that reason, companies should rarely invest their capital in litigation expenses hoping for such an award. Another consideration in deciding whether to file suit is the cost. Litigating these types of claims can be quite expensive, and a company may have to decide whether it wants to “invest” its capital in litigation, with an unknown outcome, or in a venture in which the returns are more certain. Notably, most parties to these lawsuits must bear the cost of their own legal expenses, because the law in most jurisdictions does not allow for reimbursement of those fees to the prevailing party. The UTSA awards attorneys’ fees to the defendants only if a plaintiff asserts a trade secret misappropriation claim in “bad faith,” which is a fairly difficult standard to meet. Finally, any party should be aware of potential peripheral issues and cross-claims, which include pension, profit sharing, unpaid salary/commissions and stock option rights claims, access to personal and private employee information, and possible discrimination cross-claims (age, sex, orientation, gender, etc.) by departing employees. Any company mulling over a merger or acquisition should always think a number of chess moves ahead – considering the potential deal opportunities as well as any consequences of a cratered deal. Your advisers should not only be skilled at helping you complete deals, but also at counseling you in the event that you recruit or lose key employees in the wake of failed deal talks. James Wright, a Shareholder and business litigator in the San Francisco office of Buchalter Nemer, specializes in employee defection litigation, unfair competition, class-action defense, and resolution of business disputes, including trade secret litigation. (c) 2007 Mergers and Acquisitions Journal and SourceMedia, Inc. All Rights Reserved. http://www.majournal.com http://www.sourcemedia.com