The Business Divorce Law Report
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Statutes that protect the rights of the owners of trade secrets protect against ‘misappropriation’ of confidential information, which requires a defendant to take or use the trade secret without permission.
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The inevitable disclosure doctrine can prevent an employee from working for another when the new job would inevitably require the use of the trade secrets of the former employ. Intent to misappropriate the information is not an element.
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A party seeking to prevent disclosure of a trade secret under the inevitable disclosure doctrine will probably not be able to pursue the remedies available under the federal Defend Trade Secrets Act or the state Uniform Trade Secrets Act.
When a key executive with access to key data leaves an information-intensive position to start a competing business, does the fact that inevitably the former employee will make use of sensitive state a claim under federal law? Quite possibly not.
The federal Defend Trade Secrets Act (DTSA ) and the uniform state law on which it is modelled turns on the concept of misappropriation and without it, there may be no basis. Inevitable disclosure is a common-law doctrine and in itself may not create a right to sue under the these trade secret statutes.
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The inevitable disclosure doctrine is legal principle in trade secret law that enables a former employer to prevent a former employee from accepting a new position with a rival if the new position’s responsibilities will unavoidably cause the person to divulge the trade secrets of the former employer. The doctrine may apply even if fthe former employer lacks concrete evidence that the employee has actually taken trade secrets or threatened to do so.
The Difference Between the DTSA and the Inevitable Disclosure Doctrine
In a federal court action, Paro Inc., a Delaware corporation, unsuccessfully sought an emergency temporary restraining order against former employee Luke Kohan, a New York resident, and his newly founded company, FirmKey Solutions LLC, claiming Kohan was in breach of a restrictive covenant and had misappropriated trade secrets. Paro, an artificial intelligence-powered marketplace, provides various finance and accounting solutions to businesses through its AI-powered platform.
The case was decided under federal law and the Uniform Trade Secrets Act, adopted in both New Jersey and Illinois. Illinois law was applied to the breach of contract claim, which is similar to the applicable law in most states, including New Jersey and New York.
Kohan was responsible for converting leads from Paro’s marketing team into long-term clients, managing the full sales cycle, building relationships with clients, and supporting Paro team members. Kohan voluntarily resigned from Paro in March 2023 and co-founded FirmKey in April 2023.
Kohan had signed a Non-Competition, Non-Solicitation, Non-Disclosure, and Invention Assignment Agreement (Employment Agreement) with Paro, agreeing not to disclose, use, or misappropriate Paro’s Confidential Information. The Employment Agreement also provided that Kohan could not compete directly or indirectly with Paro, solicit any of Paro’s clients and employees, or interfere with Paro’s client and employee relationships for a period of 12 months after leaving his employment.
Restraining Order Sought for Violation of Trade Secret Statute
Paro sought a temporary restraining order and alleged that Kohan would not be able to compartmentalize his knowledge of Paro’s Confidential Information while operating FirmKey and would draw on that knowledge ill draw upon his vast and intimate knowledge of Paro’s Confidential Information. Its claim was based on the allegedly inevitable disclosure by Kohan of Paro’s trade secrets.
An inevitable disclosure case can be made out when the former employee had access to trade secrets as an employ and the job duties in a new position are so similar to his or her old job duties that they would inevitably require the former employee to rely on the former employer’s trade secrets there is no feasible way to avoid disclosing the trade secrets in the course of performing the new job.
However, to secure temporary restraints, a party must first establish that it has a reasonable likely of success in its cases. Because Paro could not show that it was likely to succeed on either its federal law claim under the Defend Trade Secrets Act (DTSA) or its state-law breach of contract claim alleging the violation of the restrictive covenant that Kohan had executed when he joined the company, the temporary restraints were denied.
Analyzing the Reasonableness of the Restrictive Covenant
The non-compete covenant prohibited Kohan from engaging in the “Business,” which was defined to include the provision of outsourced financial services, financial analysis, and CFO strategy services, or the provision, development, marketing, sale, or maintenance of products or services substantially similar to those developed, marketed, distributed, sold, maintained, or actively planned to be during the term of Kohan’s employment with the Company.
The Court examined the reasonableness of the restrictive covenant in question. Before enforcing a restrictive covenant, the Court must must be satisfied that (1) the non-compete is ancillary to a valid contract and (2) is supported by adequate consideration. Under Illinois law, which applied to the case, a restrictive covenant is reasonable only if the covenant is no greater than is required for the protection of a legitimate business interest of the employer-promisee; (2) does not impose undue hardship on the employee-promisor; and (3) is not injurious to the public.
Paro argued that Paro and FirmKey are direct competitors, and that Kohan had access to and knowledge of Paro’s Confidential Information when he was an employee of Paro’s. The Court accepted that Paro and FirmKey are competitors, and that the scope of the restrictive covenant is problematic. The Court noted that it had confirmed at the TRO hearing that the term “outsource” is commonly defined as “(of a company or organization) to purchase (goods) or subcontract (services) from an outside supplier or source.”
The trial judge went on to hold that Paro had not demonstrated a likelihood of success on the merits of its claims, specifically in the case of the non-compete restrictive covenant. The court held that Paro had not supported the breadth of the specific non-compete clause, or comparably broad clauses, with any case law.
Non-Compete Agreement Unenforceable Under State Law
Enforcement of the non-compete provision would, the judge found, in effect, preclude Kohan from working in any capacity in the industry in which Paro does business anywhere in the United States, or in any other part of the world where Paro has conducted business. Counsel for Paro had argued during the TRO hearing, that Paro’s position that was that its business encompasses in the entire “outsourced financial services” sandbox, marketing to companies of all sizes, including mom-and-pop shops, Fortune 500 companies, and some of the largest accounting firms in the United States.
Paro, meanwhile, conceded that Kohan was working on the “white label suite of clients” as a Senior Account Executive at Paro, which is primarily the larger companies and accounting firms. In other words, the non-compete is not an activity restraint limited to the clients that Kohan serviced, but goes beyond those clients to those he never serviced, and restricted him from working in any capacity for a competitor.
Ultimately, the judge held that the non-compete was far broader than necessary to protect Paro’s legitimate business interests, which primarily involve protecting its confidential client and client-related information. While Paro contended the employment agreement simply memorialized the deal Kohan made and agreed to when he became an employee of Paro, that contention alone, the court held, did not make the non-compete reasonable.
The court then went on refuse to revise, or “blue-pencil” the non-compete clause enforceable, relying on Illinois law that gives trial judges discretion in deciding whether to revise a restrictive covenant to narrow its scope so as to make it enforceable. A court should not, the judge noted, blue-pencil a restrictive covenant that is not reasonable. The court found that non-compete at was unreasonable and not justified by Paro’s legitimate business interests, and declined to rewrite it so that the restriction could be enforced by Paro.
Inevitable Disclosure Not a Viable Theory Under the DTSA or UTSA
Paro also sued under both the federal Defend Trade Secrets Act and the Illinois Trade Secrets Act (taken from the Uniform Trade Secrets Act), analyzing the likelihood of success of the federal and state claims together, as both statutes are substantially identical.
For Paro to show that Kohan and FirmKey misappropriated a trade secret, Paro was required demonstrate that “(1) a trade secret existed; (2) it was misappropriated through improper acquisition, disclosure, or use; and (3) the misappropriation damaged the trade secret’s owner.”
Misappropriation under both the DTSA and the UTSA Misappropriation requires the plaintiff to prove that the trade secret was acquired by improper means; was disclosed or used without the owner’s consent; or had been obtained by inducing or causing another person to violate the owner’s secrecy obligations.
The Court was satisfied that Paro had had shown that the information was a trade secrets in that it included confidential customer lists and client-related information, and that Paro had maintained the secrecy of this information through confidentiality agreements and password protection.
However, on the issue of whether actual or threatened misappropriation of Paro’s trade secrets had occurred or was likely to occur, Paro maintained only that Kohan and FirmKey had “threatened” and will “inevitable[y]” misappropriate Paro’s trade secrets and confidential information.
Paro conceded it did not have any evidence of actual misappropriation. Thus, Paro’s theory was, the trial judge said, one of “inevitable disclosure.”
Thus, according to the court, Paro’s TRO motion was predicated on the fact that Kohan’s skills and knowledge were gained while at Paro and that alone would lead to the inevitable disclosure of Paro’s trade secrets.
The Court took note of another decision that for a claim based on inevitable disclosure under the DTSA is insufficient because the statute requires that the trade secret information actually be misappropriated.
It is important to note that the failure to show the misappropriation based only on the inevitable disclosure doctrine turned n the fact that there was not breach of a contractual prohibition under local law. Both the DTSA and USTA will consider information obtained or used in violation of a contract as misappropriation of a trade secret.
Thus, the result under statutory trade secret law could be different if the underlying contract claim were resolved differently. If the restrictive covenant was enforceable in another state, the outcome under the statutory claims might be different.