Traditionally, in Maryland, as in many states, the fiduciary obligations of corporate directors run to the corporation and its shareholders as a class, rather than to individual shareholders. A recent opinion of the Maryland Court of Appeals, however, has partially rejected that long-standing rule. In Shenker v. Laureate Education, Inc., 2009 Md. LEXIS 837 (Court of Appeals, November 12, 2009), click here, Maryland's highest court held that, in a cash-out merger situation, where a decision to sell a company has been made by its Board of Directors, those directors owe a common law fiduciary duty to maximize the value to be received from the sale by the shareholders. Moreover, individual shareholders can sue those directors for breach of that duty.
The plaintiffs in Shenker were shareholders in a successful publicly held Maryland company, Laureate Education, Inc. During 2006 and 2007, several of the directors of LEI and some private equity investors purchased LEI through a cash-out merger transaction. In a cash-out transaction, sometimes called a freeze-out, the dominant shareholder(s) generally incorporates a company to gain ownership of the target company through a cash transaction. The inside directors are, thus, able to pressure other shareholders to sell their shares to the acquiring company for cash. Shenker and other shareholders accused the interested directors of failing to maximize the price per share in the offer and misleading the shareholders with regard to the tender offer. The trial court and Court of Special Appeals dismissed the action finding that the shareholders could not maintain a direct action against the directors under Maryland law. Under their reasoning, such a claim could only be maintained derivatively. They also held that the directors owed no fiduciary duty to the shareholders, but only to the company.
The Court of Appeals rejected that analysis. It found that, while Section 2-405.1 of the Corporations and Associations Article of the Maryland Code established the duties of directors while engaged in their managerial duties for the corporation, other common law duties coexisted with those statutory duties. Specifically, it found that the directors owed the shareholders the common law duties of candor and good faith efforts to maximize shareholder value and that a shareholder alleging that directors had breached those duties could maintain a direct suit against those directors.
Relying upon the Delaware Supreme Court's decision in Revlon, Inc. v. MacAndrews & Forbes Holding, Inc., 506 A.2d 173, 182 (Del. 1986), the Court of Appeals held that those common law duties are triggered once the Board has determined to sell the corporation. And the common law duties are personal to the shareholders. In a sale situation, the directors act as fiduciaries for the shareholders and owe a duty to maximize the price per share that is realized. In addition, according to the court, the directors owe a duty to make full disclosure to the shareholders of all facts related to the transaction.
The Maryland court's holding is the opposite of the rule in Virginia. In Willard v. Moneta Building Supply, Inc., 515 S.E.2d 277 (Va. 1999), the Virginia Supreme Court expressly rejected the Revlon rule, holding that in a sale situation, a director is not required to maximize the sales price, but is only required to "act in accordance with 'his good faith business judgment of the best interests of the corporation.'" Id. at 284. Moreover, as the court found in Willard, in the absence of fraud or some other disqualification under Section 13.1-747 of the Code of Virginia, the directors, as majority shareholders, maintained the right to control the management of the corporation by voting their shares to approve the sale of the company. Id. at 288. Section 13.1-747, allows for the dissolution of a corporation where the directors are acting in a manner that is illegal, oppressive or fraudulent.
Thursday, December 17, 2009
Tuesday, November 24, 2009
Tortious Interference with Business Expectancy in the District of Columbia-- A Split Among Jurists Regarding Pleading Requirements
A split has developed between District Court judges in the District of Columbia regarding the requirements to plead a count alleging tortious interference with business expectancy. In a post on June 18, 2009, I reported that Judge Ricardo Urbina had issued an opinion requiring the plaintiff to name the third parties with which it had a relationship or expectancy in order to survive a motion to dismiss the claim. Command Consulting Group, LL v. Neuraliq, Inc., 2009 U.S. Dist. Lexis 48082 (D.D.C. June 9, 2009). In a more recent opinion, Judge Richard Roberts rejected that requirement.
In Kimmel v. Gallaudet University, 639 F. Supp.2d 34 (D.D.C. 2009), plaintiff, the former Dean of the College of Liberal Arts, Sciences, and Technologies and a tenured professor, alleged that she was harrassed by various faculty members, excluded from administrative decisions, had her job responsibilities reduced and was a victim of defamatory statements because she supported an unpopular President of the University. In her complaint she alleged that Gallaudet tortiously interfered with her "valid business expectancy that she would be able to teach, and possibly also serve as an administrator, in higher education until her retirement." She also alleged that "agents and employees of Gallaudet intentionally interfered with this business expectancy by spreading false and defamatory lies" and that "[a]t least three potential sources of prospective employment have disappeared" as a result of those actions.
Gallaudet moved to dismiss the count arguing that Kimmel had not specifically identified a third party with whom she had the business expectancy. Judge Roberts rejected the argument, holding that "[a]lthough Kimmel has not specifically named each alleged potential source of prospective employment or expressly asserted that Gallaudet had knowledge of these expectancies, reasonable inferences can be drawn from Kimmel's factual assertions that Gallaudet acted intentionally, and notice pleading does not require the complaint to specify the entities with whom she had an expectancy." Id. at 45. The court relied upon Browning v. Clinton, 292 F.3d 235,243 (D.C. Cir. 2002) where the D.C. Circuit reversed a decision dismissing a count alleging tortious interference with business expectancy. In Browning, the plaintiff did not allege the names of specific publishers that had failed to positively respond to submission of her book for publication. Nevertheless, the circuit court found that the plaintiff was entitled to proceed with the claim, holding that whether a triable issue of fact existed should be reserved for summary judgment. Id.
Accordingly, as it stands in the District of Columbia there is no consensus with regard to what must be pled to allow a claim of tortious interference with business expectancy to proceed to trial.
In Kimmel v. Gallaudet University, 639 F. Supp.2d 34 (D.D.C. 2009), plaintiff, the former Dean of the College of Liberal Arts, Sciences, and Technologies and a tenured professor, alleged that she was harrassed by various faculty members, excluded from administrative decisions, had her job responsibilities reduced and was a victim of defamatory statements because she supported an unpopular President of the University. In her complaint she alleged that Gallaudet tortiously interfered with her "valid business expectancy that she would be able to teach, and possibly also serve as an administrator, in higher education until her retirement." She also alleged that "agents and employees of Gallaudet intentionally interfered with this business expectancy by spreading false and defamatory lies" and that "[a]t least three potential sources of prospective employment have disappeared" as a result of those actions.
Gallaudet moved to dismiss the count arguing that Kimmel had not specifically identified a third party with whom she had the business expectancy. Judge Roberts rejected the argument, holding that "[a]lthough Kimmel has not specifically named each alleged potential source of prospective employment or expressly asserted that Gallaudet had knowledge of these expectancies, reasonable inferences can be drawn from Kimmel's factual assertions that Gallaudet acted intentionally, and notice pleading does not require the complaint to specify the entities with whom she had an expectancy." Id. at 45. The court relied upon Browning v. Clinton, 292 F.3d 235,243 (D.C. Cir. 2002) where the D.C. Circuit reversed a decision dismissing a count alleging tortious interference with business expectancy. In Browning, the plaintiff did not allege the names of specific publishers that had failed to positively respond to submission of her book for publication. Nevertheless, the circuit court found that the plaintiff was entitled to proceed with the claim, holding that whether a triable issue of fact existed should be reserved for summary judgment. Id.
Accordingly, as it stands in the District of Columbia there is no consensus with regard to what must be pled to allow a claim of tortious interference with business expectancy to proceed to trial.
Friday, October 23, 2009
Virginia Court Limits Reach of Preemption Provision of Uniform Trade Secrets Act
Does the Virginia Trade Secrets Act preempt all related business tort claims? Not necessarily, according to a recent unfair business practices case from the Eastern District of Virginia. In E.I. DuPont de Nemours and Co.v. Kolon Industries, Inc., 2009 U.S. Dist. LEXIS 76795, 2009-2 Trade Cas. (CCH) P76,728 (E.D. Va. August 27, 2009), click here, DuPont alleged that the defendant, Kolon, had hired one of its former employees, Michael Mitchell, and enticed him to reveal DuPont’s trade secrets not only relating to the development of KEVLAR aramid fiber, but also as to DuPont’s pricing and rebate practices. In addition, it alleged that Kolon had recruited other DuPont employees who possessed knowledge regarding the aramid fiber manufacturing process. And Kolon allegedly had solicited DuPont’s long-standing customers by using confidential pricing and rebate information and informing the customers that Kolon had hired former DuPont employees who had assisted Kolon in making significant improvements to its product.
DuPont included six counts in its complaint: (1) violation of the Virginia Trade Secrets Act, Va. Code §59.1-341; (2) statutory business conspiracy, Va. Code §18.2-499 et seq.; (3) tortious interference with contract; (4) tortious interference with business expectancy; (5) conversion; and (6) civil conspiracy. Kolon moved to dismiss the complaint in its entirety.
First, Kolon argued that the preemption provision of the Trade Secrets Act required dismissal of all counts in the complaint other than the one alleging a violation of the Act itself because all of the counts were based entirely upon a misappropriation of trade secrets theory. The court rejected this argument pointing out that Kolon disputed that the information at issue was a trade secret. As the court noted: “unless it can be clearly discerned that the information in question constitutes a trade secret, the Court cannot dismiss alternative theories of relief as preempted by the VUTSA,” quoting Stone Castle Fin., Inc. v. Friedman, Billings, Ramsey & Co., 191 F. Supp.2d 652, 659 (E.D. Va. 2002). Thus, as long as Kolon contended that the information at issue was not a trade secret the court could not consider the preemptive effect of the Trade Secrets Act based upon the pleadings alone.
Next, Kolon argued that, under the statute, all claims arising from the same nucleus of facts as the misappropriation of trade secrets claim were preempted by the Trade Secrets Act. The court rejected this argument also, holding that, under the prevailing interpretation in the Eastern District of Virginia, the preemption provision does not bar all claims that could arise out of factual circumstances that may involve a trade secret. Instead, preemption would apply only to claims that were predicated “entirely” upon the misappropriation of trade secrets.
Applying these principles to the separate counts for tortious interference with contract and business expectancy the court found that DuPont had pled facts separate from the trade secrets allegations in support of those counts. Notably DuPont alleged that Kolon had “used DuPont’s confidential information and trade secrets.” Because the allegations were phrased in the conjunctive and were not predicated solely upon the misappropriation of trade secrets, the court refused to dismiss those counts. Likewise, it denied the motion to dismiss the conspiracy counts on the basis that the concerted action included allegations separate from misappropriation of trade secrets.
Finally, Kolon argued, unsuccessfully, that the conversion count was subject to dismissal because conversion could not apply to the taking of electronic copies of a document, only to the original. The court, again, sided with DuPont, finding that even though Virginia courts have not addressed whether the possession of “copies” of documents can constitute conversion, the courts have “demonstrated a distinct willingness to expand the scope of the doctrine of conversion in light of advancing technology.” Thus, it held that “the purloining of copies of documents would constitute conversion because such action is an act of ‘dominion’ inconsistent with the true owner’s property rights.”
DuPont included six counts in its complaint: (1) violation of the Virginia Trade Secrets Act, Va. Code §59.1-341; (2) statutory business conspiracy, Va. Code §18.2-499 et seq.; (3) tortious interference with contract; (4) tortious interference with business expectancy; (5) conversion; and (6) civil conspiracy. Kolon moved to dismiss the complaint in its entirety.
First, Kolon argued that the preemption provision of the Trade Secrets Act required dismissal of all counts in the complaint other than the one alleging a violation of the Act itself because all of the counts were based entirely upon a misappropriation of trade secrets theory. The court rejected this argument pointing out that Kolon disputed that the information at issue was a trade secret. As the court noted: “unless it can be clearly discerned that the information in question constitutes a trade secret, the Court cannot dismiss alternative theories of relief as preempted by the VUTSA,” quoting Stone Castle Fin., Inc. v. Friedman, Billings, Ramsey & Co., 191 F. Supp.2d 652, 659 (E.D. Va. 2002). Thus, as long as Kolon contended that the information at issue was not a trade secret the court could not consider the preemptive effect of the Trade Secrets Act based upon the pleadings alone.
Next, Kolon argued that, under the statute, all claims arising from the same nucleus of facts as the misappropriation of trade secrets claim were preempted by the Trade Secrets Act. The court rejected this argument also, holding that, under the prevailing interpretation in the Eastern District of Virginia, the preemption provision does not bar all claims that could arise out of factual circumstances that may involve a trade secret. Instead, preemption would apply only to claims that were predicated “entirely” upon the misappropriation of trade secrets.
Applying these principles to the separate counts for tortious interference with contract and business expectancy the court found that DuPont had pled facts separate from the trade secrets allegations in support of those counts. Notably DuPont alleged that Kolon had “used DuPont’s confidential information and trade secrets.” Because the allegations were phrased in the conjunctive and were not predicated solely upon the misappropriation of trade secrets, the court refused to dismiss those counts. Likewise, it denied the motion to dismiss the conspiracy counts on the basis that the concerted action included allegations separate from misappropriation of trade secrets.
Finally, Kolon argued, unsuccessfully, that the conversion count was subject to dismissal because conversion could not apply to the taking of electronic copies of a document, only to the original. The court, again, sided with DuPont, finding that even though Virginia courts have not addressed whether the possession of “copies” of documents can constitute conversion, the courts have “demonstrated a distinct willingness to expand the scope of the doctrine of conversion in light of advancing technology.” Thus, it held that “the purloining of copies of documents would constitute conversion because such action is an act of ‘dominion’ inconsistent with the true owner’s property rights.”
Thursday, October 22, 2009
Private Regulation of Business Competition Through State Statutes and Common Law Theories
The news lately is peppered by the federal governments' (lack of?) regulation of businesses, but how do state statutes and the common law regulate businesses? That is the question addressed in the article The Use of State Statutes and Common Law Tort Theories to Regulate Business Conduct which can be found here.
The article "examine[s] how differences in state law can shape and influence what constitutes the appropriate bounds of business competition in a particular state." It focuses on the common law claims of intentional interference with contract or business expectancy and certain state statutory private rights of actions, such as the Massachusetts' Unfair and Deceptive Trade Practices Statute, North Carolina's unfair methods of competition statute or "little FTC act", and Virginia's statutory business conspiracy statute.
The article "examine[s] how differences in state law can shape and influence what constitutes the appropriate bounds of business competition in a particular state." It focuses on the common law claims of intentional interference with contract or business expectancy and certain state statutory private rights of actions, such as the Massachusetts' Unfair and Deceptive Trade Practices Statute, North Carolina's unfair methods of competition statute or "little FTC act", and Virginia's statutory business conspiracy statute.
Friday, October 9, 2009
Court Permits An Opposing Party's Lawyers to Interview a Company's Current Employees Outside the Presence of the Company's Lawyers
When an unfair business practices case arises, like in other types of cases, a company wants to know as much as possible about the adverse company's prior internal discussions and processes that resulted in the unfair business practice. But lawyers have been sensitive to the line between properly investigating a case and improper discussions with the adverse company's employees and agents.
A recent court opinion, however, allows one party's lawyers to interview the current employees of an adverse party provided that those employees are not senior enough or otherwise in a position to bind the corporation with their statements. The lawyers are even permitted to call the employees at their workplace during working hours.
This opinion is important because companies involved in a dispute may want to consider whether they should alert their employees to the potential for litigation and inform them that the opposing attorneys may call them. Companies should also consult with their attorneys about what they should say to their employees about the possibility of being contacted by the opposing party's attorney.
The case is Smith v. United Salt Corp., 2009 U.S. Dist. Lexis 82685 (W.D.Va. 2009), and can be found here. In that case, the plaintiffs brought a sexual harassment claim against their employer. Their lawyers sought to interview the employer's current employees outside the presence of the employer's lawyers. The plaintiffs argued that "it is important to speak with these employees because during the workday and while present on United Salt's premises, other employees may have learned of information relevant to the plaintiffs' allegations that defendant Foster sexually harassed them at work and that United Salt is liable for the sexual harassment."
"However, the plaintiffs contend that their intent in seeking ex parte communications with current employees of United Salt is not to obtain admissions imputable to the corporation. Instead, they state that they are merely attempting to gather information relevant to the incidents of sexual harassment that occurred on the premises of United Salt."
The court first considered Rule 4.2 of the Virginia Rules of Professional Conduct, which provides:
"In representing a client, a lawyer shall not communicate about the subject of the representation with a person the lawyer knows to be represented by another lawyer in the matter, unless the lawyer has the consent of the other lawyer or is authorized by law to do so."
Citing Rules of Supreme Court of Virginia Pt. 6, § II, Rule 4.2 (2000).
The court then looked to the opinion in Lewis v. CSX Transp., Inc., 202 F.R.D. 464 (W.D. Va. 2001), which recognized that "'[t]he general prohibition against an attorney having ex parte contact with a represented party is based on several rationales[,]' including 'preventing an attorney from circumventing opposing counsel to obtain unwise statements from an adverse party.'" "The court in Lewis found that, given this rationale, a represented corporate party retains an interest in 'preventing an opposing attorney from eliciting un-counseled statements from its employees, since such statements could affect the corporation's potential liability.'
"This court in Lewis held that when one of the parties is a corporation, as is the case here, Rule 4.2 prohibits ex parte communication with:
'(1) persons having managerial responsibility for the corporate party; (2) any other person whose act or omission in connection with that matter may be imputed to the corporate party for purposes of civil or criminal liability; or (3) any other person whose statement may constitute an admission on the part of the corporate party.'"
The court in United Salt then stated that "[i]t is important to note that, in Lewis, the employees with whom the plaintiff's counsel had ex parte contact were the very employees who used and maintained the piece of equipment at issue. In such a case, an admission by any of these co-workers stating that he knew the equipment was defective and that he had taken no action to cure the defect or warn his co-workers would, in fact, be an admission of liability imputable to the employer."
"Such is not the case in this matter. In a Title VII sexual harassment case, the employer is subject to vicarious liability only for acts of supervisory employees." "That being the case, only an admission by a supervisory employee stating that he took a 'tangible employment action' against a plaintiff or that he created a hostile work environment due to her gender would impute liability on the employer. While statements from co-workers regarding the actions of supervisory personnel could be used as evidence to prove that sexual harassment had occurred, those statements, from nonsupervisory personnel, would not be an admission imposing liability on the employer. With this distinction in mind, it appears that the rationale for the Lewis decision — to prevent an attorney from circumventing opposing counsel to obtain statements from employees which could be used to impute liability on the employer — is not present in this case."
"For all of the above-stated reasons, the court finds that Rule 801(d)(2)(D) in conjunction with Rule 4.2 of the Virginia Rules of Professional Conduct do not prohibit ex parte contact by plaintiffs' counsel with plaintiffs' co-workers, whose statements could not be used to impute liability upon the employee. The same rules, however, do prohibit ex parte contact in this context with any supervisory or managerial employees."
Before contacting an adverse party's employee, however, a lawyer will have to carefully analyze whether that employee can bind the corporation. While opening the door for lawyers to conduct broader investigations in some instances, this opinion is not without its own set of potential pitfalls.
A recent court opinion, however, allows one party's lawyers to interview the current employees of an adverse party provided that those employees are not senior enough or otherwise in a position to bind the corporation with their statements. The lawyers are even permitted to call the employees at their workplace during working hours.
This opinion is important because companies involved in a dispute may want to consider whether they should alert their employees to the potential for litigation and inform them that the opposing attorneys may call them. Companies should also consult with their attorneys about what they should say to their employees about the possibility of being contacted by the opposing party's attorney.
The case is Smith v. United Salt Corp., 2009 U.S. Dist. Lexis 82685 (W.D.Va. 2009), and can be found here. In that case, the plaintiffs brought a sexual harassment claim against their employer. Their lawyers sought to interview the employer's current employees outside the presence of the employer's lawyers. The plaintiffs argued that "it is important to speak with these employees because during the workday and while present on United Salt's premises, other employees may have learned of information relevant to the plaintiffs' allegations that defendant Foster sexually harassed them at work and that United Salt is liable for the sexual harassment."
"However, the plaintiffs contend that their intent in seeking ex parte communications with current employees of United Salt is not to obtain admissions imputable to the corporation. Instead, they state that they are merely attempting to gather information relevant to the incidents of sexual harassment that occurred on the premises of United Salt."
The court first considered Rule 4.2 of the Virginia Rules of Professional Conduct, which provides:
"In representing a client, a lawyer shall not communicate about the subject of the representation with a person the lawyer knows to be represented by another lawyer in the matter, unless the lawyer has the consent of the other lawyer or is authorized by law to do so."
Citing Rules of Supreme Court of Virginia Pt. 6, § II, Rule 4.2 (2000).
The court then looked to the opinion in Lewis v. CSX Transp., Inc., 202 F.R.D. 464 (W.D. Va. 2001), which recognized that "'[t]he general prohibition against an attorney having ex parte contact with a represented party is based on several rationales[,]' including 'preventing an attorney from circumventing opposing counsel to obtain unwise statements from an adverse party.'" "The court in Lewis found that, given this rationale, a represented corporate party retains an interest in 'preventing an opposing attorney from eliciting un-counseled statements from its employees, since such statements could affect the corporation's potential liability.'
"This court in Lewis held that when one of the parties is a corporation, as is the case here, Rule 4.2 prohibits ex parte communication with:
'(1) persons having managerial responsibility for the corporate party; (2) any other person whose act or omission in connection with that matter may be imputed to the corporate party for purposes of civil or criminal liability; or (3) any other person whose statement may constitute an admission on the part of the corporate party.'"
The court in United Salt then stated that "[i]t is important to note that, in Lewis, the employees with whom the plaintiff's counsel had ex parte contact were the very employees who used and maintained the piece of equipment at issue. In such a case, an admission by any of these co-workers stating that he knew the equipment was defective and that he had taken no action to cure the defect or warn his co-workers would, in fact, be an admission of liability imputable to the employer."
"Such is not the case in this matter. In a Title VII sexual harassment case, the employer is subject to vicarious liability only for acts of supervisory employees." "That being the case, only an admission by a supervisory employee stating that he took a 'tangible employment action' against a plaintiff or that he created a hostile work environment due to her gender would impute liability on the employer. While statements from co-workers regarding the actions of supervisory personnel could be used as evidence to prove that sexual harassment had occurred, those statements, from nonsupervisory personnel, would not be an admission imposing liability on the employer. With this distinction in mind, it appears that the rationale for the Lewis decision — to prevent an attorney from circumventing opposing counsel to obtain statements from employees which could be used to impute liability on the employer — is not present in this case."
"For all of the above-stated reasons, the court finds that Rule 801(d)(2)(D) in conjunction with Rule 4.2 of the Virginia Rules of Professional Conduct do not prohibit ex parte contact by plaintiffs' counsel with plaintiffs' co-workers, whose statements could not be used to impute liability upon the employee. The same rules, however, do prohibit ex parte contact in this context with any supervisory or managerial employees."
Before contacting an adverse party's employee, however, a lawyer will have to carefully analyze whether that employee can bind the corporation. While opening the door for lawyers to conduct broader investigations in some instances, this opinion is not without its own set of potential pitfalls.
Thursday, September 24, 2009
A Misrepresentation Made During a Contract Performance May Not Constitute Fraud
In a newly released opinion, the Virginia Supreme Court reaffirmed the Virginia rule that a fraud claim cannot be based upon one contracting party's false statements to another contracting party in absence of an independent common law duty. The opinion can be found here. This rule is designed to prevent ordinary breach of contract claims from turning into tort claims. The facts in the new case illustrate the principle neatly.
In Dunn Construction Company, Inc. v. Cloney, Cloney contracted with Dunn Construction to build Cloney a house. Dunn Construction improperly constructed the front foundation wall, and after the wall failed inspection, Dunn Construction agreed to repair the cinderblock wall with steel reinforcing bars referred to as "rebar". After a second inspection and further repairs, Dunn Construction presented Cloney a final invoice. Cloney disputed parts of the invoice and suggested putting the final payment in escrow, pending final inspection of the wall.
After a "heated exchange," Cloney gave Dunn a check for the invoice amount, and Dunn Construction gave Cloney a written statement "guaranteeing the wall's stability for ten years and averring that the wall had been repaired by placing rebar in every cell of the cinderblocks and filling the wall to its top with concrete."
Cloney then hired a structural engineer "who determined that the wall had not been filled with reinforced concrete or adequately reinforced with rebar, as Dunn had represented to [County inspector] and Cloney." Rather, "between one-third to one-half of the cells had no reinforcement" and the wall could not pass a building code inspection.
Cloney filed a complaint against Dunn Construction for breach of contract, negligence and fraud. In addition to seeking compensatory damages, "Cloney sought $100,000 in punitive damages for the alleged fraud." The jury returned a verdict for $25,000 in punitive damages.
On appeal, Dunn Construction "contended that the circuit court impermissibly permitted Cloney to convert his breach of contract action into a tort action."
The Court agreed with Dunn Construction, even though it did "not condone [Dunn Constructon's] misrepresentations":
In Dunn Construction Company, Inc. v. Cloney, Cloney contracted with Dunn Construction to build Cloney a house. Dunn Construction improperly constructed the front foundation wall, and after the wall failed inspection, Dunn Construction agreed to repair the cinderblock wall with steel reinforcing bars referred to as "rebar". After a second inspection and further repairs, Dunn Construction presented Cloney a final invoice. Cloney disputed parts of the invoice and suggested putting the final payment in escrow, pending final inspection of the wall.
After a "heated exchange," Cloney gave Dunn a check for the invoice amount, and Dunn Construction gave Cloney a written statement "guaranteeing the wall's stability for ten years and averring that the wall had been repaired by placing rebar in every cell of the cinderblocks and filling the wall to its top with concrete."
Cloney then hired a structural engineer "who determined that the wall had not been filled with reinforced concrete or adequately reinforced with rebar, as Dunn had represented to [County inspector] and Cloney." Rather, "between one-third to one-half of the cells had no reinforcement" and the wall could not pass a building code inspection.
Cloney filed a complaint against Dunn Construction for breach of contract, negligence and fraud. In addition to seeking compensatory damages, "Cloney sought $100,000 in punitive damages for the alleged fraud." The jury returned a verdict for $25,000 in punitive damages.
On appeal, Dunn Construction "contended that the circuit court impermissibly permitted Cloney to convert his breach of contract action into a tort action."
The Court agreed with Dunn Construction, even though it did "not condone [Dunn Constructon's] misrepresentations":
"As a general rule, damages for breach of contracts are limited to the pecuniary loss sustained. However, a single act or occurrence can, in certain circumstances, support causes of action both for breach of contract and for breach of a duty arising in tort, thus permitting a plaintiff to recover both for the loss suffered as a result of the breach and traditional tort damages, including, where appropriate, punitive damages. To avoid turning every breach of contract into a tort, however, we have consistently adhered to the rule that, in order to recover in tort, the duty tortiously or negligently breached must be a common law duty, not one existing between the parties solely by virtue of the contract.
Cloney contends that the present case can be distinguished . . . because the guarantee given by Dunn in exchange for Cloney making the final payment on the contract was used to procure a novation to the original contract and the false statement in the guarantee that the foundation wall had been properly repaired constituted a fraudulent inducement violative of a common law duty separate and apart from any duty arising under the contract. We disagree.
Under the contract, Dunn had a duty to construct the foundation wall in a workmanlike manner according to standard practices. Clearly, the original wall was not constructed in accord with this duty, and Dunn was required to make repairs to bring the wall in compliance with the applicable building code under that same duty. Dunn’s false representation that he had made adequate repairs thus related to a duty that arose under the contract. The fact that the representation was made in order to obtain payment from Cloney does not take the fraud outside of the contract relationship, because the payment obtained was also due under the original terms of the contract.
Nonetheless, . . . we cannot permit turning every breach of contract into an actionable claim for fraud simply because of misrepresentations of the contractor entwined with a breach of the contract."
Monday, July 27, 2009
Intentional Misconduct Could Nullify Damages Limitations Clauses in Commercial Contracts
We recently published an article in the Potomac Techwire regarding damages limitations clauses in commercial contracts. In a recent decision from the United States District Court for the Western District of Virginia, All Business Solutions, Inc. v. Nationsline, Inc., 2009 U.S. Dist. LEXIS 54693 (W.D. Va. June 29, 2009), the court held clauses that limit the ability to recover indirect. consequential or punitive damages unenforceable to bar claims for intentional misconduct based upon public policy. This is an important case, as companies who are sued for misconduct frequently seek to hide behind such clauses in commercial contracts to escape liability. To read the entire article, click here.
Wednesday, July 8, 2009
Source Code Sufficient to Prove Trade Secret
It is not uncommon for a business, whose former employee has joined or formed a competitor firm, to charge that the employee has misappropriated its trade secrets. Proving the charge is another story.
Under the Uniform Trade Secrets Act which has been adopted in Virginia, Maryland and the District of Columbia, a trade secret is defined as:
“information, including but not limited to a formula, pattern, compilation, program, device, method, technique, or process that:
1. Derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable by proper means by, other persons who can obtain economic value from its disclosure or use, and
2. Is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.”
Virginia Code § 59.1-336.
A recent decision from the Fourth Circuit Court of Appeals addressed Virginia’s trade secrets law in the context of a computer model. Decision Insights, Inc. v. Sentia Group, Inc., 2009 U.S. App. LEXIS 2654 (4th Cir. 2009). In that case, the plaintiff had developed and marketed a software program used to prepare negotiating strategies and measure risks associated with various alternatives. Three of the defendants were employees of Decision Insights (“DII”) who had worked on modifications to the software and had access to its source code. While they were still employed by DII, the employees established Sentia Group, Inc. a competitor firm. When efforts to negotiate a license of the software program from DII failed, Sentia hired the same individual who had worked with the defendants at DII to develop its own software. The result was a program that allegedly used the same methods as those used in the software owned by DII.
When DII sued, the district court granted summary judgment in favor of the defendants and dismissed the case on the basis that the plaintiff had failed to meet its burden of proof as to the existence of any trade secrets. On appeal, the Fourth Circuit took a different view and reversed (in part) the decision of the district court granting summary judgment in favor of the defendants and remanded the case for further proceedings.
In its complaint, DII claimed that its computer model, as a total compilation, was a trade secret and that within that model were 12 specific functions that individually also qualified as trade secrets. The appellate court reversed the lower court for, among other things, the failure of the district judge to consider whether the software program as a total compilation qualified as a trade secret. Id. at *19.
The court noted that the most important characteristic of a trade secret is secrecy, Id. at *17, quoting Dionne v. Southeast Foam Converting & Packaging, Inc., 397 S.E.2d 110, 113 (Va. 1990), and that it may retain that characteristic even though it is shared with others, if that disclosure is in confidence, express or implied. Id. at * 17-18, quoting Dionne, 397 S.E.2d at 113. Under long established precedent in Virginia, a “working combination” of information, all of which individually may be in the public domain, can, when combined, be protected as a trade secret. Servo Corp. of Am. v. Con. Elec. Co., 393 F.2d 551, 554 (4th Cir. 1968).
The appellate court in Decision Insights acknowledged that DII could not produce the algorithms used in the creation of the program as it was over 15 years old. Nevertheless, the court held that the source code for the software in conjunction with a flow chart and narrative explaining the software program could be an acceptable method for identifying the trade secret at issue. Id. at *21-23. On remand it directed the district judge to examine the evidence to determine whether Decision Insights adequately identified its software compilation claim such that the claim could proceed to trial. In addition the district court was directed to individually consider the independent trade secret claims separate and apart from the compilation claim. Id. at *22-23.
The take-away: For companies that had developed software programs years ago that they want to protect as trade secrets, the source code may suffice to prove trade secret status, even if the original algorithms have been destroyed. In addition, companies should not forget that the common law also protects proprietary and confidential information from disclosure by a rogue employee to a competitor in those situations where it would be difficult to prove that the information is a trade secret.
Under the Uniform Trade Secrets Act which has been adopted in Virginia, Maryland and the District of Columbia, a trade secret is defined as:
“information, including but not limited to a formula, pattern, compilation, program, device, method, technique, or process that:
1. Derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable by proper means by, other persons who can obtain economic value from its disclosure or use, and
2. Is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.”
Virginia Code § 59.1-336.
A recent decision from the Fourth Circuit Court of Appeals addressed Virginia’s trade secrets law in the context of a computer model. Decision Insights, Inc. v. Sentia Group, Inc., 2009 U.S. App. LEXIS 2654 (4th Cir. 2009). In that case, the plaintiff had developed and marketed a software program used to prepare negotiating strategies and measure risks associated with various alternatives. Three of the defendants were employees of Decision Insights (“DII”) who had worked on modifications to the software and had access to its source code. While they were still employed by DII, the employees established Sentia Group, Inc. a competitor firm. When efforts to negotiate a license of the software program from DII failed, Sentia hired the same individual who had worked with the defendants at DII to develop its own software. The result was a program that allegedly used the same methods as those used in the software owned by DII.
When DII sued, the district court granted summary judgment in favor of the defendants and dismissed the case on the basis that the plaintiff had failed to meet its burden of proof as to the existence of any trade secrets. On appeal, the Fourth Circuit took a different view and reversed (in part) the decision of the district court granting summary judgment in favor of the defendants and remanded the case for further proceedings.
In its complaint, DII claimed that its computer model, as a total compilation, was a trade secret and that within that model were 12 specific functions that individually also qualified as trade secrets. The appellate court reversed the lower court for, among other things, the failure of the district judge to consider whether the software program as a total compilation qualified as a trade secret. Id. at *19.
The court noted that the most important characteristic of a trade secret is secrecy, Id. at *17, quoting Dionne v. Southeast Foam Converting & Packaging, Inc., 397 S.E.2d 110, 113 (Va. 1990), and that it may retain that characteristic even though it is shared with others, if that disclosure is in confidence, express or implied. Id. at * 17-18, quoting Dionne, 397 S.E.2d at 113. Under long established precedent in Virginia, a “working combination” of information, all of which individually may be in the public domain, can, when combined, be protected as a trade secret. Servo Corp. of Am. v. Con. Elec. Co., 393 F.2d 551, 554 (4th Cir. 1968).
The appellate court in Decision Insights acknowledged that DII could not produce the algorithms used in the creation of the program as it was over 15 years old. Nevertheless, the court held that the source code for the software in conjunction with a flow chart and narrative explaining the software program could be an acceptable method for identifying the trade secret at issue. Id. at *21-23. On remand it directed the district judge to examine the evidence to determine whether Decision Insights adequately identified its software compilation claim such that the claim could proceed to trial. In addition the district court was directed to individually consider the independent trade secret claims separate and apart from the compilation claim. Id. at *22-23.
The take-away: For companies that had developed software programs years ago that they want to protect as trade secrets, the source code may suffice to prove trade secret status, even if the original algorithms have been destroyed. In addition, companies should not forget that the common law also protects proprietary and confidential information from disclosure by a rogue employee to a competitor in those situations where it would be difficult to prove that the information is a trade secret.
Monday, July 6, 2009
Unfair Business Practices Government Contracts Webinar Download Available
Williams Mullen's Unfair Business Practices Team hosted its second webinar, entitled Beware the Government Contract: Protecting Your Company's Assets from the Government and Other Contractors.
Topics discussed in the webinar include:
(1) Identifying corporate assets that could be in jeopardy during the award and performance of a government contract;
(2) Practical considerations to protect assets from competitors, contracting partners, and the government; and
(3) Understanding critical contract clauses that can be negotiated to your company’s benefit, whether as a prime contractor or subcontractor.
The complete audio and powerpoint presentation can be downloaded by clicking here.
The Team's next webinar is entitled Intellectual Property: Building Your Castle Moat, How to protect your company's knowledge. It will be held on July 23, 2009. To register, click here.
Topics discussed in the webinar include:
(1) Identifying corporate assets that could be in jeopardy during the award and performance of a government contract;
(2) Practical considerations to protect assets from competitors, contracting partners, and the government; and
(3) Understanding critical contract clauses that can be negotiated to your company’s benefit, whether as a prime contractor or subcontractor.
The complete audio and powerpoint presentation can be downloaded by clicking here.
The Team's next webinar is entitled Intellectual Property: Building Your Castle Moat, How to protect your company's knowledge. It will be held on July 23, 2009. To register, click here.
Thursday, June 18, 2009
D.C. Court Dismisses Case Alleging Interference With Business Expectancy For Failure To Name Names
A recent decision from the United States District Court for the District of Columbia highlights the importance of pleading specific facts in support of unfair business practices claims to survive a Motion to Dismiss. In Command Consulting Group, LLC v. Neuraliq, Inc., 2009 U.S. Dist. Lexis 48082 (D.D.C. June 9, 2009), click here, the defendant counterclaimed for, among other things, interference with prospective business advantage and breach of fiduciary duty arising out of a government contracts consulting agreement.
Apparently, the plaintiff entered into a consulting agreement with the defendant pursuant to which he agreed to assist the defendant in developing business in the federal government defense community. When the plaintiff sued for unpaid fees, the defendant counterclaimed, alleging that the plaintiff used confidential information obtained from the defendant to interfere with the defendant's business. The plaintiff then moved to dismiss two of the claims.
The court first addressed the pleading requirements for the claim of interference with a prospective business advantage under D.C. law. That claim requires: "(1) the existence of a valid business relationship or expectancy, (2) knowledge of the relationship or expectancy on the part of the interferer, (3) intentional interference inducing or causing a breach or termination of the relationship or expectancy, and (4) resultant damages. Valid business expectancies that are "commercially reasonable" include "lost future contracts and lost opportunities to obtain customers. In addition, the plaintiff must make a strong showing of intent to "disrupt a business relationship or expectancy to establish a claim for interference." Intent can be shown if the conduct is egregious, such as libel, slander, physical coercion and fraud.
Here, the court found that the allegations were both unspecific and conclusory, thus failing to meet the standard required to allow the claim to proceed. Perhaps most notable is the requirement under D.C. law that the claimant must plead the particulars of the valid business expectancy, including the names of the third parties with which the claimant had the relationship or expectancy. Simply alleging categories of relationships that may have been affected is inadequate.
The court found similar flaws in the allegations supporting the claim for breach of fiduciary duty. Preliminarily, the court noted that, even though the relationship between the consultant and his client arose out of a written contract, "where circumstances show that the parties extended their relationship beyond the limits of the contractual obligations to a relationship founded upon trust and confidence" a fiduciary duty may exist. Here, the client alleged that the duty arose because "in its capacity as a consultant to the defendant, the plaintiff was privy to sensitive, confidential and proprietary information, including financial information."
Despite alleging that the plaintiff used that information "as part of a scheme to disrupt the operation and ownership of [the defendant], with the objective ... [of placing] financial pressure on [the defendant] that would force [the defendant] to enter business deals favorable" to individuals aligned with the plaintiff "and/or [to] gain control of [the defendant] for the benefit of [the plaintiff] and its co-conspirators" the court found those allegations deficient. It noted the defendant had failed to allege: (1) specific information regarding the confidential information wrongfully used, (2) that the defendant entered into any specific deals as a result of the pressure exerted by the plaintiff, and (3) that the defendant suffered any injury as a result of that pressure. Additionally, the defendant failed to allege that the efforts of the plaintiff to gain control of the defendant resulted in any injury. Accordingly, the court granted the Motion to Dismiss.
This case points out the importance of carefully crafted, factual-laden pleadings. Two recent Supreme Court decisions, Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007) and Ashcroft v. Iqbal, 129 S.Ct. 1937 (2009), significantly tightened the pleading requirements in civil cases. Under the new standards, federal complaints must allege sufficient facts, that when accepted as true for purposes of a motion to dismiss, "state a claim to relief that is plausible on its face." Id. at 1949. "A claim has facial plausibility when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged." Id. In short, mere recitals of the elements of a cause of action, accompanied by conclusory statements, fail the test.
Apparently, the plaintiff entered into a consulting agreement with the defendant pursuant to which he agreed to assist the defendant in developing business in the federal government defense community. When the plaintiff sued for unpaid fees, the defendant counterclaimed, alleging that the plaintiff used confidential information obtained from the defendant to interfere with the defendant's business. The plaintiff then moved to dismiss two of the claims.
The court first addressed the pleading requirements for the claim of interference with a prospective business advantage under D.C. law. That claim requires: "(1) the existence of a valid business relationship or expectancy, (2) knowledge of the relationship or expectancy on the part of the interferer, (3) intentional interference inducing or causing a breach or termination of the relationship or expectancy, and (4) resultant damages. Valid business expectancies that are "commercially reasonable" include "lost future contracts and lost opportunities to obtain customers. In addition, the plaintiff must make a strong showing of intent to "disrupt a business relationship or expectancy to establish a claim for interference." Intent can be shown if the conduct is egregious, such as libel, slander, physical coercion and fraud.
Here, the court found that the allegations were both unspecific and conclusory, thus failing to meet the standard required to allow the claim to proceed. Perhaps most notable is the requirement under D.C. law that the claimant must plead the particulars of the valid business expectancy, including the names of the third parties with which the claimant had the relationship or expectancy. Simply alleging categories of relationships that may have been affected is inadequate.
The court found similar flaws in the allegations supporting the claim for breach of fiduciary duty. Preliminarily, the court noted that, even though the relationship between the consultant and his client arose out of a written contract, "where circumstances show that the parties extended their relationship beyond the limits of the contractual obligations to a relationship founded upon trust and confidence" a fiduciary duty may exist. Here, the client alleged that the duty arose because "in its capacity as a consultant to the defendant, the plaintiff was privy to sensitive, confidential and proprietary information, including financial information."
Despite alleging that the plaintiff used that information "as part of a scheme to disrupt the operation and ownership of [the defendant], with the objective ... [of placing] financial pressure on [the defendant] that would force [the defendant] to enter business deals favorable" to individuals aligned with the plaintiff "and/or [to] gain control of [the defendant] for the benefit of [the plaintiff] and its co-conspirators" the court found those allegations deficient. It noted the defendant had failed to allege: (1) specific information regarding the confidential information wrongfully used, (2) that the defendant entered into any specific deals as a result of the pressure exerted by the plaintiff, and (3) that the defendant suffered any injury as a result of that pressure. Additionally, the defendant failed to allege that the efforts of the plaintiff to gain control of the defendant resulted in any injury. Accordingly, the court granted the Motion to Dismiss.
This case points out the importance of carefully crafted, factual-laden pleadings. Two recent Supreme Court decisions, Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007) and Ashcroft v. Iqbal, 129 S.Ct. 1937 (2009), significantly tightened the pleading requirements in civil cases. Under the new standards, federal complaints must allege sufficient facts, that when accepted as true for purposes of a motion to dismiss, "state a claim to relief that is plausible on its face." Id. at 1949. "A claim has facial plausibility when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged." Id. In short, mere recitals of the elements of a cause of action, accompanied by conclusory statements, fail the test.
Monday, June 8, 2009
Competitor Raids Company's Computer Data: Passwords Are Not Trade Secrets
Your company operates a website that provides data to paid subscribers that access your website through individual passwords. Your database is so successful that one of your former clients, which is also in a similar business, offers to buy it. But you decline. Around the same time you fire your marketing director. But you think your company is protected from being injured by that employee because he is subject to a non-compete and non-disclosure agreement.
Readers of this blog, by now, know where this story is going.
You then discover that your former client--now competitor--hired your former marketing director to compete against your company, despite his non-compete agreement. Then one of your long-time clients informs you that it is switching to your competitor's services.
Suspicious, you begin to investigate and discover that for the last four years, your database had been accessed 735 times from an IP address traced to your competitor's home city. And your competitor seems to have accessed your database by using the passwords assigned to your long-time client that switched to your competitor.
What do you do?
In State Analysis, Inc. d/b/a Statescape v. American Financial Services, Assoc., et al., found here, the plaintiff, Statescape, brought suit in the U.S. District Court for the Eastern District of Virginia, asserting claims arising out of facts like those described above. Statecape filed suit against: 1) its former client -- who set-up a competing business (the "Competitor"); 2) its former client that allegedly provided its password to the competitor ("Former Client"); and 3) its former employee.
The defendants moved to dismiss many of StateScape's claims. Several of the court's findings are noteworthy because they involve unfair business practices claims.
Computer Fraud and Abuse Act ("CFAA")
"18 U.S.C. Sec. 1030 (a) (2) prohibits 'intentially access[ing] a computer without authorization or exceed[ing] authorized access, and thereby obtain[ing] . . . information from any protected computer . . ."
"Exceeds authorized access" is explicitly defined as 'to access a computer with authorization and to use such access to obtain or alter information in the computer that the accesser is not entitled so to obtain or alter.'"
Having recited the provisions, the court discussed the split between courts, some of which have limited the applicability of the CFAA to "computer hackers" who access computers without authorization. Those courts "reject[] attempts to apply the CFAA to cases where the defendants are not alleged to have 'broken into' the system but to have abused the privileges of a license." "Other courts have held that the CFAA does apply to authorized users who use programs in an unauthorized way, including employees who obtain and use proprietary information in violation of a duty of loyalty, and licensees who breach an agreement restricting their use of the software." (Internal citations omitted).
The court then found that the plaintiff stated a claim against its competitor for accessing "StateScape's website using usernames and passwords that did not belong to it. StateScape has pled that under the terms of their contract, only clients were authorized to use StateScape's subscription services, and that [the Competitor] was not so authorized. [The Competitor] therefore acted 'without authorization.'"
But the court found that StateScape did not state a claim against its Former Client because the Former Company "never went beyond the areas that StateScape authorized [it] to access." And the court did not have to resolve the case split because StateScape only reserved the right to terminate the Former Client's contract instead of having the contract automatically terminate if the Former Client breached the contract. Thus, the Former Client was never without authorization.
We have recently written about the applicability of the Computer Fraud and Abuse Act to departing employees who access their employer's computer data after they intend to join a competitor, which can be found here.
Electronic Communications Privacy Act ("ECPA")
The ECPA forbids "intentionally access[] without authorization a facility through which an electronic communication service is provided, or intentionally exceed[] an authorization to access that facility; and thereby obtain[], alter[], or prevent[] authorized access to a wire or electronic communication while it is in electronic storage."
The court found that "StateScape has stated a claim against [the Competitor] by alleging that [the Competitor], without any authorization from StateScape, accessed the password-protected areas of StateScape's site."
StateScape's claim against its Former Client, however, was dismissed under one of the ECPA's exceptions because the Former Client was "contractually entitled to see all of the information it is alleged to have accessed."
Virginia Computer Crimes Act
The court's opinion is also noteworthy because it held that StateScape's Virginia Computer Crimes Act claim was preempted by the federal Copyright Act. The claim was preempted since "software is within the subject matter of copyright" and, based on the alleged facts, the claims were not "'qualitatively' different from the Copyright Act claims."
Trespass
StateScape's claim for trespass to chattels is "based on the allegation that [the Former Client] accessed password-protected areas of StateScape's website without authorization. A trespass to chattels occurs 'when one party intentionally uses or intermeddles with personal property in rightful possession of another without authorization' and 'if the chattel is impaired as to its condition, quality, or value.'" (Internal citations omitted.)
The Former Client argued that no "impairment" was alleged. But the court found the impairment criterion was satisfied: "given that StateScape charges fees for its passwords, the value of StateScape's possessory interest in its computer network is diminished if unauthorized users access its password-protected areas."
Misappropriation of Trade Secrets
StateScape alleged that the Former Client's "sharing of its passwords for StateScape's database with [the Competitor]" violated the Virginia Uniform Trade Secrets Act ("VUTSA"). The defendants attacked the VUTSA claim, arguing that "passwords lack 'independent economic value,' but are instead a security mechanism designed to control access to information, and therefore are not trade secrets."
The court first reviewed the definition of a "trade secret" under the VUTSA: "'Trade secret' means information, including but not limited to, a formula, pattern, compilation, program, device, method, technique or process, that: 1. Derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable by proper means by, other persons who can obtain economic value from its disclosure or use, and 2. Is the subject of efforts that are reasonable under the circumstances to maintain its secrecy."
"Although the passwords at issue clearly have economic value given that they are integral to accessing StateScape’s database, they have no independent economic value in the way a formula or a customer list might have. Where a plaintiff has not alleged that its passwords are the product of any special formula or algorithm that it developed, the passwords are not trade secrets."
Blog Conclusion
This case is another spin on the types of unfair business practices that can arise in today's electronic world. Many companies make their money by providing password-protected data on their websites. Protecting that data through security features and, if needed, litigation is critical. But, on a positive note, this case again demonstrates that unfair business practices can often be unmasked by tracing electronic footprints.
Readers of this blog, by now, know where this story is going.
You then discover that your former client--now competitor--hired your former marketing director to compete against your company, despite his non-compete agreement. Then one of your long-time clients informs you that it is switching to your competitor's services.
Suspicious, you begin to investigate and discover that for the last four years, your database had been accessed 735 times from an IP address traced to your competitor's home city. And your competitor seems to have accessed your database by using the passwords assigned to your long-time client that switched to your competitor.
What do you do?
In State Analysis, Inc. d/b/a Statescape v. American Financial Services, Assoc., et al., found here, the plaintiff, Statescape, brought suit in the U.S. District Court for the Eastern District of Virginia, asserting claims arising out of facts like those described above. Statecape filed suit against: 1) its former client -- who set-up a competing business (the "Competitor"); 2) its former client that allegedly provided its password to the competitor ("Former Client"); and 3) its former employee.
The defendants moved to dismiss many of StateScape's claims. Several of the court's findings are noteworthy because they involve unfair business practices claims.
Computer Fraud and Abuse Act ("CFAA")
"18 U.S.C. Sec. 1030 (a) (2) prohibits 'intentially access[ing] a computer without authorization or exceed[ing] authorized access, and thereby obtain[ing] . . . information from any protected computer . . ."
"Exceeds authorized access" is explicitly defined as 'to access a computer with authorization and to use such access to obtain or alter information in the computer that the accesser is not entitled so to obtain or alter.'"
Having recited the provisions, the court discussed the split between courts, some of which have limited the applicability of the CFAA to "computer hackers" who access computers without authorization. Those courts "reject[] attempts to apply the CFAA to cases where the defendants are not alleged to have 'broken into' the system but to have abused the privileges of a license." "Other courts have held that the CFAA does apply to authorized users who use programs in an unauthorized way, including employees who obtain and use proprietary information in violation of a duty of loyalty, and licensees who breach an agreement restricting their use of the software." (Internal citations omitted).
The court then found that the plaintiff stated a claim against its competitor for accessing "StateScape's website using usernames and passwords that did not belong to it. StateScape has pled that under the terms of their contract, only clients were authorized to use StateScape's subscription services, and that [the Competitor] was not so authorized. [The Competitor] therefore acted 'without authorization.'"
But the court found that StateScape did not state a claim against its Former Client because the Former Company "never went beyond the areas that StateScape authorized [it] to access." And the court did not have to resolve the case split because StateScape only reserved the right to terminate the Former Client's contract instead of having the contract automatically terminate if the Former Client breached the contract. Thus, the Former Client was never without authorization.
We have recently written about the applicability of the Computer Fraud and Abuse Act to departing employees who access their employer's computer data after they intend to join a competitor, which can be found here.
Electronic Communications Privacy Act ("ECPA")
The ECPA forbids "intentionally access[] without authorization a facility through which an electronic communication service is provided, or intentionally exceed[] an authorization to access that facility; and thereby obtain[], alter[], or prevent[] authorized access to a wire or electronic communication while it is in electronic storage."
The court found that "StateScape has stated a claim against [the Competitor] by alleging that [the Competitor], without any authorization from StateScape, accessed the password-protected areas of StateScape's site."
StateScape's claim against its Former Client, however, was dismissed under one of the ECPA's exceptions because the Former Client was "contractually entitled to see all of the information it is alleged to have accessed."
Virginia Computer Crimes Act
The court's opinion is also noteworthy because it held that StateScape's Virginia Computer Crimes Act claim was preempted by the federal Copyright Act. The claim was preempted since "software is within the subject matter of copyright" and, based on the alleged facts, the claims were not "'qualitatively' different from the Copyright Act claims."
Trespass
StateScape's claim for trespass to chattels is "based on the allegation that [the Former Client] accessed password-protected areas of StateScape's website without authorization. A trespass to chattels occurs 'when one party intentionally uses or intermeddles with personal property in rightful possession of another without authorization' and 'if the chattel is impaired as to its condition, quality, or value.'" (Internal citations omitted.)
The Former Client argued that no "impairment" was alleged. But the court found the impairment criterion was satisfied: "given that StateScape charges fees for its passwords, the value of StateScape's possessory interest in its computer network is diminished if unauthorized users access its password-protected areas."
Misappropriation of Trade Secrets
StateScape alleged that the Former Client's "sharing of its passwords for StateScape's database with [the Competitor]" violated the Virginia Uniform Trade Secrets Act ("VUTSA"). The defendants attacked the VUTSA claim, arguing that "passwords lack 'independent economic value,' but are instead a security mechanism designed to control access to information, and therefore are not trade secrets."
The court first reviewed the definition of a "trade secret" under the VUTSA: "'Trade secret' means information, including but not limited to, a formula, pattern, compilation, program, device, method, technique or process, that: 1. Derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable by proper means by, other persons who can obtain economic value from its disclosure or use, and 2. Is the subject of efforts that are reasonable under the circumstances to maintain its secrecy."
"Although the passwords at issue clearly have economic value given that they are integral to accessing StateScape’s database, they have no independent economic value in the way a formula or a customer list might have. Where a plaintiff has not alleged that its passwords are the product of any special formula or algorithm that it developed, the passwords are not trade secrets."
Blog Conclusion
This case is another spin on the types of unfair business practices that can arise in today's electronic world. Many companies make their money by providing password-protected data on their websites. Protecting that data through security features and, if needed, litigation is critical. But, on a positive note, this case again demonstrates that unfair business practices can often be unmasked by tracing electronic footprints.
Thursday, May 28, 2009
The "Employee Paradox" Webinar Materials Are Now Available Online
On May 21, 2009, the Williams Mullen Unfair Business Practices Team conducted its first webinar in its four-part Summer series. The webinar was entitled The Employee Paradox: The Best Employees Can Cause the Greatest Damage to Your Company.
The webinar addressed the fiduciary obligations of corporate officers, directors and employees, restrictive covenants such as noncompetition and non-soliciation clauses in employment contracts, and protecting against corporate raiding. The webinar also supplied a checklist for hiring new employees.
To hear the webinar: click here. To download the powerpoint presentation: click here. The webinar speakers were three members of Williams Mullen's Unfair Business Practices Team: David Burton, Sean Gibbons and Mike Lord.
The Team's next webiner is entitled "Beware the Government Contract: How to Protect Your Company's Assets from the Government and Other Contractors." To register for this June 17 webinar, click here.
The webinar addressed the fiduciary obligations of corporate officers, directors and employees, restrictive covenants such as noncompetition and non-soliciation clauses in employment contracts, and protecting against corporate raiding. The webinar also supplied a checklist for hiring new employees.
To hear the webinar: click here. To download the powerpoint presentation: click here. The webinar speakers were three members of Williams Mullen's Unfair Business Practices Team: David Burton, Sean Gibbons and Mike Lord.
The Team's next webiner is entitled "Beware the Government Contract: How to Protect Your Company's Assets from the Government and Other Contractors." To register for this June 17 webinar, click here.
Thursday, May 21, 2009
Starwood Hotels & Resorts Worldwide, Inc. Sues Hilton Hotels Corporation
For an excellent example of the high-stakes nature of unfair business practices cases, Starwood Hotels & Resorts Worldwide, Inc. ("Starwood") sued Hilton Hotels Corporation ("Hilton") and several former Starwood employees on April 16, 2009. The allegations, if proven, are remarkable.
Starwood claims that Hilton recruited the President and Senior Vice President of Starwood's Luxury Brands Group to join Hilton. The executives were allegedly involved in developing Starwood's luxury hotel brands: the St. Regis, W Hotels and The Luxury Collection. The allegations are a worst-case-scenario for a company because the executives were alleged to have both misused Starwood's confidential information and recruited a group of senior-level Starwood employees to work for Hilton.
Specifically, Starwood alleges that its former executive requested "large volumes of confidential information from Starwood employees, which he took home, had loaded on a personal laptop computer and/or forwarded to a personal e-mail account, and which he then took to and used at and for Hilton." The Complaint outlines specific Starwood files that were taken to Hilton, including: Starwood's Forward-Looking Strategic Development Plans, Starwood's Property Improvement Plan, and confidential computer files containing the names and addresses of Luxury Brands Group owners, developers and designers compiled by Starwood. In total, Starwood alleges that its former executives took over 100,000 of its files to Hilton.
The complaint also alleges that after Starwood asked Hilton to preserve information relating to one of the employees who switched companies Hilton delivered to Starwood 'eight large boxes of computer hard drives, zip drives, thumb drives and paper records containing massive quantities of highly confidential and proprietary Starwood files . . . , including over 100,000 files downloaded from Starwood’s computers systems and files.
To read the entire complaint (without exhibits), click here.
Hilton’s response to the Complaint is also remarkable because Hilton takes corrective action almost immediately. A week after Starwood filed the case, Hilton agreed to a "Preliminary Injunction and Order Entered on Consent of All Defendants." The Order recites Hilton’s steps to attempt to cure any damages suffered by Hilton. First, on April 21, "Hilton placed [the executives] and their entire luxury and lifestyle team . . . on paid administrative leave of absence, and suspended all further development of the [competing] brand." Second, Hilton agreed to be enjoined from "knowingly using directly or indirectly in any way the Starwood Information, including without information contained therein or derived therefrom." Third, "all other persons who are in active concert or participation with them who receive actual notice of this order by personal service or otherwise, are hereby preliminary enjoined and shall cease all further development of the [competing] brand . . . ." The Order contains additional agreed upon actions, and it can be found by clicking here.
In addition, the parties agreed to stay the litigation pending further order of the court. It is a good bet that Starwood and Hilton are working to settle this dispute.
Starwood claims that Hilton recruited the President and Senior Vice President of Starwood's Luxury Brands Group to join Hilton. The executives were allegedly involved in developing Starwood's luxury hotel brands: the St. Regis, W Hotels and The Luxury Collection. The allegations are a worst-case-scenario for a company because the executives were alleged to have both misused Starwood's confidential information and recruited a group of senior-level Starwood employees to work for Hilton.
Specifically, Starwood alleges that its former executive requested "large volumes of confidential information from Starwood employees, which he took home, had loaded on a personal laptop computer and/or forwarded to a personal e-mail account, and which he then took to and used at and for Hilton." The Complaint outlines specific Starwood files that were taken to Hilton, including: Starwood's Forward-Looking Strategic Development Plans, Starwood's Property Improvement Plan, and confidential computer files containing the names and addresses of Luxury Brands Group owners, developers and designers compiled by Starwood. In total, Starwood alleges that its former executives took over 100,000 of its files to Hilton.
The complaint also alleges that after Starwood asked Hilton to preserve information relating to one of the employees who switched companies Hilton delivered to Starwood 'eight large boxes of computer hard drives, zip drives, thumb drives and paper records containing massive quantities of highly confidential and proprietary Starwood files . . . , including over 100,000 files downloaded from Starwood’s computers systems and files.
To read the entire complaint (without exhibits), click here.
Hilton’s response to the Complaint is also remarkable because Hilton takes corrective action almost immediately. A week after Starwood filed the case, Hilton agreed to a "Preliminary Injunction and Order Entered on Consent of All Defendants." The Order recites Hilton’s steps to attempt to cure any damages suffered by Hilton. First, on April 21, "Hilton placed [the executives] and their entire luxury and lifestyle team . . . on paid administrative leave of absence, and suspended all further development of the [competing] brand." Second, Hilton agreed to be enjoined from "knowingly using directly or indirectly in any way the Starwood Information, including without information contained therein or derived therefrom." Third, "all other persons who are in active concert or participation with them who receive actual notice of this order by personal service or otherwise, are hereby preliminary enjoined and shall cease all further development of the [competing] brand . . . ." The Order contains additional agreed upon actions, and it can be found by clicking here.
In addition, the parties agreed to stay the litigation pending further order of the court. It is a good bet that Starwood and Hilton are working to settle this dispute.
Wednesday, April 29, 2009
Summer Webinar Series: Protecting Corporate Assets from Unfair Business Practices
Williams Mullen is hosting a four-part webinar series entitled: Protecting Corporate Assets from Unfair Business Practices.
Here is a listing of the programs for each month. Click on the title for more information and to register for the individual events.
The first webinar is scheduled for May 21, 2009 from 12:00 to 1:15 p.m. (U.S.A. Eastern Daylight Time). There is no fee for participating in the webinars.
For a complete listing and registration information, click here.
Here is a listing of the programs for each month. Click on the title for more information and to register for the individual events.
May
The Employee Paradox
Your Best Employees Can Cause the Greatest Damage to Your Company
June
Beware the Government Contract
How to Protect Your Company's Assets from the Government and other Contractors
July
Intellectual Property: Building Your Castle Moat
How to Protect Your Company's Knowledge
August
Defending Your Castle
Litigating Disputes to Protect Your Company's Assets
The first webinar is scheduled for May 21, 2009 from 12:00 to 1:15 p.m. (U.S.A. Eastern Daylight Time). There is no fee for participating in the webinars.
For a complete listing and registration information, click here.
Friday, March 27, 2009
Employees Who Take Proprietary Data May Violate the Federal Computer Fraud and Abuse Act
We recently published an article discussing the federal Computer Fraud and Abuse Act in the Potomac Techwire. It focused on the developing law surrounding whether a departing employee who takes proprietary electronic data has violated the Act by accessing his employer's computer to remove the data once he has begun plans to resign and join another company. There is a split among courts regarding whether that employee was "authorized" to access the computer or "exceeded his authorized access" when he did so. For those courts which have found that the access was unlawful, this Act becomes a big stick because it creates federal jurisdiction in cases that, most often, may only be brought in state courts. To review the entire article, see the link: http://www.williamsmullen.com/employees-who-take-proprietary-data-may-violate-the-federal-computer-fraud-and-abuse-act-03-11-2009/
Tuesday, March 10, 2009
LLC Members Do Not Owe Fiduciary Duties to Each Other, Virginia Supreme Court Rules
Last Spring, we profiled two Circuit Court decisions in Virginia that addressed whether members of Virginia Limited Liability Companies owed fiduciary duties to each other. See March 30, 2008 post, click here. The cases had held that: (1) members and managers of LLCs did not owe fiduciary duties to members, but only to the entity itself; and (2) a member could not sue a manager directly for breach of fiduciary duty, but could only maintain the suit in a derivative capacity. The cases were significant because the Virginia Supreme Court had not addressed the issues.
This week the Supreme Court issued an opinion in one of those cases, Remora Investments, LLC v. Orr. Click here. The opinion affirmed the decision of the Fairfax Circuit Court sustaining the defendant’s demurrer and dismissing the case.
The Supreme Court initially focused on the statutory basis for duties owed by members of an LLC. It noted that neither the Limited Liability Company Act nor the Virginia Stock Corporation Act imposed fiduciary duties “between members of an LLC, between members and managers of an LLC, between stockholders of a corporation, or between individual shareholders and officers and directors.” General partnership law in Virginia, on the other hand, specifically provides that partners owe the duties of loyalty and care both to the partnership and to other partners. Moreover, the court reaffirmed that, in the corporate context, the fiduciary duty owed by officers and directors is owed to shareholders as a class and not individually.
The court also examined the Operating Agreement for the LLC and found that it did not establish any fiduciary duties between the members or between the members and a manager. It specifically held, however, that such duties may be included in Operating Agreements if the members so desire and, thus, arise by contract.
For these reasons the court concluded that as a member of the LLC, Orr lacked standing to pursue a direct claim against the LLC’s manager.
Now that the Supreme Court has spoken on the issue, those forming LLCs would be wise to discuss whether such duties between the members or the members and manager of the LLC should be addressed in the Operating Agreement.
This week the Supreme Court issued an opinion in one of those cases, Remora Investments, LLC v. Orr. Click here. The opinion affirmed the decision of the Fairfax Circuit Court sustaining the defendant’s demurrer and dismissing the case.
The Supreme Court initially focused on the statutory basis for duties owed by members of an LLC. It noted that neither the Limited Liability Company Act nor the Virginia Stock Corporation Act imposed fiduciary duties “between members of an LLC, between members and managers of an LLC, between stockholders of a corporation, or between individual shareholders and officers and directors.” General partnership law in Virginia, on the other hand, specifically provides that partners owe the duties of loyalty and care both to the partnership and to other partners. Moreover, the court reaffirmed that, in the corporate context, the fiduciary duty owed by officers and directors is owed to shareholders as a class and not individually.
The court also examined the Operating Agreement for the LLC and found that it did not establish any fiduciary duties between the members or between the members and a manager. It specifically held, however, that such duties may be included in Operating Agreements if the members so desire and, thus, arise by contract.
For these reasons the court concluded that as a member of the LLC, Orr lacked standing to pursue a direct claim against the LLC’s manager.
Now that the Supreme Court has spoken on the issue, those forming LLCs would be wise to discuss whether such duties between the members or the members and manager of the LLC should be addressed in the Operating Agreement.
Monday, March 2, 2009
Overreaching by Partners During Partnership Dissolution Can Be Costly
Sometimes cases serve as cautionary tales of how NOT to do business. A partnership divorce out of Fairfax County, Greenfeld v. Stitely,et al., 2007 Va. Cir. LEXIS 7 (January 5, 2007) is just such a case. It involved three partners in an accounting firm, Stitely, Karstetter & Greenfeld, LLP (“SK&G”) formed in 2002.
In 2003, the partners purchased two condominium units including the one from which the firm operated. Each of the three partners guaranteed the mortgages. Before agreeing to the purchase, Greenfeld sought and received assurances from his partners that they were satisfied with the operation of their accounting partnership.
Several months later, however, on April 18, 2004, Stitley and Karstetter informed Greenfeld that they were withdrawing from the partnership and intended to dissolve it. They presented Greenfeld with a one-sided separation agreement that offered no payment for Greenfeld’s one-third interest in the partnership, refused to refund his capital contribution and allowed Stitley and Karstetter to continue servicing all of the firm’s clients. Greenfeld rejected their proposal. The following day they formed Stitley and Karstetter, PLLC (“S&K”).
Things went downhill from there. Even though Stitley and Karstetter had signed a notice withdrawing from the partnership, they never relinquished control over SK&G’s assets or employees. In addition, they: (1) terminated Greenfeld’s access to the firm’s computer network; (2) issued an eviction notice to Greenfeld; (3) locked him out of his office and refused to release to him any personal property from his office; (4) notified a software manufacturer, for whom Greenfeld had been an authorized reseller, that S&K would be taking over the account; (5) announced that S&K would be hiring all of SK&G’s employees: (6) appropriated SK&G’s computer software; (7) began using all of SK&G’s physical assets and property to benefit S&K, without compensation; (8) collected SK&G’s receivables and deposited the proceeds into S&K’s account; and (9) rebilled SK&G clients for SK&G work as S&K and then deposited those receipts into S&K accounts.
With respect to the condominiums, Stitley and Karstetter: (1) entered into a lease with S&K for the condominiums, without notice or consultation with Greenfeld, for about 56% of the rent that SK&G had been paying for the same space; (2) paid rent and condo fees, in advance, out of SK&G’s account after S&K had taken over the office space; and (3) then issued a capital call to SK&G partners seeking $1000 each per month to make up the shortfall caused by the reduction in rent paid by S&K for the condominium space.
Finally, Stitley and Karstetter notified Greenfeld that partners would receive no more distributions from SK&G, but thereafter paid themselves $45,000 and also paid SK&G employees months after they had become employed by S&K.
Not surprisingly, Greenfeld sued his former partners and S&K. His complaint alleged: statutory business conspiracy, common law conspiracy, breach of the partnership agreement, breach of fiduciary duty, intentional interference with contractual relations, tortious interference with prospective economic advantage, fraud, violation of the Uniform Trade Secrets Act, conversion, and violation of the Virginia Computer Crimes Act. In addition, he asked the court to compel his former partners to purchase his partnership interest.
The trial took three days, after which, Judge Jane Roush issued a written opinion in Greenfeld’s favor. In particular, she found that the actions set out above satisfied the elements of conversion, breach of the partnership agreement and breach of their fiduciary duties owed to Greenfeld under the Uniform Partnership Act. These then supported her finding that the defendants were guilty of common law conspiracy and that they conspired to injure Greenfeld in his business, thus violating Sections 18.2-499 and 500 of the Virginia Code. While the judge found evidence of interference with contract and prospective economic advantage as well as misappropriation of trade secrets which she used to support the conspiracy finding, she did not hold that the evidence was sufficient for Greenfeld to recover on those theories.
In calculating damages, the court found that the value of the accounting partnership (SK&G) as of the date that the defendants took control of the assets was $1,017,000. Therefore, Greenfeld’s one-third interest was worth $339,000. The court reduced this amount by the amount of Greenfeld’s unpaid loan to SK&G, leaving a net balance of $233,066. Next the judge valued the condominiums as of the date of trial at $1,365,000, which, when reduced by the value of the unpaid mortgage, resulted in a net value of $691,089. Greenfeld’s share was worth $230,363. For purposes of the statutory conspiracy, common law conspiracy, and breach of fiduciary duty counts the court added these sums together. That total, $463,429, was then trebled under Sections 18.2-499 and 500, and that amount, $1,390,287, was enhanced by prejudgment interest from the date the defendants seized control of the assets of SK&G. Finally, the judge awarded attorneys fees and costs. All totaled, the damages awarded exceeded $1,600,000, a significant penalty for such overreaching behavior.
In 2003, the partners purchased two condominium units including the one from which the firm operated. Each of the three partners guaranteed the mortgages. Before agreeing to the purchase, Greenfeld sought and received assurances from his partners that they were satisfied with the operation of their accounting partnership.
Several months later, however, on April 18, 2004, Stitley and Karstetter informed Greenfeld that they were withdrawing from the partnership and intended to dissolve it. They presented Greenfeld with a one-sided separation agreement that offered no payment for Greenfeld’s one-third interest in the partnership, refused to refund his capital contribution and allowed Stitley and Karstetter to continue servicing all of the firm’s clients. Greenfeld rejected their proposal. The following day they formed Stitley and Karstetter, PLLC (“S&K”).
Things went downhill from there. Even though Stitley and Karstetter had signed a notice withdrawing from the partnership, they never relinquished control over SK&G’s assets or employees. In addition, they: (1) terminated Greenfeld’s access to the firm’s computer network; (2) issued an eviction notice to Greenfeld; (3) locked him out of his office and refused to release to him any personal property from his office; (4) notified a software manufacturer, for whom Greenfeld had been an authorized reseller, that S&K would be taking over the account; (5) announced that S&K would be hiring all of SK&G’s employees: (6) appropriated SK&G’s computer software; (7) began using all of SK&G’s physical assets and property to benefit S&K, without compensation; (8) collected SK&G’s receivables and deposited the proceeds into S&K’s account; and (9) rebilled SK&G clients for SK&G work as S&K and then deposited those receipts into S&K accounts.
With respect to the condominiums, Stitley and Karstetter: (1) entered into a lease with S&K for the condominiums, without notice or consultation with Greenfeld, for about 56% of the rent that SK&G had been paying for the same space; (2) paid rent and condo fees, in advance, out of SK&G’s account after S&K had taken over the office space; and (3) then issued a capital call to SK&G partners seeking $1000 each per month to make up the shortfall caused by the reduction in rent paid by S&K for the condominium space.
Finally, Stitley and Karstetter notified Greenfeld that partners would receive no more distributions from SK&G, but thereafter paid themselves $45,000 and also paid SK&G employees months after they had become employed by S&K.
Not surprisingly, Greenfeld sued his former partners and S&K. His complaint alleged: statutory business conspiracy, common law conspiracy, breach of the partnership agreement, breach of fiduciary duty, intentional interference with contractual relations, tortious interference with prospective economic advantage, fraud, violation of the Uniform Trade Secrets Act, conversion, and violation of the Virginia Computer Crimes Act. In addition, he asked the court to compel his former partners to purchase his partnership interest.
The trial took three days, after which, Judge Jane Roush issued a written opinion in Greenfeld’s favor. In particular, she found that the actions set out above satisfied the elements of conversion, breach of the partnership agreement and breach of their fiduciary duties owed to Greenfeld under the Uniform Partnership Act. These then supported her finding that the defendants were guilty of common law conspiracy and that they conspired to injure Greenfeld in his business, thus violating Sections 18.2-499 and 500 of the Virginia Code. While the judge found evidence of interference with contract and prospective economic advantage as well as misappropriation of trade secrets which she used to support the conspiracy finding, she did not hold that the evidence was sufficient for Greenfeld to recover on those theories.
In calculating damages, the court found that the value of the accounting partnership (SK&G) as of the date that the defendants took control of the assets was $1,017,000. Therefore, Greenfeld’s one-third interest was worth $339,000. The court reduced this amount by the amount of Greenfeld’s unpaid loan to SK&G, leaving a net balance of $233,066. Next the judge valued the condominiums as of the date of trial at $1,365,000, which, when reduced by the value of the unpaid mortgage, resulted in a net value of $691,089. Greenfeld’s share was worth $230,363. For purposes of the statutory conspiracy, common law conspiracy, and breach of fiduciary duty counts the court added these sums together. That total, $463,429, was then trebled under Sections 18.2-499 and 500, and that amount, $1,390,287, was enhanced by prejudgment interest from the date the defendants seized control of the assets of SK&G. Finally, the judge awarded attorneys fees and costs. All totaled, the damages awarded exceeded $1,600,000, a significant penalty for such overreaching behavior.
Friday, February 13, 2009
Court Sanctions Defendant Corporation for Issuing a Misleading Press Release
In litigating corporate crisis cases, a public relations strategy is often as an essential component as the litigation itself. That is because the company's reputation may be so adversely affected during the litigation that the survival of the company or its products is at-risk, regardless of the litigation outcome. In these moments of crisis, a company often wants to present its story to the public to preserve confidence in the company.
But what limits, if any, restrict a company's public relations strategy? And, who enforces those limits? In American Science and Engineering, Inc. v. Autoclear, LLC, (E.D. Va. Dec. 16, 2008), the court found that it had the inherent power to sanction a company for its public statements in a press release. The opinion was written by U.S. District Court Judge Raymond A. Jackson and can be found here.
In Autoclear, the defendants issued a November 16, 2008 press release stating that "a Federal District Court has rejected American Science and Engineering, Inc.'s motions for summary relief in their action with Control Screening, LLC, and AutoClear, LLC, its affiliate. Opinion at 9. The District Court also denied AS&E's motion for injunctive and other relief. . . . [T]he Federal Court did not sustain AS&E's objections to proceeding to full fact finding and a jury trial." Id. Further, "'the U.S. Patent and Trademark Office (USPTO) has formally rejected all claims of AS&E's core . . . patent' and those patent claims are now invalid." Id.
The court found that the press release "improperly suggests that the Court has denied Plaintiff's motion for summary judgment or otherwise ruled on the merits of the case. Op. at 10. Plaintiff has not even filed a motion for summary judgment, and the Court has not yet ruled on the merits of the case . . . ." Id. "The Court also finds that that the statements regarding the USPTO's actions are false." Id.
"Accordingly, the Court finds that Defendants' press release contains false, misleading, and damaging statements, and that Defendants have acted improperly." Id.
Plaintiff alleged that "as a publicly traded company, it was damaged by misleading information available on popular financial internet publications, and that some of their investors did read the press release and called the company with concerns. Furthermore, Plaintiff argued that such nationally available information has the potential to influence any potential jury pool in this case." Id.
In response, the defendants "explained that the press release was meant to convey that the Court vacated the entry of default, and that any misleading statements were unintentional and the result of Defendants' oversight." Op. at 11. Defendants' attorney admitted to editing an earlier version of the press release. Id. The court deemed the attorneys "capable of understanding the difference between default judgment and summary judgment . . . ," and found it "difficult to believe that the issuance of this press release was accidental." Id. at 12.
The court rooted its ability to sanction the defendant in the defendant's right to an impartial jury.
The court's sanctions included:
The court's sanctions should give every litigant pause before publishing any announcement about a pending litigation matter to ensure that it is entirely accurate. And, it is difficult to predict the reach of this opinion. For example, are all public statements by a litigant or its attorney potentially sanctionable? Does the answer depend on how many people did or can see or hear the statement? Or, does it depend on the type of media format in which the statement was published? What would happen if a private statement becomes publicized on the internet?
We are probably safe in predicting that future courts will examine these issues now that Autoclear has provided them with a roadmap on how to deal with misleading press releases. We can also expect that the defendants in Autoclear will appeal the sanctions award to the 4th Circuit Court of Appeals.
But what limits, if any, restrict a company's public relations strategy? And, who enforces those limits? In American Science and Engineering, Inc. v. Autoclear, LLC, (E.D. Va. Dec. 16, 2008), the court found that it had the inherent power to sanction a company for its public statements in a press release. The opinion was written by U.S. District Court Judge Raymond A. Jackson and can be found here.
In Autoclear, the defendants issued a November 16, 2008 press release stating that "a Federal District Court has rejected American Science and Engineering, Inc.'s motions for summary relief in their action with Control Screening, LLC, and AutoClear, LLC, its affiliate. Opinion at 9. The District Court also denied AS&E's motion for injunctive and other relief. . . . [T]he Federal Court did not sustain AS&E's objections to proceeding to full fact finding and a jury trial." Id. Further, "'the U.S. Patent and Trademark Office (USPTO) has formally rejected all claims of AS&E's core . . . patent' and those patent claims are now invalid." Id.
The court found that the press release "improperly suggests that the Court has denied Plaintiff's motion for summary judgment or otherwise ruled on the merits of the case. Op. at 10. Plaintiff has not even filed a motion for summary judgment, and the Court has not yet ruled on the merits of the case . . . ." Id. "The Court also finds that that the statements regarding the USPTO's actions are false." Id.
"Accordingly, the Court finds that Defendants' press release contains false, misleading, and damaging statements, and that Defendants have acted improperly." Id.
Plaintiff alleged that "as a publicly traded company, it was damaged by misleading information available on popular financial internet publications, and that some of their investors did read the press release and called the company with concerns. Furthermore, Plaintiff argued that such nationally available information has the potential to influence any potential jury pool in this case." Id.
In response, the defendants "explained that the press release was meant to convey that the Court vacated the entry of default, and that any misleading statements were unintentional and the result of Defendants' oversight." Op. at 11. Defendants' attorney admitted to editing an earlier version of the press release. Id. The court deemed the attorneys "capable of understanding the difference between default judgment and summary judgment . . . ," and found it "difficult to believe that the issuance of this press release was accidental." Id. at 12.
The court rooted its ability to sanction the defendant in the defendant's right to an impartial jury.
The Supreme Court has held that civil litigants have a constitutional right to an impartial jury. Courts may disallow prejudicial extrajudicial statements by litigants that risk tainting or biasing the jury pool. Additionally, false and misleading statements are not protected by the First Amendment. Accordingly, the Court has authority to enjoin false statements, particularly those that could potentially taint the impartiality of a jury. Additionally, the Court has inherent authority to impose sanctions,including attorneys' fees, under its inherent authority.Op. at 12 (internal citations and quotations omitted).
The court's sanctions included:
Op. at 13-14.(1) Within 24 hours of this Order, Defendants shall cause the removal of the November 16th press release from Business Wire and any other website which Defendants know are displaying the November 16th press release;
(2) Defendants shall issue a corrected press release, in the form of Plaintiff's Exhibit D to its Memorandum in Support of its Motion for Sanctions, and shall disseminate it in the same manner that the November 16th press release was disseminated;
(3) To the extent that Defendants are or become aware of instances of dissemination by any third party of the November 16th press release or any article or publication based on the press release, Defendants will take the necessary steps to provide the corrected release to the publisher within 24 hours of notice;
(4) Within 5 days of this Order, Defendants shall file a statement with the Court stating what steps it has taken to comply with this Order; and
(5) Within 14 days of this Order, Defendants shall pay to AS&E the sum of $10,000 as partial reimbursement for the attorneys' fees incurred by AS&E as a result of the issuance of the November 16th press release.
Finally, the Court orders Defendants to reimburse Plaintiff for all attorneys' fees and costs associated with bringing the second Motion for Sanctions, including any such fees and costs not covered by the $10,000 requested by Plaintiff.
The court's sanctions should give every litigant pause before publishing any announcement about a pending litigation matter to ensure that it is entirely accurate. And, it is difficult to predict the reach of this opinion. For example, are all public statements by a litigant or its attorney potentially sanctionable? Does the answer depend on how many people did or can see or hear the statement? Or, does it depend on the type of media format in which the statement was published? What would happen if a private statement becomes publicized on the internet?
We are probably safe in predicting that future courts will examine these issues now that Autoclear has provided them with a roadmap on how to deal with misleading press releases. We can also expect that the defendants in Autoclear will appeal the sanctions award to the 4th Circuit Court of Appeals.
Friday, January 30, 2009
Subtle Pleading Difference Allows Claim for Intentional Interference with Business Expectancy to Go Forward
Judge James C. Cacheris' most recent opinion in Signature Flight Support Corporation v. Landown Aviation Limited Partnership, 2009 U.S. Dist. LEXIS 1938 (E.D. Va. Jan. 13, 2009), is a good illustration of how subtle shifts in the way a case is plead can be the difference in whether a company can recover in an unfair business practices case. And, it serves as a valuable primer for claims for intentional interference with a business expectancy. A copy of the opinion can be found here.
As we discussed in our prior post, found here, in an earlier opinion in Signature Flight, the court dismissed the plaintiff's tortious interference with contract claim because the plaintiff did not allege an "intentional interference of contract inducing or causing a breach or termination of the relationship or expectancy." Signature Flight, 2008 U.S. District Lexis 93715 at *6-7 (emphasis added).
The plaintiff then amended its complaint to add a claim for intentional interference with a business expectancy as opposed to interference with a contract. To assert a claim for an intentional interference with a business expectancy, a "plaintiff must allege: (1) the existence of a business relationship or expectancy, with a probability of future economic benefit to a plaintiff; (2) defendant's knowledge of the relationship or expectancy; (3) a reasonable certainty that absent defendant's intentional misconduct, plaintiff would have continued the relationship or realized the expectancy; and (4) damage to plaintiff." 2009 U.S. Dist. LEXIS 1938, *5. "In addition, when alleging a mere business expectancy, the plaintiff must show that the defendant's actions were improper." Id. (citations and internal quotations omitted).
The meaning of "improper" methods proves to be expansive and malleable in order to accommodate wide-ranging bad acts that are not easily defined or itemized. "Methods that have been recognized as 'improper' include (1) 'means that are illegal or independently tortious,' (2) 'violence, threats or intimidation, bribery, unfounded litigation, fraud, misrepresentation or deceit, defamation, duress, undue influence, misuse of inside or confidential information, or breach of a fiduciary relationship,' (3) means that 'violate an established standard of a trade or profession,' (4) '[s]harp dealing, overreaching, unfair competition,' or 'other competitive conduct below the behavior of fair men similarly situated.' Duggin v. Adams, 360 S.E.2d at 836-37 (internal quotations and citations omitted) (collecting cases)." Id. at *6.
The defendant tried to attack the claim in a number of ways. First, it argued that the plaintiff "only allege[d] a possibility that Plaintiff would realize its expectancy, not a probability." Id. at *9. The court rejected that argument because a "valid expectancy is still merely an expectancy. It need not be absolutely guaranteed." Id.
Next, the defendants argued that the "alleged actions do not qualify as improper because Plaintiff fails to allege every element of the separate torts of unfair competition or fraud." Id. at *11. The court found, however, that "a plaintiff need not allege a separate and complete tort to state a claim for tortious interference," citing the Restatement (Second) of Torts Sec. 767 cmt. c (1979) ("One may be subject to liability for intentional interference even when his fraudulent representation is not of such a character as to subject him to liability for other torts."). Id.
The court also found that the specific alleged improper conduct was sufficient to state a claim. The plaintiff alleged that the "Defendant made false, deceptive, and misleading statement to others with the intent to divert Plainitff's repeat business to itself." Id. at *12. "The Court finds that these types of statements constitute improper conduct because, as alleged, they fall under the rubric of 'misrepresentations or deceit,' 'sharp dealing, overreaching,' or 'other competitive conduct below the behavior of fair men similarly situated.'" Id. (citing Duggin, 360 S.E.2d at 836-37).
As we discussed in our prior post, found here, in an earlier opinion in Signature Flight, the court dismissed the plaintiff's tortious interference with contract claim because the plaintiff did not allege an "intentional interference of contract inducing or causing a breach or termination of the relationship or expectancy." Signature Flight, 2008 U.S. District Lexis 93715 at *6-7 (emphasis added).
The plaintiff then amended its complaint to add a claim for intentional interference with a business expectancy as opposed to interference with a contract. To assert a claim for an intentional interference with a business expectancy, a "plaintiff must allege: (1) the existence of a business relationship or expectancy, with a probability of future economic benefit to a plaintiff; (2) defendant's knowledge of the relationship or expectancy; (3) a reasonable certainty that absent defendant's intentional misconduct, plaintiff would have continued the relationship or realized the expectancy; and (4) damage to plaintiff." 2009 U.S. Dist. LEXIS 1938, *5. "In addition, when alleging a mere business expectancy, the plaintiff must show that the defendant's actions were improper." Id. (citations and internal quotations omitted).
The meaning of "improper" methods proves to be expansive and malleable in order to accommodate wide-ranging bad acts that are not easily defined or itemized. "Methods that have been recognized as 'improper' include (1) 'means that are illegal or independently tortious,' (2) 'violence, threats or intimidation, bribery, unfounded litigation, fraud, misrepresentation or deceit, defamation, duress, undue influence, misuse of inside or confidential information, or breach of a fiduciary relationship,' (3) means that 'violate an established standard of a trade or profession,' (4) '[s]harp dealing, overreaching, unfair competition,' or 'other competitive conduct below the behavior of fair men similarly situated.' Duggin v. Adams, 360 S.E.2d at 836-37 (internal quotations and citations omitted) (collecting cases)." Id. at *6.
The defendant tried to attack the claim in a number of ways. First, it argued that the plaintiff "only allege[d] a possibility that Plaintiff would realize its expectancy, not a probability." Id. at *9. The court rejected that argument because a "valid expectancy is still merely an expectancy. It need not be absolutely guaranteed." Id.
Next, the defendants argued that the "alleged actions do not qualify as improper because Plaintiff fails to allege every element of the separate torts of unfair competition or fraud." Id. at *11. The court found, however, that "a plaintiff need not allege a separate and complete tort to state a claim for tortious interference," citing the Restatement (Second) of Torts Sec. 767 cmt. c (1979) ("One may be subject to liability for intentional interference even when his fraudulent representation is not of such a character as to subject him to liability for other torts."). Id.
The court also found that the specific alleged improper conduct was sufficient to state a claim. The plaintiff alleged that the "Defendant made false, deceptive, and misleading statement to others with the intent to divert Plainitff's repeat business to itself." Id. at *12. "The Court finds that these types of statements constitute improper conduct because, as alleged, they fall under the rubric of 'misrepresentations or deceit,' 'sharp dealing, overreaching,' or 'other competitive conduct below the behavior of fair men similarly situated.'" Id. (citing Duggin, 360 S.E.2d at 836-37).
Tuesday, January 27, 2009
Williams Mullen Announces Creation of Unfair Business Practices Team
We are pleased to announce that Williams Mullen has created an Unfair Business Practices Team of seasoned litigators who understand bet-the-company litigation and have managed many cases like those that have been the subject of this Blog. Jim Kinsel and I are its Co-chairmen. The Team includes lawyers with significant experience in complex business litigation, intellectual property, employment, government and white-collar investigations and e-discovery.
The Unfair Business Practices Team members have a long history representing clients with cases involving business-to-business competition, misappropriation of proprietary information, corporate raiding, mass resignation of employees to start or join competing companies, business conspiracies, breach of fiduciary duties and corporate control issues. Our lawyers look for creative, outcome-driven strategies to manage a case as a crisis response. For more information about the Team and the types of Unfair Business Practices cases that we have handled, click here: http://www.williamsmullen.com/unfair-business/ .
The Unfair Business Practices Team members have a long history representing clients with cases involving business-to-business competition, misappropriation of proprietary information, corporate raiding, mass resignation of employees to start or join competing companies, business conspiracies, breach of fiduciary duties and corporate control issues. Our lawyers look for creative, outcome-driven strategies to manage a case as a crisis response. For more information about the Team and the types of Unfair Business Practices cases that we have handled, click here: http://www.williamsmullen.com/unfair-business/ .
Monday, January 26, 2009
Split of Opinion in Virginia Federal Courts Over Independent Personal Stake Exception to Intra-corporate Conspiracy Claims
A recent decision by Judge Mark S. Davis of the United States District Court for the Eastern District of Virginia has set up a clash between judges in that district over whether Virginia recognizes the “independent personal stake” exception to the intra-corporate immunity or intra-corporate conspiracy doctrine. It has long been understood in Virginia that because a corporation acts only through its agents, officers and employees, a conspiracy between a corporation and its agents, acting within the scope of their employment, is a legal impossibility. Griffin v. Electrolux Corp., 454 F. Supp. 29, 32 (E.D.Va. 1979). This principle, known as the intra-corporate immunity or intra-corporate conspiracy doctrine, has a recognized exception: if the agent, employee or officer has an “independent personal stake” in the conspiracy, then a conspiracy with the corporation may exist.
In December, Judge Davis in White v. Potocska, 2008 U.S. Dist. LEXIS 102204 (E.D.Va. December 3, 2008) refused to recognize the personal stake exception on the basis that the Supreme Court of Virginia had never recognized it. He drew support for his conclusion from two cases, Phoenix Renovation Corp. v. Rodriguez, 461 F. Supp.2d 411, 429 (E.D. Va. 2006) and Little Professor Book Co. v. Reston N. Point Village Ltd. Pshp., 41 Va. Cir. 73, 79 (Fairfax County 1996), an opinion by now federal district judge, Gerald Bruce Lee. Judge James C. Cacheris was the author of the Phoenix Renovation Corp. opinion. In 2007, however, Judge Cacheris reversed the view he expressed in Phoenix Renovation Corp. and recognized the “independent personal stake” exception in Buffalo Wings Factory, Inc. v. Mohd, 2007 U. S. Dist. LEXIS 91324 (E.D. Va. December 12, 2007). He reaffirmed that view in The Flexible Benefits Council v. Feltman, 2008 U.S. Dist. LEXIS 46626 (E.D.Va. June 16, 2008).
http://unfairbusinesspractices.blogspot.com/2008/11/virginia-court-limits-intra-corporate.html
Judge Davis did not mention either the Buffalo Wings Factory, Inc. or Feltman decisions in his opinion in White. Neither did he acknowledge the long line of Fourth Circuit cases that have recognized the personal stake exception, Greenville Publishing Co. v. Daily Reflector, 496 F.2d 391 (4th Cir. 1974); Buschi v.Kirven, 775 F.2d 1240 (4th Cir. 1985); Detrick v. Panaplina, 108 F.3d 529 (4th Cir. 1997); and American Chiropractic v. Trigon Healthcare, 367 F.3d 212 (4th Cir. 2004) or that a decision from the Western District of Virginia had followed the Fourth Circuit position on the issue. Selman v. American Sports Underwriters, Inc., 697 F. Supp. 225 (W.D. Va. 1988). All of those cases, with the exception of Greenville Publishing Co. originated in Virginia.
While there are several other Virginia Circuit Court opinions that have not recognized the “personal stake exception”, Softwise, Inc. v. Goodrich, 63 Va. Cir. 576 (Roanoke, January 28, 2004): Ashcon Int’l, Inc. v. Westmore Shopping Ctr. Assoc., 42 Va. Cir. 427 (Fairfax County, June 19, 1997) both recognize that the Virginia Supreme Court has been silent on the issue. And, in both cases, the courts found that, even had it been recognized, the plaintiffs had not alleged sufficient facts to implicate the exception.
It is unclear at this point how this divergence of views will be resolved in the federal courts, or whether the Virginia Supreme Court will ultimately address the issue. Meanwhile, the personal stake exception remains a very important doctrine in the unfair business practices arena. Where it is recognized, injured parties have a strong tool available to use in protecting their business interests by being able to pursue conspiracy claims.
In December, Judge Davis in White v. Potocska, 2008 U.S. Dist. LEXIS 102204 (E.D.Va. December 3, 2008) refused to recognize the personal stake exception on the basis that the Supreme Court of Virginia had never recognized it. He drew support for his conclusion from two cases, Phoenix Renovation Corp. v. Rodriguez, 461 F. Supp.2d 411, 429 (E.D. Va. 2006) and Little Professor Book Co. v. Reston N. Point Village Ltd. Pshp., 41 Va. Cir. 73, 79 (Fairfax County 1996), an opinion by now federal district judge, Gerald Bruce Lee. Judge James C. Cacheris was the author of the Phoenix Renovation Corp. opinion. In 2007, however, Judge Cacheris reversed the view he expressed in Phoenix Renovation Corp. and recognized the “independent personal stake” exception in Buffalo Wings Factory, Inc. v. Mohd, 2007 U. S. Dist. LEXIS 91324 (E.D. Va. December 12, 2007). He reaffirmed that view in The Flexible Benefits Council v. Feltman, 2008 U.S. Dist. LEXIS 46626 (E.D.Va. June 16, 2008).
http://unfairbusinesspractices.blogspot.com/2008/11/virginia-court-limits-intra-corporate.html
Judge Davis did not mention either the Buffalo Wings Factory, Inc. or Feltman decisions in his opinion in White. Neither did he acknowledge the long line of Fourth Circuit cases that have recognized the personal stake exception, Greenville Publishing Co. v. Daily Reflector, 496 F.2d 391 (4th Cir. 1974); Buschi v.Kirven, 775 F.2d 1240 (4th Cir. 1985); Detrick v. Panaplina, 108 F.3d 529 (4th Cir. 1997); and American Chiropractic v. Trigon Healthcare, 367 F.3d 212 (4th Cir. 2004) or that a decision from the Western District of Virginia had followed the Fourth Circuit position on the issue. Selman v. American Sports Underwriters, Inc., 697 F. Supp. 225 (W.D. Va. 1988). All of those cases, with the exception of Greenville Publishing Co. originated in Virginia.
While there are several other Virginia Circuit Court opinions that have not recognized the “personal stake exception”, Softwise, Inc. v. Goodrich, 63 Va. Cir. 576 (Roanoke, January 28, 2004): Ashcon Int’l, Inc. v. Westmore Shopping Ctr. Assoc., 42 Va. Cir. 427 (Fairfax County, June 19, 1997) both recognize that the Virginia Supreme Court has been silent on the issue. And, in both cases, the courts found that, even had it been recognized, the plaintiffs had not alleged sufficient facts to implicate the exception.
It is unclear at this point how this divergence of views will be resolved in the federal courts, or whether the Virginia Supreme Court will ultimately address the issue. Meanwhile, the personal stake exception remains a very important doctrine in the unfair business practices arena. Where it is recognized, injured parties have a strong tool available to use in protecting their business interests by being able to pursue conspiracy claims.
Tuesday, January 20, 2009
Court Dismisses Tortious Interference with Contract Claim Because It Only Alleged a Decrease in Business
In Signature Flight Support Corporation v. Landown Aviation Limited Partnership, the U.S. District Court dismissed the plaintiff's tortious interference with contract because the plaintiff failed to allege an "intentional interference of contract inducing or causing a breach or termination of the relationship or expectancy." 2008 U.S. District Lexis 93715 at *6-7 (E.D. Va. 2008) (emphasis added).
Rather, the plaintiff "only alleged that Defendant has induced or caused a decrease in the business that it expected to gain as a result of the contract." Id. at 7 (emphasis added). Thus, the Court found that "[b]y bringing a claim for 'intentional interference with contract' and failing to allege a breach or termination of that relationship, Plaintiff has failed to state a claim for tortious interference with contract." Id. The court relied about the Virginia Supreme Court's opinion in Chaves v. Johnson, 230 Va. 112 (1985)
To state a claim for tortious interference with contract, a plaintiff must allege: "(1) the existence of a valid contractual relationship; (2) the interferor's knowledge of the relationship; (3) intentional interference inducing or causing a breach or termination of the relationship; and (4) resulting damage to the plaintiff’s relationship. Id. at 5.
It will be interesting to track this decision to determine whether Virginia state courts will follow this interpretation of Chaves and the claim for intentional interference with contract.
Rather, the plaintiff "only alleged that Defendant has induced or caused a decrease in the business that it expected to gain as a result of the contract." Id. at 7 (emphasis added). Thus, the Court found that "[b]y bringing a claim for 'intentional interference with contract' and failing to allege a breach or termination of that relationship, Plaintiff has failed to state a claim for tortious interference with contract." Id. The court relied about the Virginia Supreme Court's opinion in Chaves v. Johnson, 230 Va. 112 (1985)
To state a claim for tortious interference with contract, a plaintiff must allege: "(1) the existence of a valid contractual relationship; (2) the interferor's knowledge of the relationship; (3) intentional interference inducing or causing a breach or termination of the relationship; and (4) resulting damage to the plaintiff’s relationship. Id. at 5.
It will be interesting to track this decision to determine whether Virginia state courts will follow this interpretation of Chaves and the claim for intentional interference with contract.
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