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A recent decision[1] by Judge Stearns of the U. S. District Court for the District of Massachusetts demonstrates that companies should periodically examine their IP protection. In that case, an employee signed an employment agreement with a company in 2005. That agreement stated that “[t]he following are the terms of employment. . . You will be required to endorse the ‘Confidentiality and Non Compete Agreement’ enclosed.” Later, in 2012, the employee signed a new employment agreement which made no reference to any confidentiality or non competition provisions.

The court concluded that the language of the 2012 agreement precluded application of the 2005 ‘Confidentiality and Non Compete Agreement’ as a matter of law. The Court stated that there was no factual question as to whether the parties intended that the 2005 ‘Confidentiality and Non Compete Agreement’ to apply to the 2012 employment agreement, because:

“The 2012 employment agreement states on its face that it contains “the terms of [the employee’s] employment” without any reservation or reference to any other document or agreement.”

Thus, the provisions of the 2005 ‘Confidentiality and Non Compete Agreement’ were extinguished by the 2012 agreement.

This case appears specific to its facts. The lesson, however, is that a company’s IP protection should be periodically reviewed to avoid problems of non enforceability. Two further examples illustrate this. I recently looked at a company’s confidentiality agreement and concluded that because it applied to three different situations, three separate types of contracts were necessary; we therefore changed the company’s IP protection system. Second, as I have previously blogged, the whole field of non competition agreements is constantly being reviewed for change by the Massachusetts legislature. I have drafted certain IP protection agreements in anticipation of such a change.

[1]           Meschino v. Frazier Industrial Company, 2015 WL 7295463 (D. Mass. 2015).

 

 

The SEC has adopted new crowdfunding rules. They are somewhat complex but will offer the smaller venture a safer way to accomplish a “friends and family” offering. The rules will also give that venture other sources of capital. Crowdfunding may, in addition, give, to those so inclined, a new avenue for fraud. An article in The New York Times, here, gives an overview and I give you a link to the text of the regulation. The release is long but the rule is not really that complex. I plan to post a blog on the effect of the new rule of the SEC upon the existing Massachusetts crowdfunding rules soon.

I am representing two individuals who had made an investment in a start up venture. The projections of the principals of the venture were, to be charitable, optimistic. The litigation resulting from this investment has been horrendously expensive (over $300,000 to date) and has taken a toll on everyone concerned. It is far better to do due diligence on an “Angel Investment” in advance. The article “Tips for the Aspiring Angel Investor” in a recent issue of The New York Times, which I attach a link to is helpful.

In addition, the venture seeking investors in a traditional private placement would be wise to prepare a disclosure document at least explaining the investment and outlining its risks.   The venture, its principals and its advisor in the aforementioned case have incurred significant legal fees in litigation of the matter over a period, so far, of almost four years.   On the other hand, I participated in drafting a private placement memorandum of a venture that went bust, therein explaining the investment and setting forth risks.   After the venture’s demise, an investor complained to a securities regulator. The regulator examined the offering materials and took no action against the venture, its principals or advisors. A properly drafted offering memo is pretty cheap insurance.

Minority shareholders in closely held corporations are frequently denied information necessary to determine whether there is wrongdoing by entrenched management. The shareholder may suspect that there is wrongdoing but cannot elicit sufficient evidence. Fortunately the Massachusetts corporate statute enables a shareholder to readily and effectively get a wide variety of information about the shareholder’s corporation. This right can be enforced in the courts.

By statute, a shareholder may inspect and copy the following records of the corporation, during regular business hours, at the place where the records are kept, on 5 business days’ written notice:

  1. its charter documents
  2. its bylaws and amendments,
  3. resolutions of the board creating stock and fixing shareholder rights,
  4. shareholder minutes for the past 3 years,
  5. a list of the names and business addresses of its directors and officers, and
  6. a copy of its most recent annual report filed with the Secretary of the Commonwealth.

There is no requirement that the shareholder make any showing of purpose or the like. The shareholder is simply entitled to these records. This right, however, is relatively meaningless because, except for the bylaws and their amendments, all of this information may be gleaned on line primarily from the Secretary of the Commonwealth’s website.

But there is a more substantial right granted by the statute. A shareholder is entitled to inspect the following, during regular business hours, at a location specified by the corporation, upon 5 business days’ written notice, the following:

  1. excerpts of directors’ (including committees) and shareholders’ actions,
  2. accounting records of the corporation.[1] and
  3. the shareholder list required to be kept by law.

The catch, is that to receive these records the shareholder must demonstrate:

  1. That the shareholder’s request is made “in good faith and for a proper purpose”,
  2. That the request describes with “reasonable particularity” the purpose and the records to be inspected, and that the records are directly connected with the shareholder’s purpose.

Even if the shareholder demonstrates the foregoing, the records may be produced only if corporation hasn’t determined in good faith that disclosure of the records would adversely affect the corporation’s business.[2]

The two battleground areas are (a) what is “in good faith and for a proper purpose” for inspection and (b) what type of information would, if disclosed, adversely affect the corporation’s business.

What then is a “in good faith and for proper purpose”? The drafters of the statute stated that “the phrases . . . are traditional and well understood”. “A ‘proper purpose’ means a purpose that is reasonably relevant to the demanding shareholder’s interest as a shareholder.”

Obtaining a shareholders’ list for the solicitation of proxies in order to change management was deemed a “proper purpose”.  On the other hand, obtaining a shareholders’ list to determine if others were willing to sell the shareholder stock was not. This demand was for “personal investment concerns” not related to the shareholder’s interest as a shareholder in the corporation. Seeking a list to contact other shareholders to elect a management that would seek a merger is a “proper purpose”. That is an interest of the shareholder in the corporation.

A shareholder without a “proper purpose” should check the corporation’s bylaws (or articles of organization, both of which can be obtained without the showing of “proper purpose”). Although the right cannot be limited by the bylaws (or articles), it can be expanded to require less than the “proper purpose” or for that matter no purpose.

The second caveat is that a corporation need not disclose information that adversely affects its business. There is little in the way of reported decisions on what type of information adversely affects business. I had, however, some success in prohibiting disclosure to a shareholder who had a competing business.

In the event that the foregoing statutory right does not give the shareholder the information desired there is a “common law” right for inspection. The breadth of that right has not been fully determined and, of that matter, that right has not been defined in recent reported decisional law.

[1]           If financial statements are audited, inspection is limited to the financial statements and the supporting schedules reasonably necessary to verify any line item thereon.

[2]           In the case of a public corporation, also excluded is information which would constitute “material non-public information”, at the time the request was made.

On July 1, 2015 the Massachusetts Earned Sick Time Law took effect implementing Ballot Question 4, which required an employer to provide its employees with sick leave benefits. The act requires an employer with eleven or more employees to provide its employees with 40 hours of PAID sick leave per year. Two of my clients that had 10 or fewer employees did not realize that they were required to provide 40 hours of UNPAID sick leave a year on basically the same terms as paid leave. Frankly, I was unaware of the breadth of the act’s application until an associate of the firm, Kate Buyuk, and I were working on a project related to the act on behalf of one of my clients.

This post is a brief summary and is intended only to alert business owners to the act and some of its requirements. The act and the attorney general’s regulations are detailed and someone familiar with its requirements should at least review an employers’ compliance.   The requirements set forth in the act and regulations are a minimum and an employer’s plan may provide greater benefits. The highlights of the act’s and regulations’ requirements for both paid and unpaid sick leave follow.

Sick leave may be used:

  1. To care for the employee’s child, parent, spouse or parent of a spouse suffering from a physical or mental illness, injury or medical condition which requires home care, professional medical diagnosis or care, or preventive medical care,
  2. To care for the employee’s own physical or mental illness, injury or medical condition which requires home care, professional medical diagnosis or care, or preventive care,
  3. To attend a routine medical appointment for the employee or the employee’s child, spouse, parent or parent of a spouse,
  4. To address the physical, legal or psychological effects of domestic violence,
  5. To travel to an appointment, pharmacy or other location related to the purpose for which the sick leave was taken.

Employers with 11 or more employees must provide PAID sick leave and employers with 10 or fewer employees must provide UNPAID sick leave.

Employees must earn an hour of sick leave for every 30 hours worked if their primary place of employment is in Massachusetts, up to a maximum of 40 hours of leave per year. An employee may begin to use accrued sick leave on the 90th day after hire and, thereafter as accrued. Employees may carry-over sick leave, but cannot use more than 40 hours in any year.

The act and attorney general’s regulations contain detailed requirements for employee documentation of sick leave. They also detail the way sick leave may be calculated and who may be a covered “employee.” Additional refinements, however, will be necessary to clarify some unclear areas.

An employer may require an employee to verify in writing that the employee is using sick leave for an approved purpose and the attorney general has adopted an acceptable form. We recommend its use verbatim. There is an “official notice” that should be posted in all Massachusetts workplaces.

The act and regulations provide very detailed requirements for an employer’s plan. In addition to providing requirements for a plan, the act and regulations have prohibitions against retaliatory acts and actions against employees regarding sick leave.

The attorney general was given broad rulemaking and enforcement powers by the act.

Six bills have been introduced in the Massachusetts Legislature that would limit or eliminate the enforcement of non competition agreements. These proposals were a favorite of the Patrick Administration. The thinking was that Massachusetts could be made more competitive by eliminating non competition agreements; after all, that thinking supposed that California was eating the commonwealth’s lunch when it came to attracting tech because California had long prohibited those agreements.

On January 14, 2015 Senator Jason M. Lewis introduced a new bill that is far more restrictive than the bill commented on in the prior post. Senate No. 169 would make “void and unenforceable” any non competition agreement of an employee or independent contractor to work after the employee or independent contractor relationship has ended, except in certain limited instances.[1]   The Bill also includes a version of the Uniform Trade Secrets Act with respect to the protection of trade secrets.

The Joint Committee on Labor and Workforce Development held a hearing on June 23, 2015 regarding the proposed legislation.

I attended the hearing and was frankly surprised and disappointed by the testimony, which was mostly for the proposed legislation. Much of it was related to the “brain drain” in high tech from Massachusetts to California. The proponents of the bills then attributed the drain to Massachusetts’s enforcement of non competition agreements. Yet those proponents offered no empirical evidence, at the hearing, that non competition agreements caused this “brain drain.” Could climate, business climate or favorable financing opportunities have made California more attractive?   The “pro” testimony also gave anecdotal—not empirical—evidence of the abuses of non competition agreements.

Both pros and cons missed the point.  Two somewhat competing considerations are involved with respect to enforcement of non competition agreements; (1) the protection of trade secrets and other intellectual property and (2) an employee’s free access to employment opportunity.

A non competition agreement is the best and least expensive way to protect trade secrets and intellectual property.   In litigating those agreements, I have found that if an employee, subject to a non competition agreement, is employed by a competitor, the former employer could seek a temporary restraining order against the individual prohibiting him or her from working for the competitor.  Thereafter, we would seek that prohibition for the remainder of the case’s pendency; a preliminary injunction. Although the case could proceed to trial, cases are generally settled at this point. There is little reason to proceed to trial because, while the case winds through the court system for a couple of years, the employee is either permitted to keep his job with the competitor or in enjoined from doing so. In short, within 10 or so days or less, any intellectual property or trade secrets are protected or the employee is free to compete. Because of the abbreviated time frame, the cost to both litigants is low and the decision swift.

Senate No. 169 contemplates enforcement of intellectual property and trade secrets.   Trade secret litigation, however, generally requires enormous amounts of discovery and, in my estimation, frequently a trial several years later to determine whether to prohibit the disclosure of the trade secret and, if disclosed, what the damages are.[2] I have found that, without extensive (and expensive discovery) it is difficult to determine what, if any, trade secrets or intellectual property has been appropriated and whether, if appropriated, what has been communicated to the competitor. This is a very expensive proposition for the party seeking to enforce the trade secret and the employee who may or may not have misappropriated the trade secret.

On the pro side, the lack of a non competition agreement promotes the free flow of information and innovation. Employees are free to start competing businesses. Businesses are forced to innovate or change. As mentioned above, enforcing a trade secret is difficult and expensive and many a trade secret or proprietary intellectual property, in the absence of a non competition agreement, finds its way to a competitor. I do not think this is necessarily bad; copying and improvement of technology advances business. Mozart and Beethoven copied other composers’ work in pre copyright days. In a local example, the textile mills of Lowell and Lawrence owed their being to (clandestine) copying the English textile mills. They did nicely until their technology was copied in a cheaper labor market. The upshot is that better goods were produced for a cheaper price and the public gained. It is no surprise that venture capitalists are in favor of the proposed legislation—it fosters more and better ventures to fund.

Neither side mentioned that if one of the bills were to become law, companies might devise devious methods that have the effect of non competition agreements. In the absence of non competition agreements in California, several tech companies in that state allegedly colluded to prevent employees from being hired by the other participants.

Neither side mentioned that, at the present time, enforcing a non competition in a Massachusetts court requires the proponent to show necessity. To obtain a temporary restraining order and a preliminary injunction, the proponent must first show, among other things, that it will suffer irreparable harm without the order and that the balance of equities favors the proponent—this is no easy task. Next, a proponent must then show need and reasonableness. The highest court in Massachusetts stated:

“A covenant not to compete is enforceable only if it is necessary to protect a legitimate business interest, reasonably limited in time and space, and consonant with the public interest . . . Covenants not to compete are valid if they are reasonable in light of the facts of each case.”[3]

A federal court in Massachusetts stated that in, addition to the foregoing, “[c]ourts will not enforce non-compete provisions if their sole purpose is to limit ordinary competition.”[4] I believe the fact that courts view non competition agreements in the foregoing manner is an important consideration. It is thus misleading not to disclose that non-competition agreements are given judicial scrutiny to determine fairness.

There are valid reasons for limiting or eliminating non competition agreements and there are valid reasons for continuing their use in Massachusetts. I’ve found both sides a bit disingenuous and a little short on facts. As the discussion continues, I hope both sides do better. Both positions should be explored thoroughly. Few states have eliminated non competition agreements and if Massachusetts becomes one of those states, I hope it does so carefully and intelligently.

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[1]           Those instances are:

  • Covenants not to solicit or hire employees or independent contractors of the employer,
  • Covenants not to solicit or transact business with customers of the employer,
  • Non disclosure agreements,
  • Covenants in connection with the sale of a business if “the party restricted is an owner of at least a 10 percent interest of the business who received significant consideration for the sale,”
  • Covenants outside of an employment relationship,
  • Forfeiture agreements, and
  • Agreements by which an employee agrees to not reapply for employment to the same employer after termination of the employee.

[2]           An additional drawback of a trade secret case is that damages in this kind of case are extremely difficult to prove.

[3]           Boulanger v. Dunkin’ Donuts, Inc., 442 Mass. 635, 639 (2004).

[4]           RE/MAX of New England, Inc. v. Prestige Real Estate, Inc., 2014 WL 3058295 (D. Mass. 2014).

Regulation A+ will become effective June 19, 2015. It updates and expands Regulation A and was mandated by the Jumpstart Our Business Startups (JOBS) Act. Will it facilitate capital formation. I think wit probably will not because it requires greater expense than a Regulation D offering but does not offer the offering company the equity distribution to form a viable market in the way an IPO does.

The regulation provides for two tiers of offerings. Tier one provides for up to $20 Million in offerings in a 12 month period with not more than $6 Million by Selling Shareholders that are affiliates of the issuer. Tier two provides for offerings for up to $50 Million in a 12 month period with not more than $15 Million by selling shareholder affiliates. The regulation limits sales by all selling shareholders to no more than 30% of the issuers initial Reg A offering and for subsequent Reg A offerings in the 12 months following the initial offering.

Both Tier one and Tier two offerings permit issuers to submit draft offering statements for non public review bye SEC staff, permit the use of offering materials after filing the offering statement and require electronic filings.

In addition issuers utilizing Tier 2 must:

  1. Provide audited financials,
  2. File annual semiannual and current event reports,
  3. Have limitation upon non-accredited investors.

Both tiers have disclosure requirements and certain Tier 2 offerings preempt certain state security laws. The latter is being challenged in court by Secretary Galvin.

An earlier blog post commented upon a bill limiting non-competition agreements presented by Senator Brownsberger and Representative Ehrlich and submitted during the 2011-12 session of the legislature.  This year, a more simplified bill, S846, was presented by Senator Brownsberger.

The bill provides that a non-competition agreement having a duration of longer than six months is presumed unreasonable, and shall be unenforceable unless:

• The employee has breached his or her fiduciary duty to the employer,

• The employee has unlawfully appropriated the employer’s property, or

• The employee has at any time received an annualized taxable compensation of $250,000 or more.

In the event any of the foregoing exceptions exist, a court may enforce the restrictive covenant for a period “determined by the court to be appropriate.”

While this may seem unduly restrictive another section of the bill provides that the following agreements are not so restricted:

• Covenants not to solicit or hire employees of the employer,

• Covenants not to solicit or transact business with customers of the employer,

• Covenants in connection with the sale of a business if the party restricted “is an owner of at least a ten percent interest of the business who received significant consideration for the sale,”

• Covenants outside of an employment relationship,

• Forfeiture agreements, or

• Agreements by which an employee agrees to not reapply for employment to the same employer after termination of the employee.

The bill applies to agreements signed on or after January 1, 2014.

Two other bills are also pending in the Massachusetts legislature; both of which would adopt the California approach to non-competition agreements.  California, by constitutional edict, renders void any non-competition agreements.  Representative Bradley presented a bill, H 1225, which would adopt the Uniform Trade Secrets Act.  Part of that bill renders void a covenant not to compete that is part of an agreement of employment (without rendering void the remainder of the agreement).  Representative Harrington presented another bill, H. 1729, which would effectively render “unlawful” any contract that serves to restrict an employee from engaging in any lawful employment, excepting restrictions in the sale of a business or of departing partners or LLC members.

The Joint Committee on labor and Workforce Development is conducting hearings on these bills in September of 2013.

The absence of non-competition agreements would have the effect of making protection of intellectual property and trade secrets extremely difficult, time consuming and expensive.  A non-competition agreement may be enforced by simply seeking and obtaining a temporary restraining order and/or a preliminary injunction preventing the employee from competing.  If this relief is granted the employer’s trade secrets and/or confidential information are secure—or at least protected by a court order.  Such relief can be obtained in days with little or no discovery.   If the “California” approach is adopted, however, an employer would have to show that the employee has revealed or appropriated trade secrets and confidential information in order to get relief from a court.  I have found this a very difficult task which involves protracted discovery and more than a little luck.  Rather than a court proceeding under a non-competition agreement that lasts days, one faces weeks, if not years of protracted litigation—all the while the competitor and the ex-employee may be utilizing the former employer’s confidential information or trade secrets.

Massachusetts adherents of the California approach, point to the drain of entrepreneurial businesses leaving or not starting up in the Commonwealth and attributing it to the lack of mobility of the workforce.  I would suggest California’s climate, availability of financing and a larger population plus the attitude of Californians have a lot more to do with its business generation than its absence of non-competition agreements.

I have been away from my blog for more than a year. I am hopeful that I can post more often. My goal is to provide timely and useful information to shareholders and management in close corporations. I have not been timely but my hope is that the information has been useful.

Much of what I do involves shareholder litigation in close corporations, preventing the same and the related area of succession planning. The preventative measures and succession planning techniques utilize creative estate planning, gifts, buy-sell agreements, voting trusts and agreements–the usual suspects. I came across a piece in The New York Times which added a new dimension to the discussion. A link is http://nyti.ms/12phzMV

Non competition agreements have long been central to protecting intellectual property and confidential information (together “IP”) of a business against unfair competition.  That may change because of a bill being considered by a committee of the Massachusetts legislature.  The text of the bill may be found here

In brief, the bill provides that a covenant not to compete must among other things:

1.   be in writing, signed by the employee and employer, be supported by fair and reasonable consideration and comply with certain procedural requirements,

2.    be necessary to protect trade secrets, confidential information or goodwill of an employer,

3.    be of a reasonable duration, and with one exception, not exceeding one year after the employee’s termination (6 months is presumptively reasonable),

4.    be reasonable in geographic scope,

5.    be reasonable in scope of prescribed activities in relation to the protected interests, and

6.    be “consonant with public policy.”

In the event that the agreement does not meet 2-6 above, it must be capable of being reformed by a court to meet those requirements.

If certain conditions are not met, the court must award the employee attorneys’ fees if it declines to enforce a material restriction or substantially reforms it. On the other hand, a court  may, if certain conditions are met, award the employer attorneys’ fees in connection with enforcement of the restriction.

The bill, however, does not include in the above, among other things, covenants not to solicit employees, or transact business with customers, of the employer.  These are important exceptions.

In addition, whether or not the bill becomes law, non competition agreements should not be the sole means of protection of a company’s IP.  Non-disclosure and trade secret agreements are also protective.  This is best illustrated by a recent case.  An ex-employer was trying to stop an ex-employee from duplicating its products in a company the ex-employee had just started. The ex-employer brought suit.  The court found that the ex-employee’s non competition agreement had lapsed.  The court, however, let the case progress on the basis of confidentiality agreements the then employer had required the then employee to sign and on the basis of the ex-employee’s possible appropriation of trade secrets.

When a business seeks to enforce the foregoing agreements, courts look carefully and critically at the agreements and systems the business has taken to protect a company’s IP.  Needless to say, these agreements and systems must be carefully crafted.  Thus the court in the above case, on oral argument, focused upon the systems the employer had put in place to protect its trade secrets.

Boston attorney, Theodore A. Lund, Esq., brought to my attention, an excellent discussion regarding non competition agreements.  This may be found here.