You Can’t Have Your Cake and Eat It Too – A Texas Court of Appeals Explains When Proceeding With Litigation Will Waive Arbitration Rights

Almost every contract now contains some sort of an arbitration clause. In fact, it is one of the first clauses an attorney looks for in an agreement when a dispute between the parties arises. This week, the Dallas Court of Appeals’s decision in Ideal Roofing, Inc., et al. v. Armbruster, et al. serves as a reminder that, at some point, proceeding with litigation of a dispute in court can result in a waiver of an applicable and otherwise enforceable arbitration clause.

In this case, Ideal Roofing and Ambrusters entered into a construction contract containing an arbitration clause. When Ambrusters’ roof started leaking, they filed a lawsuit against Ideal Roofing.  Although the defendant could have compelled arbitration almost immediately, it proceeded to litigate the case for eighteen and a half months before filing a motion to compel arbitration.  The trial court denied the motion and the Court of Appeals affirmed, providing an useful overview of the waiver standard.

In general, a party seeking to compel arbitration under the Federal Arbitration Act (FAA) must establish: (1) the existence of a valid, enforceable arbitration agreement and (2) that the claims at issue fall within that agreement’s scope. The party seeking to avoid arbitration must then establish an affirmative defense to enforcement of the otherwise valid arbitration agreement. Since Ambrusters had conceded on appeal that the arbitration agreement was enforceable, only one question remained – whether Ideal Roofing had waived its arbitration rights by participating in the litigation.

Under both federal and state law, there is a strong presumption against waiver of contractual arbitration.  A party waives its contractual arbitration rights when it “substantially invokes judicial process.” According to the Court of Appeals, a party does so when “it has taken specific and deliberate actions, after the filing of the suit, that are inconsistent with the right to arbitrate or has actively tried, but failed, to achieve a satisfactory result through litigation before turning to arbitration.”

What constitutes a “substantial” litigation conduct depends on the context, but a court must consider the following factors when deciding whether a party moving to compel arbitration has waived its contractual arbitration rights:

  • when the movant knew of the arbitration clause

  • how much discovery has been initiated and who initiated it

  • the extent to which discovery related to the merits rather than arbitrability or standing

  • how much of the discovery would be useful in arbitration

  • whether the movant sought judgment on the merits

  • whether the movant sought to compel arbitration on the “eve of the trial”

While the Court of Appeals emphasized that that delay (in moving to compel arbitration) alone does not establish waiver, in this case, the following five out of six factors supported the finding of a waiver:

  • Ideal Roofing was aware of the arbitration agreement at least four months after answering the lawsuit, but it did not move to compel arbitration until the case has been pending for 18 1/2 months and the case had been set for trial three times

  • Ideal Roofing both propounded and answered written discovery, took several expert witnesses’ depositions, and inspected the Ambrusters’ roof

  • None of the discovery conducted in this case related to arbitrability or standing

  • Ideal Roofing asserted affirmative defenses in court, filed a counter-claim, attended a two-day mediation, and filed a motion for summary judgment and set it for hearing twice

  • Ideal Roofing filed its motion to compel four months before the trial date

In addition to the burden of showing that a party seeking to compel arbitration has substantially invoked the judicial process, the party seeking to avoid arbitration must also show prejudice or “inherent unfairness in terms of delay, expense, or damage to its legal position that occurs when the party’s opponent forces it to litigate an issue and later seeks to arbitrate that same issue.” Prejudice is more easily shown when a party delays his request for arbitration and in the meantime engages in pretrial activity inconsistent with an intent to arbitrate.

The Court of Appeals found that the following evidence was sufficient to establish prejudice to Ambrusters: (1) plaintiffs’ attorney, whom they hired on contingency, would have to travel from Dallas to Houston to arbitrate; (2) plaintiffs had already paid for two days of mediation and over $3,500 in expert fees; (3) the arbitration agreement was silent as to whether discovery conducted during litigation could be used during arbitration; and (4) the Ambrusters had completed their discovery and were ready to proceed with trial when Ideal Roofing filed it motion to compel arbitration.

CONCLUSION: While answering a lawsuit and even conducting some discovery will probably not waive one’s arbitration rights, a party who is aware of an enforceable arbitration agreement, should proceed cautiously in court while it assesses whether to enforce the agreement or not and should avoid taking a position that is inconsistent with the intent to arbitrate.

For more information regarding enforcement of arbitration agreements in Texas, contact Leiza Dolghih.

A Texas Court of Appeals Weighs In On The Defensive Use of The Uniform Declaratory Judgment Act

For plaintiffs, filing a claim for breach of contract and seeking a declaratory judgment almost always go hand in hand. What happens, however, when a party threatened with such claims beats the plaintiff to the punch and files its own declaratory judgment suit on the same contract? The Fourteenth Court of Appeals has recently blessed such approach in Drexel Corp. v. Edgewood Development, Ltd., as long as certain conditions are met.

In this case, Drexel Corporation and Edgewood Development entered into a written contract in which Edgewood promised to pay Drexel a portion of the proceeds when a certain property was sold. Seventeen years later, Drexel sent Edgewood a demand letter in which it stated that the parties omitted to include in the contract a date by which the property would be sold and final payment made to Drexel. The demand letter stated that a reasonable time for the property’s sale had passed and that a reasonable estimation of Drexel’s share of the proceeds from a hypothetical sale was $1.2 million. If Edgewood did not pay $1.2 million within thirty days, Drexel would sue for “a declaratory judgment with respect to the missing term (i.e., the outside date for a sale of the property) and a monetary judgment” for Drexel’s share of the sales proceeds, plus attorneys’ fees, costs, and interest.

In response to the letter and before the 30-day deadline expired, Edgewood filed its own suit for declaratory judgment under the Uniform Declaratory Judgment Act (“UDJA”). See Tex. Civ. Prac. & Rem. Code Ann. § 37.004(a). Drexel moved to dismiss the suit for lack of subject matter jurisdiction arguing that: (1) the controversy was not ripe since Edgewood did not plead or prove that it would suffer any imminent injury or harm without the judicial declaration; and (2) the UDJA should not be used “to deprive the real plaintiff of the traditional right to choose the time and place of suit.” The Court of Appeals affirmed the trial court’s subject-matter jurisdiction rejecting both arguments.

Requirement No. 1: Justiciable Controversy

Under the UDJA, a person interested under a written contract or whose rights are affected by it “may have determined any question of construction or validity arising under the . . . contract.” Tex. Civ. Prac. & Rem. Code Ann. § 37.004(a). A court may construe the contract “either before or after there has been a breach.” Id. § 37.004(b). According to the Court of Appeals, a declaratory judgment under the UDJA is appropriate only if “a justiciable controversy exists as to the rights and status of the parties and the controversy will be resolved by the declaration sought,” and the Act cannot be used to resolve a hypothetical or contingent situation. Since Drexel asserted in the demand letter that Edgewood was obligated to pay $1.2 million under the contract and Edgewood denied that obligation, there was a justiciable controversy between the parties.

Requirement No. 2: Ripeness

In addition to the justiciable controversy requirement, the parties’ dispute must be ripe for adjudication. To evaluate the ripeness of a claim, courts will consider “whether, at the time a lawsuit is filed, the facts are sufficiently developed ‘so that an injury has occurred or is likely to occur, rather than being contingent or remote.’” The threat of harm “can constitute a concrete injury, but [it] must be ‘direct and immediate’ rather than conjectural, hypothetical, or remote. To show that such injuries are likely to occur, for example, parties must demonstrate that the harm is imminent, but has not yet impacted them.” Pursuant to this standard, because Drexel made a demand for payment under the contract, the declaratory judgment by Edgewood called not for an advisory opinion upon a hypothetical basis, but for an adjudication of its rights and obligations under the parties’ agreement, making the parties’ dispute ripe for adjudication.

Thus, as long as a party can establish the above requirements, it can seek a declaration of contractual non-liability in response to a demand made under a contract by another party.  The Court of Appeals specifically rejected Drexel’s argument that Edgewood’s filing of a declaratory judgment lawsuit deprived the “real” plaintiff of its “traditional right to choose the time and place of suit.”  It explained that while this principle might apply to tort claims, it has no application in a contractual dispute because “only a plaintiff may seek redress for a tort. But in a contract case, either party may breach the agreement and either party may sue for a breach or a judicial determination of rights under the contract.” Thus, since both parties might have suffered damages in a contract situation, there is no “real” plaintiff.

PRACTICAL IMPLICATIONS:  When considering how to respond to a demand under a contract, a potential defendant should consider the pros and cons of filing its own declaratory judgment suit instead of waiting for the plaintiff to act on its threat.  Filing such a suit can create a certain strategic advantage since it allows the party to pick the court and the venue for filing, control the posture of the suit, and frame the facts and issues for the court.

On the other side, unless a potential plaintiff thinks that the demand letter will succeed in persuading the other party to fulfill its contractual obligations, it might want to hold off on making the presentment under Tex. Civ. Prac. & Rem. Code § 38.002 until after it files the suit so as to not tip off the other side and allow it time to file its own suit under the UDJA.

For more information regarding contract disputes in Texas, contact Leiza Dolghih.

In Texas, a Court Can Rewrite Your Non-Compete For You, But It Might Cost You a Pretty Penny

Texas courts have the authority to rewrite non-compete agreements that they find to be unreasonable. Thus, a business might be tempted to draft a broad non-compete agreement thinking that when a push comes to shove, it can just ask the court to reform the agreement to make it more reasonable.  However, the recent First Court of Appeals’ decision in Sentinel Integrity Solutions, Inc. v. Mistras Group, Inc., et al.illustrates why relying on reformation as a way of fixing an overly-broad non-compete agreement could end up being very costly to the employer.

At issue in this case was a non-compete agreement signed by Sentinel’s employee, Olson, upon his promotion within the company. The agreement required that he “refrain from competing with [Sentinel] or otherwise engaging in ‘Restricted Activities'” for a period of 3 years after the termination date within a region including 7 cities and 4 counties in Texas, locations in 6 states and 1 country, and  “a twenty (20) mile radius around all customers’ job sites and/or project facilities that [the employee] called on or services on behalf of [Sentinel] in all geographic regions, wherever located.”  Olson only worked at the Sentinel’s Corpus Christi location.

When Olson left to work for another company, Sentinel immediately sued him and his new employer seeking enforcement of the non-compete agreement under Tex. Bus. & Com. Code Ann. 15.50(a) and, alternatively, reformation of the agreement under Tex. Bus. & Com. Code Ann. 15.51(c) if the court found that the covenant was not reasonably limited as to time, geographic area, or scope of activity.

Until the last day of trial, Sentinel maintained that the covenant not to compete was enforceable as written. On the last day, its counsel conceded on the record that the agreement was unreasonable at least as to the geographic area it covered. Still, Sentinel did not request reformation until after the jury returned its verdict requiring it to pay Olson’s $750,000 attorney’s fees. The trial court reformed the non-compete agreement as requested by Sentinel, but also adopted the jury’s award of the attorney’s fees.

The award was based on Tex. Bus. & Com. Code Ann. 15.51(c), which allows a trial court to award an employee against whom a non-compete is being enforced his attorneys fees if the employee proves that:

  • plaintiff knew at the time the employment agreement was executed that the covenant did not contain limitations as to time, geographical area, and scope of activity to be restrained that were reasonable and the limitations imposed a greater restraint than necessary to protect [plaintiff’s] goodwill or other business interest, and
  • plaintiff sought to enforce the covenant to a greater extent than was necessary to protect its goodwill or other business interest.

Sentinel argued on appeal that there was not enough evidence to support the findings under Section 15.51(c), but the Court of Appeals disagreed based on the following:

  • Sentinel’s manager testified that he purposefully made the geographical area covered by the non-compete provision broad “to cover pretty much all of the general areas that we think or anticipate would be covered” and he relied on a provision allowing a trial court to reform the agreement if necessary;
  • The covenant not to compete expressly stated that “Employee and Company agree that the limitations as to time  and scope of activity to be restrained are reasonable,” but it was silent on the reasonableness of the geographic area;
  • Sentinel’s manager sent an email to Olson prior to his signing of the non-compete agreement assuring him that the agreement would not prevent Olson from working as an inspector;
  • Sentinel attempted to enforce the covenant’s ban on competition in “in any capacity” that overlapped with managerial duties at Sentinel, i.e. “inspector, manager, supervisor, dishwasher, it doesn’t matter”;
  • Sentinel attempted to enforce the covenant’s general ban on “competing,” including restricting Olson from working in geographic areas that were not tailored to Olson’s work on behalf of Sentinel or even to Sentinel’s own current business.

CONCLUSION:  Sure, you can always ask a Texas court to reform a non-compete agreement, and the court will most likely do so.  However, if it finds that a company knew at the time the non-compete agreement was executed that it contained unreasonable restrictions and it tried to enforce it to a greater extent than was necessary to protect its business interest, the company might end up paying the other side’s hefty attorney’s fees bill on top of the reformation.

Thus, instead of handing employees a boiler-plate broad non-compete agreement with a hope that a court can later “fix” it if necessary, a business should attempt to draft its non-compete agreements to reflect the particular geographic areas and the job duties of the employees that sign them.

While it is not always possible to know where an employee will end up working over the years, a language in a non-compete agreement that ties the “restricted area” of competition to the area where the employee is going to work, without naming specific geographic locations, plus a reasonable mile radius, can help a company avoid a Section 15.51(c) award.

Similarly, instead of including every possible activity in a list of competitive activities to be restrained, catering the language to the job description of the employee who will be signing the agreement, might help ward off a Section 15.51(c) award.

Leiza litigates non-compete and trade secrets lawsuits on behalf of EMPLOYERS and EMPLOYEES in a variety of industries, and knows how such disputes typically play out for both parties. If you need advice regarding your non-compete agreement, contact Ms. Dolghih for a confidential consultation at Leiza.Dolghih@GodwinLewis.com or (214) 939-4458.

Practical Guide to Enforcing Non-Compete Agreements in Texas (Part II)

If you have followed the steps in Part I, you might now be in possession of evidence confirming that your ex-employee is violating his or her non-compete agreement. Such evidence will do you no good, however, if the non-compete agreement that you are relying upon is not enforceable. So, before you race to the courthouse asking for a temporary injunction, an assessment of enforceability is in order. This analysis needs to be done quickly, if not simultaneously, with the steps described in Part I.

Over the years, Texas courts have steadily moved toward making the enforceability of non-compete agreements easier. This post addresses the most current general requirements as spelled out by the Texas Supreme Court over the last decade, but beware of the old cases that used to impose additional requirements, but are no longer good law.

In Texas, non-competition agreements are governed by Section 15.50(a) of the Texas Business & Commerce Code, which states that “a covenant not to compete is enforceable if it is ancillary to or part of an otherwise enforceable agreement at the time the agreement is made to the extent that it contains limitations as to time, geographical area, and scope of activity to be restrained that are reasonable and do not impose a greater restraint than is necessary to protect the goodwill or other business interest of the promisee.”

Thus, Texas courts require two factors to enforce a non-compete agreement that is ancillary to an otherwise enforceable agreement:

1. There must be consideration.

2. The limitations on time, geographical area, and scope of activity to be restrained must be reasonable.

Question 1: Did the Employee Receive Adequate Consideration for His/Her Promise Not to Compete?

Because Texas is an at will employment state, an employer’s offer of employment can be terminated at any time, is illusory, and does not by itself constitute sufficient consideration for an employee’s promise not to compete. Therefore, an employer must promise its employees something other than an offer of employment in exchange for their signature on the non-compete, which includes confidential information, trade secrets or specialized training provided by the employer. Consideration can also include stock options or other financial incentives that are “reasonably related” to the employer’s interest that is worthy of protection.

Question 2: Are the Limitations on Time, Geography and Scope Imposed by the Non-Competition Agreement Reasonable?

Non-competition agreement must restrain no more activity than is necessary to protect the legitimate business interest of the employer. Texas courts have consistently refused to enforce agreements that prohibit all competitive activity or prohibit employment in any capacity for a competitive entity. The courts have also refused to enforce agreements that prohibit activity unrelated to the work the employee preformed for the former employer.

Similarly, Texas courts have also determined that non-competition agreements that contain no geographical limitations or fail to limit the scope of activity to be restrained are unreasonable and unenforceable. Generally, a reasonable area of restraint consists of only the territory in which the employee worked for the former employer.  Thus, courts in the past have refused to enforce non-competition agreements with nationwide applicability when the employee did not have nationwide responsibilities for the former employer.

While the court in Texas have authority to reform a non-competition agreement to narrow the scope or the geographical area of the agreement so as to make it enforceable, they will not always do so.

So, hopefully, you had legal advice regarding the non-compete agreements when they were drafted and the above issues are not going to prevent you from enforcing them. If not, you need to revise your current non-compete agreements and the employment policies that affect the exchange of consideration to ensure that the above-described requirements are met.

If, after conducting the above enforceability analysis, you believe that your non-compete agreements contain reasonable limitations and the former employee was given some sort of consideration in exchange for signing the non-compete agreement, you might have an enforceable agreement on your hands. I will discuss the next steps of enforcing a non-compete agreement in Part III.

Leiza litigates non-compete and trade secrets lawsuits on behalf of EMPLOYERS and EMPLOYEES in a variety of industries, and knows how such disputes typically play out for both parties. If you need advice regarding your non-compete agreement, contact Ms. Dolghih for a confidential consultation at Leiza.Dolghih@lewisbrisbois.com or (214) 722-7108.

The Fifth Circuit Triples an Overtime Payment Award; Says the Fluctuating Workweek Method Was Not Warranted in a FLSA Misclassification Case

Last Friday, the Fifth Circuit in Black v. SettlePou, PC ruled that the Northern District of Texas erred in applying the Fluctuating Workweek (FWW) method of calculating an overtime payment award where there was no evidence that the employee had agreed to the flexible work hours. The Court of Appeals remanded the case and ordered a recalculation of damages using 1 1/2 times the regular hourly rate of pay instead of 1/2 under the FWW, which would result in a tripling of the actual and liquidated damages.

Black was employed as a legal secretary and paralegal at SettlePou, P.C. from 2005–2010. She was first hired as a non-exempt legal secretary, then promoted to a paralegal, but remained a non-exempt employee, as defined by the Fair Labor Standards Act, 29 U.S.C. §§ 201–19 (FLSA), earning overtime at 1 1/2 regular rate of pay. In 2007, SettlePou informed Black that she was to begin supervising one of their legal secretaries, therefore, she would be reclassified as exempt, making her ineligible for overtime pay as an exempt employee. Immediately following her reclassification Black complained both verbally and in writing to her supervisor and to the human resources department stating that she thought she should be paid overtime for her extra hours worked.  After she was terminated in 2010, she filed a suit against SettlePou on behalf of herself and all other similarly situated paralegals for violations of the FLSA.

The jury found that SettlePou had willfully violated the FLSA by misclassifying Black as exempt and the she was owed 274 hours of overtime pay. Apparently, when Black was promoted to a supervisor position, she was told that she would be given supervisory authority, but was never actually given one.  Thus, she continued to perform the same duties, but was now ineligible for overtime.

The district judge calculated the amount of overtime premium due to Black by multiplying her 274 overtime hours by one-half of her hourly pay rate.  Black filed a motion to alter or amend the judgment, arguing that the district court should have used 1 1/2 times the regular hourly rate of pay instead of 1/2 in its calculation of damages, but the district court denied the motion.

In overruling the district court, the Fifth Circuit explained that “[t]he FWW method of calculating overtime premiums in a misclassification case is appropriate when the employer and the employee have agreed that the employee will be paid a fixed weekly wage to work fluctuating hours,” and that the existence of such agreement is a question of fact.  The record evidence in this case – both the parties’ initial understanding and their course of conduct – showed that there was no such agreement between Black and her employer because:

  • SettlePou’s Human Resources Director testified that she was unaware of any fluctuating workweek agreement with Black
  • Black testified that her understanding was that she would be compensated with a fixed weekly wage for working a regular schedule of 37 1/2 hours
  • the payroll records showed that Black was being compensated for full time employment, which was defined in the Employee Handbook as 37 1/2 hours per week
  • the Employee Handbook only stated that exempt employees would not be compensated for overtime, but did not explain that the full-time paralegals like Black were expected to work a fluctuating work week or overtime

The critical issue in this case, was “not only whether SettlePou paid Black a fixed salary for varying hours, but whether SettlePou and Black had agreed that a fixed salary would compensate her for all of the hours she worked each week.” The fact that Black complained to the Human Resources Director and her supervisor about having to work overtime without receiving overtime payment, showed that she did not agree to compensation based on the fluctuating work week.

MORAL OF THE STORY:  First, make sure your employees are classified correctly as exempt or non-exempt.  Second, if you expect employees to work flexible hours, make sure that they are made aware of that, preferably in writing, and that the compensation system reflects this arrangement. It won’t hurt to have employees sign a statement acknowledging that they are expected to work fluctuating hours.  Third, make sure that your employee handbooks, employment applications, payroll records, and other paperwork associated with the fluctuating work week positions reflect the specific nature of that arrangement. Finally, make sure that the human resources department is knowledgeable about any fluctuating work week positions.

For more information regarding the Fair Labor Standards Act, contact Leiza Dolghih

The ADA Does Not Require a Nexus Between a Requested Accommodation and an Essential Job Function – Says the Fifth Circuit

The Fifth Circuit Court of Appeals recently ruled in Feist v. State of Louisiana, that a “reasonable accommodation” under the Americans with Disabilities Act (ADA), does not need to “relate to the performance of essential job functions.” In reversing the district court, the Court of Appeals held that an accommodation could be reasonable even if it does not relate to the essential job functions as long as it makes the workplace “readily accessible to and usable” by a disabled employee, or, alternatively, it allows an employee with a disability to “enjoy equal benefits and privileges of employment as are enjoyed by [the employer’s] other similarly situated employees without disabilities.” Thus, the district court erred by requiring a nexus between the employee’s requested accommodation, a reserved parking space, and her job functions as an assistant attorney general.

The ADA prohibits covered employers from “discriminat[ing] against a qualified individual on the basis of disability.” 42 U.S.C. § 12112(a). Discrimination includes failure to make “reasonable accommodations to the known physical or mental limitations of an otherwise qualified individual with a disability . . . unless such covered entity can demonstrate that the accommodation would impose an undue hardship.” 42 U.S.C. § 12112(b)(5)(A). According to the Fifth Circuit Court of Appeals, a plaintiff asserting a discrimination claim under the ADA, must show the following:

  • s/he is a “qualified individual with a disability;”
  • the disability and its consequential limitations were “known” by the covered employer; and
  • the employer failed to make “reasonable accommodations” for such known limitations.

The district court in Feist held that the plaintiff established the first two elements, but failed to show that the requested accommodation was “reasonable” because she had failed to demonstrate that not having a reserved parking spot limited her ability to perform “the essential functions of her job” as an assistant attorney general. The Court of Appeals, however, ruled that “the ADA, and all available interpretive authority” indicated that “reasonable accommodations” were not restricted to modifications that enabled performance of essential job functions.

Under the ADA, a reasonable accommodation may include:

(A) making existing facilities used by employees readily accessible to and usable by individuals with disabilities; and

(B) job restructuring, part-time or modified work schedules, reassignment to a vacant position, acquisition or modification of equipment or devices, appropriate adjustment or modifications of examinations, training materials or policies, the provision of qualified readers or interpreters, and other similar accommodations for individuals with disabilities. 42 U.S.C. § 12111(9)(A).

Moreover, the ADA implementing regulations define “reasonable accommodation” as follows:

(i) Modifications or adjustments to a job application process that enable a qualified applicant with a disability to be considered for the position such qualified applicant desires; or

(ii) Modifications or adjustments to the work environment . . . that enable an individual with a disability who is qualified to perform the essential functions of that position; or

(iii) Modifications or adjustments that enable a covered entity’s employee with a disability to enjoy equal benefits and privileges of employment as are enjoyed by its other similarly situated employees without disabilities. 29 C.F.R. § 1630.2(o)(1) (emphasis added).

Thus, the Court of Appeals concluded that a modification that enables an individual to perform the essential function of a position is only one of three categories of reasonable accommodation.

What does this mean for Texas business owners? When addressing an accommodation request by an employee with a disability, the employer should not deny the request simply because the accommodation does not relate to the employee’s essential job functions.  The employer should further consider whether the accommodation will allow the employee to enjoy the same benefits and privileges that other similarly situated employees without disabilities enjoy.  If the answer to that question is “yes,” then the employer will have to provide the accommodation, unless it creates an undue hardship.

For more information regarding the Americans with Disabilities Act, contact Leiza Dolghih.

Defamatory Statements Made In Another State: Can You Sue In Texas?

These days, virtually anybody can write something online and have it go viral in a matter of hours. A person’s or a business’s reputation can be ruined in a matter of days by somebody’s thoughtless or malicious remarks. So, what is a person to do? Sometime, a lawsuit for defamation might be an answer. However, when a defamatory and damaging statement is made online, one question arises with frequency – where can the defamed party file the lawsuit? Obviously, it is more convenient to file it in the state where the defamed party lives or conducts business, but is that always possible?

The Fifth Circuit Court of Appeals recently considered whether Louisiana plaintiffs could file a lawsuit in their home state against California defendants who made allegedly defamatory statements about the plaintiffs online. Because the Louisiana long-arm statute is coextensive with the Due Process Clause limits, just like the Texas long-arm statute, the Court of Appeals’s analysis, applies to Texas as well.

In Herman v. Cataphora, the plaintiffs’ steering committee in In Re: Chinese-Manufactured Drywall Products Liability Litigation in the Eastern District of Louisiana hired Cataphora for litigation support. When their relationship soured, Cataphora filed and won a breach of contract lawsuit against the steering committee in the Northern District of California. Afterwards, a technology counsel for Cataphora gave an interview to Above the Law about the lawsuit and stated (presumably referring to the plaintiffs’ steering committee) that “[t]hese guys are the worst of hypocrites you can possibly find. They claim to be trying to help the little guy, but what they are doing is trying to put more money in their own pockets.” The interview took place in California and was quoted on the Above the Law website, which is published by Breaking Media, Inc., headquartered in new York.

Two of the steering committee members sued Cataphora and the technology counsel in the Eastern District of Louisiana for defamation and interference with prospective advantage. The defendants moved to dismiss for lack of personal jurisdiction or to transfer to a proper venue. Without holding an evidentiary hearing, the district court dismissed the case due to lack of personal jurisdiction and ordered a transfer under 28 U.S.C. § 1406(a) to the Northern District of California. The plaintiffs appealed the dismissal order.

The Fifth Circuit held that Louisiana lacked personal jurisdiction over the defendants and explained that when it comes to defamatory statements, the main question is whether the statements are directed at the forum state. Even when a plaintiff feels the harm from the defamatory statements in his home state, it is not enough to gain personal jurisdiction over the defendants in another state, if the statements focus on activities and events outside the forum state.  Thus, even if the plaintiffs in Herman made a prima facie showing that the harm caused by the defendants’ statements would be felt in Louisiana where they practiced law, this was not enough, and “[w]ithout a showing that the statements’ focal point was Louisiana . . . the district court lacked personal jurisdiction over the defendants.” Specifically, the following factors were lacking to establish specific personal jurisdiction over the defendants in Louisiana:

  • Louisiana was not the “focal point” of both the article itself and the harm suffered
  • There was nothing in the comments that explicitly or implicitly connected the parties’ dispute to Louisiana
  • There was no evidence that the statements or the article itself were directed at Louisiana residents
  • There was no evidence that Above the Law had a disproportionately high Louisiana readership

Due to these factors, the Court of Appeals proceeded to remand the case back to the trial court and order it to transfer the controversy to the Northern District of California.

BOTTOM LINE: Unless a defendant who makes defamatory statements about a business or person located in Texas also happens to have “continuous and systematic contacts” with Texas, i.e., general personal jurisdiction, a plaintiff in this state will have to show that the defamatory remarks were directed at Texas, or Texas activities were the “focal point” of such remarks, in order to be able to sue the defendant in Texas.  Plaintiffs, of course, always have an option of suing defendants in their home states.

For more information regarding defamation claims in Texas, contact Leiza Dolghih.

Defamation in Texas: Being Called a “Liar” Will Not Get You Presumed Damages

Texas law recognizes two types of defamation: defamation and defamation per se. While a plaintiff has to prove actual damages in a defamation claim, such damages are presumed in a defamation per se lawsuit, making it a much easier claim for the plaintiff to prove. Whether a particular statement constitutes a defamation or a defamation per se depends on the nature of the statement. Texas law presumes that the following statements are defamatory per se: (1) statements that unambiguously charge a crime, dishonesty, fraud, rascality, or general depravity or (2) statements that are falsehoods that injure one in his office, business, profession, or occupation. See Main v. Royall, 348 S.W.3d 318, 390 (Tex. App.—Dallas 2011, no pet.).

Recently, in the case of Hancock v. Variyam, the Texas Supreme Court found that the statements that a doctor “lacked veracity” and “dealt in half truths” and circulated to his colleagues were not defamatory per se because they did not injure him in his profession as a physician. The Supreme Court proceeded to reverse $181,000 award of damages ($90,000 in actual damages and $85,000 in exemplary damages) because the doctor had failed to provide any proof of them at trial.

The Supreme Court explained that “because the [defamatory] statements did not ascribe the lack of a necessary skill that is peculiar or unique to the profession of being a physician” they were not defamatory per se. Furthermore, because “the specific trait of truthfulness is not peculiar or unique to being a physician,” but is a trait that is necessary in every profession, the defendant’s statement that the plaintiff “lacked veracity” was not defamatory per se. Thus, the plaintiff had to provide evidence of actual damages he had suffered due to the plaintiff’s statements – either evidence that he had lost patients or suffered mental anguish – in order to recover under this claim.

The Supreme Court rejected the Court of Appeals’ reasoning that accusing somebody of being a liar is so obviously hurtful to the person that the damages should be presumed. It also rejected the plaintiff’s argument that the statements by the defendant that the plaintiff “lacked veracity” would so clearly impact his patient care, teaching, research, and publication, that the damages had to be presumed.

Providing an example of what statements would be considered defamatory per se, the Supreme Court relied on the Restatement (Second) of Torts § 573, explaining that statements that a physician is a drunkard or a quack or that he is incompetent or negligent in the practice of his profession or that he is dishonest in his fees, would constitute defamation per se, and the damages would be presumed.

THE PRACTICAL EFFECT: Defamation is a great tool for protecting one’s professional reputation or reputation as a business owner. However, before diving into a defamation lawsuit, it is important to assess what evidence a party will need to prove a claim of defamation and what evidence it has. If the purported defamatory statements fall under the defamation per se category, then the damages will be presumed. However, if the statements are of general nature and do not specifically relate to the party’s profession or occupation, the injured party will have to put on evidence of actual damages incurred as the result of such statements.

According to Hancock, unless being truthful is a specific trait of a profession or a business, being called or labeled a “liar” is not enough to allow a presumption of actual damages.

For more information regarding defamation claims in Texas, contact Leiza Dolghih.

To Protect Trade Secrets, Make Sure the Temporary Injunction Explains What They Are

When a company learns that its former employees are releasing or using the company’s trade secrets, it needs to act fast. No company, therefore, wants to spend precious time and money trying to obtain a temporary injunction preventing the release of the confidential information, only to have it overturned by a Court of Appeals because it was not detailed enough. Yet, that’s exactly what happened in Ramirez, et al. v. Ignite Holdings Ltd., et al.where the Texas Fifth Court of Appeals reversed a temporary injunction because it failed to describe specifically what trade secrets and proprietary information the company’s former employees were prohibited from releasing.

In RamirezStream Energy, a provider of electricity and natural gas, and its marketing subsidiary, Ignite Holdings, employed independent sales associates, who had signed non-compete and non-solicitation agreements. When Stream Energy and Ignite found out that Ramirez and several other sales associates were working for their competitors, they fired them and, shortly thereafter, filed a lawsuit. The companies had no trouble obtaining a temporary injunction because of plentiful evidence of violations, but the sales associates appealed the injunction under Texas Civil Practice and Remedies Code Ann. § 51.014(a)(4), arguing that it was not detailed enough.

Most of the restrains in the temporary injunction had expired by the time the appellate court considered them, but the following provision remained in force, prohibiting defendants from: “possessing, disclosing to any third party, or using for their own benefit or to the detriment of Ignite and Stream Energy any of Ignite’s or Stream Energy’s Proprietary Information/Trade Secrets (including but not limited to proprietary information, confidential information, training materials, templates, or sales or customer lists.)”  The injunction defined “Proprietary Information/Trade Secrets” as “valuable business, training, and sales techniques, methods, forms, materials, guides, lists, downline associate and customer lists, including personal identifying information, and other confidential and proprietary information as discussed above.”

The Court of Appeals found that this prohibition failed to pass the muster under the Texas Rule of Civil Procedure 683, which requires an injunction to “describe in reasonable detail and not by reference to the complaint or other document, the act or acts sought to be restrained,” and reversed and remanded the injunction to the trial court.  The ruling explained that “techniques,” “materials,” “proprietary information,” and “confidential information” were too broad and general to give the sales associates adequate notice of the type of information they were restrained from releasing or using.  In contrast, the categories of information such as “downline associate and customer lists” and “organizational reports” were detailed enough to meet the requirements of Rule 683.  The Court of Appeals explained that the broad description of the types of the information that the sales associates were prohibited from releasing required them to infer whether any particular information or item in their possession was “proprietary information” or “confidential information” covered by the injunction, and this was “impermissible.”

Since this ruling, the Texas Uniform Trade Secrets Act (TUTSA) has become effective.  It now provides a definition of “trade secrets” as “information, including a formula, pattern, compilation, program, device, method, technique, process, financial data, or list of actual or potential customers or suppliers.”  It appears that under Ramirez, simply including the TUTSA definition of a trade secret in an injunction will most likely not meet the requirements of Rule 683.

CONCLUSION: If you do not want your injunction reversed on appeal, make sure to specify in detail the categories of trade secrets you want to be protected.  Broad phrases such as “confidential information,” “proprietary information,” or “trade secrets” will most likely result in a reversal of the injunction, and even if they do not, they will be useless when it comes to determining whether a party is complying with the injunction. The Texas Courts of Appeals have found that attaching a customer list or an example of protected trade secret to an injunction meets the requirements of Rule 683. Any confidentiality concerns associated with such practice, may be assuaged by using the TUTSA‘s new “preservation of secrecy” procedures under Section Sec. 134A.006, which authorizes courts do what is necessary to preserve the secrecy of trade secrets. 

For more information regarding protection of trade secrets in Texas, contact Leiza Dolghih.

Out With the Old, In With the New: The Texas Uniform Trade Secrets Act (TUTSA) Explained

The Texas Uniform Trade Secrets Act (TUTSA) became effective on September 1, 2013, replacing the hodgepodge of common law, restatements and the Texas Theft Liability Act with a well-established statutory framework that 46 other states are already employing. TUTSA is a welcome change in our state because it modernizes and clarifies a lot of outdated rules, some of which have not been updated since 1930s. TUTSA does not apply to any misappropriation, including continuing misappropriation, occurring prior to September 1, 2013.

This post explains the major changes brought by TUTSA and their effect on trade secret litigation n Texas.

1.         TUTSA clarifies and expands the definition of “trade secret.

Under TUTSA § 134A.002(6), “trade secret” means information that derives independent economic value from not being generally known or readily ascertainable and for which reasonable efforts are made to maintain its secrecy.  Such “information” includes “a formula, pattern, compilation, program, device, method, technique, process, financial data, or list of actual or potential customers or suppliers.”

  • The new definition omits the “continuous use” language, thus allowing plaintiffs to claim as trade secret information that they have not yet had an opportunity to use.
  • Trade secrets now include not only positive information, but “negative knowhow,” which is information that has commercial value from a negative viewpoint, such as the results of lengthy and expensive research which proves that a certain process will not work could be of great value to a competitor.  See UTSA § 1 cmt.
  • Whether the information is considered “secret” is now determined by whether a party undertook “reasonable efforts to maintain the secrecy of such information,” rather than the difficulty with which such information could be acquired.  The new standard allows a fact finder to consider the nature of the trade secret and the facts and circumstances surrounding the efforts to maintain its secrecy in order to determine whether these efforts were reasonable under the circumstances.

2.         TUTSA requires “knowing” misappropriation.

Under TUTSA § 134A.002(3), “misappropriation” includes: (1) acquiring a trade secret by improper means or (2) disclosing a trade secret without consent.  Unlike the old common law, this new statutory definition makes clear that liability applies only to those who know or have reason to know that a trade secret was acquired by improper means, rather than accident or mistake.  Thus, for example, if an employee misappropriates a former employer’s trade secrets and uses them in his new job, the new employer is not liable for misappropriation of trade secrets unless the employer had actual or constructive knowledge that the material was improperly obtained. Needless to say, this provision is a great improvement for employers.

3.         Under TUTSA, “improper means” might include reverse engineering.

Under TUTSA § 134A.002(2), “improper means” includes theft, bribery, misrepresentation, breach or inducement of a breach of a duty to maintain secrecy, to limit use of, or to prohibit discovery of a trade secret, or espionage through electronic or other means.  When a license agreement prohibits reverse engineering, such activity would constitute a breach of the duty to limit the use of trade secret information and would constitute “improper means.”  In absence of any prohibition in a license agreement, however, reverse engineering would constitute “proper means” as defined in § 134A.002(4).

4.       TUTSA broadens injunctive relief

  • Texas courts have traditionally been reluctant to expressly recognize the idea of “threatened misappropriation,” which is often linked to the “inevitable disclosure” doctrine.  TUTSA § 134A.003 now includes a provision that allows injunctive relief for both actual and threatened misappropriation of trade secrets.  In some states that have adopted a version of the Uniform Trade Secrets Act,  “threatened misappropriation” does not equal “inevitable disclosure,” while in other states, the courts have found that as long as an employer can show that an employee will perform duties in his new employment that will inevitably cause the employee to use or disclose the former employer’s trade secrets, the old employer can establish “threatened misappropriation.”  Only time will tell, which way Texas will lean.
  • TUTSA § 134A.003 allows the continuation of an injunction for additional time to eliminate any commercial advantage derived from misappropriation, rather than termination of the injunction once the protected information is no longer secret.
  • The same section, “in exceptional circumstances,” allows an injunction that conditions future use of a trade secret upon payment of a reasonably royalty for no longer than the period of time for which use could have been prohibited.  “Exceptional circumstances” include a material and prejudicial change of position before acquiring knowledge or reason to know of misappropriation that renders a prohibitive injunction inequitable.
  • Finally, TUTSA § 134A.003 gives courts the power to compel “affirmative acts to protect a trade secret” under appropriate circumstances.

5.        TUTSA creates a cap for exemplary damages

Under TUTSA § 134A.004, “if willful and malicious misappropriation is proven by clear and convincing evidence, the fact finder may award exemplary damages in an amount not exceeding twice any award” of actual damages.  Such cap did not exist under Texas common law.

6.        TUTSA allows recovery of attorneys fees

Prior to TUTSA, the only way a party could recover attorneys’ fees for misappropriation of trade secrets was by filing a claim under the Texas Theft Liability Act, which allows for the recovery of attorneys’ fees to the prevailing party.  Now, under TUTSA § 134A.005, a court may award reasonable attorney’s fees to the prevailing party if: (1) a claim of misappropriation is made in bad faith; (2) a motion to terminate an injunction is made or resisted in bad faith; or (3) willful and malicious misappropriation exists.

7.       TUTSA enhances protection of trade secrets in court

TUTSA provides “a presumption in favor of granting protective orders to preserve the secrecy of trade secrets” and under TUTSA § 134A.006, “protective orders may include provision limiting access to confidential information to only the attorneys and their experts, holding in camera hearings, sealing the records of the action, and ordering any person involved in the litigation not to disclose an alleged trade secret without prior court approval.”

8.        TUTSA has not changed the following rules:

  • Damages. Under TUTSA § 134A.004(a), “in addition to or in lieu of injunctive relief,” a claimant is entitled to recover damages for misappropriation, which can include both the actual loss caused by misappropriation and the unjust enrichment caused by misappropriation that is not taken into account in computing actual loss.  A court may also impose reasonable royalty for a misappropriator’s unauthorized disclosure or use of a trade secret.  These are the same type of damages allowed under Texas common law prior to TUTSA‘s enactment.

For more information regarding the Texas Uniform Trade Secrets Act, contact Leiza Dolghih.