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Time Limits and NDA/Confidentiality Agreements

Friday, June 8th, 2012

It is common for companies to share confidential information with a third party in order to achieve an operational objective, where the third party may be a prospective joint venturer, an acquirer, an investor or even a client.  Prior to disclosing such confidential information, however, these same companies usually require the execution of a confidentiality/non-disclosure agreement by the other party.

This blog has previously discussed issues surrounding confidentiality/non-disclosure agreements.  Today’s topic however is specific: the time limits, if any, that should be considered in such agreements.

Most companies if given a choice would prefer to include in their  NDA/confidentiality agreements a perpetual term, which essentially means that the confidential information can never be disclosed by the third party except in limited circumstances.  Often times however, this desire is diluted in the course of negotiations, leading to a final agreement containing just a limited time for confidentiality, ie, for example, 2, 5 or even 10 years. 

Unbeknownst to such parties, agreeing to this watered-down time limit may lead to substantial future risks with regard to confidential information.  An example is the California case of Silicon Image, Inc. v. Analogk Semiconductor, Inc.   In furtherance of its goal to protect its confidential information, Silicon Image took numerous prudent steps to protect its trade secrets, including: i) requiring its own employees, customers and business partners to sign confidentiality agreements; ii) maintaining a key card access system and by requiring visitors to sign in to protect its trade secrets; iii) protecting computer systems through network security and access control; iv) labeling confidential proprietary information and watermarking all information disclosed outside the company with the name of the individual receiving the information; and, v) providing training sessions to employees on its trade secret protection program.

Yet in spite of its strict adherence to the protection of its confidential information, Silicon Image decided to limit the term of its confidentiality agreements to a set number of years, instead of a perpetual term, due to the fact that that’s what other high-tech companies were doing, and due to the fact that many partners, investors and other third parties pushed back and refused to execute non-disclosure agreements containing a perpetual duration of confidentiality.

Despite its best practices described above, Silicon allowed itself to frequently enter into confidentiality agreements with terms of 2 to 4 years, which proved to be a serious error when the time came for Silicon to seek a preliminary injunction in California Court against a competitor it alleged misappropriated its confidential information.

In denying Silicon’s request for a preliminary injunction, the Court analyzed whether Silicon Image made reasonable efforts to protect its confidential information.  One of the key factors the Court focused on was whether or not the non-disclosure agreements between Silicon Image and its customers and distributors provided adequate protection.  Unfortunately for Silicon, the Court concluded that reasonable steps to protect trade secrets were not shown by Silicon, pointing particularly to the time limits included in its confidentiality agreements.

The Court held that “one who claims that he has a trade secret must exercise eternal vigilance,” requiring all persons to whom a trade secret becomes known to acknowledge and promise to respect the secrecy in a written agreement.  A time limit contained in an NDA demonstrated to the Court that Silicon’s own expectations of maintaining its trade secrets were time limited and, thus, a failure to demonstrate “eternal vigilance” over its trade secrets. 

As a result, Silicon lost a serious case in its attempt to protect its confidential information.  The moral of this story is a simple one.  Companies who include time limits in their confidentiality agreements do so at their peril.  In order to avoid the Silicon Image outcome, it is prudent to stand firm and refuse to include a set time limit for the receiving party’s obligations to maintain the confidential information.  The best practices are for the trade secret owner to insist that the obligation to maintain confidentiality survive as long as the information disclosed qualifies as a trade secret under the requirements of applicable law.

Isolated Sales Exemption in the New York Franchise Act

Wednesday, March 7th, 2012

N.Y. CLS Gen. Bus. Law § 684(3)(c) of the New York Franchise Act provides an exemption to franchisors from the general registration requirements of the Act for what is deemed an “isolated franchise sale.”  Under this exemption, no franchisor is required to register its FDD/UFOC in New York where:

(1)   “The transaction is pursuant to an offer directed by the franchisor to not more than two persons . . .

 (2)   if the franchisor does not grant the franchisee the right to offer franchises to others,

 (3)   a commission or other remuneration is not paid directly or indirectly for soliciting a prospective franchisee in this state, and

 (4)   the franchisor is domiciled in this state or has filed with the department of law its consent to service of process on the form prescribed by the department.”  N.Y. CLS Gen. Bus. Law § 684(3)(c).

 New York courts have interpreted § 684(3)(c) to mean in essence that  the sale of the first franchise unit is exempt from registration if the unit was only offered to a maximum of two people (See BMW Co., Inc. et al. v Workbench Inc. et al. (No. 86 CIV 4200 1988 WL 45594 (S.D.N.Y. April 29, 1988); CCH Business Franchise Guide ¶ 9104, at 18,850). 

This exemption is well settled law in New York:  “This isolated franchise sale exemption is potentially useful for new U.S. franchisors or foreign franchisors that are new to the United States. It permits them to sell one franchise in New York without having to register a disclosure document with the state.”  LJN, Law Journal Newsletters, Franchising Business & Law Alert, Volume 18, Number 4, January 2012, by George J. Eydt. 

Further, in a recent New York case, Burgers Bar Five Towns, LLC v. Burger Holdings Corp., 897 N.Y.S. 2d 502 (2d Dep’t 2010), again upheld the existence of the isolated franchise sale exemption under § 684(3)(c) provided the franchisor is able to meet the four prongs of the statute.  In reversing a summary judgment that had been entered by the trial court against a franchisor that had failed to register its UFOC/FDD, the appeals court stated that the matter be remanded back to the trial court to determine whether the franchisor indeed met the exemption factors.  Further, the appeals court held that even if the exemption was not available, the franchisee had to prove that it sustained damages as a result of the failure to register and that the failure to register was willful.

There is some support for the proposition that not only does § 684(3)(c) exempt a franchisor from the registration requirement of the New York Franchise Act for the isolated franchise sale, the franchisor is also exempted from the disclosure requirements of the Act.

§ 683(8) of the New York Franchise Law provides that:  “A franchise which is subject to registration under this article shall not be sold without first providing to the prospective franchisee, a copy of the offering prospectus, together with a copy of all proposed agreements relating to the sale of the franchise.” 

No New York Court has yet delved this deeply into the disclosure exemption question.  The few Courts that have addressed the issue, BMW Co., supra, The National Survival Game of New York, Inc., supra, and Burgers Bar Five Towns, LLC, supra., have either failed to examine the relationship between the two statutes, or resolved the merits of their cases on other grounds.

Nevertheless, a franchisor faced with a registration and disclosure violation in New York for an isolated franchise sale would be smart to argue that both registration and disclosure are exempted.

The Legal Standard for Fraud in Maryland

Wednesday, March 7th, 2012

To prevail on a claim of fraudulent misrepresentation in Maryland, a plaintiff must establish, by the heightened evidentiary standard of clear and convincing evidence:

“(1) that the defendant made a false representation to the plaintiff, (2) that its falsity was either known to the defendant or that the representation was made with reckless indifference as to its truth, (3) that the misrepresentation was made for the purpose of defrauding the plaintiff, (4) that the plaintiff relied on the misrepresentation and had the right to rely on it, and (5) that the plaintiff suffered compensable injury resulting from the misrepresentation.”  VF Corp. v. Wrexham Aviation Corp., 350 Md. 693, 703 (1998), quoting Nails v. S&R, 334 Md. 398, 415 (1994).

The defendant must actually be aware of the falsity, or atleast the potential for falsity.  The requirement concerning knowledge of the falsity or reckless indifference as to the truth of the representation means either the defendant’s actual knowledge that the representation was false or the defendant’s awareness that he does not know whether the representation is true or false. Ellerin v. Fairfax Savings, 337 Md. at 231, 652 A.2d at 1124.  

Negligence or misjudgment, “‘however gross,’” does not satisfy the knowledge element. Ellerin, 337 Md. at 232, 652 A.2d at 1125, quoting Cahill v. Applegarth, 98 Md. 493, 502, 56 A. 794, 796 (1904). See also VF Corporation and Blue Bell, Inc. v. Wrexham Aviation Corp., 350 Md. 693 (1998).

A defendant must have the intent, the scienter, to cheat another: “It is well recognized under Maryland law that an action for fraud cannot be supported … without any design to impose upon or cheat another.”  VF Corp. v. Wrexham Aviation Corp., 350 Md. 693, 703 (1998).  

The complaining party though, must have reasonably relied on the defendant’s representations.  To determine whether one party’s reliance upon the allegedly fraudulent statements of another party is reasonable, a court looks to all the facts and circumstances present in the particular case.  “In determining whether reliance is reasonable, a court is required to view the act in its setting….” Parker v. Columbia Bank, 91 Md. App. At 361-362. 

The One of the most important circumstances in this regard is the plaintiff’s background and experience.  For example, a complaining person who is knowledgeable in the commercial real estate realm could not be said to have reasonably relied on another’s false representations in that realm, as the complainant would have the requisite knowledge and resources to determine whether such statements were true in the first place.

 

 

Foreign LLCs and Corporations That Transact Business in Maryland But Fail to Register in Maryland Cannot File Suit Here

Wednesday, March 7th, 2012

          Before transacting interstate or foreign business in Maryland, a foreign limited liability company (“LLC”) shall register to transact business with the State Department of Assessments and Taxation (“SDAT”) in accordance with Md. Corp. & Ass’ns. Code Ann. § 4A-1002:

“(a) Requirement. — Before doing any interstate, intrastate, or foreign business in this State, a foreign limited liability company shall register with the Department.”

           Under § 4A-1002, a foreign LLC is required to complete an application setting forth, among other information, its name, state of organization, business purpose, and resident agent, and pay a filing fee to SDAT.

          Md. Corp. & Ass’ns. Code Ann. § 4A-1007 states that any foreign limited liability company that fails to register with the SDAT in accordance with § 4A-1002 is barred from maintaining a lawsuit in any court of this State, as follows:

“(a) Barred from maintaining suit. — If a foreign limited liability company is doing or has done any intrastate, interstate, or foreign business in this State without complying with the requirements of this subtitle, the foreign limited liability company and any person claiming under it may not maintain suit in any court of this State, unless the limited liability company shows to the satisfaction of the court that:

   (1) The foreign limited liability company or the person claiming under it has paid the penalty specified in subsection (d)(1) of this section; and

   (2) (i) The foreign limited liability company or a successor to it has complied with the requirements of this title; or

     (ii) The foreign limited liability company and any foreign limited liability company successor to it are no longer doing intrastate, interstate, or foreign business in this State.”  

In essence, Md. Corp. & Ass’ns. Code Ann. § 4A-1007 bars a foreign LLC from acting as a plaintiff in any Maryland state or federal court if the LLC is doing or has done “any intrastate, interstate, or foreign business” in Maryland without registering or qualifying with SDAT. 

Foreign corporations face nearly identical Maryland statutes.  See Md. Corp. & Ass’ns. Code Ann. §§ 7-202,  and 7-301, respectively. 

The Maryland Court of Appeals stated the following in Yangming Marine Transport Corporation v. Revon Products U.S.A., Inc., 311 Md. 496 (1988):

“As pointed out above, under § 7-301, a foreign corporation that has not complied with § 7-202 or § 7-203 is barred from suing in Maryland if the corporation “is doing . . . any intrastate, interstate, or foreign business in this State.”  …. Instead, we have held that § 7-301 embodies a test for determining whether a foreign corporation is “doing business” in Maryland. See G.E.M., Inc. v. Plough, Inc., 228 Md. 484, 486, 180 A.2d 478, 480 (1962). Under this test, § 7-301 bars an unqualified or unregistered foreign corporation from suing in Maryland courts only if the corporation is doing such a substantial amount of localized business in this State that the corporation could be deemed “present” here. See, e.g., S.A.S. Personnel Consult. v. Pat-Pan, 286 Md. 335, 339-340, 407 A.2d 1139, 1142 (1979); G.E.M., Inc. v. Plough Inc., supra, 228 Md. at 488-489, 180 A.2d at 480-481.

 

 

The Importance of an Attorneys Fees Clause

Thursday, January 20th, 2011

I was recently asked to litigate a breach of contract claim on behalf of a party who was wronged by the breach of another party to a contract. The kind of contract is immaterial for the purpose of this article. It could have been an independent contractor agreement, or employment agreement, or an asset purchase, stock purchase, non-compete, or non-solicitation agreement, or any one of a dozen other types of contracts. Regardless, as I have said previously in these posts, there are certain contractual provisions that should be found in just about every contract. What may be possibly be the single most important provision, from my perspective, happened to have been omitted from this particular contract, that is, a provision addressing the potential recovery of attorney’s fees resulting from litigation.

I say that this may be the single most important provision in a contract not in a substantive sense, as the material terms of the contract must of course be included with specificity. The services to be performed or the products to be sold are obviously vital, since without which there may be no meeting of the minds and thus no contract in the first place. And there are other material provisions related to the deal itself that must be included as well, ie the duration of the agreement, compensation, termination, etc.

But aside from the substantive points of the deal, there is not a more important procedural, boilerplate, provision than a provision addressing attorney’s fees. Why? Because in many cases, the lack of such a provision makes litigating over a contract a financially untenable idea. A party to a contract may have the facts and the law on its side. The case may essentially be a slam dunk, if such things exist. However, if at the end of the day, the damages available to the winning party only barely exceed the amount the party paid to its attorney’s to prosecute the case, then regardless of how great a case it is, the filing of a lawsuit or arbitration makes little sense from a bottom line perspective. None of us, clients or attorneys, litigate in order to achieve moral victories. If maintaining a lawsuit does not make sense from a financial point of view, then regardless of right and wrong and getting even, I always advise my clients to consider the case strictly from a business perspective, leaving aside emotion.

That is why it is such a huge benefit when a contract at issue contains a prevailing party clause with regard to attorney’s fees. This magic language allows a wronged party to sue with the understanding that if the facts and the law support her case, then she will be made whole in regard to not only the actual damages she sustained as a result of the breach of contract, but in addition, all costs, expenses and attorney’s fees she expended in litigating the matter. Please then, I ask you to review EVERY agreement your business has signed, as well as every agreement you sign from here on out, and prior to execution, include a provision similar to the following:

“In the event of litigation [or arbitration] for any matter arising out of or related to this Agreement, the party prevailing in any such action shall be entitled to recover from the losing party its reasonable attorney’s fees and all other legal costs and expenses, including filing fees, expended in the matter.”

The importance of this provision cannot be overstated, since attorney’s fees on even a fairly “routine” matter can easily run into the tens of thousands of dollars, and for more complex cases against defendants with deep pockets, it would not be a surprise to see attorneys’ fees in the hundreds of thousands of dollars.

Mere Projections Cannot Constitute Fraud

Wednesday, January 5th, 2011

In Flynn v. Everything Yogurt, et al., 1993 U.S. Dist. Lexis 15722 (D. Md. 1993), the Maryland Federal District Court granted a motion to dismiss a fraud claim for failure to state a claim under Rule 12(b)(6). The Court held that ““Projections of future earnings are statements of opinion rather than statements of material fact. Projections cannot constitute fraud because they are not susceptible to exact knowledge at the time they are made. Layton v. Aamco Transmissions, Inc., 717 F. Supp. at 371 (D. Md. 1989); See also, Johnson v. Maryland Trust Co., 176 Md 557, 565, 6 A.2d 383 (1939) (statement referring to value of securities representing collateral for the payment of trust notes was a matter of expectation or opinion). Thus, the Defendants’ projections can not constitute statements of material fact under § 14-227(a)(1)(ii).”

The Maryland Federal District Court also held in Payne v. McDonald’s Corporation, 957 F.Supp. 749 (D. Md. 1997) that claims of fraud against McDonald’s must be dismissed: “McDonald’s projections concerning the future building costs of the Broadway restaurant and concerning the impact of new restaurants on future sales of the Broadway facility are just as much predictions of ‘future events’ as are projections of future profits. Accordingly, this Court concludes that it was unreasonable for plaintiff Payne to rely on any of McDonald’s predictive statements as a basis for the assertion of fraud-based claims in this case.”

In addition to the McDonald’s case cited above, see Miller v. Fairchild Industries, Inc., Finch v. Hughes Aircraft Co., and Hardee’s v. Hardee’s Food System, Inc., all of which stand for the proposition that predictions or statements which are merely promissory in nature and expressions as to what will happen in the future are not actionable as fraud.

Trademark Infringement and Available Remedies

Wednesday, October 6th, 2010

If you have registered your business trademark or service mark with the U.S. Patent and Trademark Office (“USPTO”), then you have the right to sue a party that is infringing your trademark rights. The criteria used to determine whether the use of your mark or a similar mark qualifies as infringement is whether such use causes a “likelihood of confusion” to the public. Likelihood of confusion exists when a court believes that the public would be confused as to the source of the goods, or as to the sponsorship or approval of such goods.

Courts deciding a trademark infringement action will mainly look at two issues in deciding an infringement action: 1) the similarity of the two marks, for example, are the marks identical or merely similar; and, 2) what goods or services are the marks associated with. The more similar the marks, and the more related the products or services of the two marks are, the more likely a court will find a likelihood of confusion and enjoin the offending party’s use of the mark.

Should your prevail in a trademark infringement action, you are entitled to some or all of the following remedies: 1) injunctive relief to enjoin the other party from using the mark; 2) profits the opposing party made as a result of its use of the infringing mark; 3) monetary damages you sustained as a result of the infringing party’s use of the mark; and, 4) the costs you incurred in bringing the infringement action. In addition, a court may award treble (triple) damages if there is a finding of bad faith on the part of the offending party.

So You Have Formed Your Corporation/LLC, Now What?

Wednesday, July 28th, 2010

Start-up companies many times do not know the extent of their legal and other needs after forming a business. The drafting and filing of Articles of Incorporation or Articles of Organization are just the beginning of your company’s service needs. I recommend that each new business owner immediately reach out to establish relationships with the myriad of services providers your business needs, now and in the future. Such service providers include many of the following:

- a corporate law attorney specializing in employment, contracts, intellectual property, litigation and other corporate issues;

- a CPA for your business accounting and tax services;

- an insurance broker for your business liability, E&O, and other insurance needs;

- a banker with whom you have a personal relationship with;

- a financial advisor for your 401K, retirement and other accounts;

- an IT services firm to be on call for your computer networking needs;

- a payroll company to handle weekly payroll and taxes for your employees; and

- a company to develop your website, and then focus on your internet advertising, search engine optimization, and other advertising needs in order to properly publicize your business over the internet.

Please don’t hesitate to contact me should you need referrals in any of the above areas.

How Does a Franchisor Prove Damages in Litigation Against a Franchisee?

Friday, July 9th, 2010

In representing franchisor clients against defaulting franchisees, it is imperative to give adequate thought to how the franchisor is going to prove its damages that resulted from a franchisee’s breach of the franchise agreement. When confronted with this issue, I most often utilize a financially competent representative of the franchisor to testify with regard to that amount of monetary damage suffered by the franchisor. The franchisor’s representative must be able to prove the damage by evaluating the franchisee’s financial statements, including revenues and/or profits, expenses, and royalties paid to the franchisor, and then determine what sums the franchisor would have earned either during and/or after the franchise term had it not been for the franchisee’s breach.

In order to testify convincingly and thoroughly, the franchisor’s representative must be able to analyze the franchisee’s financial numbers and draw a conclusion from such numbers. Therefore, a chief financial officer of a small franchisor, or an auditor or accountant of a larger franchisor, is an ideal representative in these instances, provided that the representative has been with the company long enough to be able to testify knowledgeably with regard to the details of the franchisor’s system.

Generally, a well-prepared franchisor representative will be permitted to testify as to the value or the projected profits of a franchised business provided the representative has a sufficient foundation for the analysis and opinion, including particular knowledge of the financial issues presented by virtue or his or her position in the franchisor company. This simply means that a franchisor representative may opine on the issue of lost profits where they know the franchisor and franchisee’s business and financial system intimately, and have the professional ability to analyze the franchisee’s financial statements.

To see how a franchisor SHOULD NOT approach the issue of proving its damages against a franchisee, see Lifewise Master Funding v. Telebank, 374 F.3d 917 (10th Cir. 2004), which in essence holds that a company’s witness as to damages must have personal knowledge of all items factored into his opinion in order for the opinion to be admissible. The court concluded that a business owner or executive may give “a straightforward opinion as to lost profits using conventional methods based on [the company's] actual operating history.” However, because in this case the witness lacked personal knowledge of the factors used in the damages analysis, the opinion was inadmissible.

Enforcement of Non-Compete Not Dependent on Solicitation of Former Clients or Use of Confidential Information

Monday, April 12th, 2010

In TEKsystems, Inc. v. Bolton, (2010), the Maryland Federal District Court recently reinforced Maryland law on the point that the enforcement of a covenant not to compete is not dependent on whether the competing former employee solicits his former employer’s clients or uses its confidential information, but rather on whether or not the scope of the restrictive covenant is reasonable. The only factors that will determine whether the non-compete is valid are its temporal and geographical limits, the employer’s legitimate business interests, the employee’s unique and specialized skills, any undue hardship on the employee, and the public interest served by enforcing the restrictive covenant.

The non-compete found in the former employee’s employment agreement contained standard language prohibiting the former employee from engaging “in the business of recruiting or providing on a temporary or permanent basis technical service personnel, industrial personnel, or office support personnel” for a period of 18 months after termination of employment, and within a geographical limitation of a 50-mile radius of the employee’s former office. Both the period of time of 18 months and the geographical scope of 50 miles have been held as reasonable on numerous occasions by Maryland courts.
The Court also found that the employer had legitimate business interests in enforcing the covenant, the employee possessed unique and specialized skills, and the employee would not suffer undue hardship by enforcing the covenant. The enforcement of the non-compete was upheld against the former employee.

To read a comprehensive blog of all of the issues address by the Court in this case, visit the blog of the Business Law Section of the Maryland State Bar Association at http://marylandbusinesslawdevelopments.blogspot.com/search/label/Injunctive%20Relief.