Thursday, January 2, 2014

An employee must abide by a trade secrets injunction but is free to compete and solicit his former employer’s clients

There have been few if any reported cases until now involving the recently-enacted Puerto Rico Law of Commercial and Trade Secrets. It is not difficult to discern that controversy is likely to arise at the intersection between non-competition agreements (especially in their absence) and confidentiality obligations created by the new trade secrets law.

As shown by American Paper Corporation v. Irizarry, 2013 WL 5522747 (TCA Aug. 9, 2013), confidentiality and non-competition agreements have ramifications in distribution cases. There, an employee of plaintiff American Paper, a Puerto Rico distributor of paper products, defected to form his own company to compete for the same business. Not thrilled by the prospect that the defendant–employee would make a living and form a company to compete, plaintiff sued the employee under Puerto Rico’s trade secret law and sought enforcement of a non-compete agreement.

The employer alleged that one of its most important customers transferred business to the employee’s new company. The trial court issued an order compelling defendant not to use or divulge plaintiff’s “trade secrets” which include contact persons of plaintiff’s clients, profit margins, and marketing strategies. As far as reaching out to bar defendant from using his knowledge or information to compete with the clientele, the trial court invalidated the non-competition agreement as a matter of Puerto Rico law.

Only plaintiff appealed the order invalidating the non-competition agreement. In granting certiorari and affirming the judgment below, the appellate court held that the non-compete obligation was overbroad for it was not restricted to commercial activities similar to his employer and was excessive in terms of the clients that could not be served. “Said another way, Mr. Irizarry could not make any type of solicitation or offering of service directly or indirectly to no one, that has been a client of the employer or is engaged in the paper distribution business.” (translation ours). Because the non-compete clause is legally incapable of being reformed by the court, the entire agreement was declared to be null and void.

The trial court’s injunction under Puerto Rico’s Trade Secrets Law and the appellate court's invalidation of the non-compete agreement can be reconciled. This case demonstrates that a non-compete agreement is severable from an obligation imposed by law or required by contract to preserve the confidentiality of trade secrets. A prohibition from using or divulging confidential information or trade secrets does not necessarily extend in scope to prohibit the employee from using his knowledge, information, or business acumen to compete or solicit business from his employer’s customers at least when there is no non-competition agreement or it is determined to be invalid.

During 2013, local intermediate appellate courts remained active in Law 75 cases

In Marchosky Kogan v. Antillas Marketing, 2013 WL 5522664 (TCA Aug. 20, 2013), the local appellate court affirmed the dismissal of a tortious interference and damages action finding just cause under Law 75 for termination of a sub-distribution agreement.

Plaintiff Marchosky, an individual, was a sub-distributor of Defendant Antillas Marketing, the defendant and the distributor-grantor. The principal Golden Omega Inc. had appointed Antillas as the exclusive distributor of Linoflax products in Puerto Rico. A google search of Linoflax USA reveals that Linoflax products are health and nutritional supplements. The sub-distributor filed suit in the Court of First Instance Humacao Part against the distributor and others (apparently not against the principal) alleging a breach of exclusive sub-distribution rights in a designated region. The claims sounded in tortious interference and damages for emotional distress. In the answer and counterclaim, Defendants denied the existence of an exclusive contract, asserted just cause, and that plaintiff’s acts breached Antilles’ agreement with its principal.

After a bench trial, the trial court found for defendants and dismissed both the complaint and the counterclaim for damages. The judge determined that there was an insufficient basis to pierce the corporate veil and no actionable claim existed under Law 75 as there was just cause and no evidence of actual damages. It is unclear from the opinion if the issue of just cause should have been decided without joinder of the principal as a party or if the distributor had standing as the grantor to allege just cause (sub silentio it did). Plaintiff appealed. The appellate court affirmed the dismissal of the action. The appellate court determined that the trial court had correctly found just cause for termination based on a breach of an essential contractual obligation or acts that adversely and substantially affected the principal’s or grantor’s interest in Puerto Rico.

The sub-distributor had encroached upon an exclusive territory of other resellers which affected the marketing activities of other distributors. The sub-distributor had also refused to collect and administer payments by certain customers within the assigned territory; issued post-dated checks; and made hiring decisions and negotiated prices with pharmacies without obtaining the distributor’s authorization. It is unclear if any of those actions breached an essential contractual obligation. After applying a deferential standard of review to factual determinations and judgments about the weight or credibility of the evidence, the court held that the totality of the circumstances established that plaintiff’s actions and omissions caused the defendant-grantor to suffer financial harm and cash flow problems which adversely affected the “good functioning of the business.”

An interesting and unusual case came up in Jimenez Ayala v. BC Services, Inc., 2013 WL 4073349 (TCA May 31, 2013). The case involves the issue whether a Law 75 counterclaim may be interposed to defeat a summary procedure to adjudicate an eviction action. There, BC Food Services signed Lease and Operating Business Agreements (“acuerdos de negocio en marcha”) to lease real property and operate the restaurant franchise of Bebo’s Café in Condado. Plaintiff paid money of what was ostensibly a royalty or license fee to use the mark or brand of Bebo’s Café. After expiration of the agreement, Plaintiff filed suit under Law 75 for injunctive relief to compel the lessor or franchisor to renew the agreements. The case settled by stipulation and a dismissal without prejudice. The stipulation required the lessee to pay back rent and commit to pay monthly rent in consideration for a renewal of the agreements. The lessor filed an eviction action when the lessee fell behind in its payments and invoked the summary procedure which does not legally permit any defenses other than proof of payment of rent. Lessee counterclaimed for wrongful termination under Law 75. The trial court in San Juan found for plaintiff and evicted defendant which appealed. On appeal, the lessee argued that the trial court erred when it failed to convert the action into an ordinary proceeding to adjudicate the Law 75 claim. The trial court found that the lessee breached the settlement agreement by issuing rent payments with insufficient funds. The appellate court affirmed and ruled that the Law 75 counterclaim would be decided in the ordinary course and was legally inadmissible to convert the summary eviction procedure into an ordinary action. The majority opinion did not decide any issues under Law 75.

One judge (Hon. Migdalia Fraticelli Torres) dissented. The dissent reasoned at length that the lease agreements were also license or franchise agreements that deserved special protection under Law 75. The dissent reasoned that, as a matter of public policy, the counterclaim under Law 75 should receive treatment as an ordinary action when joined in a summary eviction proceeding. The dissent emphasized that market conditions and the diminished value of rental properties required the lessee to renegotiate the monthly rent of $52,000 and that the lessor’s refusal to negotiate in good faith was not just cause for termination under Law 75. The claims, said the dissent, should have been consolidated and allowed both to proceed in the ordinary course.

In V. Suarez v. Bacardi Corporation, 2013 WL 4037215 (TCA June 25, 2013), cert. pending, the appellate court affirmed the trial court’s confirmation of a final partial arbitration award in favor of Bacardí and dismissal of the sub-distributor’s motion to vacate. A Panel of the AAA determined that contractual provisions for the computation of damages in the event of an unjustified termination of the sub-distribution agreement were valid and enforceable under Law 75 and did not have the effect of waiving any rights. The local appellate court ruled that there was no cause under the Federal Arbitration Act, which was the exclusive procedure, to set aside the award. The sub-distributor filed a petition for certiorari in the Puerto Rico Supreme Court. On related note, the U.S. Supreme Court denied certiorari of the Judgment of the First Circuit in Bacardí International Limited v. V. Suarez & Co., 719 F. 3d 1 (1st Cir. 2013) abstaining under Colorado River from deciding Bacardi’s parallel federal proceeding to confirm the award. Note: the author is lead counsel for Bacardi in these cases.