SC Lawyer, May 2004, #4. Intellectual property protection as an effective covenant not to compete.

• Author: By Douglas W. Kim and John A. Demos

South Carolina Lawyer

2004.

SC Lawyer, May 2004, #4.

Intellectual property protection as an effective covenant not to compete

South Carolina LawyerMay 2004Intellectual property protection as an effective covenant not to competeBy Douglas W. Kim and John A. DemosProtecting a company's intangible assets is a challenge that has existed for many years. One of the most valuable intangible assets is the knowledge, know-how and technical information possessed by a company. Particularly challenging is how to protect this asset when it is created and monitored across the employee base. Today's difficult economic climate has increased the number of employees leaving companies to explore new opportunities in the business world. Also, employees are more and more beginning to moonlight while starting their own companies or working for second companies while engaged in employment with other companies. Further, companies must deal with independent contractors as employees. While hiring an independent contractor may be a good business decision as far as saving in the short term, in the long term there are several issues with that employee's rights as it relates to the work he completes for the company.

An employee leaving a company can have severe repercussions on that company, particularly when several employees leave at once. The company not only needs to hire replacements, insuring the business continues to operate without the employee, but also needs to protect itself from employees unfairly using or competing with the company by improperly using company assets.

Generally, employees work in a specific field for a company and obtain and develop knowledge, know-how and technical information that can become the property of the company. This information can be extremely useful by a competitor if that employee decides to work for the competitor. It is not uncommon for an employee to leave one company to start his own competing company or to go to work for a competitor. While it is permissible for an employee to take existing skills and general knowledge to another company, the employee cannot take proprietary information, trade secrets or other protectable intangible assets. To prevent the employees from taking such information, companies need to establish methods for protecting themselves from such misappropriation.

Oftentimes, employees leaving to start their own companies moonlight in order to work on their new corporate endeavors. They may use knowledge and inside information from their current employer to help them create their new company and will eventually compete with their current employer. This moonlighting may also take away from their effective performance while at work. Companies would be wise to limit the ability of their employees to moonlight.

Companies may hire independent contractors which again may allow that independent contractor to use the company's property to compete with the company. Specific to independent contractors, there are the issues concerning ownership of created intellectual property. For example, when an independent contractor creates source code, the independent contractor may own the copyrights in the source code, not the hiring company.

Companies, especially those in competitive technology fields, seek to protect the intangible asset of their employees' and consultants' knowledge. Through the normal course of employment, especially in research and development, employees gain information and knowledge that gives companies their competitive advantage. Clearly, the ability to prevent the improper use of such information and reduce or eliminate competition from former employees is one advantage that furthers these goals. A covenant not to compete has traditionally been used to keep employees from going to a competitor and taking the information and knowledge gained. However, the restrictions that can be placed on an employee's ability to compete are quite limited. Covenants not to compete are narrowly construed and do not allow a company to keep an employee from working for an indefinite period of time or indefinite geographic area. At some point, the company will have to face competition from the employee.

Covenants not to compete are not the most effective tool in protecting a company's intangible assets. They are disfavored by courts and can be viewed as an inequitable restraint on trade. A company must carefully draft a covenant not to compete to prevent the employee from competing in a limited geographic area for a limited period of time. With today's emerging technology and shorter product cycle, a 12-month period may be more beneficial than it has been in the past; however, it is not nearly enough time to protect the great deal of investment a company puts into an employee and into a product. Also, as the geographic area must be limited, there is nothing stopping the former employee from going to a new company some distance away that is still competing with the employer's company. Several employees, especially highly sought after employees, may simply refuse to sign a covenant not to compete.

Covenants not to compete are not the ideal way for a company, especially a technology company, to protect its assets. Therefore, proper protection of a company's assets through intellectual property protection must be considered as an opportunity to effect the results of a covenant not to compete.

Intellectual property protection can be a powerful tool to protect a company. Through covenants not to compete, companies attempt to secure exclusive rights to the work of employees. This exclusivity is a common thread throughout intellectual property protection and, due to the exclusive nature of intellectual property, makes it a good tool for employers. Combined with covenants not to compete, intellectual property protection can provide more secure protection to prevent unfair competition by former employees.

While this discussion has focused upon the employer-employee relationship, it is equally true with the purchase of a business, mergers, acquisitions and other technology transfers. In any transaction where a covenant not to complete would be advisable, an intellectual property audit should also be put in place to ensure that the business can eliminate or avoid unfair competition through intellectual property.

Patents

Patents are a statutory monopoly. 15 U.S.C. § 1 (2002). The Sherman Antitrust Act specifically excludes patent rights from the "anti-competition" prohibition of the Act. Id. Patents provide statutory exclusivity for the patented invention or technology and prevent others from making, using, offering for sale or importing the patented invention. 15 U.S.C. § 271 (2002). The exclusivity and non-competition effect of patents was clearly felt by 3Com and Palm on December 20, 2001. On this date, a U.S. District Court ruled that Xerox had a valid and enforceable patent in the "Unistroke" technology for handwriting embodied within the Palm Pilot. Xerox Corp. v. 3 Com Corp. 267 F.3d 1361 (2001). Additionally, the ruling held that 3Com and Palm were infringing Xerox's patent. Id. In February 2002, the defendants were ordered to post a $50 million bond upon appealing the ruling.

Xerox has effectively achieved the ability to exclude competition from the marketplace, regardless of the employees of the competitors. Whether or not an employee quit Xerox and began working for 3Com or Palm, neither company would be able to use the Palm software, effectively preventing Palm and 3Com from competing with this technology. The patent protection prevented former employees from competing with Xerox.

The exclusivity of intellectual property allows it to serve as a powerful non-competition tool for businesses. For patents, the owner is allowed to prevent any employee from taking technologies covered by patent protection and using them for himself or for competitors. With proper patent protection, the employer can prevent an exiting employee or other entity from using such technology in competition with the patent owner. While covenants not to compete must be for a limited time and a limited geographic area, patents give far better protection. An employee whose invention has been patented by a company will not be able to use that invention anywhere else for a specified term of years after the filing of the patent and for potentially a worldwide area. 35 U.S.C. § 155 (2002). The geographic bounds on a patent are up to the company and the number of countries in which it wishes to seek patent protection. In the case of a United States patent, the patented invention cannot be used for a period of 20 years from the filing of the patent throughout the United States. Id. Obviously, patent protection for a company will provide a much broader scope of protection than any covenant not to compete could provide.

Trademarks

Trademark rights provide the means to protect the time, money and effort used to create a "brand" or "corporate signature" and to prevent competitors from using existing goodwill or reputation represented by these marks from being used in competition with the mark owner. Since trademark and service marks stem from use (15 U.S.C. § 1052 (2002)), an employee cannot simply leave a company and begin using the same or similar mark with the same or related product. Additionally, were an employee to misappropriate a mark, it would be evidence of willful infringement and subject the employee's new company to enhanced damages. 15 U.S.C. § 1119 (2002).

The issue of preventing competition is much more important in the merger and acquisition arena than with the employer-employee relationship. It is the business that first uses the mark in commerce that secures the trademark rights. 15 U.S.C. § 1052 (2002). The employee would not acquire rights superior to the company and, as such, would not be able to use the mark upon exiting the organization. However, with respect to the asset transfer, merger or acquisition, it is critically important to ensure that the goodwill associated with the marks is also transferred with the appropriate assets. It is the authors' experience that specifically worded contractual agreements need to be utilized in these situations to avoid confusion. Such transfer should be filed and recorded with the United States Trademark Office to provide notice to the public of the new ownership in the mark. Imagine the surprise of a buyer purchasing a business to find out that the marks of the purchased business did not travel with the transaction or even were never owned by the purchased business. Improperly crafted transfers can become invalid assignments or licenses that undermine the trademark owner's rights in the mark.

Copyrights

Copyrights provide protection for books, movies, songs, technical documents, lab notebooks, computer software and designs, manuals, computer graphics, notes and other forms of expression created in the course of business. 17 U.S.C. § 102 (2002). Clearly, the ability of a company to prevent anyone from copying such material can provide a commercial advantage in light of employees leaving that may inappropriately take such materials with them.

Copyrights and their enforcement have increased the ability of companies to prevent employees from taking material upon their departure, prevent such materials from being used by competitors and put in place a hurdle to competition by requiring copyrighted material to sit with the company. Particularly, copyrights are being used in the computer consulting and design, architectural and graphic arts industries. It is important for companies to secure copyright registrations as soon as possible in order to take advantage of statutory damages. 17 U.S.C. § 504(c) (2002). If a company fails to receive a registration prior to three months from publication or prior infringement, statutory damages can be lost. Id.

Copyrights can preclude employees from taking computer source code, object code, instruction manuals, technical documents designs, graphics, plans, blueprints and other materials when they leave a business. 17 U.S.C. § 102 (2002). By providing exclusive rights to such materials, copyrights allow the owner to prevent others from copying the work that the business has invested time and effort into creating. 17 U.S.C. § 106 (2002). As has been discussed above repeatedly, a covenant not to compete will only be allowed for a limited time and a limited geographic area. A computer programmer for a North Carolina company could begin working for a California company and use the software she wrote for the North Carolina company. However, if the software is protected by copyright, then this activity can result in copyright liability. Id. It is particularly true in this case considering that the preparation of derivative works are one of the protected rights. Id.

Trade secrets

For employers attempting to prevent exiting employees from providing information that allows a competitor some advantage, the problem is generally with an employee who has no interest in maintaining an employer's secrets. States have enacted specific legislation protecting trade secrets. S.C. Code § 39-8-10 et seq. When an employee quits a company and goes to work for a competitor, the ability of the statutory scheme to protect the trade secret can become unclear as some statutes cover "employee" not "ex-employee." Nevertheless, trade secret protection has one powerful advantage over covenants not to compete. In the U.S. District Court, Middle District of North Carolina, the court ruled that an injunction would be granted based upon the theory of "inevitable disclosure." Merck & Co. v. Lyon, 941 F. Supp. 1443 (1996) When a plaintiff proves a claim of trade secret misappropriation by demonstrating that the defendant's new employment would inevitably lead the defendant to rely upon the plaintiff's trade secret information, an injunction can be issued. Therefore, an employer can utilize the inevitable disclosure doctrine to prevent former employees from working for competitors as if the employee was bound by both a non-compete agreement and/or a non-disclosure agreement.

Enforcement of IP

Merely having the property rights is meaningless without the vehicle of enforcement. The benefits of intellectual property protection are that they provide a federal court venue to have the rights enforced. 28 U.S.C. § 1581 (2002). Both patents and copyrights are pre-empted and exclusively federal, See 17 U.S.C. § 102 (2002); Sears, Roebuck and Co. v. Stiffel Co., 376 U.S. 225 (1964). The federal trademark law can be heard in both federal and state courts. 28 U.S.C. § 1581 (2002) It should be cautioned that intellectual property litigation can be time consuming and costly; however, most times, the market advantage being protected outweighs the enforcement costs.

Conclusion

Covenants not to compete attempt to prevent employees and other entities from competing with the interested party. While convenants not to compete are disfavored by courts, many times intellectual property protection can achieve the same goals. Covenants not to compete should still be used where appropriate, but companies can do themselves a great service by protecting their market advantages with patents, copyrights, trademarks and trade secrets. When a business or other entity wishes to reduce or eliminate unfair competition and protect it intellectual assets, performance of an intellectual property audit and the securing of intellectual property protection can serve these goals. Proper intellectual property protection gives an employer exclusive rights that protect the employer from unfair competition from former employees more effectively than covenants not to compete.

Douglas W. Kim is an intellectual property attorney with the McNair Law Firm in Greenville. He practices in the areas of patent (prosecution and litigation), trademark, copyright, technology licensing, cyber and trade secret law.

John A. Demos is an intellectual property attorney with the McNair Law Firm in Greenville. He practices in the areas of patent prosecution, trademark, copyright, licensing and computer law.

Copyright (c) 2004 by the South Carolina Bar. All rights reserved. No part of this publication may be reproduced without written permission.