Course No. 9200-704 (and 804)-801
ID No. 16545
MW 3:00 - 4:30 p.m.
Room 231D (IP Alcove)
|Copyright © 2000, 2002, 2003, 2006, 2008 Jay Dratler, Jr. For permission, see CMI.|
Water Services, Inc. v. Tesco Chemicals, Inc.
410 F.2d 163, 162 U.S.P.Q. (BNA) 321 (5th Cir.1969)Before Wisdom and Ainsworth, Circuit Judges, and Johnson, District Judge.
[*164] Wisdom, Circuit Judge:
Clyde A. Farris developed the first successful, fully automatic system for purifying water for industrial purposes. He sold this system through Water Services, Inc. and Farris Chemical Company under the name "TREAT-A-MATIC".
* * *Since 1953 Farris has engaged in the business of supplying chemicals and equipment for the treatment of water circulated through boilers and large air conditioning systems such as are found in office buildings. The purpose of the treatment is to maintain this water in as near a pure form as possible to minimize injury to the circulating pipes, storage tanks, and other parts of the heating or cooling system caused by corrosion, scale, and algae, wasting as small an amount of water as possible.
The water purification industry is highly competitive. There are between 100 and 150 companies in the business in the southeastern area of the country, with 20 to 25 in Atlanta alone. In this industry, as in many others, the increase in labor costs has accentuated the demand for automation. [*165]
Farris Chemical has its headquarters in Knoxville, Tennessee, but employs nine or ten field engineers for the southeastern area, one of whom is responsible for sales and services in the State of Georgia. Farris Chemical has had a substantial growth and now has some 25 employees in management, sales, and the mixing or producing of chemicals sold to the trade. The district court found that the company's success is attributable to the ingenuity, industry, and drive of Clyde Farris, president and founder of the company.
The evaporation of water in air conditioning leaves damaging solids in the system. Until 1960, the "bleeding" of these damaging solids, the testing of acidity and alkalinity by pH content, and the mixture of control chemicals had to be done manually with inferior measuring devices. Various companies experimented with automatic devices to perform these functions, but the first models were expensive and required considerable manpower. In 1960, after four years of trial-and-error experimentation with pumps, timers, and electronic devices, and the expenditure of $18,000 for materials, Farris perfected the TREAT-A-MATIC system.
The district court described the system as made of two basic units:
Tesco Chemicals is a direct competitor of Farris. At least as early as April of 1962, Tesco Chemicals, Inc. realized the absolute necessity for automated equipment in order to survive. Tesco began in the business of swimming pool treatment. It hired Mr. Frank Parker to establish and develop an Industrial Division. Parker immediately began to work on automating, but in late 1965 he was writing to component suppliers for any [*166] information they could give on equipment "packages", despite having had a TREAT-A-MATIC system in the Tesco laboratory for detailed inspection and disassembly in early 1965.
In 1963, Farris hired Philip Glad as a field engineer and sales representative. At the time, Farris stressed the highly competitive nature of the industry and the need for tight secrecy on all information concerning equipment, chemicals, and prices. Glad signed a contract containing a two-year non-competition provision covering the northern third of Georgia and a few towns on the Tennessee side of the line. Despite Glad's formal education in electrical engineering, the great bulk of his present expertise was obtained from his experience and training with Farris (for 3 months under close supervision, then seminars three or four times a year). Farris gave Glad the names of the component suppliers, the wiring method, the design detail, and other confidential information. Indeed, he became privy to all construction and sales information concerning the TREAT-A-MATIC system.
After two years with Farris, Glad telephoned Parker and arranged to meet with him to discuss the possibility of Tesco's employing him.(2) By that time Parker had experimented with various components in an attempt to create an automated system similar to TREAT-A-MATIC but had met with no success. v He had lost several sales for lack of such a system. Parker had seen TREAT-A-MATIC installations at the sites of customers and, as noted earlier, on at least one occasion had disassembled a TREAT-A-MATIC unit. Tesco hired Glad. The district court found that the "hiring of Glad was with the specific intent of acquiring for Tesco the skill and knowledge necessary to create a fully automated system similar to the TREAT-A-MATIC.". Glad began immediately to work on reproducing for Tesco the TESCOMATIC system, based on his knowledge of the TREAT-A-MATIC system. The district court commented:
I.Philip Glad, like all other Farris employees, signed the following covenant:
As the district court observed, the problem of noncompeting covenants in Georgia is one which has caused great difficulty for the courts and practitioners over a long period of time. Under Georgia law, covenants not to compete are upheld if they are limited as to time and territory and definite as to the nature, kind, and character of the activities prohibited. Georgia, like most states, has a public policy prohibiting contracts in "general restraint of trade." See Georgia Code § 20-504. But, [w]hile public policy forbids any agreement which unreasonably restrains a person from exercising his trade or business, it is equally true that public policy also requires that the freedom of persons to enter into contracts shall not be lightly interfered with.
It is undisputed that Tesco hired Glad within the prohibited two-year period and that Tesco competes with Water Services. The district court held that the covenant here was reasonable as to "time" and "territory" but that it was invalid and unenforceable on the ground that the provision was "unreasonably indefinite" as to "the nature, kind and character of the activities prohibited by the contract". It "contemplates", the court said, "any activity for any competitor whether it relates to the functions and duties of the original employment or not, whether as a truck-driver, bookkeeper, custodian or as an executive or salesman[.]"
Our review of the Georgia law, including [ a case] decided after the district court rendered its decision in the instant case, compels us to conclude that today Georgia courts would uphold the covenant as a reasonable restraint.
* * *
[*168] In determining whether the restraint is reasonable two factors are important. First, is the employer trying to protect confidential information relating to the business, such as a trade secret, method of operation, sources of suppliers, and names of customers? Such confidential business information may or may not rise to the level of a trade secret. Second, is the restraint reasonably related to the protection of the confidential information? See Restatement of Contracts §§ 515(a), 516; Blake, Employee Agreements Not To Compete, 73 Harv.L.Rev. 625 (1960). When these factors have been present, Georgia courts have approved the covenant not to compete even when the covenant defined the "nature" of the activities only in the broad language of serving a competing employer "in any capacity".
* * * [*169] * * * [*170] * * *
In short, Glad possessed confidential information revealed
to him by Farris concerning the composition of the TREAT-A-MATIC system.
This system was not patented, but was nonetheless the industry's
only fully automated, integrated system for controlling and supplying
purified industrial water. Even though the system had been marketed
for a number of years, competitors had been unable to duplicate it.
As a result of this competitive advantage, Farris and Water Services
had enjoyed substantial financial success. It was reasonable,
therefore, for Farris and Water Services to attempt to preserve their
limited competitive advantage by keeping the composition of the TREAT-A-MATIC
system secret through rigid internal security and elaborate concealment
measures. Employee loyalty was especially important since knowledge
of the suppliers of the components was a key to the system. In
view of the nature of the interest sought to be protected and the competitive
environment of the industry, the covenant not to compete meets the .
. . test [of Georgia law that] the restraint be "reasonably necessary
to protect [a legitimate] interest of the [appellant] in whose favor
it is imposed[.]"
* * *
II.The district court took pains to point out that the equities were with Farris . . . .
* * *No Georgia case goes so far as to say that the existence of a trade secret is the sine qua non of an action to enforce a restrictive covenant ancillary to an employment contract. Although covenants not to compete are proper to protect trade secrets they may also be valid simply to prevent a former employee's using his expertise against his former employer. . . . [*171] . . . Conversely, even without an express restrictive covenant, one of the implied terms of a contract of employment is that the employee will not disclose a trade secret learned during his employment, to a competitor of his former employer. But since it may be difficult to determine, as a matter of law, what is a trade secret, the covenant not to compete is a pragmatic solution to the problem of protecting confidential information. Technological refinements in industrial espionage increase the employer's need for covenants not to compete.
An action for breach of a covenant not to compete and an action for misappropriation of a trade secret by breach of a confidential relationship are independent actions. They are related here, however, because an employer has a legitimate interest in protecting a trade secret by means of a restrictive covenant. And the existence of a trade secret bears on the reasonableness of the restraints imposed by the covenant.
* * *The policy reasons for affording protection to these commercial intangibles are to prevent exploitation by reprehensible business methods and to encourage innovation. If a trade secret is protected, the competitive advantage realized by the owner of the secret will enable him to recoup his development costs, hopefully before his competitors can "reverse-engineer" the product and duplicate it.
* * * [*172] * * *A patent may be distinguished from a trade secret in that a patent is totally exclusionary for the period of time for which it is granted; there are necessarily substantial anticompetitive effects. An ordinary trade secret, however, is not totally exclusionary; it is protected only as long as competitors fail to duplicate it by legitimate, independent research. The anticompetitive effects are relatively slight since the competitive advantage exists only for what is usually a short period, either because the restrictive covenant, if there be one, is for a small number of years (here, only two years) or because a competitor, by reverse-engineering, may legitimately duplicate the device. This limited protection with its relatively slight anticompetitive effects is helpful to insure growth characteristic of innovative genius.
Georgia law follows the majority view and the Restatement rationale for protecting trade secrets on the ground of a confidential relationship. [The elevant] decisions seem to establish a broad area of protection of trade secrets and suggest that a Georgia court would follow the generally accepted requirements for protection of a trade secret. Basically, these requirements are that the parties view the process or device as a secret and that the secret be revealed in confidence.
Tesco urges this Court to impose a requirement of novelty as a prerequisite to protection as a trade secret. The Restatement of Torts, § 759, Comment b states:
Some courts have adopted a requirement of novelty. We make an Erie
guess that a Georgia court would follow [*173] the majority view
and not require novelty.
1. [court's foonote 2] Farris concealed the
identity of the components by replacing the label of the original manufacturer
with a Farris Chemical label, and by replacing the standard colors with
2. [court's foonote 3] Glad suffers from
leg "trouble" and other ailments. His work entailed climbing on
tanks and other parts of an industrial system. The district court found
that partly because of these ailments and partly because of "apparent
disenchantment between him and Farris, early in 1966 Glad began to look
around for other employment, which would provide him an inside job."