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Claims By and Against (Former) Officers, Directors and Employees

Presented by: Todd Bartels, Karen Glickstein, and Bart Starr

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Agenda

Employment Law Due Diligence to Avoid Litigation

Intellectual Property and Trade Secret Litigation

Standards of Conduct and Review of Fiduciaries’ Acts and Omissions

Exculpatory and Indemnification and Advancement Provisions Protecting Officers, Directors, and Employees

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Karen R. Glickstein is a Chambers-rated shareholder in Polsinelli’s Kansas City office. She focuses her practice on assisting employers in a wide variety of employment and human resources law issues. She has first chair experience in both jury trials and arbitrations and also focuses her practice on employment and HR compliance and advice work, including assisting with employment law issues related to corporate transactions. She also works extensively in the area of social media law.

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Employment Law Due Diligence

Status of employees and contractors

– At will v. contract?

– What do Contracts say?

• Payouts or special provisions to “key” employees?

• Obtain copies of all contracts

• Change of control or severance provisions?

– What about Exempt/Non-Exempt?

– Independent Contractors?

• Properly classified?

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More on Employment Law Due Diligence

Questions that must be asked?

– Union v. non-union? CBA?

– Pending claims or charges?

• Recent terminations that could lead to suit?

– Work comp claims?

– Confidentiality and Proprietary Information?

– Non-Compete and Non-Solicit

– Are employees properly classified? (need list of all employees, titles, f/t or p/t status)

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Additional Factors Which May Cause Problems

Social Media Policies/Platforms

Whistleblowers? Compliance Issues?

Who is staying on? Who is leaving?

– WARN Act (federal and state)

– Census analysis if only keeping some employees

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Some New Considerations

DTSA

Severance Agreement language (SEC and other agency enforcement issues)

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Items to Gather

Contracts (including confidentiality and non-compete/non-solicit)

Arbitration and Severance agreements

Handbooks and policies

Ensure compliance with required posters

EEO-1 and AAP if gov’t contractor

Training records

PTO Payout?

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Current Workforce

Personnel Files (includes all required documentation and I-9)

Contracts/agreements

Leave status

Medical files

Accommodations

Sick Leave/Vacation?

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Bart Starr has spent 10 years in the engineering business and 15 years as a patent and intellectual property litigator. As a registered patent attorney with the U.S. Patent and Trademark Office, Bart has focused his practice on:

• Patent litigation

• Trademark and unfair competition litigation

• Trade secret litigation

• Copyright litigation

Bart’s clients include well-known Fortune 500 companies as well as new and growing businesses. As a result of his success, Bart has been repeatedly selected as an "IP Star" by Managing Intellectual Property magazine, most recently in 2016.

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Assigning Patents and IP

Patents, trademarks, copyrights, and other intellectual property may be transferred and assigned in a transaction or agreement, like real property and other corporate assets

Assignment of Patents:

– Make sure the assigning company (vs. an individual employee inventor) is the owner/assignee and can assign the patent(s) to the acquiring company

– Specifically identify all U.S. and (if applicable) foreign patents being assigned/transferred in an exhibit or elsewhere

– Expressly assign the right for the purchaser/assignee to sue past, current, and future patent infringers and to recover past infringement damages

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Assigning Patents and IP

Assignment of Patents (continued):

– Register all patent assignments in the U.S. Patent and Trademark Office (“PTO”). See https://www.uspto.gov/patents-maintaining-patent/patents-assignments-change-search-ownership

Assignment of Trademarks and Service Marks:

– Make sure the assigning company is the owner/registrant and can assign the trademark(s) to the acquiring company

– Specifically identify all U.S. and (if applicable) foreign trademarks and service marks, registered or otherwise, being assigned/transferred in an exhibit or elsewhere

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Assigning Patents and IP

Assignment of Trademarks and Service Marks (continued):

– Register all trademark and service mark assignments in the U.S. Patent and Trademark Office (“PTO”). See https://www.uspto.gov/trademark/trademark-assignments-change-search-ownership

Example of Employment Agreement Provision: “[Name] presently assigns and transfers to the Company all right, title, and interest in and to any inventions or works created, made, conceived, invented, developed, discovered, or reduced to practice in the performance of [Name’s] duties on behalf of the Company, including any and all Intellectual Property Rights (as defined herein) pertaining thereto.”

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Assigning Patents and IP

Presumptions of Validity and Built-In “Due Diligence” by PTO:

– All unexpired U.S. patent are presumed valid under the U.S. Patent Act, 35 U.S.C. § 282.

– Trademarks and service marks registered on the PTO’s principal register are presumed valid, and the owner is presumed to have the exclusive right to use the mark in commerce throughout the U.S.

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Assigning Patents and IP

Patent Assignor Estoppel: – An effective tool and defense for those who purchase or are assigned

presumptively-valid patents through, e.g., a corporate merger or acquisition

– An equitable doctrine that prevents some allegations that a patent is invalid

– The patent estoppel doctrine has been expressed “in terms of unfairness and injustice” that would result if a patent assignor was “permitted to sell something and later assert that what was sold is worthless, all to the detriment of the assignee.” Diamond Scientific v. Ambico, 848 F.2d 1220, 1224 (Fed. Cir. 1988).

– The doctrine also applies to those in privity with the patent assignor

– Example: Jane Doe works for Acme Co., invents a widget, gets a patent on the widget, and assigns the patent to Acme. Jane later resigns and starts a new competitor company, Beta Co. Beta infringes the patent that Jane invented and Acme now owns. Acme sues Beta for infringement. Jane and Beta are equitably estopped from alleging or counter-claiming that the patent is invalid.

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Assigning Patents and IP

Provisions to Include (if true):

– The Company represents that it is not aware and has no notice of any

pending or threatened challenge to or regarding the validity, enforceability, ownership, or registration of any Intellectual Property defined in Section X of this Agreement in any U.S. court, the U.S. Patent and Trademark Office, the International Trade Commission, or any other court or tribunal.

– The Company represents that is it not aware and has no notice of any pending or threatened lawsuit in any U.S. court or any pending or threatened proceeding in the U.S. Patent and Trademark Office, the International Trade Commission, or any other court or tribunal involving or implicating any Intellectual Property defined in Section X of this Agreement.

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Assigning Patents and IP

Provisions to Include (continued):

– Company A hereby assigns and transfers to Company B all goodwill and know-how arising from or related to Company A’s patents, trademarks, trade secrets, and intellectual property. • Goodwill = Intangible assets resulting from the acquisition of a company,

including the value of a company’s name, brand name(s), trademark and service marks, customer base and relations, employee relations, and intellectual property and trade secrets.

• Know-How = Knowledge and Information (e.g., trade secrets, practical knowledge, techniques, processes, skills, etc.) that give an acquiring company the ability to produce something that the company “otherwise would not have known to produce with the same accuracy or precision found necessary for commercial success.”

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The Defend Trade Secrets Act (DTSA)

Signed by President Obama and became effective on May 11, 2016

Technically an amendment to the existing Economic Espionage Act (18 U.S. Code Chapter 90)

Provides a federal cause of action for trade secret misappropriation

Supplements and does not preempt various state versions of the Uniform Trade Secret Act (UTSA)

Intended in large part to “harmonize” trade secret laws and provide a more predictable, nationally-consistent law

“Trade secret” defined at 18 U.S. Code §1839

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The Defend Trade Secrets Act (DTSA)

DTSA immunity and exception provisions:

– Prevents injunctions that unfairly limit employee mobility;

– Provides for limited use and disclosure of trade secrets in anti-retaliation lawsuits; and

– Protects “whistleblowers” who disclose trade secrets in the course of reporting unlawful behavior. • See 18 U.S. Code §1833 (“exceptions to prohibitions”)

DTSA statute of limitations:

– Must file suit within three years “after the date on which the misappropriation … is discovered or by the exercise of reasonable diligence should have been discovered.”

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The Defend Trade Secrets Act (DTSA)

DTSA remedies for trade secret misappropriation:

– Seizure in some instances of misappropriated trade secrets and related documents, information, and things

– Court injunctions preventing: (1) actual or threatened misappropriation; and (2) use of misappropriated trade secrets

– Reasonable royalty payments

– Damages for actual loss and/or unjust enrichment caused by the misappropriation

– Exemplary damages and attorney’s fees in cases of willful and malicious misappropriation (if notice to employees is provided)

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The Defend Trade Secrets Act (DTSA)

DTSA Extraterritoriality Provision

– The DTSA applies to conduct occurring outside the United States if:

• the “offender is a natural person who is a citizen or permanent resident alien of the United States, or an organization organized” in the United States; or

• “an act in furtherance of the offense was committed in the United States.”

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The Defend Trade Secrets Act (DTSA)

Recommendations: – Revisit your perspective on filing trade secret misappropriation

actions?

– Revisit and define inventory of trade secrets and current means and methods of protecting them; Shore up protection as necessary; Work with IT department on detection, etc.

– Develop response plans for when trade secrets are misappropriated by employees, competitors, etc.

– Revisit entry and exit procedures for new and departing employees

– Provide notice to current and new employees, contractors, and consultants of the immunities and exceptions provided in 18 U.S. Code §1833

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Todd Bartels is a litigation shareholder whose practice focuses on complex financial issues relating to bankruptcy, real estate and disputes arising out of complex business transactions. A significant part of his practice relates to litigating claims of successor liability, alter ego/veil-piercing, and fraudulent transfers, and in this regard he frequently counsels clients both before and after merger and acquisition transactions.

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Summary of Fiduciary Duties of a Board of Directors

The Delaware General Corporation Law (the “DGCL”) creates a board-centric governance structure, subject to their authorization to delegate certain but not all of those responsibilities.

In discharging this responsibility, decisional law holds that the directors owe “unyielding” fiduciary duties: namely, the duties of care and loyalty.

These duties are owed to the corporation and to its stockholders, the latter as an undifferentiated whole.

“[S]tockholders' best interest must always, within legal limits, be the end.

Other [corporate] constituencies may be considered only instrumentally to advance that end.”

Must act prudently, loyally, and in good faith to maximize the corporation’s value over the long-term for the benefit of its stockholders.

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Duty of Loyalty

Forbids fiduciaries from using “their position of trust and confidence to further their private interests.”

“[b]est interest of the corporation and its shareholders take[] precedence over any interest possessed by a director . . . and not shared by the stockholders generally.”

A director may not engage in self-interested transactions with the corporation unless the terms of those transactions are entirely fair, or the transaction is conditioned at the outset on (a) a recommendation by an effective special committee and (b) approval by a majority of the unaffiliated stockholders.

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Duty of Loyalty - Independence

The duty of loyalty implicates director “independence” and “disinterestedness.”

Independence means that a director’s decision is based on the corporate merits of the subject before the board rather than extraneous considerations or influences.

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Duty of Loyalty - Interested

A director is interested in a matter if he or she “expects to derive a material personal financial [or other] benefit from the transaction that does not devolve on all stockholders generally.”

Where an inside director stands to receive a material change-in-control payment as the result of a transaction, or where she stands to lose her job as an officer of the corporation if the transaction is not consummated.

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Duty of Loyalty – Good Faith

The duty of loyalty also encompasses a subsidiary duty of good faith.

The absence of good faith where directors “knew that they were making material decisions without adequate information and without adequate deliberation, and that they simply did not care if the decision caused the corporation and its stockholders to suffer injury or loss.”

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Duty of Loyalty – Bad Faith

The Delaware Supreme Court has articulated three categories of fiduciary misconduct that are “candidates for the ‘bad faith’ pejorative label.” They are:

– conduct undertaken with an actual intent to harm the corporation;

– action undertaken with a lack of due care rising to gross negligence but without malevolent intent; and

– intentional dereliction of duty reflecting a conscious disregard for one’s responsibilities.

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Duty of Care

Requires directors to “use that amount of care which ordinarily careful and prudent [individuals] would use in similar circumstances.”

Consideration of all material information reasonably available in making business decisions.

Deliberative process important.

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Duty of Care

Directors should obtain and consider all pertinent information; solicit and consider the advice of experts where necessary

– ask questions of management and others, and test assumptions where appropriate

– fully understand the terms of important transactions; engage in candid discussion

– stay apprised of the corporation’s financial and operational performance and monitor internal controls

– monitor the performance of management

– and probe conditions that may (for example) signal a failure of internal controls or compliance with applicable law.

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Duty of Care

Breaches of the duty of care typically are not found where directors merely fail to follow best practices

Rather, breaches of fiduciary duty are found where there has been conduct that is grossly negligent or directors have acted with reckless indifference to stockholder concerns

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Duty of Care

Examples of grossly negligent conduct:

(1) ratification or implementation of a deal “after a very brief consideration by the board,”

(2) the “board had only three independent members out of six” and “failed to appoint a special committee of independent directors to evaluate the Agreement,”

(3) “acted without any independent advice as to legality,” and

(4) “acted without any independent advice as to” “valuation” – there is “a reasonable possibility that the plaintiff may prevail.”

Kosseff v. Ciocia, et al., 2006 WL 2337593, at *7-8 (Del. Ch. Aug. 3, 2006).

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LLC Fiduciary Duties

In August 2013, the Delaware Limited Liability Company Act (the “LLC Act” at section 18-1104) was amended to make clear that, unless stated otherwise in the operating agreement, managers and controlling members of Delaware limited liability companies (“LLCs”) owe the common law fiduciary duties of care and loyalty owed by directors and officers of Delaware corporations.

The LLC Act expressly does provide that fiduciary duties may be eliminated or restricted in the operating agreement.

The LLC Act also permits the LLC agreement to exculpate managers for liability for breaches of duties, including fiduciary duties.

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Standards of Review

Standards of review differ from fiduciary duties (or standards of conduct)

The standard of review is the test applied to evaluate whether a standard of conduct has been met when a transaction is challenged in court.

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Standards of Review

Three Standards of Review

– Business Judgment Rule (default)

– Enhanced Scrutiny (intermediate)

– Entire Fairness (heightened)

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Standards of Review

Business Judgment Rule

– Default standard of review

– Presumes that directors act on an informed basis and with the honest belief that their decisions are in the best interests of the corporation.

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Standards of Review

Enhanced Scrutiny

– Intermediate standard of review

– Applies to certain types of transactions, including some mergers and acquisitions

– Directors must show that they acted reasonably to obtain the best value reasonably available under the circumstances, including no transaction at all

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Standards of Review

Entire Fairness

– Heightened standard of review

– Applies when a director is interested or not independent

– Directors must show that the challenged act or transaction was entirely fair

– Fairness has two basic aspects: fair dealing and fair price

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Fiduciary Conduct

Entire fairness review is triggered by grossly negligent process, and in failing to consider material facts when making the decision. Brehm v. Eisner, 746 A.2d 244, 264 n.66 (Del. 2000). Examples of proper process by fiduciaries:

(1) engaged in a “multi-year process;”

(2) formed a “Special Committee of outside directors to negotiate the sale,”

(3)“reviewed strategic alternatives,” “and recommendations to Board;”

(4) “independently selected and retained legal” “advisors,”

(5) “independently selected and retained” “financial advisors,” and

(6) “fairness opinions ..supported by a number of financial analyses.”

In re CompuCom Sys., Inc. S’holders Litig., 2005 WL 2481325, at *7 (Del. Ch. Sept. 29, 2005).

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Exculpatory & Indemnification Provisions

§ 102(b)(7) – Exculpatory Provision

– Eliminates or limits personal liability for monetary damage arising from breach

Indemnification and Advancement Provisions

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Polsinelli provides this material for informational purposes only. The material provided herein is general and is not intended to be legal advice. Nothing herein should be relied upon or used without consulting a lawyer to consider your specific circumstances, possible changes to applicable laws, rules and regulations and other legal issues. Receipt of this material does not establish an attorney-client relationship. Polsinelli is very proud of the results we obtain for our clients, but you should know that past results do not guarantee future results; that every case is different and must be judged on its own merits; and that the choice of a lawyer is an important decision and should not be based solely upon advertisements. © 2016 Polsinelli PC. In California, Polsinelli LLP. Polsinelli is a registered mark of Polsinelli PC