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In a previous post we discussed a few basic principles of confidentiality agreements (also known as non-disclosure agreements or NDAs). That post discussed the basic of these agreements and the important principles of restrictive covenants and trade secrets. Left unanswered was the critical question: How long can, or should, a confidentiality obligation last?

Reasonable Periods of Confidentiality
Now let’s get back to the question of a reasonable amount of time for confidentiality obligations to last with respect to CBI that does not meet the definition of a trade secret. As discussed above, a factor is the nature of the CBI owners legitimate business interests that are protected by the agreement. An example of a legitimate business interest of the owner is to protect the confidentiality its cost of goods sold or COGS. Disclosure of that information to competitors may give them an unfair advantage when bidding for the business of new customers. But how long does that legitimate business interest last? That depends on the nature of the goods and the nature of the industry. In some industries, costs are sufficiently stable that knowledge of a company’s COGS from five years ago enables a competitor to make an accurate estimate of the company’s COGS today, and a court might consider a confidentiality period of five years to be very reasonable. In other industries, costs change much more quickly, and a court might find that a confidentiality period of five years is unreasonable and rule that the agreement is unenforceable — unless the COGS also meets the definition of a trade secret.

Here’s where things get more complicated because the definitions of CBI in most confidentiality agreements are not identical to the definition of a trade secret. In most cases, all trade secrets are also CBI, but not all CBI qualifies as a trade secret. So what to do?

One one might consider writing a confidentiality agreement that, for CBI that qualifies as a trade secret, lasts for as long as that is true and, for all other CBI, lasts for only, say, three years. And one can certainly write a contract with precisely that provision, but it will pose a dilemma for the recipient: The recipient will probably not be able to tell the difference between CBI that qualifies as a trade secret and CBI that does not. Here are some possible ways to resolve that dilemma.

  • The recipient may decide to simply live with the dilemma and assume that all CBI must be protected essentially forever. Some recipients find that acceptable.
  • The owner of the CBI may accept a time limitation for all CBI, including CBI that qualifies as a trade secret. However, that may create other problems for the CBI owner. Note the second part of the definition of a trade secret — it must be subject to reasonable precautions to protect its secrecy. Is it a reasonable precaution to disclose information under a confidentiality agreement that permits the disclosure or use of the information after a certain period of time? Some courts say no, with the result that the information loses its status as a trade secret.
  • The confidentiality agreement may impose a limit that applies to ALL CBI, but only if, and for as long as, the CBI qualifies as a trade secret. In that case, the owner accepts the possibility that some CBI may have no protection at all because it never qualifies as a trade secret. For some owners in some situations, that is a more acceptable risk than the possibility of having its CBI lose status as a trade secret.

In short, there is no single solution that works in every case. Each situation must be negotiated individually, with the interests of both sides of the agreement taken into account.
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Confidentiality agreements (also known as non-disclosure agreements or NDAs) are common in today’s business world. They are sometimes in the form of stand-alone agreements, often used when two businesses are discussing a potential deal and at least one of them needs to disclose to the other information that is not available to the public (sometimes called confidential business information or CBI). Other times, they are embedded in agreements with a broader scope, such as employment contracts, service contracts, and contracts for the sale and purchase of a business.

The fundamental concept of a confidentiality agreement is simple. The person receiving or possessing the other person’s CBI promises not to disclose it to others and (usually) not to use the information for any purpose other than the discussions of a potential transaction or the purpose of the larger contract in which the confidential provision is embedded.

The details, however, can be tricky, and one of the thornier details is the question of how long the obligations of nondisclosure and nonuse last. Naturally, the person disclosing the CBI wants the commitments to last forever, but the person making the commitments wants them to expire at some point in time, not necessarily because he or she wants to use or disclose the information, but because he or she wants the possibility of being sued for breach to come to an end, and the sooner the better.

So how long can, or should, a confidentiality obligation last? Before answering that question, a little review of some legal principles is in order. Note that these issues are very fact-sensitive and that the law varies a fair amount from state to state. For that reason, this discussion is based on general concepts; the results may be very different in any particular case.

Restrictive Covenants
Confidentiality agreements are sometimes considered to be within a larger category of contracts known as restrictive covenants, i.e., agreements that in one way or another restrict commercial trade. With freedom of trade and commerce being so important to American society, restrictive covenants are not favored by public policy or the law. That doesn’t mean restrictive covenants are necessarily void or illegal, but they may be unless the restrictions are sufficiently narrow. At least some courts have held that confidentiality obligations can last for only a reasonable period of time (with an exception discussed below), and a confidentiality obligation that lasts too long may result in a court refusing to enforce the agreement.

Unfortunately, there are no clear rules to tell us what amount of time is reasonable for the duration of a confidentiality obligation. Instead, there are factors that must be weighed and balanced. Those factors include the nature of the legitimate business interests of the owner of the CBI; the effect of the restrictions on the person making the non-disclosure and non-use commitments; and the public interest.

So far we know that it may be necessary for a confidentiality obligation to expire after a reasonable period of time, and, if it doesn’t, the agreement may be unenforceable. HOWEVER, there is a major exception, and that exception is for CBI that also meets the definition of a “trade secret.”

Trade Secrets
Although “confidential business information” does not have a universal meaning,the definitions contained in most confidentiality agreements are broad enough to encompass “trade secrets,” a term defined by state statute. In Indiana, section 24-2-3-2 of the Indiana Code defines a trade secret as information that

  1. has independent economic value because others who could obtain economic value from the information do not have the information and cannot reasonable acquire it; and
  2. is the subject of reasonable efforts to maintain its secrecy.

Trade secrets are a form of intellectual property, and the trade secret statute provides protection against improper use or disclosure, in addition to the protection provided by a confidentiality agreement. Unlike most forms of intellectual property, such as patents, trade secrets never expire; they remain protected by statute for as long as the information continues to meet the definition. For that reason, some courts have ruled that the requirement for confidentiality agreements to be limited to a reasonable period of time is subject to an exception for trade secrets. To the extent a confidentiality agreement covers a trade secret, the confidentiality obligation is permitted to last forever, or at least for as long as the information continues to qualify as a trade secret under the statutory definition.

Here’s where that leaves us: With respect to trade secrets, confidentiality obligations do not need to expire. (In fact, as we’ll see later, they should not expire.) With respect to other CBI, confidentiality obligations may need to expire after a reasonable period of time to ensure enforceability. In the next article, we will consider how to deal with that bifurcation.
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Last session, the Indiana General Assembly passed, and Governor Pence signed, House Enrolled Act 1494, amending Indiana Code Title 12, Article 17.2 by establishing new requirements for national criminal history background checks for employees and volunteers of regulated child care providers.

A national criminal history background check involves the submission of an individual’s fingerprints to the Federal Bureau of Investigation for comparison to a national database. (Note that there is a separate process for background checks for individuals under 18 years of age.) The new requirement for a national background check replaces a previous requirement for a background check at the state level, but it is in addition to the requirement for substance abuse testing.

This article discusses the new requirement for background checks in broad terms. More detailed information is available from the Bureau of Child Care of the Indiana Family and Social Services Administration. Note also that HEA also creates some other new requirements for some child care providers that are not addressed by this article.

Applicability

The requirement for background checks applies to essentially all individuals who have any contact with children at any type of regulated child care providers, which include

For all types of regulated providers, background checks are required for all individual caregivers, including both employees and volunteers. For child care homes, the requirement also extends to any member of the household who is 18 years of age or older (or, if younger than 18, who has been previously been charged with a crime and waived from juvenile court to adult court), even if he or she will have no contact with children.

Background checks are required when the child care center, home, or ministry applies for a license or registration; when an unlicensed provider applies for certification of eligibility to receive CCDF funding; when a new employee is hired or a new volunteer begins work; and every three years after that. The requirements for new applications and new employees and volunteers (and for child care homes, new household members) took effect on July 1, 2013. Other regulated providers have until July 1, 2014, to comply with the requirements for existing caregivers and household members.

Prohibitions

The purpose of the background check is to identify individuals who are prohibited from being child care provider, an employee or volunteer of a child care provider, or a member of the household at a child care home. An application for a license, registration, or CCDF certification may be denied if the provider, a caregiver, or (for child care homes) a household member has been convicted of certain types of felonies or misdemeanors or if the individual has been charged of such a crime while the application is pending. Note that only convictions or pending charges count; previous charges that were dismissed or resulted in an acquittal do not disqualify an individual.
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Earlier this year the General Assembly passed HEA 1394 which made several changes to the Indiana Business Flexibility Act, the statute that governs limited liability companies. We have already looked at some changes to the Act that enhance the use of Indiana LLCs for estate planning purposes. This article discusses new alternatives for LLC management structure.

The Indiana Business Flexibility Act already provided for a great deal of flexibility for management structure. One of the key steps in designing the management structure of a limited liability company is to establish who has the apparent authority to bind the company, for example by signing contracts on behalf of the LLC. Prior to the changes there were essentially two choices. In a member-managed LLC, the members have that authority. In a manager-managed LLC, the members appoint managers (who may or may not also be members) who have that authority.

HEA 1394 provides a third choice — officers, who may or may not be members. At first blush, there may seem to be little difference between officers and managers because, like the managers in a manager-managed LLC, officers have the apparent authority to bind the LLC to third party agreements. But there is at least one important difference: In a manager-managed LLC, only the managers, and not the members, have the apparent authority to bind the company. The new revisions allow the members of an LLC to establish officers who have the apparent authority to bind the company, while also retaining that authority themselves. In fact, a manager-managed LLC can also have officers. In that case, both the managers and the officers, but not the members, have apparent authority to bind the LLC.

HEA 1394 includes other changes to the statute that enhance the alternatives for LLC governance. For example, the Act now permits the operating agreement to make certain significant decisions, including mergers, dissolutions, and amendments to the operating agreement, subject to the approval of a third party who need not be a member.

One context in which such provisions may prove useful is in estate planning. Imagine the founder of a business, held by a limited liability company, with multiple heirs, who wants the business to remain in the family. Although the operating agreement may create significant restrictions on transfers of membership interests and admission of new members, the heirs could later agree to amend the operating agreement to remove those restrictions. The Act now allows the operating agreement to name a trusted outside party who must approve any amendments to the operating agreement, thus increasing the likelihood that the founder’s desires will be honored.
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July 17, 2014. Update. Today the Indiana Supreme Court reversed the decision of the Court of Appeals. Check back soon on the Indiana Business Law Blog for a discussion of the Supreme Court’s decision.

A ruling in a recent case, Fischer v. Heymann, illustrates the pitfalls one can encounter when selling real estate. By not changing a light bulb and pushing the little red button on a couple of electrical outlets, the seller lost over $90,000!

The Case
Gayle Fischer entered into a contract to sell a condominium to Michael and Noel Heymann for $315,000. The buyers could inspect the property and, if they found serious defects, cancel the sale unless she agreed to fix the problems. On February 10, 2006 the Heymanns demanded that Fischer fix some minor problems: a couple outlets weren’t working and a light bulb needed to be changed. Fischer wrote back on Feb. 13th, saying she’d respond by Feb. 28th. The Heymanns wrote back two days later, demanding a response by Feb. 18th. Fischer did not make any further replies until the 19th, when the Heymanns attempted to cancel the contract, and the lawsuit ensued, with Fischer claiming total damages of more than $94,000, including $75,000 in direct damages (which represented the difference between the agreed price of $315,000 and the best offer Fischer later received, $240,000.)

The Decision
The Court of Appeals applied two standard contract principles but to reach a result that may seem surprising. First, the buyers committed an “anticipatory breach”.or “breach by repudiation,” which occurs when one party declares its intent to breach the contract. Here, the Heymanns’ refused to buy the condo unless Fischer made repairs, which the Court of Appeals held was an anticipatory breach. (The Heymanns would have had the right to cancel the contract if the defects in the condo were serious, but they weren’t.) An anticipatory breach is treated the same as an actual breach. Fischer did not need to wait until Heymanns failed to show up at the closing.

Second, once a breach has occurred (anticipatory or otherwise), the other side has an obligation to mitigate damages, or to take reasonable steps to avoid ‘piling up’ additional damages. One way of mitigating damages when a buyer backs out of a real estate purchase is to attempt to find another buyer. Here, the agreed price was $315,000. If the best price Fischer could get from another buyer was $300,000, the Heymanns would have owed her only $15,000. However, if Fischer passed up the $300,000 offer and later sold it for only $240,000, the Heymanns would still owe only $15,000 because that’s what the damages would have been if Fischer had mitigated.

Although the Court of Appeals did not describe its analysis quite this way, it essentially treated the Heymanns demand for repairs as a breach of the original purchase agreement and a new offer to buy the condo for the same price after the repairs were made, repairs which cost only $117 — the price for an electrician to make a service call to reset the ground fault interruptors and change a light bulb. Certainly, if, immediately after the Heymanns breached, a third person had offered to buy the property for the same price, less $117, mitigation of damages would have required Fischer to accept it. The Court of Appeals held that mitigation of damages required Fischer to make the repairs requested by the Heymanns. Result: The Heymanns owed Fischer $117, not $94,000!

Note that these principles apply to contracts in general, not just to real estate purchase agreements. Does it surprise you that one party can make the other party choose between accepting an amendment to the contract or collecting damages that are worth no more than the amendment? That’s effectively what happened in this case, and it surprised the Court of Appeals judge who dissented from the decision. I don’t know if Fischer’s lawyer has petitioned to transfer the case to the Indiana Supreme Court. If so, it will be interesting to see if the Supreme Court accepts the case. And if the decision stands, it will be interesting to see how later Indiana court decisions apply Fischer to other situations.
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[Note: The Department of Labor guidance relevant to this article, Fact Sheet #71, has been superseded.  See the discussion of the revised policy here.]

Two years ago we discussed whether nonprofit organizations and businesses can lawfully use unpaid interns. One of the key questions is whether the intern is actually an employee subject to the Fair Labor Standards Act. If so, the intern must be paid at least minimum wage and overtime pay if the intern works more than 40 hours in a week. The answer?

I don’t know very much about the fashion industry, but apparently it makes wide use of interns. And according to a class action lawsuit recently filed against a New York modeling agency in U.S. District Court for the Southern District of New York, many of them are unpaid.

The case is Davenport vs. Elite Model Management Corp. The plaintiff, a former unpaid intern, alleges that the agency uses interns as a source of free labor, which is precisely what the Fair Labor Standards Act forbids. According to the complaint, “Without the free labor of its interns like Ms. Davenport, Elite would be forced to do what every other reputable employer in this country does: pay an honest day’s wage for an honest day’s work.”

The complaint steps through the six criteria for determining whether Ms. Davenport and the other interns at Elite qualify as trainees and argues that they do not. Whether that’s correct remains to be seen, but the stakes are significant: The complaint alleges that Elite owes damages of at least $50 million for unpaid wages, overtime, and benefits for a class of plaintiffs that includes at least 100 interns.
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The “Indiana Smoke Free Air Law,” which was passed last year by the Indiana General Assembly and took effect on July 1, 2012, bans smoking in most Indiana businesses and nonprofit organizations. We thought the General Assembly might reconsider some of the details this year, but that hasn’t happened. Based on our non-scientific observations, it seems that Indiana businesses and nonprofits have not been very diligent about implementing the law, particularly those regarding signs. So we think it’s a good time to review the requirements, or at least some of them.

“Does the smoking ban affect my business?”

Smoking is now prohibited by law in “public places” and “places of employment,” as well as the area within 8 feet of public entrances to either of them. “Public places” and “places of employment” sound as if they encompass a lot, and they do. A public place includes any enclosed area of a structure in which the public is permitted or invited, and a place of employment includes any enclosed area of a structure (excluding a private vehicle) that is a place of employment. Lest we forget, there’s one other category — smoking is also banned in government vehicles being used for governmental purposes.

There are some exceptions, but the bottom line is that the smoking ban affects most businesses and nonprofit organizations in Indiana.

“Okay, my office is covered. What do I have to do?”

  • Not surprisingly, you must inform your employees and prospective employees that smoking is prohibited.
  • You must post conspicuous signs that read “Smoking is Prohibited by State Law,” or something to that effect. The law has a specific requirement that restaurants must have a conspicuous sign at each entrance informing the public that smoking is prohibited in the restaurant.
  • You must also post signs at each entrance (logically, the sign should be outside or at least visible from the outside) stating “State Law Prohibits Smoking Within 8 Feet of this Entrance” or something similar.
  • If someone smokes on the premises anyway, you must ask him or her to refrain, and if he or she refuses to stop, you must have him or her removed from the premises. (Note: Don’t try to do it yourself! In the unlikely event it becomes necessary, call the police.)

“I own a bar. Does the smoking ban REALLY apply to my business?”

It depends. There are some exceptions to the smoking ban, and one of them is for bars and taverns, but you have to meet certain requirements. For example, you may not have any employees under 18, and you must exclude anyone else under 21. There are more exceptions for several other types of places of employment and public places, each subject to particular qualifications or additional requirements.

“Does the law apply to our nonprofit organization?”

Probably. There is an exception that covers some social clubs and fraternal organizations or lodges that are tax exempt under Internal Revenue Code Sections 501(c)(7), (c)(8), or (c)(10), and it’s possible that some other types of nonprofits fit into an exception, but most nonprofits are subject to the smoking ban.

“I have a home office. Is smoking banned there, too?”

Again, it depends. The ban does not apply to a business located in the business owner’s residence, but only if all the people who work there live in the residence. Let’s assume that only you (the owner) and your spouse work in your office. In that case, you’re allowed to smoke, but if you have any employees who don’t live in your home, smoking is prohibited.

“Are there other exceptions?”

Yes. For a complete list see Ind. Code 7.1-5-1-5.

“My facility falls within an exception to the smoking ban, so I’m home free. Right?”

Well, not entirely. There are some other requirements that apply to public places and places of employment in which smoking is permitted. Here’s an interesting one — you have to post signs that state “WARNING: Smoking is allowed in this establishment.” You must also certify to the Indiana Alcohol and Tobacco Commission that your bar qualifies for the exception.

Moreover, even if most of your facility or building is exempted from the ban, smoking is prohibited in halls, elevators, and common areas where people under 18 are permitted or in rooms intended for use by people under 18.

And don’t forget that even if the state law does not ban smoking in your business, it may be prohibited by local no-smoking laws — such as the Indianapolis Ordinance — which are allowed to be more restrictive than the state law.

Other resources

NOTE: This is not a comprehensive analysis of the Indiana Smoke Free Air Law. There are other exceptions and other requirements that may apply to your business or nonprofit (even if it is exempt from the ban itself) that we have not discussed. Here are some other resources:

  • The full text of the statute can be found at Ind. Code 7.1-5-1.
  • Signs that comply with the state law are readily available from a number of suppliers.

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UPDATE, February 19, 2013.
Yesterday, the House Judiciary Committee amended HB1394 to remove the language discussed in this blog post — the changes to IC 23-18-6-7 that would have expressly provided that a charging order is the only right that the creditor of an LLC member has with respect to the LLC. It appears that Indiana will remain in the fourth category of states listed in the article — those in which there is no reverse veil piercing for multi-member LLCs, with the issue remaining unsettled with respect to single member LLCs. The most recent version of the bill is available here.

In my last post, I discussed HB 1394, a bill pending in the Indiana General Assembly that would make several amendments to the statute that governs Indiana limited liability companies. One of the most important changes is to strengthen the so-called “charging order” protection, which I’ll describe shortly after a brief review of some attributes of LLCs and corporations.

Recall that corporations and LLCs both have liability shields that protect the owners of the company (for a corporation, the shareholders; for a limited liability company, the members) from being personally liable for the company’s obligations. That liability shield (whether it’s for a corporation or LLC) is sometimes called a corporate veil, and in some circumstances courts will ignore the shield, or pierce the corporate veil, to allow creditors of the business to reach the personal assets of the owners. I’ve previously discussed precautions that LLC members can take to keep that from happening.

When a court allows a creditor of the business to reach the personal assets of the owners, it’s sometimes called “inside-out veil piercing,” which implies there might be something else called “outside-in veil piercing.” And there is.

Consider what happens when a shareholder of a corporation owes money to a creditor. The shareholder’s stock is just like any other asset, like a bank account, a house, or a car. And just like any other asset (well, most other assets), the stock is subject to foreclosure, which effectively means the creditor takes over ownership. The creditor, now the new shareholder, receives all the rights associated with the stock, including the economic rights (i.e., the right to receive dividends, if there are any) and the non-economic rights (including the right to vote in elections of the board of directors). That’s called “outside-in veil piercing” or sometimes “reverse veil piercing.” If the creditor takes over enough shares of stock, he or she can gain control of the company. Even if the creditor does not gain control of the company, the other shareholders may suddenly find themselves co-owners with someone they don’t even know, maybe even with someone they despise. For large, publicly traded companies with millions of shareholders, that’s no big deal. For family businesses or other businesses with only a few shareholders, it can be a very big deal.

The area of reverse veil piercing is one in which LLCs differ tremendously from corporations, at least in some states, and it is one of the reasons that I advise clients to set up LLC’s far more often than I advise them to set up corporations. When it comes to the rights of a member’s creditors, many states, including Indiana, treat the member’s economic rights and non-economic rights separately. For example, IC 23-18-6-7 allows a court to issue an order requiring a limited liability company to pay to a member’s creditors anything that the LLC would otherwise be required to pay to the member. That’s called a charging order, and it’s something like an order for the garnishment of wages, applied to a member’s right to receive LLC distributions.

The question is whether a charging order is the only remedy a creditor has against the member’s rights. If so, there is no reverse veil piercing, and a member’s creditors cannot take over control of the business or gain a seat at the table with the other members. I believe there are currently five categories of states:

  1. Those in which reverse veil piercing is not allowed for LLCs.
  2. Those in which reverse veil piercing is allowed for single-member LLCs but not for multi-member LLCs.
  3. Those in which reverse veil piercing is allowed for both single-member LLCs and multi-member LLCs (essentially treating LLCs the same as corporations).
  4. Those in which there is no reverse veil piercing for multi-member LLCs but for which the law is unresolved for single-member LLCs.
  5. Those in which the law is unresolved for reverse veil piercing both single-member and multi-member LLCs.

Until fairly recently, Indiana was in the fourth group of states. As I’ve discussed elsewhere, a 2005 decision of the Indiana Court of Appeals, Brant v. Krilich, held that there is no reverse veil-piercing for multi-member LLCs, but apparently leaving the question open for single-member LLCs.

HB 1394 would add a provision to IC 23-18-6-7 expressly stating that a charging order is the exclusive remedy for a judgment creditor of a member and that the creditor has no right to foreclose on the member’s interest. Because the bill makes no distinction between single-member and multi-member LLCs, it appears that HB 1394 would place Indiana in the first category of states — those for which reverse veil piercing is not allowed for either single-member or multi-member LLCs.
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Statutes governing limited liability companies, or LLCs, vary considerably from state to state. In our opinion, Indiana’s statute is already among the best in the country, and a bill introduced in the 2013 session of the Indiana General Assembly proposes several changes that would make it even better for small business owners, particularly family-owned businesses. Among other things, HB 1394, introduced by Rep. Greg Steuerwald (R Avon) would:

Later posts will discuss these proposed changes in more detail, including a few suggestions for possible revisions to the bill that would make it even better. In the meantime, however, small business owners in Indiana may want to contact their state representatives and senators urging them to support HB 1394.
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The Internal Revenue Service has announced the following standard mileage rates used to calculate income tax deductions for business travel expenses and for travel expenses incurred while serving charitable organizations.

  • Business, $0.565 per mile
  • Charitable service, $0.14 per mile
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