Datto, Inc. v. Falk
RULING ON CROSS MOTIONS FOR SUMMARY JUDGMENT. For the reasons stated in the attached ruling, Datto's motion for summary judgment (Doc. # 73 ) as to Count Two and as to Counterclaims One and Two is GRANTED. Falk's cross-motion for summary ju dgment (Doc. # 91 ) as to Counts One and Two and as to Counterclaims One and Two is DENIED. In addition, Falk's motion for an order to show cause to reopen discovery and briefing (Doc. # 114 ) is DENIED for substantially the reasons set forth in Datto's response (Doc. # 117 ). This ruling is without respect to Datto's remaining breach-of-contract claim in Count One regarding Falk's alleged solicitation of Datto employees and use of confidential information. Signed by Judge Jeffrey A. Meyer on 3/13/2018. (Zuckier, C.)
UNITED STATES DISTRICT COURT
DISTRICT OF CONNECTICUT
No. 3:16-cv-00889 (JAM)
RULING ON CROSS MOTIONS FOR SUMMARY JUDGMENT
A “non-compete” agreement is an agreement between an employer and an employee that
an employee will not work for a competing business if she stops working for her employer. Noncompete agreements have proved controversial for hundreds of years since their origin in
mercantile England. See Harlan M. Blake, Employee Agreements Not to Compete, 73 Harv. L.
Rev. 625, 629-46 (1960). They continue nonetheless to thrive in the American workplace today
and remain a frequent subject for litigation in U.S. courts. See generally J. Gregory Grisham,
Beyond the Red-Blue Divide: An Overview of Current Trends in State Non-Compete Law, 18
Federalist Soc’y Rev. 82 (2017); Norman D. Bishara, Fifty Ways to Leave Your Employer:
Relative Enforcement of Covenants Not to Compete, Trends, and Implications for Employee
Mobility Policy, 13 U. Pa. J. Bus. L. 751 (2011).
A non-compete agreement outright bars an employee from going to work for the
competition. Sometimes employers use a less restrictive alternative: to allow an employee to
jump ship to the competition but discourage this by docking them with a loss of certain company
benefits. “Federal cases draw a distinction between provisions that prevent an employee from
working for a competitor and those that call for a forfeiture of certain benefits should he do so.”
Tatom v. Ameritech Corp., 305 F.3d 737, 744 (7th Cir. 2002). This latter form of agreement is
commonly known as a forfeiture-for-competition agreement. See, e.g., Lucente v. Int’l Bus.
Machines Corp., 75 F. Supp. 2d 169, 172-73 (S.D.N.Y. 1999).
That is the type of agreement at issue in this case. Plaintiff Datto, Inc. seeks to forfeit the
stock option rights of defendant William Falk as a consequence of his leaving Datto to work for
one of Datto’s competitors. Now the parties have cross-moved for summary judgment, and I
conclude that Falk agreed to forfeit his stock options and that his agreement to do so is
enforceable as a matter of law.
Datto is a privately-held company based in Connecticut that furnishes data protection and
back-up services for businesses. Falk began working for Datto as its Chief Revenue Officer in
February 2014. Datto and Falk entered into a series of agreements over the course of his
employment that are all necessary to an understanding of this case.
At the start of his employment, Falk signed a document titled “Confidentiality,
Assignment of Inventions, and Non-Compete Agreement” that the parties refer to as the
“Restrictive Covenant Agreement.” Doc. #45-1. This agreement was designed in part to impede
Falk from harming Datto if he left his job there. It barred Falk from working for a competitor for
one year after the termination of his employment, from soliciting any Datto employees for two
years after the termination of his employment, and from thereafter disclosing or using Datto’s
confidential information. Id. at 2-4.
Datto offered Falk stock options as part of his employment package. Doc. #75 at 3. These
options were governed by a separate agreement titled “Datto, Inc. 2013 Stock Incentive Plan,”
which the parties refer to simply as “the Plan.” Id. at 16-40. The declared purpose of the Plan
was to aid Datto in recruiting and retaining employees as well as to benefit the company from the
added interest that employees will have in the welfare of the company as a result of having a
proprietary interest in the company. Id. at 16.
Most importantly for purposes of this litigation, the Plan stated that any stock award
“shall immediately terminate” and any stock options “shall no longer be exercisable” if a
participant engages in a “Detrimental Activity.” Id. at 33. The Plan defined “Detrimental
Activity” in relevant part to include a participant’s working for a business competitor. Id. at 18.
In July of 2014, Falk executed a “Notice of Stock Option Grant” agreement providing
Falk with the stock options as promised in Datto’s employment offer. Id. at 11-14. The Grant set
the price and vesting schedule for the exercise of stock options. It made clear that it was “subject
to the terms and conditions of the Plan, this Notice of Grant, and the attached Stock Option
Agreement.” Id. at 11. The Grant also stated that the “Option shall terminate and shall no longer
be exercisable on the date on which the Participant engages in a Detrimental Activity.” Id. at 13.
For reasons not clear on this record Falk’s employment with Datto did not work out as
the parties had hoped. And so they negotiated a “Separation Agreement” for Falk to leave. Id. at
50-66. Under the terms of this agreement, Falk was in a limbo status of “transition leave” from
January 2015 to September 30, 2015, during which time he continued to receive his salary but
with few job duties for him to do. Id. at 51-52.
The Separation Agreement relieved Falk from the Restrictive Covenant Agreement to the
extent that it had barred him from working for a competitor after he left the company’s employ at
the end of September 2015. Id. at 53. Indeed, the agreement “encouraged” Falk to pursue
employment “with any other potential employer” during the transition as long as the employment
began no earlier than October 1, 2015. Id. at 51.
The Separation Agreement also addressed the issue of Falk’s stock options. It provided
that subject to board approval, the parties would execute an amended agreement that
significantly reduced the number of shares for which he would have options. Id. at 52, 64-65.
The Separation Agreement otherwise provided that Falk’s prior agreements with Datto
would remain in effect to the extent not modified by the Separation Agreement: “this Agreement
does not supersede the Restrictive Covenant Agreement (as conditionally amended herein),
Notice of Stock Option Grant, and the Plan, all of which are referenced herein and shall continue
to be in full force and effect in accordance with their terms (except to the extent as may be
amended herein).” Id. at 58.
Falk signed the Separation Agreement on March 16, 2015. Id. at 61. Nearly three months
later, the parties executed on June 11, 2015, an “Amendment to Notice of Stock Option Grant
and Stock Option Agreement” as contemplated by the Separation Agreement. Id. at 68-70. This
new agreement—which the parties refer to simply as “the Amendment”—specified the reduced
number of stock options for Falk and a new vesting and exercise schedule. Id. at 68-69.
Importantly, the Amendment also included the following clause describing the status of
the Amendment in relation to the parties’ prior stock option agreements:
No Further Modifications or Amendment. Except as amended hereby, the Original Grant
Notice and the Original Option Agreement each shall remain in full force and effect and
the parties agree that no other modification or amendment exists or is valid or
enforceable. For the avoidance of doubt, to the extent there is any conflict between this
Amendment and the Original Grant Notice, the Original Option Agreement or the Plan,
this Amendment shall control.
Id. at 69.
Nearly six months after his employment with Datto ended, Falk accepted a position with
Infrascale in February 2016. The parties do not dispute that Infrascale is one of Datto’s
competitors. Datto sent Falk a letter reminding him of his continuing obligations under the
Restrictive Covenant Agreement, including with respect to his duties not to disclose or use
confidential information or to solicit Datto employees. Doc #45-2 at 2-4.
Datto initially filed this lawsuit after Falk allegedly engaged in conduct in May 2016 that
Datto believed to violate the confidentiality and solicitation provisions of the Restrictive
Covenant Agreement. See Doc. #1. Datto later amended its complaint to allege that Falk’s stock
options were now void because of his employment with a competitor that amounted to
“Detrimental Activity” in accord with the parties’ agreements. Doc. #45.
Falk in turn has filed two counterclaims against Datto. Doc. #69. Counterclaim One
alleges that Datto breached its contract with Falk by refusing to allow Falk to exercise his stock
options in violation of the Separation Agreement. Counterclaim Two is a request for declaratory
judgment that the Separation Agreement modified the Grant and the Plan, such that the
“Detrimental Activity” provision of the Plan does not apply to negate Falk’s right to exercise his
The parties have now filed cross-motions for partial summary judgment. In essence, these
motions ask me to decide as a matter of law if Falk validly agreed to forfeit his rights to Datto
stock options as a consequence of his choice to work for one of Datto’s competitors.
The principles governing the Court’s review of a motion for summary judgment are well
established. Summary judgment may be granted only if “the movant shows that there is no
genuine dispute as to any material fact and the movant is entitled to a judgment as a matter of
law.” Fed. R. Civ. P. 56(a). I must view the facts in the light most favorable to the party who
opposes the motion for summary judgment and then decide if those facts would be enough—if
eventually proved at trial—to allow a reasonable jury to decide the case in favor of the opposing
party. My role at summary judgment is not to judge the credibility of witnesses or to resolve
close contested issues but solely to decide if there are enough facts that remain in dispute to
warrant a trial. See generally Tolan v. Cotton, 134 S. Ct. 1861, 1866 (2014) (per curiam);
Pollard v. New York Methodist Hosp., 861 F.3d 374, 378 (2d Cir. 2017).
In order to resolve the parties’ cross-motions, I need to consider three issues in turn. First,
I must decide which state’s law applies. Second, I must interpret the meaning of the parties’
agreements—to parse them to decide if Falk actually agreed to forfeit his stock options. Lastly,
in the event that I conclude that Falk did agree to such forfeiture, I must decide if his agreement
is permissible under the law that limits an employer’s right to impose non-competition
restrictions on employees.
Choice of Law
As an initial matter, the parties dispute the proper substantive law to apply to their dispute
concerning Falk’s right to any stock options. Falk argues that California law should apply,
because he is a resident of California and negotiated the agreements at issue while there. I can
see why Falk wants California law to apply, because the law of California is notoriously adverse
to the enforcement of non-compete agreements. See, e.g., Stryker Sales Corp. v. Zimmer Biomet,
Inc., 231 F. Supp. 3d 606, 620-21 (E.D. Cal. 2017). By contrast, Datto argues that Delaware law
applies, in view that the parties expressly agreed to Delaware law in the Plan, the Stock Option
Agreement, and the Amendment. Doc. #75 at 40, 46, 69.
I agree with Datto that Delaware law applies. Insofar as the parties’ dispute is about stock
options, the Amendment supersedes the Separation Agreement (which specified the application
of Connecticut law), both in time and in specificity of subject matter. It is clear to me as a matter
of basic contract interpretation that the parties unambiguously chose Delaware law to apply to
any dispute about Falk’s rights to stock options.
Is the parties’ choice of Delaware law enforceable? To answer that question, a federal
court sitting in diversity must look to the choice-of-law rules of the forum state. See Int’l Bus.
Machines Corp. v. Liberty Mut. Ins. Co., 363 F.3d 137, 143 (2d Cir. 2004). Under the law of
Connecticut, a choice-of-law provision is enforceable “so long as it bears a reasonable
relationship to the dispute and was not procured by misrepresentation.” Johnson v.
Priceline.com, Inc., 711 F.3d 271, 276 n.2 (2d Cir. 2013) (citing Elgar v. Elgar, 238 Conn. 839,
Applying this standard, I conclude that the parties’ choice of Delaware law is
enforceable. Delaware law has a reasonable relationship to the parties’ dispute, because the
dispute concerns a stock ownership interest in the shares of a company that is incorporated under
Delaware law. And there is no genuine argument that Falk’s agreement to the Amendment was
procured by any misrepresentation. I will therefore apply Delaware law to this aspect of the
parties’ dispute concerning Falk’s right to Datto stock options.
Applicability of “Detrimental Activity” Limit
The next issue is whether the parties’ agreements require Falk to forfeit his stock options
because of his decision to work for one of Datto’s competitors. As an initial matter, Falk does
not contest that his work for a competitor is within the scope of the “Detrimental Activity” clause
of the Plan. Instead, Falk argues that the “Detrimental Activity” restriction did not survive the
parties’ later Separation Agreement and the Amendment.
Falk points to the fact that the Separation Agreement relieved him altogether from the
non-compete restriction of the Restrictive Covenant Agreement, and it “encouraged” Falk to
pursue employment “with any other potential employer.” Doc. #75 at 51 (emphasis added). He
argues that he relied on this assurance that he could work for any other employer and should not
now lose his stock options as a consequence.
But what Falk overlooks is that neither the Separation Agreement nor Amendment did
anything to extinguish the separate “Detrimental Activity” limitation as set forth in the Plan and
the Grant and its application to Falk’s decision to work for a competitor. To the contrary, the
Separation Agreement provided that it did not supersede the parties’ prior agreements including
the Plan and the Grant which included the “Detrimental Activity” limitation. Doc. #75 at 58. And
the Amendment provided that the parties’ earlier agreements—including the Grant— “remain in
full force and effect.” Id. at 69.
Could Datto have done more to warn Falk when the parties negotiated the Separation
Agreement and the Amendment that he would lose his stock option rights if he decided to work
for a Datto competitor? No doubt so. But my role is to enforce what the parties agreed to. And
the short of it is that the parties’ later agreements did nothing to supersede or negate the
applicability of the Detrimental Activity clause from earlier agreements.
Nor does it defy common sense that the parties would agree to lift the non-compete
restriction while continuing the forfeiture-for-competition restriction. It is one thing for a
company to relieve an employee from a non-compete agreement after his employment ends (as
Datto did for Falk here). But it is quite another thing for a company to agree that a former
employee who may choose to work for the competition should also retain his insider rights to
private company ownership through stock options. Accordingly, I construe the parties’
agreements to provide for the forfeiture of Falk’s stock options upon his decision to work for one
of Datto’s competitors.
Validity of the “Detrimental Activity” Limit
All this brings me last of all to the issue of whether—apart from what the parties have
actually agreed—the forfeiture-for-competition provision is enforceable as a matter of law.
Under Delaware law, a traditional non-compete provision is subject to a general reasonableness
test. See Kan-Di-ki, LLC v. Suer, 2015 WL 4503210, at *19 (Del. Ch. 2015). Although Delaware
courts have not taken a position whether the same reasonableness test applies to a forfeiture-for8
competition agreement, the Third Circuit has concluded that “[b]ecause of the similarity between
the enforceability of a forfeiture-for-competition provision in a management incentive
compensation plan and a covenant not to compete in an employment contract we believe that the
Delaware courts would apply the same test of reasonableness in both contexts.” Pollard v.
Autotote, Ltd., 852 F.2d 67, 72 (3d Cir. 1988); see also Gaver v. Schneider’s O.K. Tire Co., 289
Neb. 491, 500-01 (2014) (citing cases to same effect); Deming v. Nationwide Mut. Ins. Co., 279
Conn. 745, 769 (2006) (“When pruned to their quintessence, [standard non-compete agreements
and forfeiture-for-competition agreements] tend to accomplish the same results and should be
Under Delaware law, a restrictive covenant is reasonable and hence enforceable if “(1) it
meets general contract law requirements, (2) is reasonable in scope and duration, (3) advances a
legitimate economic interest of the party enforcing the covenant, and (4) survives a balance of
the equities.” Kan-Di-Ki, LLC, 2015 WL 4503210, at *19; see also Pollard, 852 F.2d at 72
(stating similar factors). Applying these four factors, I conclude that the forfeiture-forcompetition agreement at issue here satisfies the reasonableness test.
As to the first of the four factors (whether the agreement “meets general contract law
requirements”), there is no dispute that Falk received significant consideration for his entry into
the multiple agreements at issue in this case. He was a very highly paid employee and highly
paid still after he began on transitional leave. Moreover, Falk was represented by counsel when
he entered into the Separation Agreement, and there is no evidence to support Falk’s suggestion
that he was not or should not have been aware of the Detrimental Activity restriction.
As to the second factor (whether the forfeiture is “reasonable in scope and duration”),
Falk points out that the Amendment allowed Datto to exercise his stock options within ten years,
and he argues that this ten-year time frame is excessive. But, as Datto notes, under the original
Plan, Falk would have had to exercise his stock options at the time he left the company or within
30 days thereafter. See Doc. #75 at 26. The ten-year time frame was a benefit negotiated between
the parties to allow Falk yet a longer period to exercise his stock options. Accordingly, the fact
that Falk was able to negotiate the added benefit of having ten years to exercise his stock options
cannot serve to show that the detrimental activity limit was of unreasonable duration.
As to geographical scope of the burden on competition, Delaware courts evaluate the
reasonable of territorial scope by determining whether it “reasonably serves the legitimate
economic interests” of the party imposing the restriction. See Delaware Exp. Shuttle, Inc. v.
Older, 2002 WL 31458243, at *11 (Del. Ch. 2002). So in the classic non-compete context, it is
unreasonable if a company imposes a worldwide bar to block an employee from working for a
competitor who is far away and in no genuine position to carve into the company’s home
business. See id. at *13. Although it is true that there is no geographical limitation to the
forfeiture provision here, a geographical limitation would make almost no sense in the context of
the Internet-cloud-based product that Datto and competitors sell: electronic data protection and
back-up. This industry does not depend in the least on where employees work, customers reside,
or business offices are located. Accordingly, I give minimal weight to the fact that the forfeiture
provision applies here regardless of conventional geographic boundaries. This is not a case of an
employee who is barred altogether from working for the competition anywhere in the world.
As to the third factor, Dattto’s legitimate interests are preserved by enforcement of the
forfeiture-for-competition agreement. “Stock options, in contrast to other types of regular and
bonus compensation, give an employee the right to acquire an ownership interest in a company;
that interest in turn gives the employee a long-term stake in the company and supplies him an
incentive to contribute to the company’s performance.” Tatom, 305 F.3d at 745. Accordingly, a
contractual provision “calling for the forfeiture of such options in the event that the holder goes
to work for a competitor thus serves to keep the option holder’s interests aligned with the
company’s.” Ibid. The forfeiture-for-competition provision reasonably allows Datto to prevent
“former employees whose interests become adverse to the company from maintaining an
ownership interest.” James V. Garvey & Frederic T. Knape, Employee Stock Forfeiture
Provisions - A Different Breed of Restrictive Covenant, 94 Ill. B.J. 376, 377 (2006).
Datto also has a legitimate economic interest in protecting confidential company
information from a potentially subversive shareholder. Under Delaware law, a shareholder has
the right to access company information and “to inspect and to make copies and extracts
from . . . the corporation’s stock ledger, a list of its stockholders, and its other books and
records.” See 8 Del. C. § 220. Delaware courts have construed “books and records” to include a
wide variety of corporate materials. See Amalgamated Bank v. Yahoo! Inc., 132 A.3d 752, 78899 (Del. Ch. 2016). Although Delaware law may not provide unlimited access for shareholders
to private company information, Datto has an obvious interest in ensuring that Falk—as an
employee of its competitor—is not privy to Datto’s sensitive internal documents.
Finally, on the balance of equities, I conclude that the equities favor enforcement of the
forfeiture-for-competition agreement. Had Falk simply been terminated in January of 2015, he
would not have had any vested stock options to exercise. Following extensive negotiations in
which both sides were represented by counsel, Falk obtained the quite lucrative benefits of the
Separation Agreement and a reduced number of stock options that would be exercisable over a
ten-year period. Datto quite reasonably relies on the forfeiture-for-competition agreement to
foreclose Falk’s stock option rights as a consequence of his choice to work for the competition.
To summarize, I conclude that the parties’ stock options dispute is governed by Delaware
law, that the parties agreed to a forfeiture-for-competition agreement with respect to Falk’s stock
options, and that the forfeiture-for-competition agreement is reasonable and therefore
enforceable as a matter of law. Accordingly, I will grant Datto’s motion for summary judgment
and deny Falk’s cross-motion for summary judgment.
Datto’s motion for summary judgment (Doc. #73) as to Count Two and as to
Counterclaims One and Two is GRANTED. Falk’s cross-motion for summary judgment (Doc.
#91) as to Counts One and Two and as to Counterclaims One and Two is DENIED. In addition,
Falk’s motion for an order to show cause to reopen discovery and briefing (Doc. #114) is
DENIED for substantially the reasons set forth in Datto’s response (Doc. #117). This ruling is
without respect to Datto’s remaining breach-of-contract claim in Count One regarding Falk’s
alleged solicitation of Datto employees and use of confidential information.
It is so ordered.
Dated at New Haven this 13th day of March 2018.
/s/ Jeffrey Alker Meyer
Jeffrey Alker Meyer
United States District Judge
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