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Realpage, Inc. v. Enterprise Risk Control, LLC

United States District Court, E.D. Texas, Sherman Division

August 3, 2017

REALPAGE, INC.; REALPAGE VENDOR COMPLIANCE LLC
v.
ENTERPRISE RISK CONTROL, LLC; LONNIE DERDEN

          MEMORANDUM OPINION AND ORDER

          AMOS L. MAZZANT UNITED STATES DISTRICT JUDGE.

         Pending before the Court is Plaintiffs' Application for Preliminary Injunction (Dkt. #10). After considering the relevant pleadings, exhibits, and argument at the preliminary injunction hearing, the Court finds Plaintiffs' motion should be granted in part.

         BACKGROUND

         Lonnie Derden (“Derden”) has been in the vendor compliance and tenant screening industry for sixteen years. In 1999, Derden created his own company, Resident Data. Derden sold Resident Data to Choice Point and became Vice President of the department at Choice Point. In 2005, Derden created Compliance Depot. Derden created Compliance Depot by using rules and code he found on the internet, six months of labor, and a $250, 000 investment. By 2011, Compliance Depot had annual revenues of $6 million.

         In 2011, RealPage Vendor Compliance LLC, a wholly owned subsidiary of RealPage, Inc. (collectively “RealPage”) purchased Compliance Depot for nearly $24 million. As part of the Compliance Depot purchase, Derden and RealPage entered into three agreements: (1) the Asset Purchase Agreement (“APA”); (2) the Significant Owners' Agreement (“SOA”); and (3) the Employment Agreement. Each agreement contained non-competition, non-solicitation, and confidentiality agreements.

         Tom Bean (“Bean”) was one of Derden's long-time friends and colleagues. In early 2012, Bean left RealPage. Around May 2012, Bean decided to create a software consulting firm, IDC Software. In April 2012, Bean emailed another former RealPage employee, David Boyle (“Boyle”) a “wish list” of equipment to support IDC Software's projects. Also in April 2012, Bean worked with a third former RealPage employee James Beavers (“Beavers”) to obtain a quote for Dell computers, using Compliance Depot's account number. Derden provided the funding for IDC Software to purchase this equipment and software. On May 17, 2012, Bean received an employer identification number from the IRS. At this time, IDC Software had two projects, but focused primarily-if not exclusively-on getting “[Derden's] core software business developed.” On May 19, 2012, Bean emailed Richard Wolff (“Wolff”) and copied Boyle. Bean's email to Wolff contained several “.sql” files and instructed Wolff to “change table and column names and layouts so we aren't just copying what we did the first time.” Derden agreed to pay Wolff $115, 000 for this task. Over the next year, Derden was the sole source of funds for operating expenses, ultimately investing $160, 000 in IDC Software.

         In December 2012, Derden created Enterprise Risk Control, LLC (“Enterprise”). In July 2013, Derden purchased IDC Software's vendor compliance code and hired Bean as an employee of Enterprise. At that time, Bean uploaded his code onto Enterprise's servers. Bean continued to develop Enterprise's code until April 2017. Enterprise began marketing its product to potential customers in February 2014, and to its first multi-family customer in August 2015.

         In February 2014, RealPage caught wind of Enterprise's new application and potential misappropriation of trade secrets. RealPage sent Defendants a cease and desist letter demanding assurances that Defendants were not soliciting RealPage clients and were not using RealPage secrets. Defendants responded with assurances that they did mistakenly approach a RealPage client, but immediately backed off when they learned of the mistake. Defendants also assured RealPage that they did not have any trade secret information.

         In April 2016, RealPage received more information that Defendants might be using trade secrets when a disgruntled ex-Enterprise employee, Cheryl Freudiger (“Freudiger”) approached RealPage claiming that Enterprise gave her various trade secret materials. However, Freudiger did not produce corroborating evidence to RealPage until August 5, 2016. In early September, RealPage also received an email from one of its clients, explaining how Enterprise approached with a new vendor compliance application.

         On September 23, 2016, RealPage filed suit against Derden and Enterprise asserting claims for misappropriation of trade secrets, breach of contract, and breach of fiduciary duty (Dkt. #1). On December 2, 2016, RealPage served Enterprise and Derden with its first set of requests for production. In its requests for production, RealPage requested, among other things, all of Enterprise's source code. Defendants produced all source code after early July 2013, but denied having access to any source code from before July 2013. Defendants based their position on Bean's declaration because he was the primary developer of code before July 2013. Bean swore under oath that when he left RealPage, he “did not take any of RealPage's confidential information” (Dkt. #21, Exhibit 3 at ¶ 4). On February 17, 2017, RealPage filed a motion to compel production of documents (Dkt. #40) followed two weeks later by a motion to compel computer images (Dkt. #49).

         RealPage argued that there was an unexplained gap in the development of Enterprise's code. RealPage based this argument on several comments, visible in post-July 2013 code, that were made as early as July 2012. However, despite being able to see these comments, the code was not accessible. In response to RealPage's motions to compel, Defendants relied again on Bean's sworn testimony that he did not take any confidential information with him and did not use any of RealPage's confidential information during his employment with Enterprise (Dkt. #44, Exhibit 2 at ¶¶ 6, 9, 11). Further, Bean swore that “[a]fter I transferred the earlier IDC code onto [Enterprise's] TFS server, I removed the previous work from the IDC computer I had been using because it was no longer ‘my' code or ‘IDC's' code - it was [Enterprise's] code” (Dkt. #44, Exhibit 2 at ¶ 8). Finally, Bean swore that he looked for remnants of Enterprise's source code from the IDC Software computer that he used before July 2013, but did not locate any (Dkt. #44, Exhibit 2 at ¶ 10).

         Seemingly at a stalemate, the Court held that it could not order Defendants to compel what they did not have. However, finding that RealPage was entitled to verify Bean's allegations regarding the code's destruction, the Court ordered Defendants to produce mirror images of computers and storage devices used by Tom Bean in July 2013 (Dkt. #62 at p. 5). The Court limited the examination to determine if the source code was recoverable. If the code was not recoverable, the Court permitted the neutral forensic examiner to determine the details of any deletions so that RealPage could adequately cross-examine at trial.

         The forensic examination conducted on April 6, 2017, showed that Bean did not delete the IDC Software code in July 2013 as he previously swore to. Instead, Bean destroyed thousands of files in September 2016, after RealPage filed this suit. The forensic examination also showed nearly 1, 000 files deleted on April 3, 2017, after the Court ordered a forensic examination. In all, nearly 100, 000 files were deleted from Enterprise's code since RealPage filed suit. Although the forensic exam shows which files were deleted, it cannot show any information about what the deleted code contained.

         After the forensic examination, Defendants withdrew Bean's two declarations, which claimed that he did not take any RealPage information and that the Enterprise code was created without leveraging anything from RealPage. Bean has now admitted that he took a thumb drive with “everything” from RealPage and took the thumb drive home in April 2012.

         In addition to Derden, Enterprise had six former RealPage employees: Bean, Beavers, Boyle, Linda Jones (“Jones”), Shawn Davis (“Davis”), and Michele Head (“Head”). Shortly after the forensic examination revealed Bean's misrepresentations to the Court, Enterprise terminated his employment. Enterprise spent approximately 9, 500 development hours and $3.3 million creating its current product. Today, Enterprise provides vendor risk-management and credentialing services to school districts, restaurant chains, construction companies, homeowners' association management companies, commercial real estate, and multi-family properties.

         On September 23, 2016, Plaintiffs filed suit against Derden and Enterprise asserting claims for misappropriation of trade secrets, breach of contract, and breach of fiduciary duty (Dkt. #1). On October 4, 2016, Plaintiffs filed their Application for Preliminary Injunction (Dkt. #10). On November 7, 2016, Defendants filed their response (Dkt. #21). On June 23, 2017, Plaintiffs filed a supplemental brief and exhibits (Dkts. #78-82). On July 3, 2017, Defendants filed their supplemental brief and exhibits (Dkts. #86-88). On July 12, 2017, Plaintiffs filed a supplemental reply (Dkt. #90). On July 13, 2017, the parties submitted joint deposition submissions in lieu of several witnesses' live testimony (Dkt. #92). On July 16, 2017, Defendants filed a supplemental surreply (Dkt. #93). On July 17, 2017, the Court held an evidentiary hearing. After the hearing, the parties submitted an admitted exhibit list (Dkt. #95).[1]

         LEGAL STANDARD

         A party seeking a preliminary injunction must establish the following elements: (1) a substantial likelihood of success on the merits; (2) a substantial threat that plaintiffs will suffer irreparable harm if the injunction is not granted; (3) that the threatened injury outweighs any damage that the injunction might cause the defendant; and (4) that the injunction will not disserve the public interest. Nichols v. Alcatel USA, Inc., 532 F.3d 364, 372 (5th Cir. 2008). “A preliminary injunction is an extraordinary remedy and should only be granted if the plaintiffs have clearly carried the burden of persuasion on all four requirements.” Id. Nevertheless, a movant “is not required to prove its case in full at a preliminary injunction hearing.” Fed. Sav. & Loan Ins. Corp. v. Dixon, 835 F.2d 554, 558 (5th Cir. 1985) (quoting Univ. of Tex. v. Comenisch, 451 U.S. 390, 395 (1981)). The decision whether to grant a preliminary injunction lies within the sound discretion of the district court. Weinberger v. Romero-Barcelo, 456 U.S. 305, 320 (1982).

         ANALYSIS

         Before addressing the merits of RealPage's application for preliminary injunction, the Court will address Defendants' assertion of the equitable defense of laches. To establish laches, Defendants must prove that RealPage (1) delayed in asserting the rights at issue; (2) the delay is inexcusable; and (3) Defendants have suffered undue prejudice because of the delay. Uptown Grill, L.L.C. v. Shwartz, 817 F.3d 251, 256 (5th Cir. 2016). In the context of laches, prejudice means “defendant has done something it otherwise would not have done absent the plaintiff's conduct.” Conan Props., Inc. v. Conans Pizza, Inc., 752 F.2d 145, 153 (5th Cir. 1985).

         “The period for laches begins when the plaintiff knew or should have known of the infringement.” Elvis Presley Enters. v. Capece, 141 F.3d 188, 205 (5th Cir. 1998). The Fifth Circuit has devised a formula of “‘LACHES = DELAY x PREJUDICE, ' a factual calculation of the trial court.” Gruma Corp. v. Mexican Rests., Inc., No. 4:09-cv-488-MHS-ALM, 2013 WL 12134147, at *8 (E.D. Tex. Sept. 27, 2013) (citing Armco, Inc. v. Armco Burglar Alarm Co., 693 F.2d 1155, 1162 (5th Cir. 1982)). “There is no bright-line rule on how long of a delay is sufficient to establish the defense of laches.” Id.

         Defendants argue that RealPage's claims are barred by laches because RealPage did not seek legal action for over two years after receiving Defendants' response to the cease and desist letter. Defendants argue that based upon RealPage's lack of action after its cease and desist letter, Defendants invested significant time and resources, totaling $3.3 million, in developing their application. RealPage argues that Defendants' unclean hands prevents them from asserting the laches defense.[2] RealPage also argues that it was justified in its delay until 2016 because Defendants represented in 2014 that they were not using trade secrets.

         The Court finds that Defendants have failed to show a prima facie case of either unreasonable delay or undue prejudice.[3]

         RealPage did not unreasonably delay in asserting its rights. The clock for laches can be stopped by a plaintiff's act showing intent to enforce its rights, such as by sending a cease and desist letter. Gruma, 2013 WL 12134147, at *8 (citing Elvis Presley Enters., 141 F.3d at 206). RealPage sent Defendants a cease and desist letter on March 25, 2014, in which it raised concerns about Defendants soliciting RealPage clients and providing a multi-family real estate management service (Exhibit 4). RealPage demanded a comprehensive written response “(i) detailing the specific nature of Enterprise's services . . ., and (ii) confirming that none of Enterprise's services is competitive to RealPage” (Exhibit 4 at p. 2). Defendants responded on April 1, 2014, unequivocally denying the allegations in the cease and desist letter and describing the accidental contact with one of RealPage's (although not Compliance Depot's) clients (Exhibit 5). Defendants' response was satisfactory. Therefore, the clock for laches did not begin.

         Further, the clock did not start in April 2016 when Freudiger tipped off RealPage to potential trade secret violations. RealPage was reasonably skeptical of Freudiger's initial tip because she was a disgruntled ex-Enterprise employee (See Exhibit 177). Freudiger did not substantiate her claims with physical evidence until August 5, 2016. RealPage filed suit on September 23, 2016, one week after receiving an email from a Compliance Depot client about Enterprise's sales pitch. The Court finds that this period does not constitute unreasonable delay to support laches.

         Defendants have not shown that they suffered undue harm due to the delay. Defendants assert that they expended additional time and resources to develop their application based on RealPage's implied acquiescence. However, Defendants do not substantiate this assertion. While Defendants claim that they expended $3.3 million in total to develop their application, they do not account for how much of that money was spent during the two years before the cease and desist letter. Therefore, the $3.3 million is misleading. Without any reference to what was spent before April 2014, Defendants have failed to meet their burden to show undue prejudice after their reliance.

         For these reasons, Defendants fail to prove their affirmative defense of laches. The Court will now address the merits of RealPage's application for injunction.

         A. Likelihood of Success on the Merits

         To prevail on their motion for preliminary injunction, Plaintiffs must demonstrate a substantial likelihood of success on the merits. This requires a movant to present a prima facie case. Daniels Health Scis., LLC v. Vascular Health Scis., 710 F.3d 579, 582 (5th Cir. 2013) (citing Janvey v. Alguire, 647 F.3d 585, 595-96 (5th Cir. 2011)). A prima face case does not mean Plaintiffs must prove they are entitled to summary judgment. Byrum v. Landreth, 566 F.3d 442, 446 (5th Cir. 2009).

         1. Breach of Contract

         Under Texas law, “[t]he elements of a breach of contract claim are: (1) the existence of a valid contract between plaintiff and defendant; (2) the plaintiff's performance or tender of performance; (3) the defendant's breach of the contract; and (4) the plaintiff's damage as a result of the breach.” In re Staley, 320 S.W.3d 490, 499 (Tex. App.-Dallas 2010, no pet.). RealPage claims that it can establish each element. Derden argues that the noncompete is invalid because it is overly broad and that even if the covenant is valid, he did not breach the terms. The Court will address each argument in turn.

         Covenants not to compete are generally disfavored by Texas courts. Marsh U.S., Inc. v. Cook, 354 S.W.3d 764, 768 (Tex. 2011). However, the Supreme Court of Texas noted that the Texas Legislature enacted the Covenants Not to Compete Act to restore the well-established rule in Texas that non-competition clauses “pertaining to employment were not normally considered to be contrary to public policy.” Marsh, 354 S.W.3d at 733 (alteration omitted). To be enforceable under Texas law, a covenant not to compete must be: (1) ancillary to or part of an otherwise enforceable agreement; (2) contain reasonable limitations as to time, geographical area, and scope of activity to be restrained; and (3) not impose a greater restraint than is necessary to protect the goodwill or other business interest of the promisee. Tex. Bus. & Comm. Code Ann. § 15.50(a). Whether a noncompete is a reasonable restraint of trade is a question of law for the court. Peat Marwick Main & Co. v. Haass, 818 S.W.2d 381, 388 (Tex. 1991); Martin v. Credit Protection Ass'n, 793 S.W.2d 667, 668-69 (Tex. 1990). Restraints are unreasonable if they are broader than necessary to protect the legitimate interests of the employer. DeSantis v. Wakenhut Corp., 793 S.W.2d 670, 681-82 (Tex. 1990); Henshaw v. Kroenecke, 656 S.W.2d 416, 418 (Tex. 1983). Defendants do not contest the first element. Therefore, the Court will analyze only the final two elements.

         Derden and RealPage entered into three agreements surrounding the purchase of Compliance Depot and Derden's subsequent employment with RealPage: The APA, SOA, and Employment Agreement.

         Under the APA, Derden agreed that for a period of sixty months after the closing date, they would not “engage in the Business” (Exhibit 76 at p. 39). “Business” means “the Compliance Depot business, which provides ...


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