Trading Secrets : Trade Secrets Lawyers & Attorneys : Seyfarth Shaw Law Firm : Computer Fraud, Confidentiality Agreements, Corporate Espionage

The U.S. Court of Appeals for the Tenth Circuit recently held that a former employer’s price quotations to prospective customers were not trade secrets under Oklahoma law because they did not contain a confidentiality provision, but the former employee who took advantage of those quotations on behalf of his new employer did violate his non-compete covenant.  Southwest Stainless, LP v. Sappington, No. 08-5127 (10th Cir.  Sept. 21, 2009).

An Oklahoma court is permitted to blue-pencil unreasonable contractual geographic limits in a non-compete to make them reasonable. The Tenth Circuit held that the  trial court’s damages award with respect to business lost due to violation of the non-compete was properly based on the ex-employer’s historic profit margins on business with the relevant customers. Moreover, injunctive relief should have been awarded because the ex-employee took advantage of the "personal contacts [with] and a knowledge of the special needs and requirements of" the ex-employer’s customers which the former employee learned during the employment relationship.

Coincidentally, only a few weeks earlier, an Oklahoma district court granted a motion for partial summary judgment in a breach of contract and trade secrets case, based on the plaintiff company’s "legitimate interest in . . . relationships . . . with . . . existing and established customers."   The Court thereby upheld a "hands-off" non-solicitation covenant an independent contractor sales agent signed with the plaintiff.  The plaintiff’s trade secret misappropriation claim was not discussed in the ruling on the partial summary judgment motion.  Drummond Am., LLC v. Share Corp., No. CIV-08-1004-F (W.D. Okla., Aug. 3, 2009), 2009-2 CCH Trade Cases ¶ 76.701.

These decisions teach that in a state (such as Oklahoma) where covenants are enforceable, a breach of contract claim against former sales personnel may be at least as strong a cause of action for a jilted employer as a suit for misappropriation of trade secrets.

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In a recent decision, the federal Ninth Circuit Court of Appeals joined a growing number of federal courts that have limited the use of the Computer Fraud and Abuse Act ("CFAA") in suits brought against former employees accused of taking data from a company’s computer system before leaving the company.

In LVRC Holdings LLC v. Brekka, Case No. 07-17116, 2009 WL 2928952 (9^th Cir. September 15, 2009), the Court held that an employer could not maintain its claim under the CFAA, 18 U.S.C. § 1030, against a former employee accused of e-mailing company property to his personal e-mail account because the employer could not establish that the former employee accessed its computer system “without authorization” or “in excess of authorization,” causing a loss. The employee argued that he was authorized to access the computer system in connection with his job duties, and was, therefore, authorized to access the computer system. 

In its opinion in Brekka, the Ninth Circuit explicitly rejected the Seventh Circuit Court of Appeals’ reasoning in International Airport Ctrs., L.L.C. v. Citrin, 440 F.3d 418 (7th Cir. 2006) (Judge Posner, presiding), in which the Seventh Circuit held that a defendant employee’s authorization to access his employer’s computer files terminated when he violated his duty of loyalty to his employer.

Concluding that “[n]o language in the CFAA supports [plaintiff’s] argument that authorization to use a computer ceases when an employee resolves to use the computer contrary to the employer’s interest,” the Ninth Circuit switched the focus of inquiry from the former employee’s motive to an objective standard: What actions did the employer take to define what was authorized access and what was not? “If the employer has not rescinded the defendant’s right to use the computer, the defendant would have no reason to know that making personal use of the company computer in breach of a state law fiduciary duty to an employer would constitute a criminal violation of the CFAA.” 

In Brekka, plaintiff allowed its employee to e-mail company documents to his personal computer in the course of his duties. In addition, plaintiff promulgated no employee guidelines to prohibit employees from e-mailing company documents to personal computers. These were facts fatal to its CFAA claim and may provide a basis to distinguish subsequent cases where employers attempt to assert CFAA claims against former employees accused of e-mailing company information to their personal accounts, provided that they have clear policies prohibiting such activities.

The Brekka Court held “that a person uses a computer ‘without authorization’ under §§ 1030(a)(2) and (4) when the person has not received permission to use the computer for any purpose (such as when a hacker accesses someone’s computer without any permission), or when the employer has rescinded permission to access the computer and the defendant uses the computer anyway.” 

The Brekka decision is a wake-up call to employers to take measures to define for their employees the type of computer activity that is permissible (and impermissible) so that the employers can, to the extent allowable, avail themselves of a CFAA claim.

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By Tim Nelson and Robert Milligan

A highly publicized cyberbullying case recently came to an apparent end with the acquittal of a Missouri woman who was accused of violating the Computer Fraud and Abuse Act (“CFAA”).

In the case, a Central District of California court addressed the novel issue of whether a computer user’s violations of an Internet website’s terms of service constitute a crime under the CFAA, 18 U.S.C. § 1030. United States v. Drew, --- F.R.D. ---, 2009 WL 2872855 (C.D. Cal. Aug. 28, 2009).

According to the indictment in Drew, Lori Drew, a resident of O’Fallon, Missouri, allegedly was a member of a conspiracy to intentionally access a computer used in interstate commerce without (and/or in excess of) authorization in order to obtain information for the purpose of committing the tortious act of intentional infliction of emotional distress upon a 13-year old girl named Megan Meier, also a resident of O’Fallon, Missouri. Id.at *1. 

Megan was a classmate of Drew’s daughter, Sarah. Pursuant to the conspiracy, the conspirators established a profile for a fictitious 16 year old male named “Josh Evans” on the website www.myspace.com, on or about September 20, 2006. The conspirators also posted a photo of a boy on this website without that boy’s knowledge or permission. This conduct violated the terms of service of the Myspace website, which prohibited providing information that the user knew was false or misleading, and also prohibited including a photograph of another person that was posted without that person’s consent. 

The conspirators contacted Megan and flirted with her through the Myspace website using the “Josh Evans” profile over several days. Eventually, the conspirators informed Megan that “Josh” was moving away. The conspirators also informed Megan that “Josh” no longer liked her and that “the world would be a better place without her in it.” Later the day this message was delivered, Megan committed suicide. After learning that Megan had killed herself, Drew caused the “Josh Evans” Myspace account to be deleted. Id.

Lori Drew was charged with one count of conspiracy in violation of 18 U.S.C. § 371 and three counts of violating a felony portion of the CFAA (18 U.S.C. §§ 1030(a)(2)(C) and 1030(c)(2)(B)(ii)), which prohibits accessing a computer without authorization or in excess of authorization and obtaining information from a protected computer where the conduct involves an interstate or foreign communication and the offense is committed in furtherance of a crime or tortious act. 

The jury was instructed that they could consider whether Drew was guilty of the lesser included misdemeanor CFAA violation (which involved accessing a protected computer without authorization or in excess of authorization). The jury deadlocked on the conspiracy charge, and found Drew not guilty on the three felony counts of violating the CFAA. The jury did, however, find Drew guilty of the three misdemeanor counts of violating the CFAA. Drew’s attorneys filed a motion for a judgment of acquittal under Federal Rule of Criminal Procedure 29(c).

Judge Wu of the Central District of California addressed the central question raised by Drew: whether a computer user’s intentional violation of one or more provisions in an Internet website’s terms of service satisfies the first element of section 1030(a)(2)(C) (whether the computer access was without authorization or exceeded authorized access). Id.at *6.  The court  noted that the latter two elements of section 1030(a)(2)(C) (obtaining information from a “protected computer” and the accessing of the computer must involve an interstate or foreign communication) would always be met when an individual using a computer contacts or communicates with an Internet website. Id.

To address the central question raised in Drew, the court analyzed and applied the void-for-vagueness doctrine, which has two prongs: 1) a definitional/notice sufficiency requirement; and 2) a guideline setting element to govern law enforcement. Id.at *12. 

The court, quoting Justice Holmes, observed that, as to criminal statutes, there is a “fair warning” requirement:

Although it is not likely that a criminal will care-fully consider the text of the law before he murders or steals, it is reasonable that a fair warning should be given to the world in language that the common world will understand, of what the law intends to do if a certain line is passed. To make the warning fair, so far as possible the line should be clear.

Id. (citing McBoyle v. United States. 283 U.S. 25, 27 (1931)).

The court found that basing a CFAA violation upon the conscious violation of a website’s terms of service runs afoul of the void-for-vagueness doctrine, because of the absence of minimal guidelines to govern law enforcement and because of actual notice deficiencies. Id.at *14. The court found that if any conscious breach of a website’s terms of service is sufficient to constitute a violation of the CFAA, the law would afford too much discretion to the police and too little notice to citizens who wish to use the Internet. Id.at *17.

The Drew decision is significant because it recognizes the limitations of the CFAA and is a victory for internet privacy proponents. According the court, the government’s interpretation of the CFAA in Drew “would convert a multitude of otherwise innocent Internet users into misdemeanant criminals.” Id.at *16. The court recognized that breaching a website’s terms of service, alone, was not sufficient to violate the CFAA.

One news source has indicated that the U.S. Attorney will determine whether the government will appeal after reviewing the written ruling. 

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In a battle of competing noodle franchises, a federal district court in Arizona recently granted a franchisee’s motion to compel arbitration in a trade secret and breach of contract dispute with its franchisor.   

Apart from its colorful facts, the court’s ruling is significant.  First, it demonstrates that franchisors that include arbitration provisions in their franchise agreements may be precluded from obtaining immediate injunctive relief in court against their franchisees, particularly where they include provisions that only permit the franchisor to obtain injunctive relief outside the arbitration proceeding (at least under Arizona law). Next, it demonstrates that a nonsignatory to a franchise agreement may be permitted to compel arbitration in the Ninth Circuit where the signatory’s claim against the nonsignatory involves a dispute that is “intertwined with the contract providing for arbitration.” The decision is also a reminder that although binding arbitration with franchisees may be beneficial, franchisors must keep abreast of the ever-changing law in the governing jurisdiction(s) to ensure that arbitration rather than litigation in the courts is the appropriate dispute resolution forum for their business objectives.  Simply put, if a rogue franchisee’s actions put a franchisor’s system in jeopardy, a franchisor may not be willing to put the fate of its misappropriated intellectual property in the hands of an arbitrator. 

In Noodles Development, LP v. Latham Noodles, LLC, 2009 WL 2710137 (D. Ariz. August 26, 2009), a federal district court in Arizona (District Judge Neil V. Wake, presiding) granted the franchisee’s motion to compel arbitration and stayed the civil action initiated by the franchisor.

The plaintiff, a franchisor owing the rights to the “Nothing But Noodles” franchise of restaurants, entered into a franchise agreement with the defendant franchisee which permitted the franchisee to open a franchise in New York. See id. at *1.

The franchise agreement provided that “any dispute or claim relating to or arising out of this Agreement must be resolved exclusively by mandatory arbitration by and in accordance with the Commercial Arbitration Rules of the American Arbitration Association (“AAA”) or another arbitration service agreed to by the parties.”  See id.

The franchise agreement also provided the franchisor with the right to petition a court of competent jurisdiction for the entry of temporary and permanent injunctions of specific performance enforcing the provisions of the franchise agreement relating to “(a) Franchisee's use of the Marks or the System ...; (d) Franchisee's violation of the provisions of this Agreement relating to confidentiality and the covenants not to compete; and (e) any act or omission by Franchisee or Franchisee's employees that ... (2) is dishonest or misleading to the guests or customers of the Franchised Restaurant or other Nothing But Noodles Restaurants ..., or (4) may impair the goodwill associated with the Marks or the System.” Id.at *1.

The franchisor challenged the franchisee’s motion on the grounds that 1) the agreement did not encompass the claims that it had brought against the franchisee; 2) it need not first arbitrate the substantive merits of its claims because pursuant to the franchise agreement it may bring an action for injunctive relief before the court and principles of judicial economy should allow it to litigate its damages claims in court as well; and 3) it need not arbitrate with one of the co-defendants because he was not a signatory to the franchise agreement.  The court rejected all three of the franchisor’s arguments.  See id. *1-*4.

First, the court stated that the franchisee agreement requires arbitration of “any dispute or claim relating to or arising out of this Agreement.”  The noted that the Ninth Circuit has observed that the phrase “arising out of or relating to” creates an arbitration clause that is “broad and far reaching” in scope.  Id. at *1 (citing Chiron Corp. v. Ortho Diagnostic Sys., Inc., 207 F.3d 1126, 1131 (9^th Cir. 2000)).  The court found that an arbitration clause with a broad and far reaching scope “reaches every dispute between the parties having a significant relationship to the contract and all disputes having their origin or genesis in the contract.”  Id. at *1 (citing Simula, Inc. v. Autoliv, Inc., 175 F.3d 716, 719 (9^th Cir. 1999)).

The court stated to require arbitration, the factual allegations of the complaint “need only ‘touch matters' covered by the contract containing the arbitration clause.” Id. (quoting Mitsubishi Motors Corp. v. Soler Chrysler-Plymouth, Inc., 473 U.S. 614, 624 n. 13 (1985)).

The court found that all of the facts alleged in franchisor's complaint have a significant relationship to the franchise agreement.  The court noted that the complaint alleges trademark and trade dress infringement, misappropriation of trade secrets, and breach of contract.  The court reasoned that the factual predicate of these claims was the franchisee's alleged misuse of the Nothing But Noodles marks and system.  Because the franchisee's use of the Nothing But Noodles marks and system was the core subject of the franchise agreement, the court found that the franchisor's claims have a significant relationship to the franchise agreement and must be arbitrated.  See id. at *2.

The court also noted that the franchisor alleged that franchisee tortiously interfered with its business relationships.  The court found that the claim was significantly related to the confidentiality clauses and covenants not to compete in the franchise agreement and an area development agreement signed by the parties, which also contained an arbitration clause.  The area development agreement provided the franchisee with the right to sell new franchises on behalf of the franchisor.  The court stated that the franchisor alleged that the franchisee had instead been soliciting existing Nothing But Noodles franchises to re-brand their restaurants under another mark.  See id.

The court found that the facts of this allegation were significantly related to the franchisee's duties as a representative of franchisor under the area development agreement, especially those provisions relating to confidentiality and competition.  The court found that the franchise agreement therefore required arbitration of the tortious interference claim.  See id.

In sum, the court found that the substance of each claim asserted by the franchisor in its complaint was covered by the arbitration agreement and therefore could not be adjudicated by the court.  See id. at *2.

Next, the court acknowledged that the franchise agreement does, however, reserve to the franchisor the ability to seek preliminary or permanent injunctive relief in court for certain types of claims. The court remarked that typically courts in our circuit [Ninth Circuit] may not grant preliminary injunctive relief where interim relief is available from an arbitral tribunal.  See id.

The court found, however, that the terms of the agreement control the scope of the arbitration clause in the suit.  The franchise agreement specifically permitted the franchisor to seek injunctive relief from the court despite the availability of such relief under the rules of the American Arbitration Association.  See id.

However, the court found that the franchise agreement did not specify whether the franchisor may seek permanent injunctive relief in court before obtaining a substantive determination of the merits of its claims from an arbitral tribunal.  The franchisor argued that it need not first arbitrate the substantive merits of its claims and that because it may bring an action for injunctive relief before the court, principles of judicial economy should allow it to litigate its damages claims in court as well.  See id. at *3.

The court found that such an interpretation nullified the arbitration clause because once the court decided the merits of the franchisor's claims, there was little purpose in involving an arbitral tribunal.  The court found that the franchisor’s interpretation conflicted with the parties' demonstrated intent to have an arbitral tribunal, not a court, decide the merits of “any dispute or claim arising out of or related to” the franchise agreement.  See id. at *3.

The court stated that the franchise agreement's injunction provision may simply be intended to preserve the availability of a court to impose an injunctive remedy, rather than decide the merits of the claims.  “In other words, it may allow Franchisor to seek preliminary injunctive relief to maintain the status quo during arbitration and to seek permanent injunctive relief if the arbitral tribunal rules in its favor.”  Id. at *3.  The court found that this interpretation was equally as plausible, if not more plausible than the franchisor's interpretation.  The court held that the ambiguous relationship between the franchise agreement’s arbitration clause and the injunction provision must be reconciled in favor of arbitration.  See id. at *3.

The court found that the franchisor may seek emergency injunctive relief to preserve the status quo while it arbitrates, but it must obtain a substantive determination of the merits of its claims from an arbitral tribunal before applying for a permanent injunction from the court.  The court noted that the franchisor had not yet moved for any emergency injunctive relief.  See id.

The court also stated that at least one court had recently held that, under Arizona law, an arbitration agreement that reserves the right to seek judicial injunctive relief to only one party is substantively unconscionable.  See id. (citing Wernett v. Serv. Phoenix, LLC, 2009 U.S. Dist. LEXIS 62593 at *26-28, 2009 WL 1955612 at *8 (D.Ariz. July 6, 2009)).  The court stated that should the franchisor seek preliminary injunctive relief from the court instead of from the arbitral tribunal, it will first have to address the validity of the franchise agreement’s “one-sided injunction provision under Arizona law.”  Id.at *3. (emphasis added).

Lastly, the franchisor argued that it need not arbitrate with one of the co-defendants because he was not a signatory to the franchise agreement.  The court stated that a nonsignatory to an arbitration agreement may estop a signatory from refusing to arbitrate its claim against the nonsignatory where the dispute is “intertwined with the contract providing for arbitration.”  Id. at *3 (citing Mundi v. Union Sec. Life Ins. Co., 555 F.3d 1042, 1047 (9th Cir.2009)). “[A]pplication of equitable estoppel is warranted ... when the signatory to the contract containing the arbitration clause raises allegations of ... substantially interdependent and concerted misconduct by both the non-signatory and one or more of the signatories to the contract.”  Id. at *3 (citing Brantley v. Republic Mortgage Ins. Co., 424 F.3d 392, 396 (4th Cir.2005)). 

The court noted that the complaint alleges that “the Individual Guarantors and [non-signatory] Defendant . . . have contacted Noodles' franchisees and made attempts to induce such franchisees into breaching their respective agreements with Noodles.”  Id. at *3.  The court found that the complaint therefore raises allegations of substantially interdependent and concerted misconduct by the non-signatory defendant and the defendant signatories to the franchise agreement.  Accordingly, the court found that the franchisor was estopped from refusing to arbitrate its claim against the non-signatory defendant.  See id. at *3.

The court stayed the civil action until the arbitration has been completed, having concluded that all claims in the suit were subject to arbitration, but indicated that the franchisor may apply to the court for injunctive remedies.

The court’s decision has a number of general take-aways for franchisors. Franchisors should carefully consider whether to include an arbitration provision in their franchise agreement. Arbitration can provide a number of benefits to franchisors, such as a cost-effective and seemingly uniform method of resolution with franchisees. There can be significant drawbacks though depending upon the applicable governing law, such as having to pay for the costs of the arbitration, losing or having a limited right to seek immediate injunctive relief in a court of law, only having a limited review of arbitration decisions, and having non-signatories to the arbitration agreement made part of the arbitration proceeding. Before including arbitration provisions in their franchise agreements, franchisors should consult counsel to determine the ever changing state of the law in the governing jurisdiction and decide whether arbitration provides an adequate forum to protect any misappropriated intellectual property, such as the franchisor’s system.

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By Robert Milligan and Carolyn Sieve

As mentioned in a previous blog entry, the California Court of Appeal issued a significant trade secret decision earlier this year providing additional clarification concerning the trade secret identification disclosures which a party pursuing claims for trade secret misappropriation must make before commencing civil discovery in California state court.

The California Supreme Court subsequently denied Sylvester Stallone's and another named cross-defendant's petition for review challenging the Court of Appeal's decision.

Accordingly, the Court of Appeal decision is binding case authority.

A California statute requires that trade secrets be identified with particularity before commencing discovery relating to the trade secret in suits alleging the misappropriation of trade secrets under California’s Uniform Trade Secrets Act.

Specifically, Code of Civil Procedure § 2019.210 provides:

In any action alleging the misappropriation of a trade secret under the Uniform Trade Secrets Act (Title 5 (commencing with Section 3426) of Part 1 of Division 4 of the Civil Code), before commencing discovery relating to the trade secret, the party alleging the misappropriation shall identify the trade secret with reasonable particularity subject to any orders that may be appropriate under Section 3426.5 of the Civil Code.

In Brescia v. Angelin, 172 Cal.App.4th 133 (Mar. 17, 2009), the Court of Appeal found that Code of Civil Procedure § 2019.210 does not require in every case that a trade secret claimant explain how the alleged trade secret differs from the general knowledge of skilled persons in the field to which the secret relates. The Court found that such an explanation is required only when, given the nature of the alleged secret or the technological field in which it arises, the details provided by the claimant to identify the secret are themselves inadequate to permit the defendant to learn the boundaries of the secret and investigate defenses or to permit the court to understand the designation and fashion discovery. The Court found that the trade secret designation is to be liberally construed, and reasonable doubts regarding its adequacy are to be resolved in favor of allowing discovery to go forward.

Our recent article published by the Oxford Journals in the Journal of Intellectual Property Law & Practice discusses the Court of Appeal decision in depth and its practical significance.

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Zynga Game Network, Inc., which describes itself as “the number one social gaming company with 30 million daily active users,” obtained an ex parte temporary restraining order against its competitor Playdom, Inc. and two former Zynga employees. Z ynga both filed the case in the Superior Court of the State of California, Santa Clara County, and obtained the temporary restraining order on Wednesday, September 9, 2009.  Zynga asserted its entitlement to injunctive relief on trade secret misappropriation and unfair competition grounds under California law.

In its Complaint and Motion for Temporary Restraining Order (posted on TechCrunch) Zynga alleges that two of its employees retained trade secret-laden documents prior to resigning to join Playdom. Specifically, the Motion asserts that Zynga employee David Rohrl copied three files to a USB storage device before business hours roughly two weeks before his resignation. The files in question concern the design and modification of some of Zynga’s online games. The Motion further alleges that Zynga employee Raymond Holmes e-mailed a number of documents to his personal e-mail account on the days leading up to his August 24, 2009 resignation from Zynga. Among the e-mailed documents was Zynga’s “Playbook,” a document that Zynga describes as “literally the recipe book that contains Zynga’s ‘secret sauce,’ and its contents would be invaluable to a competitor like Playdom.” Zynga adds that Holmes deleted these e-mails from his "Sent" e-mail folder on his computer on the date of his resignation.

Zynga also sets forth a series of allegations that Playdom obtained Zynga trade secrets through its process of recruiting Zynga employee Martha Sapeta. Playdom recruiter Jennifer Farris gave Sapeta assignments to provide suggestions to improve Playdom games, including an instruction that Sapeta’s proposed features “can be a straight up ripoff from our competitors [sic] app.” Zynga also asserted (albeit in a vaguer fashion) that Playdom also obtained Zynga trade secrets in its recruitment of Zynga employee Scott Siegel.

Although not central to its Motion for Temporary Restraining Order, Zynga also adds in a back story concerning Playdom’s alleged previous efforts to obtain Zynga trade secrets and confidential information. Zynga describes an effort by Playdom to use a sophisticated computer algorithm to obtain information about users of Zynga’s Texas Hold ‘Em game and then to solicit those users to play Poker Palace, a competing Playdom game. Zynga also claims that Playdom used the trademark of Mafia Wars, a Zynga game, in an advertisement for Mobsters, a competing Playdom offering.

The Court entered the Temporary Retraining Order in exactly the form submitted by Zynga. The Order forbids Playdom, Holmes, and Rohrl from a variety of activities, including using certain Zynga information, attempting to recreate Zynga’s applications to which Holmes and Rohrl had access at Zynga, and inducing Zynga employees to violate contractual obligations or their duties of loyalty. The Court further executed an Electronic Preservation Order that compels the Defendants to preserve potentially relevant information, identify a number of categories of data, and, most significantly, provide a number of electronic storage devices to Zynga’s forensic expert for imaging.  Finally, the Court set forth an expedited discovery schedule culminating in a preliminary injunction hearing on October 1, 2009.  We expect a flurry of activity in the case leading up to that date.

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Jerry Powers, the founder of Miami's successful magazine, Ocean Drive, has sued the purchaser of the business and now-publisher of the magazine, Niche Media Holdings, LLC ("Niche Media")  seeking a declaratory judgment that the non-compete restrictions contained in the parties' asset purchase agreement ("APA") and the employment agreement he entered into following the sale do not (a) prevent Powers from helping inner-city youth publish their own magazine (Inspire, Enrich & Empower or IE2) as part of a non-profit effort and (b) prevent Powers from working in the luxury magazine world after November 1, 2009.   In the 126-page complaint, including exhibits, Powers alleges that there are inconsistencies in the provisions of the APA and his employment agreement, but that under the APA, his restrictive covenants cease as of November 1, 2009.  Niche Media, according to the complaint, contends that the restrictive covenants last until February 17, 2011 -- a rather significant difference in time.  In support of his theory, Powers points to the provision in the employment agreement that says that terms of the APA are controlling if there is any conflict between the APA and the employment agreement.

In the complaint, Powers claims that he filed suit based on the "intermeddling" of Niche Media in his efforts to publish IE2.  Indeed, Powers claims that Niche Media threatened to sue to stop the publication of IE2. 

The parties' dispute has attracted some media attention with the Miami Herald   and Law360 reporting on it.  The interest may derive in part from the charity involved in publishing IE2, Overtown Youth Center, is supported by Alonzo Mourning Charities.  Alonzo Mourning is a retired NBA star who played for the Miami Heat.  

Yet, without so much as an opposing brief being filed by Niche Media, the day after filing, the Court denied Powers's request for emergency relief.  The Court rejected the emergency nature of the brief, saying

the Complaint and Motion fail to set out in detail good cause of the necessity of expedited procedures, as required in an emergency motion.  Finally, the Court notes that the Complaint does not clearly allege a case or controversy that is ripe for adjudication, specifically as to the request for declaratory and injunctive relief regarding the expiration of the non-competition and non-solicitation provisions. 

This early of a set-back in a case of this sort may not bode well for Powers.  And, solely in my opinion (of course), Powers may need to be considering amending his complaint to avoid a motion to dismiss based on the Court's statements in her order. 

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By Kurt Kappes and Jim McNairy

            On August 20, 2009, the California Court of Appeal for the Fourth Appellate District issued an order certifying publication of its decision in The Retirement Group v. Galante, No. D054207, 2009 WL 2332008 (Cal. App. 4th July 30, 2009). In Galante, the Court analyzed the tension between California’s strong public policy favoring competition, as embodied in Business and Professions Code section 16600, and the longstanding body of law recognizing an employer’s right to guard against misappropriation of its trade secrets. 

Under the facts presented, the Court concluded that an employer who seeks to prohibit a former employee from soliciting former customers to transfer their business away from the former employer to the employee's new business, cannot specifically enforce a covenant not to compete without showing a tort. The employer must show more than that the former employee had access to customer lists that qualified as trade secrets while employed, and solicited customers once he left. Instead, the former employer must show that the former employee actually used the trade secret list to identify or facilitate the solicitation of existing customers.

In Galante, The Retirement Group (TRG), described as a business “association”, provided broker/dealer, investment advice, and securities sales services to customers on a fee for service basis. TRG provided these services through, among other things, the use of independent contractors, many of whom were registered investment advisors and registered representatives licensed to sell securities. Some of TRG’s customers used the registered representative to buy and sell securities through a third party broker/dealer known as Security Services Network, Inc. (SSN). TRG’s registered representative independent contractors also entered into independent contractor relationships with SSN. 

TRG undertook extensive marketing efforts, including seminars. About 95% of TRG’s customers were obtained through this marketing. TRG’s list of customers and potential customers was maintained in a secure database designed to prevent copying of information in the database.

As a condition to allowing access to the secure database, TRG required execution of a Marketing and License Agreement (MLA). In pertinent part, the MLA defined TRG's confidential information, and provided that (both during the term of the relationship and thereafter) the signing party would keep the information confidential and would not “disclose or use” the information, except as the MLA permitted.   

After one of TRG’s principals left to form a competing business (Monarch) with several of the independent contractors who had worked for TRG, the independent contractors and Monarch allegedly began contacting TRG’s customers and asking them to switch their business to Monarch and Monarch’s new broker/dealer, SII Investments, Inc.

TRG filed suit, alleging among other things, misappropriation of TRG’s trade secret information contained on its database. TRG sought and obtained a preliminary injunction.

The preliminary injunction prohibited certain conduct, including:

“[d]irectly or indirectly soliciting any current TRG [customers] to transfer any securities account or relationship from TRG to [Advisors] or any broker-dealer or registered investment advisor other than TRG[.]”(“Non-solicitation Provision”); and

“[u]sing in any manner TRG information found solely and exclusively on TRG databases. [However,] [s]imilar information found on servers, databases and other resources owned and operated by other entities or businesses is excluded from the injunction[.]” (“Database Provision.”)

The Court of Appeal addressed the propriety of the Non-Solicitation Provision. In doing so, the Court analyzed (1) Bus. & Prof. Code section 16600 and the cases interpreting and applying it, and (2) trade secret case law providing that former employees may not misappropriate the former employer’s trade secrets to compete unfairly with the former employer.

In its analysis of Section 16600, the Court focused on the 2008 California Supreme Court decision in Edwards v. Arthur Andersen LLP, 44 Cal.4th 937 (2008). In Edwards, the Supreme Court held that covenants not to compete are void in California under Bus. & Prof. Code section 16600 unless permitted by a statutory exception.   Section 16600 provides that “[e]xcept as provided in this chapter, every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.”

After noting that Edwards “appears pivotal to resolution of this appeal,” the Galante Court highlighted that “[a]though Edwards reaffirmed the broad California rule that invalidates noncompetition agreements falling outside of the statutorily-prescribed exceptions, Edwards expressly stated it was not ‘[a]ddress[ing] the applicability of the so-called trade secret exception to section 16600.’” The Retirement Group, 2009 WL 2332008 at *5 (quoting Edwards, 44 Cal.4th at 946 n. 4). 

In analyzing the trade secrets line of cases, the Galante Court started by noting “[a]n equally lengthy line of cases has consistently held former employees may not misappropriate the former employer's trade secrets to unfairly compete with the former employer.” The Court continued, “in accordance with these principles, the courts have repeatedly held a former employee may be barred from soliciting existing customers to redirect their business away from the former employer and to the employee's new business if the employee is utilizing trade secret information to solicit those customers.” Id. at *6, emphasis in original. The Court then concluded “[T]hus, it is not the solicitation of the former employer's customers, but is instead the misuse of trade secret information, that may be enjoined.” Id. (emphasis in original).

Having analyzed section 16600 and the trade secrets line of cases, the Court concluded that :

“We distill from the foregoing cases that section 16600 bars a court from specifically enforcing (by way of injunctive relief) a contractual clause purporting to ban a former employee from soliciting former customers to transfer their business away from the former employer to the employee's new business, but a court may enjoin tortious conduct (as violative of either the Uniform Trade Secrets Act and/or the Unfair Competition Law) by banning the former employee from using trade secret information to identify existing customers, to facilitate the solicitation of such customers, or to otherwise unfairly compete with the former employer. Viewed in this light, therefore, the conduct is enjoinable not because it falls within a judicially-created “exception” to section 16600’s ban on contractual nonsolicitation clauses, but is instead enjoinable because it is wrongful independent of any contractual undertaking." Id. (bolding added).

Applying this reasoning to the facts before it, the Court concluded that the Non-Solicitation Provision of the preliminary injunction facially violated Edwards and could not be viewed as limited in scope to only enjoining the misappropriation of TRG's trade secrets.  

The Court also rejected the argument that the Non-solicitation Provision could be upheld as an injunction designed to have the limited effect of protecting against the misappropriation of TRG's trade secrets because the Database Provision of the injunction granted the full range of trade secret protections to which TRG was entitled. The Court further held that “[a]bsent the provisions of [the Non-solicitation Provision] [defendants] could compete with TRG for the business of TRG's existing customers by employing all available resources and information except for those materials found ‘solely and exclusively on TRG's databases,’” which constituted protectable trade secrets. Id. at * 7.

TRG’s argument regarding the so-called “trade secret exception” to section 16600 was also rejected by the Court. TRG argued that the conduct enjoined by the Non-solicitation Provision is outside the boundaries of Edwards because Edwards expressly excepted from its ruling noncompetition clauses falling within the trade secret exception to section 16600. Id. Significantly, the Galante Court noted that “[E]dwards did not approve the enforcement of noncompetition clauses whenever the employer showed the employee had access to information purporting to be trade secrets. Instead, Edwards merely stated it was not required to “address the applicability of the so-called trade secret exception to section 16600 [citation] because it was not germane to the claims raised by the employee.” Id.

            Additional reasons for the Court holding that the Non-solicitation Provision was invalid included:

·        TRG did not dispute that the names and contact information for existing customers were readily available to defendants from independent third party sources, thus negating that the names and contact information of existing customers constituted protectable trade secret information;

·        Because the Database Provision already protected against defendants’ use of TRG's trade secrets, the Non-solicitation Provision could not have any additional effect, except to bar solicitations not involving the use of trade secret information; and

·        The Non-solicitation Provision was not enforceable as a mere “narrow restraint” on defendants because the “narrow-restraint” exception developed by 9th Circuit Court of Appeal was rejected in Edwards.

The Court ordered the trial court to vacate the preliminary injunction and enter a new injunction deleting the Non-Solicitation Provision.

The distinction that the Court drew between enforcing a contractual clause and enjoining tortious conduct, introduces new uncertainty whether a covenant not to compete in California explicitly tied to the protection of trade secrets is viable. Although future cases may address this issue, neither Galante nor Edwards expressly held that one cannot by contract prohibit conduct that is otherwise unlawful under one or more statutes.  

The lessons from this case are:

1. Businesses should continue to use caution before utilizing any covenants not to compete in California and should carefully assess whether the restriction on competition can be tied to one of the statutory exceptions to section 16600 or to the protection of trade secrets. However, if tied to the protection of trade secrets, a covenant which seeks to restrict a former employee or contractor from competing against the former employer should be tied to the former employee’s/contractor’s actual misuse of trade secrets. Simply referencing prior access to trade secrets during the term of employment/contract alone is unlikely to address the misuse of that information.

2. This case highlights what the California Supreme Court made clear in its Edwards v. Arthur Andersen opinion: unless falling within one of few exceptions to CBPC § 16600, post-term covenants not to compete are invalid in California regardless of whether such covenants are narrowly drawn.

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