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California Federal District Court Finds That Plaintiffs May Assert A Claim For Alleged Misleading Actions of Agent and Misuse of Confidential Information Not Rising To Level Of A Trade Secret In Youth Hostel Dispute

Posted in Breach of Fiduciary Duty, Practice & Procedure, Trade Secrets

By Robert Milligan and Jeffrey Oh

In business, as in life, trust and communication are key to healthy and productive relationships. When these crucial elements are lost, as in the case of What 4 LLC v. Roman & Williams, Inc., 2012 WL 1815629 (N.D.Cal.), the fallout is often contentious and requires court intervention.

In a recent decision granting in part and denying in part defendants’ motion to dismiss, Judge Edward M. Chen of the United States District Court for the Northern District of California examined the principal-agent relationship between the parties to determine what responsibilities each had to the other based on the relationship’s underlying agreements and under California law.

On defendants’ motion to dismiss, the court found that plaintiffs had stated a claim for alleged breach of fiduciary duty and concealment predicated on defendants’ alleged misleading statements/conduct as to their intentions to perform under the parties’ alleged agreement. The court further held that plaintiffs were permitted to assert an alleged claim for breach of fiduciary duty and concealment predicated on the disclosure of confidential information not rising to the level of a trade secret, notwithstanding California Uniform Trade Secrets Act ("CUTSA") preemption.

The plaintiffs, What 4 LLC and 1095 Market Street Holding LLC, planned and secured financing for a joint venture to open a “premium youth hostel” at 1095 Market Street, San Francisco, CA, including purchasing the property and conducting market research and analysis. After completing their designs, applying and receiving all requisite entitlements and permits, plaintiffs allegedly approached the defendants, Roman & Williams (“R & W”) as well as its sole shareholders, Robin Standefer and Stephen Alesch, in November 2010 about hiring them for architectural and design services. On November 4, 2010, R & W signed a nondisclosure agreement prohibiting it from disclosing any of the confidential information given to it by plaintiffs, including market research and design. 1095 Market Street Holding eventually hired R & W on January 31, 2011 to work on the youth hostel, entering into a Letter Agreement. The Letter Agreement stipulated that R & W was to complete the project in six different phases ranging from concept to construction, and that other details would be finalized at a later date in a Definitive Agreement meant to supersede the Letter Agreement. In the interest of time, the parties agreed to proceed with the first two stages without signing a Definitive Agreement, which defendants completed in August 2011.

While R & W waited for orders to begin work on the next phase of the project, in October 2011 it allegedly began negotiations with plaintiffs’ competitor, Sydell, to provide services for their own premium youth hostel project. In a subsequent meeting with Sydell on November 1, 2011, Ms. Standefer allegedly disclosed plaintiffs’ confidential information in a bid to win the contract. On November 15, 2011, R & W allegedly met with plaintiffs to discuss the next steps of the 1095 Market Street project, failing to inform them that it had entered into a multi-year exclusive contract with Sydell to provide the same services it had, and was to provide plaintiffs. Allegedly learning about R & W’s agreement with Sydell from a Wall Street Journal article on November 23, 2011, plaintiffs asserted the following causes of action: (1) breach of the nondisclosure agreement, (2) breach of fiduciary duty, (3) concealment, (4) breach of contract, and (5) violation of CUTSA. Defendants then brought a motion to dismiss plaintiffs’ claims except the CUTSA claim.

Lumping the first and fourth causes of action together,  the court began its analysis by examining defendants’ contention that the two breach of contract claims (i.e., the Nondisclosure Agreement and the Letter Agreement) should be dismissed. Due to the fact that the two individual defendants, Ms. Standefer and Mr. Alesch, were not a party to either contract, a point which plaintiffs conceded, the Court granted the motions to dismiss the claims for these two. However, the court noted that “there are still viable claims for breach of contract against R & W. "

Next in its analysis, the court determined whether or not R & W’s actions constituted a breach of fiduciary duty and concealment. For its part, defendants argued that the claims are preempted by the CUTSA and that the claims are not plausible given the insufficient allegations that they owed a duty to plaintiffs. Codified in California Civil Code § 3426, the CUTSA includes a provision which states that the statute “does not affect… (2) other civil remedies that are not based upon misappropriation,” which courts have interpreted to “preempt alternative civil remedies based on trade secret misappropriation.” Plaintiffs stated in their complaint that all of the confidential information disclosed by R & W constituted trade secrets under the CUTSA. Although they argued in court that some of the disclosed information did not constitute trade secrets, Judge Chen agreed with defendants that CUTSA preempts the breach of fiduciary duty and concealment claims based on plaintiffs’ original filing stating otherwise. The court, however, provided plaintiffs with leave to amend the claims to include, as an alternative theory, allegations that plaintiffs’ confidential information did not constitute trade secrets but was otherwise actionable.

In response to R & W’s assertion that they did not owe a duty to What 4 LLC or 1095 Market Street Holding LLC, plaintiffs argued that defendants did “because (1) they were Plaintiff’s architects and (2) they were Plaintiff’s agents.” Citing Palmer v. Brown, where the court found that an architect’s fiduciary duty to one client does not prohibit the architect from working with a client’s potential competitor, the court did not find plaintiffs’ first argument convincing. However, because plaintiffs hired R & W “to act as their agent” to bid and negotiate with suppliers on their behalf, the court found the existence of an agency relationship to be plausible. Citing the Restatement of the Law of Agency (3rd ed., 2006), the court noted that while an agent is not required to disclose its intentions to compete with a principal, it does have a duty not to mislead the principal about its own intentions. R & W allegedly continued to meet with plaintiffs and led them to believe it was committed to proceeding with the next phase of development while previously entering into a multi-year exclusive contract with Sydell that prevented any such work. Therefore, although it found that there is no viable claim for breach of fiduciary duty based on defendants working for a competitor or concealing that fact, the court denied defendants’ motion to dismiss these claims based on the allegations that defendants allegedly misled the plaintiffs.

This decision is noteworthy because the court rejected plaintiffs’ claim that defendants’ alleged breach of the exclusivity provision in their agreement constituted a breach of fiduciary duty and for the court’s willingness to leave the door open to plaintiffs to assert a claim for breach of fiduciary duty and concealment based upon the misuse of information not rising to the level of a trade secret, notwithstanding CUTSA preemption.

Additionally, the case highlights that selecting reliable and trustworthy agents to assist with the implementation of a vision is paramount to the success of any business venture. When a principal-agent relationship fails, the costs to all parties can be enormous. The threat of these costs, including lost productivity and the price of litigating these disputes, should motivate business planners to be exceptionally thorough in vetting potential business partners. While these considerations are essential, it is also important for any business relationship to be anchored by a comprehensive contractual agreement which explicitly details the duties and responsibilities each party has to the other. By clearly outlining the parameters of a business relationship, both the principal and agent can attempt to protect themselves from any unwanted or unexpected results. Consultation with experienced legal counsel is often necessary to position a party for the best outcome, particularly in California where non-compete agreements and claims of theft of trade secrets and confidential information are highly scrutinized.