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

Amy E. Bivins recently published another article in the Daily Labor Report addressing the effects of the Ninth Circuit's Brekka decision, which we have posted about previously.  Ms. Bivins quotes Seyfarth attorney Carolyn Sieve on the issue.  Carolyn reminded employers that they "should not rely solely on a potential CFAA claim to protect their proprietary information."  Indeed, employers will need to consider what access to computer systems is "authorized." 

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In an article published today by the Daily Journal, "Economy Leads Companies to Sue Ex-Workers," (linked with permission) author Laura Ernde talks with a number of California practitioners about what they see happening with trade secrets litigation in the wake of the California Supreme Court's ruling in Edwards v. Arthur Anderson  and the economy.  

Although Ernde indicates that the anecdotal evidence is that interest in trade secrets is on an "upswing," according to Seyfarth Shaw's own Carolyn Sieve and Robert Milligan, research regarding filings in Los Angeles indicates that the actual number of lawsuits mentioning "trade secrets" has decreased over the last two years. 

Ernde's article also touches on the "inevitable disclosure" doctrine, noting that under FLIR v. Parrish, 2009 DJDAR 8598, the doctrine is no longer applicable in California. 

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As mentioned in a previous blog entry, the U.S. Court of Appeals for the Ninth Circuit held in Comedy Club, Inc. v. Improv West Associates, 553 F.3d 1277 (9th Cir. 2009), that an in-term (during the term of the contract/relationship) covenant not to compete governed by California law was enforceable to the extent that it did not foreclose competition in a substantial share of a business, trade, or market. 

The Court overturned an arbitrator’s ruling that permitted a nationwide in-term covenant not to compete as a “manifest disregard of the law.” The Court relied on an apparent variant of the Ninth Circuit’s “narrow restraint” doctrine and older California state law authority to support a watered-down version of the covenant not to compete. 

As detailed in a recent article on Comedy Club authored by Robert Milligan and Jim McNairy and published in Business Law News ("BLN") Comedy Club is a significant decision because (1) the Court’s ruling relied in part on the so-called “narrow restraint” exception to California’s statutory prohibition against covenants not to compete, even after the California Supreme Court had just expressly rejected the narrow restraint exception in Edwards v. Arthur Andersen, 44 Cal. 4th 937 (2008); and (2) arbitration decisions are notoriously difficult to overturn, but the Ninth Circuit had little trouble doing so in Comedy Club.

As Robert and Jim explain in the BLN article, in light of Comedy Club, in-term covenants not to compete may be enforceable in the franchise context in California “to protect trademarks, trade names, and goodwill of a licensor” if they are narrowly tailored and do not foreclose a party from engaging in its business or trade in a substantial section of the market.

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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 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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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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By Rina Wang, summer associate, and Timothy B. Nelson

The California Court of Appeal recently addressed the issue of the interpretation of arbitration clauses in the context of claims for misappropriation of trade secrets in the case of Valentine Capital Asset Management, Inc. v. Agahi, 174 Cal.App.4th 606 (1st Dist. 2009).

In Valentine, respondent John Valentine was the founder and president of Valentine Capital Asset Management, Inc. (“VCAM”) and Valentine Wealth Management, Inc. (“VWM”), neither of which was a member of the Financial Industry Regulatory Authority (“FINRA”). John Valentine was subject to FINRA rules and regulations through his affiliation with FINRA member Geneos Wealth Management, Inc., but not through his affiliation with VCAM and VWM. Appellants Agahi, Luippold and Ortale worked as employees of VCAM and VWM. In their capacity as employees of VCAM and VWM, Agahi, Luippold and Ortale were given business leads, and they were responsible for following up on the leads, developing a client relationship, and providing services to those clients. Agahi resigned from VCAM and VWM to form a competing firm, which added Luippold and Ortale as employees. The competing firm was also not a member of FINRA. The three defendants allegedly brought VCAM and VWM client databases with them to the competing firm. Valentine allegedly discovered that Agahi had e-mailed VCAM and VWM’s client database to Ortale, and that files and e-mails had been deleted from Agahi’s work computer prior to his departure. Valentine also allegedly discovered that Agahi was attempting to persuade clients of the Valentine companies to move their assets to Agahi and his competing firm. Valentine sued Agahi, Luippold and Ortale for misappropriation of trade secrets, intentional interference with contractual relations, intentional interference with prospective economic advantage, trade libel, slander, and common law and statutory unfair competition.

Agahi, Luippold and Ortale moved to compel arbitration, arguing that the dispute was subject to mandatory arbitration under FINRA’s arbitration clause because all of the parties were members of FINRA. Valentine opposed the motion, contending that the defendants had waived their right to arbitrate and that the disputes in the litigation were not subject to FINRA arbitration. The trial court denied the motion to compel arbitration, finding that FINRA was inapplicable because the parties’ dispute did not arise out of their business activities as FINRA members.

The Court of Appeal affirmed. The court first explained that written arbitration provisions in interstate commercial transactions are enforceable under the FAA. Thus, the FAA applied to determine the scope of arbitration provisions in contracts with FINRA-member firms. Before engaging in activities as a registered representative for a FINRA-member firm, all registered representatives of broker-dealers, investment advisors, and securities issuers must sign a “Uniform Application for Securities Industry Registration or Transfer,” also known as Form U-4. See McManus v. CIBC World Markets Corp., 109 Cal. App. 4th 76, 88 n. 3 (2003). Form U-4 contains an arbitration provision. Valentine and the defendants signed this form, thereby agreeing to arbitrate every dispute required to be arbitrated under FINRA rules. Arbitration of a dispute between associated persons is required under FINRA Rule 13200 only “if the dispute arises out of the business activities of a member or an associated person . . . .”

The Valentine court found that the phrase “business activities of . . . an associated person” is limiting and cannot include the activities of every possible business enterprise in which an individual “associated person” might be engaged. Valentine, 174 Cal.App.4^th at 615. According to the Valentine court, this language, when reasonably read, must require arbitration of disputes only if they arise out of the business activities of an individual as an associated person of a FINRA member. Id.at 616.

The court held that there was no allegation that any of the parties were acting for any FINRA-member firm or as an associated person. No relation was alleged between any FINRA-member firm and the work performed for Valentine. The Court further determined that none of the purported wrongdoing was alleged to have occurred in the course of the parties’ duties as associated persons with a FINRA-member firm. Rather, it allegedly occurred with investment advisory firms that were not members of FINRA. The disputes thus related to defendants, but not to their business activities as associated persons of a FINRA member.

Although Valentine is based on the distinction between “broad” and “narrow” arbitration clauses, the court reached its conclusion based on the language of the pleadings. The plaintiff pled multiple causes of action alleging misconduct by various defendants.  When the court ruled on the motion to compel arbitration, the legal characterization of the parties in the Complaint controlled the ruling. 

The Valentine decision makes it clear that when prosecuting or defending a claim for misappropriation of trade secrets, one must be mindful of what forum is appropriate, arbitration or litigation. Furthermore, the Valentine decision also provides an example of the importance of pleading causes of action properly based upon the forum. Because Valentine pled his causes of action in a way that made it clear they were not based on the defendants’ business activities as associated persons of a FINRA member, Valentine was able to avoid FINRA arbitration.

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By Carolyn Sieve and summer associate Rina Wang

A California federal court has added to the body of decisional law on preemption under the California Uniform Trade Secrets Act, Cal. Civ. Code §§ 3426, et seq. (“CUTSA”). In Aversan v. Jones, No. 2:09-cv-00132-MCE-KJM, 2009 WL 1810010 (E.D. Cal. June 24, 2009), the Court denied defendants’ motion to dismiss plaintiff’s claims for interference with contractual relations, interference with prospective economic advantage, breach of duty of loyalty, and unfair competition, finding that plaintiff had sufficiently pled facts supporting these claims without relying on the same nucleus of facts as its CUTSA misappropriation of trade secrets claim.

Civil Code section 3426.7 provides that CUTSA “does not affect (1) contractual remedies, whether or not based upon misappropriation of a trade secret, (2) other civil remedies that are not based upon misappropriation of a trade secret, or (3) criminal remedies, whether or not based upon misappropriation of a trade secret.” (Emphasis added.) This provision has been interpreted to mean that CUTSA preempts common law claims that are based on the same nucleus of facts as the CUTSA claim. Thus, preemption is not triggered where the facts in an independent claim are similar to, but distinct from, those underlying the misappropriation claim.

Defendants Jones and Mellse were employees of plaintiff Aversan, which recruits and trains engineers to perform services for Aversan’s customers and clients of its customers. They later quit to work for one of Aversan’s clients, Ambire, which had retained Aversan to provide engineers to one of Ambire’s clients, CalPERS.  Defendants had been assigned by Aversan to work on the CalPERS project. While assigned to CalPERS, defendants wrote custom software programs using Aversan’s proprietary software script. 

Aversan’s complaint alleged that defendants violated CUTSA by using Aversan’s proprietary and confidential information to continue performing work for Ambire and CalPERS. Defendants also allegedly used Aversan’s confidential information to solicit employees, contractors and recruits. In addition, Aversan sought damages for Jones’ alleged interference with a residential lease agreement, and defendants’ supposed interference with Aversan’s customer relationships.

Defendants moved to dismiss plaintiff’s claims for interference with contractual relations, interference with prospective economic advantage, breach of duty of loyalty, and unfair competition. The district court denied the motion, holding that the facts supporting these tort claims were sufficiently independent of the CUTSA claim. Under these causes of action, Aversan claimed that defendants prevented Aversan from participating in and profiting from its agreements with Ambire by working directly for Ambire and that defendants allegedly interfered by usurping Aversan's position with CalPERS.  Aversan also claimed that Jones encouraged and convinced an apartment lessor to terminate its lease with Aversan. Aversan had already paid for that month's rent as an employee benefit to Jones and re-let the same apartment unit to Jones directly. These claims survived dismissal because they did not rely on the same nucleus of facts as Aversan's CUTSA claim and they sufficiently stated an independent claim for relief.  

Aversan thus provides some guidance as to what allegations will overcome dismissal of tort claims in a case alleging CUTSA violations. If a party in a trade secrets case is faced with a possible preemption argument, it is worth comparing this decision with the recent California Court of Appeal decision in K.C. Multimedia, Inc. v. Bank of America Technology & Operations, Inc., 171 Cal.App.4^th 939 (2009).

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The California Court of Appeal’s recent decision in FLIR Systems, Inc. v. Parrish, 2d Civil No. B209964, 2009 WL 1653103 (Cal. App. 2d Dist. June 15, 2009), affirming a $1.6 million attorney fee award to defendants upon a finding that the action was brought in bad faith, provides a useful and interesting discussion of various factors that may lead a court to conclude that a misappropriation case has been brought in bad faith. The decision highlights the importance of considering carefully whether to bring a misappropriation claim against former employees, particularly where there is little or no evidence of actual damage, or of actual misappropriation or threatened misappropriation.

In 2004, FLIR acquired the assets of Indigo, of which defendants Parrish and Fitzgibbons were officers. Indigo manufactures and sells microbolometers, devices used in connection with infrared cameras, night vision, and thermal imaging. After the sale, defendants continued to work for Indigo. About a year later, defendants decided to start a new company to mass produce bolometers. The new company was based on a business plan developed by Fitzgibbons several years before FLIR acquired Indigo. Before leaving Indigo, defendants advised FLIR and Indigo of their business plan and invited FLIR and Indigo to participate. FLIR rejected the offer. 

In 2006, defendants began negotiations with Raytheon Company in accord with their business plan. Defendants assured FLIR and Indigo that they would not misappropriate Indigo’s trade secrets and that they would use an intellectual property filter similar to the one used at Indigo to prevent the misuse of trade secrets. In June 2006, FLIR and Indigo sued defendants on the theory that defendants could not mass produce low-cost microbolometers without misappropriating trade secrets. Upon learning of the lawsuit, Raytheon terminated business discussions with defendants, and one month after the suit was filed, defendants advised FLIR and Indigo that they would not go forward with their new business.

FLIR and Indigo, before trial, dismissed their damages claims and tried only the misappropriation of trade secrets and California Unfair Competition Act claims. On December 6-17, 2007, the case was tried. In a statement of decision issued in June 2008, the trial court found no misappropriation or threatened misappropriation of trade secrets. It was undisputed that defendants received no funding for their business plan, never started their new business, had no employees or customers, did not lease any facility or develop technology, and did not design, develop or sell any infrared products. The trial court ultimately denied permanent injunctive relief and awarded defendants $1,641,216.78 in attorney fees.

The California Uniform Trade Secrets Act allows for an award of reasonably attorney fees to the prevailing party where the claim was brought in bad faith. Civ. Code § 3426.4. The court ultimately held that FLIR and Indigo had essentially brought the action based on the doctrine of “inevitable disclosure,” as there was no evidence of misappropriation or threatened misappropriation, and the FLIR and Indigo witnesses were unaware of such evidence though they maintained suspicions that misappropriation would occur. Given that the “inevitable disclosure” doctrine has been definitively rejected in California, the Court found FLIR and Indigo to have brought and maintained the action in bad faith. The items the Court considered significant: 

•           The absence of any economic harm.

•           The absence of any evidence of misappropriation or threatened misappropriation of trade secrets. Notably, there was evidence at trial that one of the defendants, Parrish, had downloaded technological data onto a hard drive before leaving Indigo, and that he destroyed the hard drive a few months before the lawsuit was filed. Although evidence that an employee has downloaded confidential information shortly before leaving his employer is typically significant to support a misappropriation claim, here, the evidence was discounted because defendants first learned of the download after the complaint was filed, so it was not a consideration for bringing suit, and the download was not a threatened misappropriation because there was no evidence that the contents of the hard drive, “if such contents existed, were improperly accessed, used, or copied before the drive was destroyed.”

•           Evidence that FLIR and Indigo had an anticompetitive motive in filing the lawsuit.  On this point, the court found significant the testimony of FLIR’s CEO, who testified that “we can’t tolerate a direct competitive threat by [Parrish] and [Fitzgibbons],” inferring that the CEO had no evidence of wrongdoing but was bothered that defendants planned to compete with FLIR in the future. The Court also found significant the fact that another FLIR officer had voted to file the lawsuit but had no personal knowledge that defendants had committed a wrongful act.

•           Failure by FLIR and Indigo to identify what trade secrets would be subject to the permanent injunction. The Court found as “strong evidence of bad faith” FLIR and Indigo’s proposed injunction, which barred defendants from developing certain products for a 12-month period even if they did not use FLIR and Indigo’s technology or trade secrets.

•           Imposition of unnecessary settlement conditions. When defendants notified FLIR and Indigo of their business plan, FLIR and Indigo responded with a demand for $75,000, a non-competition agreement, and agreement that defendants would not hire FLIR and Indigo’s employees, and agreement that they would not challenge Indigo’s patent applications. The Court found these restrictions to be unlawful restraints on trade.

•           FLIR and Indigo’s experts at trial admitted there was no scientific methodology to predict trade secret misuse and agreed that no trade secrets were misappropriated.

The FLIR decision is a reminder to employers to be cautious when determining to bring a lawsuit against former employees for trade secret misappropriation. California courts may not tolerate the filing of misappropriation claims where it appears the employer is merely fearful or suspicious of wrongdoing. In such cases, the employer plaintiff risks not only a dismissal of its claims but the possibility of being sanctioned for bringing the action. 

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Attorneys for Sylvester Stallone and another named cross-defendant recently filed a petition for review with the California Supreme Court challenging a significant published California Court of Appeal decision (Brescia v. Angelin, 172 Cal.App.4^th 133 (March 17, 2009)) regarding the sufficiency of a trade secret identification statement.

In 2007, a Los Angeles Superior Court judge entered judgment in favor of Stallone and another cross-defendant on a claim for trade secret misappropriation in a cross-complaint brought against him and others by a manufacturer of high protein, low carbohydrate pudding. 

In March 2009, a Court of Appeal for the Second Appellate District, Division Four reversed the judgment on the grounds, among other things, that cross-complainant’s trade secret identification statement was sufficient. 

The parties have briefed Stallone’s petition for review, with Stallone’s reply filed with the California Supreme Court on May 22, 2009. The Supreme Court has yet to rule on the petition.

According to the Court of Appeal decision, the cross-complainant alleges that Stallone participated with other cross-defendants in misappropriating cross-complainant’s trade secrets, which are described in the cross-complaint as: “a formula, manufacturing process, marketing plan, funding plan and a distribution and sales plan for a high protein, low carbohydrate pudding with an extended shelf life and a stable and appealing consistency and most important, when mass produced, an appetizing flavor.” See id. at 139-140. 

According to the decision, Stallone was the chairman of the board for a company (also a cross-defendant) that allegedly conspired to steal cross-complainant’s ideas for the alleged high protein, low carbohydrate pudding that was allegedly unlike any other pudding on the market. See id. at 139. The company and another allegedly began producing and selling a pudding based on cross-complainant’s formula and business plan. See id. at 139.

At the trial court level, judgment was entered in Stallone’s and another cross-defendant’s favor on the trade secret misappropriation claim, after the court sustained their demurrer to cross-complainant’s third amended cross-complaint, based on the alleged inadequacy of the manufacturer’s trade secret designation statement.

The trial court reasoned that the trade secret designation was defective, because it made “no attempt . . . to identify why certain aspects or all of the aspects of the manufacturing process are anything other than matters generally known to persons skilled in the field,” and “no attempt . . . to indicate why the peculiar product formulation here that is stated with precision is a trade secret, as opposed to the typical ingredients involved in formulating other low-calorie, low-fat puddings.” See id. at 142. 

The trial court commented that cross-complainant’s submission was silent on the question whether the alleged trade secrets were known to skilled persons in the field: “So by its silence it's doomed to failure, because there's no attempt even to commence to describe why this formula is unique and not known to others. [] It just is a formula. Likewise, it is a cooking or manufacturing process of many steps. Some of which apparently, according to matters of which I believe I can take judicial notice are actually fairly familiar when you are trying to make a comparable product.” See id.

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 underSection 3426.5 of the Civil Code.

Cross-complainant appealed the trial court’s decision. On appeal, the Court of Appeal found that section 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.

Specifically, the Court held that cross-complainant’s trade secret designation met the reasonable particularity standard of section 2019.210. According to the designation statement, two alleged trade secrets were identified: the pudding formula and the manufacturing process. The statement “particularly described” the details of the pudding formula as of the last quarter of 2003, listing the 15 specific ingredients by common name and the percentage of the total pudding. The statement also listed the same 15 ingredients by their supplier and brand name and particularly described each step in the mixing, testing, and code marking of the pudding. 

The Court concluded that cross-complainant’s statement was adequate because: 1) the statement permitted cross-defendants to investigate possible defenses; 2) there was no deficiency in the trade secret designation that would hamper its ability to protect the parties' proprietary information or to determine the scope of relevant discovery; and 3) there was no showing that the trial court was unable to understand the nature of the alleged secrets and fashion discovery. 

The Court concluded that the nature of the identification required in any particular case need only be reasonable under the circumstances. The Court further stated the 2019.210 requirement cannot be divorced from the statutory goals which it is intended to serve and “[t]he identification is to be liberally construed, and reasonable doubts concerning its sufficiency are to be resolved in favor of allowing discovery to commence.”

The Court of Appeal decision received some media coverage after its publication. 

The issues presented to the California Supreme Court on the petition for review are:

1)      “Does Code of Civil Procedure section 2019.210 . . . permit plaintiffs to designate purported trade secrets by simply listing all of their product manufacturing specifications, without distinguishing them from matters known in the trade, thereby forcing defendants to guess as to what aspect(s) the plaintiffs will argue at trial constitutes the actual trade secret?

2)      Does this new, diminished designation standard, which conflicts with the designation standard utilized for over a decade (which required plaintiffs to distinguish their purported secret from matters known in the trade) undermine the legislative intent behind Section 2019.210 and Business and Professions Code section 16600 . . .?.

3)      Does this new designation standard create de facto non-compete covenants (unlimited as to time or geography), restraining the mobility of technical employees , and allowing employers to circumvent Edwards v. Arthur Andersen (2008) 44 Cal.4^th 937, 946 . . .?

4)      When plaintiffs designate patented information as their trade secret, and cannot distinguish their purported secret from these patents, may trial courts take judicial notice of the designation and patents, and grant demurrer? Or, must trade secret defendants always face costly litigation, no matter how incurably insufficient the information designated as trade secret?”

Pending the California Supreme Court’s decision on the petition review, the Court of Appeal’s decision serves as a significant decision providing additional clarification concerning the disclosure requirements of Section 2019.210.  We will provide an update once the Supreme Court issues a ruling on the petition for review.

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Under California Civil Procedure Code section 425.16, a defendant sued for exercising its constitutional rights may assert that the action is Strategic Litigation Against Public Participation (“SLAPP”) and move to strike the complaint on that basis. Section 425.16, also known as the “anti-SLAPP statute,” when properly invoked, can be a powerful defense tool because it imposes an automatic stay on discovery until a ruling on the motion, potentially forces the plaintiff to establish with evidence a “probability” that plaintiff will prevail on its claim, and exposes the plaintiff to a fee award if the motion is granted. The invocation of the anti-SLAPP statute in cases involving trade secrets disputes between business competitors will most likely be futile, however, as a recent decision by the California Court of Appeal indicates.

In World Financial Group, Inc. v. HBW Insurance & Financial Service, Inc. et al., 2009 WL 1019118 (Cal. App. 2d Dist. April 16, 2009), plaintiff World Financial Group, Inc. (“WFG”), a company that provides insurance, pension and financial services, sued its direct competitor, HBW Insurance & Financial Services, Inc. and a number of former WFG associates (collectively, “defendants”) for, among others, trade secret misappropriation and use of WFG’s confidential information to solicit WFG’s associates and customers. 

Defendants filed an anti-SLAPP motion, arguing that all of WFG’s claims were based on defendants’ speech and conduct in furtherance of their right of free speech in connection with a public issue. Specifically, defendants claimed that their speech and conduct involved the pursuit of lawful employment, workforce mobility, and free competition, all of which are matters of public interest and protected policy. Both the trial court and appeals court disagreed, holding that defendants failed to meet their burden of showing that WFG’s complaint arose from speech and conduct in connection with a public issue. As the Court of Appeal explained, “[A]ll of the allegedly wrongful conduct and speech that plaintiffs attribute to defendants was committed in a business capacity, and was directed at a competitor’s associates and customers for the sole purpose of promoting the competing business as a superior employer and provider of products and services.” 

The Court of Appeal also rejected defendants’ strategy of couching their argument in terms of society’s general interest in the subject matter of the dispute—lawful employment, free competition and employee mobility—rather than focusing on the specific speech or conduct at issue in the complaint. “The focus of the anti-SLAPP statute must be on the specific nature of the speech rather than on generalities that might be abstracted from it.” Applying the statute in the general manner defendants proposed, the Court of Appeal observed, would mean that “every case alleging breach of a noncompetition agreement or the related misappropriation of trade secrets would be categorically subject to the anti-SLAPP statute,” effectively eviscerating the unfair business practices laws.

Finally, even if defendants had argued that the specific speech and conduct at issue was protected, that argument would still be unavailing because the statements by which defendants attempted to solicit employees and customers were not of public interest, were irrelevant to WFG’s claims, and were merely incidental to the conduct upon which the complaint is based.

If defendants’ immediate goal was to delay discovery, then the use of the anti-SLAPP statute essentially accomplished that objective—for the short term.  Beyond that, use of the anti-SLAPP statute to strike garden-variety misappropriation and non-solicitation claims, as confirmed in the World Financial Group decision, will likely be unsuccessful.

The Seyfarth Trade Secrets, Computer Fraud & Non-Competes practice group attorneys congratulate their colleagues, Brian Ashe, Erik von Zeipel, Daniel Sable, Kurt Kappes, and Timothy Nelson, who represented WFG at the trial and appellate levels!

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By Robert Milligan & Jim McNairy

After obtaining a sweeping nationwide injunction from an arbitrator that enjoined licensee Comedy Club, Inc. (“CCI”) from opening any new comedy clubs until 2019 pursuant to a trademark license agreement, licensor/competitor Improv West Associates (“Improv”) could not have been in the mood for laughs when the U.S. Court of Appeals for the Ninth Circuit modified the arbitrator’s injunction by significantly narrowing its scope and breadth. The decision is an important one for franchisors because the court indicated that in-term covenants not to compete in franchise like agreements will be void if they foreclose competition in a substantial share of a business, trade, or market.

The Ninth Circuit held in Comedy Club, Inc. v. Improv West Associates that an arbitrator’s injunction based on in-term covenant not to compete in a trademark license agreement, which precluded CCI and its affiliates (including tangential relatives of CCI principals) from competing in the comedy club business (apart from existing licensed “Improv” clubs that CCI continued to operate under the license agreement) until 2019, was not enforceable. Specifically, the court modified the nationwide scope and inclusion of tangential relatives of CCI principles in the arbitrator’s injunction.

The court found that the arbitrator’s injunction violated California Business & Professions Code Section 16600 (“CBPC § 16600”). With respect to the injunction barring affiliates from competing, the court stated:

Moreover, precluding non-party relatives or ex-spouses from opening or operating improv-comedy-related businesses or restaurants violates CBPC § 16600. . . . By restricting non-party relatives and ex-spouses from engaging in a lawful business, the injunctions, with respect to those persons, exceed the arbitrator’s authority.

 Regarding the scope of the nationwide injunction, the court stated that under existing California case law that it was evident that under CBPC § 16600 an in-term covenant not to compete in a franchise-like agreement will be void if it forecloses competition in a substantial share of a business, trade, or market. The court also stated that California courts are less willing to approve in-term covenants not to compete outside a franchise context because there is not a need to protect and maintain the franchisor’s trademark, trade name and goodwill.

The court indicated that under existing California case law that the franchisor-franchisee context was different from an employment or partnership context. The court stated that CCI’s relationship with Improv was in essence a franchise agreement as CCI contracted with Improv to use Improv’s trademarks and open comedy clubs modeled on Improv’s clubs. Assessing the requirements of California law, the court weighed CCI’s right to operate its business against Improv’s interest “to protect and maintain its trademark, trade name and goodwill.”  The court concluded that “this balance tilts in favor of Improv with regard to counties where CCI is operating an Improv club, but under the restraint of CBPC § 16600 California law does not permit an arbitrator to foreclose CCI’s competition in opening comedy clubs throughout the United States.” Accordingly, the court upheld a more limited injunction that restricted competition by CCI and those persons in active concert or participation with CCI but only in counties where CCI continued to operate comedy clubs using the licensed “Improv” name. Because the parties did not address its application, the court did not address whether the in-term covenant could be upheld under the trade secrets exception to CBPC § 16600.

Lessons from this case include:

1. In-term covenants not to compete may be enforceable in the franchise context “to protect trademarks, trade names, and goodwill of a licensor” if they are narrowly tailored and do not foreclose a party from engaging in its business or trade in a substantial section of the market—the geographic scope should be the territory where the company is or companies are doing business during the agreement. If franchisors can show that the in-term covenant is necessary to protect trade secrets, then they may be able to support a broader covenant. Franchisors should review their agreements to ensure that they comport with the court’s decision. 

2. Businesses should use caution before utilizing any covenants not to compete in California and should assess whether the restriction on competition can be tied to one of the statutory exceptions to California Business and Professions Code section 16600, to the protection of trade secrets, or the court’s in-term “franchise” exception to section 16600. These exceptions to California’s general prohibition against non-compete agreements were recognized by the court.

3. Franchisors should not include overly broad definitions of affiliates in their franchise agreements in California. Courts will not enforce overly broad covenants that restrict non-party relatives and ex-spouses from engaging in a lawful business because such covenants violate Business and Professions Code Section 16600.

4. The court’s decision highlights what the California Supreme Court made clear in its Edwards v. Arthur Andersen opinion: unless falling within one of few exceptions to Business and Professions Code Section 16600, post-term covenants not to compete are invalid in California regardless of whether such covenants are narrowly drawn.

5. The court’s decision places an increased focus on trade secrets. The court’s decision may be seen by some franchisees/employees as allowing greater mobility, even where proprietary information is taken. Auditing your organization’s trade secret protections is a valuable first step toward protecting against this risk, ensuring that your organization’s intellectual capital is adequately protected, and attempting to enforce a non-compete/non-solicit provision under the trade secrets exception to Business and Professions Code Section 16600.

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Our own Robert Milligan and Damon Anastasia published an oustanding article in the California Lawyer on the status of the law in California on non-competition agreements in light of Edwards v. Arthur Anderson.  The article is publicly available here.

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 By James McNairy & Robert Milligan

A new Ninth Circuit case, Asset Marketing Systems, Inc. v. Gagnon, 2008 WL 4138181 (Sept. 9, 2008), acknowledges (at least in dicta) that there is a trade secrets exception to Business and Professions Code Section 16600.

In the case, Gagnon, an independent contractor who developed computer programs for AMS, a field marketing organization, alleged, among other things that AMS had misappropriated his trade secrets that were contained in the programs’ source code.

The Ninth Circuit rejected Gagnon’s claims that AMS misappropriated his trade secrets.  The Ninth Circuit affirmed the district court’s determination that Gagnon had granted AMS an implied, unlimited license to retain, use, and modify the software, thus destroying any trade secret status the code might have had.

In rejecting Gagnon’s trade secret claim, the Court affirmed the district court’s holding that the noncompetition agreements signed by Gagnon’s employees were invalid. Gagnon contended that even if AMS obtained an implied license, it still misappropriated his trade secrets that were contained in the programs’ source code by hiring away his employees in violation of their employment agreements. One of the provisions in the employees’ agreements was an agreement not to engage in any employment or personal contractual agreement for AMS for twenty-four months without written consent from Gagnon.

Citing the California Supreme Court’s recent decision in Edwards v. Arthur Andersen LLP, 189 P.3d. 285, 288 (2008), the Ninth Circuit stated (arguably in dicta) that noncompetition agreements in California are invalid unless necessary to protect an employer’s trade secrets. The California Supreme Court in Edwards, however, specifically did not address what it called the so-called trade secret exception to Bus. & Prof. Code § 16600 and rejected the Ninth Circuit’s narrow restraint exception to section 16600 (the “narrow restraint” exception interpreted section 16600 to allow noncompetition agreements where departing employees were barred from pursuing only a small or limited part of a business, trade or profession). According to the Ninth Circuit, the non-competition agreements that Gagnon had his employees execute “were no longer enforceable” because they were no longer necessary to protect Gagnon’s trade secrets against AMS.

In this first post-Edwards published Ninth Circuit decision regarding section 16600, the Court did not provide any specific analysis concerning the nature of the trade secrets exception and what one must show to make defensible use of it. The Court’s dicta appears to suggest that non-competition agreements executed “to protect” an employer’s trade secrets will be enforceable. But as with most things legal, with trade secrets, the devil is in the details. What exactly the Court meant by a non-competition agreement to protect trade secrets is unclear. Further, mere assertions in employee/employer noncompetition agreements that the agreement has been executed “to protect” trade secrets without more is unlikely to withstand challenge.

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 In Contemporary Services Corp. v. Hartman, 2008 WL 3049891 (C.D. Cal.), the United States District Court for the Central District of California recently declined supplemental jurisdiction over state law claims removed to the court where federal jurisdiction was based solely on the Computer Fraud and Abuse Act, 18 U.S.C. § 1030. Finding that state issues substantially predominated, the court noted that the “[e]lements and facts that Plaintiffs must prove to establish their CFAA claim are different from what they must prove to establish their other claims.”   

 The court retained jurisdiction over the CFAA claim and remanded all of the state law claims.

Plaintiffs filed suit in state court against defendant Hartman, asserting seven claims for relief: (1) violation of the CFAA; (2) Breach of Fiduciary Duty; (3) Conversion; (4) Breach of Contract; (5) Fraud; (6) Intentional Interference with Prospective Economic Advantage; and (7) Breach of Fiduciary Duty.   Defendant removed the case to federal district court.  Defendant moved to remand the case to state court.  Defendant also moved to dismiss several of plaintiff's claims.

Plaintiffs filed a First Amended Complaint in which they abandoned their sixth and seventh causes of action. Defendant answered and filed five counterclaims arising under state law for: (1) Unpaid Wages; (2) Waiting Time Penalties; (3) Violation of Cal. Lab. Code § 2802; (4) Indemnification under Cal. Lab Code § 2802 and Cal. Corp. Code § 317; and (5) Unfair Competition Under Cal. Bus. & Prof. Code § 17200.

Turning to plaintiffs’ motion for remand, the district court held that “[i]n all important respects, this action involves an employment dispute between the parties that has given rise to nine state law claims and counterclaims which substantially predominate over the sole federal claim.” Continuing, the court noted that all of the claims and counterclaims derived from the facts triggered by defendant's decision to leave plaintiffs' employment, including that defendant allegedly breached her fiduciary duties owed to plaintiffs by deleting work product stored on her work computer and defrauding plaintiffs by making false representations about the information contained on plaintiffs' shared drive and computer. 

Defendant's counterclaims for unpaid wages and unfair competition arose from Plaintiffs' alleged conduct after defendant ended her employment.   

Distinguishing the CFAA from the other claims in suit, the court noted “[T]he elements and facts that Plaintiffs must prove to establish their CFAA claim are different from what they must prove to establish their other claims.” Plaintiffs' claims for breach of fiduciary duty and breach of contract derive from the parties' rights and responsibilities under the employment contract. Plaintiffs' claim for fraud arises from Defendant's alleged misrepresentations during her employment. Defendant's counterclaims for unpaid wages and indemnification were based on Plaintiffs' conduct after defendant returned the computer and left their employment.

In contrast, to prove a CFAA claim, one must show that the computer in question was a “protected computer,” and that the conduct involved one of five categories of harm that are a necessary element of a civil action under the CFAA. As plaintiffs did here, claimants most often meet the “harm” element by alleging a loss of at least $5,000 in value. When relying on this element, under 18 U.S.C. § 1030(a)(5)(B), plaintiffs are limited to economic damages.

Finally, the court found it “[n]oteworthy that the relief Plaintiffs seek under the CFAA is not unique to that claim; Plaintiffs also seek compensatory damages and injunctive relief pursuant to all four of their state claims for relief. *** In short, even as to the array of remedies that Plaintiffs seek, their state claims predominate; indeed, rather than “trailing” the federal remedies, the state-based claims encompass additional prayers for relief, such as punitive damages.”

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On August 7, 2008, in Edwards v. Arthur Andersen LLP, No. S147190, the California Supreme Court seemingly ruled that Section 16600 of the Business and Professions Code prohibits every attempt by an employer to enforce a non-competition agreement. The court indicated that the only exceptions are those expressly set forth in the statute (agreements in connection with the sale or dissolution of a business).

The same day, a class-action complaint was filed in Contra Costa County Superior Court, Vokes, et al. v. Central Garden & Pet Co., No. C 08-01994, that could test the reach of the Edwards decision.  Plaintiffs are asking the court to invalidate a non-compete agreement signed by Vokes when he became Central Garden’s Senior VP Sales and Trade Relations and, on behalf of all all Central Gardens employees, seeking to invalidate all of Central Gardens’ non-compete agreements as violating Section 16600 and related California statutes.

For more than 20 years prior to going to work for Central Gardens, Vokes had been employed by Doskocil, a competitor of Central Gardens. When he left in January 2007, he was VP of Sales. Upon becoming employed by Central Gardens as its Senior VP Sales and Trade Relations, he signed a non-compete agreement. It provided for 24 months of paid post-termination “independent contractor” status (according to the complaint, however, the compensation amount was “a small fraction of his wages as [a Central Gardens] employee”). The agreement mandated non-competitor employment and non-customer solicitation, in virtually any geographic market served by Central Gardens' market, during and for the 12 months following the “independent contractor” period.

In July 2008, Vokes resigned from Central Gardens and returned to Doskocil, in Texas. Central Gardens immediately sued in Texas to enforce the agreement and obtained a TRO (according to the Contra Costa County complaint, ex parte and without notice) against Vokes and Doskocil. They then filed the Contra Costa County complaint.

Whether the Contra Costa County court will adjudicate the complaint or will stay the action in light of the earlier-filed Texas complaint is uncertain. Also unclear is whether the Contra Costa County Court will certify the class and whether the agreement might be enforceable at least during the 24-months “independent contractor” period. The outcome of this case, if it proceeds, will be interesting.

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 By Robert Milligan, Kurt Kappes and James McNairy

The California Supreme Court released its highly anticipated decision in Edwards v. Arthur Andersen LLP  today and held that employee non-competition agreements are invalid, even if narrowly drawn, unless the agreement falls within a statutory exception. 

In doing so, the Court rejected the Ninth Circuit’s narrow restraint exception, which excepted the prohibition contained in Business and Professions section 16600 on non-competition agreements where one was barred from pursuing only a small part or limited part of the business, trade or profession.

In its decision, the Court limited its review to two issues:

1)      To what extent does Business and Professions Code section 16600 prohibit employee non-competition agreements;

2)      Is a contract provision requiring an employee to release “any and all” claims unlawful because it encompasses nonwaivable statutory protections, such as the employee indemnity protection of Labor Code section 2802.

The Court concluded that Business and Professions Section 16600 prohibits employee non-competition agreements unless the agreement falls within the applicable statutory exceptions of sections 16601, 16602, or 16602.5. The Court also held that a contract provision whereby an employee releases “any and all” claims does not encompass nonwaivable statutory protections, such as the employee indemnity protection of Labor Code section 2802.

On the first issue, the Court found that California state courts have consistently affirmed that section 16600 evinces a settled legislative policy in favor of open competition and employee mobility. Section 16660 states: “Except 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.” (emphasis added) The chapter excepts non-competition agreements in the sale or dissolution of corporations (§ 16601), partnerships (§ 16602), and limited liability corporations (§ 16602.5). 

The Court noted that it had previously invalidated an otherwise narrowly tailored agreement as an improper restraint under section 16600 because it required a former employee to forfeit his pension rights on commencing work for a competitor (citing Muggill v. Reuben H. Donnelley Corp. (1965) 62 Cal.2d 239, 242-243). The Court, quoting Muggill, stated section 16600 invalidates provisions in employment contracts and retirement pension plans that prohibit “an employee from working for a competitor after completion of his employment or imposing a penalty if he does so unless they are necessary to protect the employer’s trade secrets.”

The two clauses at issue in Edwards’ agreement with Andersen provided:

1)      If you leave the Firm, for eighteen months after release or resignation, you agree not to perform professional services of the type you provided for any client on which you worked during the eighteen months prior to release or resignation. This does not prohibit you from accepting employment with a client. 

2)      For twelve months after you leave the Firm, you agree not to solicit (to perform professional services of the type you provided) any client of the office(s) [Los Angeles] to which you were assigned during the eighteen months preceding release or resignation. 

Andersen argued that the Court should interpret the term “restrain” under section 16600 to mean simply to “prohibit,” so that only contracts that totally prohibit an employee from engaging in his or her profession, trade, or business are illegal. 

The Court rejected that argument and found that Andersen’s non-competition agreement was invalid because the two specific clauses at issue in the agreement restricted Edwards from performing work for Andersen’s Los Angeles clients and therefore restricted his ability to practice his accounting profession. 

Earlier in the decision, the Court expressly stated it did not address the applicability of the “so-called trade secret exception to section 16660.” Before the Supreme Court granted the petition for review in Edwards, the lower appellate court’s decision remanded the case to the trial court to determine if the trade secret exception applied, i.e. the non-competition agreement was necessary to protect trade secrets. The Court’s disposition indicates that the issue is closed though and that there will be no such remand to the trial court:

We hold that the noncompetition agreement here is invalid under section 16600, and we reject the narrow-restraint exception urged by Andersen. Noncompetition agreements are invalid under section 16600 in California even if narrowly drawn, unless they within the applicable statutory exceptions of sections 16601, 16602, or 16602.5

Andersen asked the Court to adopt the limited or “narrow-restraint” exception to section 16600. The Court noted that confusion over the Ninth Circuit’s application of section 16600 arose in a paragraph in the Ninth Circuit’s decision in Campbell v. Trustees of Leland Stanford Jr. Univ. (9^th Cir. 1987) 817 F.2d 499, in which the Ninth Circuit stated that some California state courts have excepted application of section 16600 “where one is barred from pursuing only a small or limited part of the business, trade or profession” (citing Boughton v. Socony Mobil Oil Co. (1964) 231 Cal.App.2d 188 and King v. Gerold (1952) 109 Cal.App.2d 316). The Court found that the reasoning in these state court cases does not provide persuasive support for adopting the narrow restraint exception because Boughton involved the use of land, not a restriction upon a plaintiff’s practice of a profession, and King relied upon a trade secret exception to the statutory rule. 

The Court acknowledged that recent Ninth Circuit cases have followed Campbell to create a narrow-restraint exception to section 16600 in federal court. The Court stated that California state courts have not embraced the Ninth Circuit’s narrow restraint exception and stated “no reported California state court decision has endorsed the Ninth Circuit’s reasoning, and we are of the view that California courts have been clear in their expression that section 16660 represents a strong public policy of the state which should not be diluted by judicial fiat” (citing Scott v. Snelling and Snelling, Inc. (N.D. Cal. 1990) 732 F. Supp. 1034, 1042).

In sum, while the Court’s decision clearly states California does not recognize a “narrow restraint” exception to the general rule that employee non-competition agreements are invalid, the Court did not specifically address when non-solicitation of customer and employee clauses are permissible to protect trade secrets. 

The San Francisco Chronicle also has posted an article about this case.

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           According to the California Supreme Court's website, the Court’s highly anticipated decision in Edwards v. Arthur Andersen, LLP will be available tomorrow, August 7, 2008 at 10:00 a.m. on the Court’s website.

            Trade secret and employment attorneys have been closely following the Edwards case after the Supreme Court granted review of the case on November 29, 2006. 

            In the lower court, the Court of Appeal for the Second Appellate District expressly rejected somewhat settled Ninth Circuit case law that provides an exception to the general rule in California that covenants not to compete are unlawful in the employment context pursuant to Business and Professions Code section 16600. The narrow restraint exception essentially provides that a noncompetition agreement is not unlawful where it leaves a substantial portion of the market open to the employee. The lower court expressly found that the narrow restraint exception was a “misapplication of California law when applied to an employee’s noncompetition agreement.” The court further stated “[i]n our view, section 16600 prohibits noncompetition agreements between employers and employees even where the restriction is narrowly drawn and leaves a substantial portion of the market available for the employee.”

            The lower court also found that the broadly worded release that Edwards allegedly was required to sign was unlawful because it purportedly waived Edwards’ Labor Code section 2802 rights. Labor Code section 2802, subdivision (a), provides: "An employer shall indemnify his or her employee for all necessary expenditures or losses incurred by the employee in direct consequence of the discharge of his or her duties . . ." The lower court held that “[b]ecause Labor Code section 2802's indemnity provisions implement public policy, requiring Edwards to waive indemnity rights as a condition of continued employment violated public policy and constituted an independently wrongful act for purposes of . . .[Edwards’] intentional interference with prospective economic advantage claim.”

            The issues that the Supreme Court are expected to address in tomorrow’s decision are:

 (1) Is a non-competition agreement between an employer and an employee that prohibits the employee from performing services for former clients invalid under Business and Professions Code section 16600, unless it falls within the statutory or judicially-created trade secrets exceptions to the statute?

(2) Does a contract provision releasing "any and all" claims the employee might have against the employer encompass non-waivable statutory protections, such as the employee indemnity protection of Labor Code section 2802?

            We will provide a follow-up blog entry once the decision comes out.  

By Robert Milligan, James McNairy and Summer Associate Julia Brodsky

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