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

By Scott Schaefers

            In a recent decision involving whether a former employer could obtain a temporary restraining order under its broad non-competition agreement with its former employees and former software development company, the federal court in Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158 (N.D.Cal. July 1, 2011) granted plaintiff’s request and enjoined defendants from competing with plaintiff while using its proprietary information. The court attempted to balance plaintiff’s property interests in its confidential data and business reputation against California’s long held public policy against noncompetition agreements. Ultimately, the court held there was sufficient evidence of defendant’s alleged wrongdoing to justify a TRO. 

            The Richmond court effectively “blue penciled,” or reformed, plaintiff’s broad non-compete agreement, rolling back its provisions to conform with California’s “trade secret exception” to California’s statutory bar on employee non-competes. Such blue penciling is arguably inconsistent with several recent California state court decisions prohibiting such reformation of overbroad noncompetes. In the end, the case highlights the difficulty in applying a trade secret exception to Business and Professions Code section 16600 and determining whether sued-upon noncompete covenants are necessary to protect an employer’s trade secrets.

Plaintiff’s Allegations in Richmond Technologies

            The plaintiff in Richmond was a distributor of enterprise planning software. Plaintiff sued defendants, which were plaintiff’s source-code company and plaintiff’s former employees, for misusing plaintiff’s source code and proprietary customer data to unfairly compete with plaintiff, before and after defendants terminated their relationships with plaintiff. In doing so, defendants (plaintiff alleged) breached their noncompete, non-solicitation, and non-disclosure agreements with plaintiff, violated California’s unfair competition statute, and were liable under other related common law theories. Notably, plaintiff did not make a claim for trade secret misappropriation under California’s Uniform Trade Secret Act (Cal. Civ. Code § 3426.1 et seq.).

.           The noncompete agreement prohibited defendants from competing with plaintiff for one year after their relationships terminated, and the non-solicitation agreements prohibited defendants from soliciting plaintiff’s customers during defendants’ employment and for one year thereafter. There appeared to be no significant difference in the broad application of the non-solicitation and noncompete agreements; in fact, the non-solicitation agreements, which contained certain exceptions regarding time lapse and the employees pre-existing relationship with the customer, were narrower than the noncompete. The non-disclosure agreement prohibited defendants from using plaintiff’s proprietary data.

The Court’s Decision

            Even though the court denied an injunction based on plaintiff’s non-solicitation agreements because they were overbroad and likely unenforceable under California’s statutory bar against restrictive covenants (Cal. Bus. & Prof. Code § 16600), the court issued a limited injunction based on the non-competition agreement. The court noted and discussed at some length the “trade secret exception” under Section 16600, which, despite California’s strong public policy against non-competition agreements, permitted claims for breach of noncompete agreements if necessary to protect a trade secret. Retirement Group v. Galante, 176 Cal.App.4th 1226, 1237, 98 Cal.Rptr.3d 585 (Cal.Ct.App.2009) and Edwards v. Arthur Andersen LLP, 44 Cal.4th 937, 81 Cal.Rptr.3d 282, 189 P.3d 285 (2008).  Plaintiff presented sufficient evidence, the court found, that:

• defendants had access to Richmond’s customers’ specialized requirements;
• defendants set up their competing business almost a year prior to terminating relationship with plaintiff;
• prior to terminating, defendants stopped using their Richmond e-mail accounts to communicate with plaintiff’s customer, and instead began using their Aumtech e-mail accounts;
• defendants listed plaintiff’s customers on Aumtech’s website as Aumtech customers;
• defendants contacted specific plaintiff customers and induced them to switch to defendants; and
• one of the individual defendants, prior to resigning from plaintiff, wiped her Richmond computer using three wiping programs, thus forever deleting many customer files and e-mails that Richmond needed to carry on its business with those customers.

            In light of this evidence, the court found that there were, at a minimum, “serious questions going to the merits” of plaintiff’s claims which justified its TRO.

            Nevertheless, to balance plaintiff’s interests against California’s policy against noncompetes, the court “narrowly” drew its injunction, such that defendants were prohibited from:

• holding out plaintiff’s customers on Aumtech’s website as defendants’ customers;
• initiating contact with plaintiff’s customers that defendants knew of or had contact with during their employment with plaintiff (except for broad-based marketing of its products), but defendants were not prohibited from responding to requests initiated by such customers;
• using plaintiff’s proprietary data to negotiate or do business with plaintiff’s customers, but defendants were allowed to do business with those customers so long as defendant’s did not use such plaintiff’s proprietary information; and
• using plaintiff’s source code in their business, but defendants were allowed to market and sell similar products so long as they did not use plaintiff’s trade secrets.

The Court’s Decision and State Court Authority

            The court’s findings are arguably inconsistent with recent California state court decisions; however, this is just a decision on the temporary restraining order and not a preliminary injunction. On the one hand, the Richmond court held that plaintiff’s broad non-solicitation agreements were unenforceable under Section 16600 because they were not “narrowly tailored” to protect plaintiff’s trade secrets, even though the agreements contained certain exceptions. Plaintiff’s noncompete agreement, however, was just as broad, if not more so - it provided that, upon defendants’ termination of their relationships with plaintiff and without exception, they “will not compete with [plaintiff] with similar product and or Service using its technology for a period of one year thereafter.” Nevertheless, the court issued the injunction under the noncompete.

             In effect, the court blue-penciled or reformed the noncompete to conform to the trade-secret exception under Section 16600. Such blue-penciling has been held impermissible by several California cases, including those which held that employers violate California’s unfair competition statute (Cal. Bus. & Prof. Code § 17200) by even requiring employees to sign overly broad noncompete agreements at the beginning of their employment. See Kolani v. Gluska, 64 Cal.App.4th 402, 407-08 (1998) (holding that trial court properly declined to rewrite illegal covenant not to compete into a narrow bar on theft of confidential information); D’Sa v. Playhut, Inc., 85 Cal.App.4th, 927, 934-35 (2000) (refusing to narrowly construe invalid covenant not to compete so as to make it enforceable); Dowell v. Biosense Webster, Inc., 179 Cal.App.4th 564, 579  (2009).                                                                     

Lessons Learned           

               The takeaways from the Richmond decision are that (1) California courts still struggle with whether there is a trade secret exception to Section 16600 that would permit certain narrow noncompete restrictions; (2) when drafting restrictive covenants, employers should make sure they are tailored to protect against the misuse of trade secrets; (3) employers should monitor employee’s conduct and keep an eye out for unlawful activity (defendants in Richmond allegedly engaged in unlawful activity for almost a year without plaintiff knowing), and (4) when suing a former employee for breach of contract and trade secret theft, recognize that courts will likely impose heavy pleading and proof burdens, and diligently investigate and document alleged misconduct.

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There is wiener controversy brewing, but this one does not involve Twitter™ or a Representative from New York. Rather, this dust up concerns a Chicago hot dog dynasty and allegations of misappropriated trade secrets, false advertising, unfair competition, and trademark infringement.

On June 21, 2011, District Court Judge Sharon Coleman denied Vienna Beef LTD’s motion for a temporary restraining order which sought to enjoin competitor hot dog maker Red Hot Chicago , Inc. ("RHC") and its founder, Scott Ladany (collectively, "Defendants"), from engaging in various alleged conduct, including using Vienna Beef recipes or claiming that their recipes are century old, date back to 1893, or that they are Sam Ladany or Ladany family recipes. Vienna Beef claims, among other things, that its hot dog recipes are trade secrets and that RHC is using them without permission.

Scott Ladany is the grandson of company founder Samuel Ladany, who in 1893 began selling sausages using a family recipe. Scott Ladany began working for Vienna Beef in 1971 and obtained a 10% stock interest. The Ladany family sold Vienna in the early 1980s to plaintiff Vienna Beef ("Vienna"). Scott Ladany remained employed by Vienna until 1983, when he sold his 10 percent stake in Vienna. At the time Ladany left Vienna, he signed agreements which prohibited him from using or disclosing Vienna’s trade secrets and competing with Vienna for a specified term.

In 1986, at the end of the non-compete term, Ladany started RHC.

As to its trade secrets claim, Vienna offered the following evidence of misappropriation (1) that Defendants included language in their advertising stating that Defendants have been making hot dogs "using" a century-old "time honored family recipe" which "is the foundation for a true Chicago-style hot dog…"; and (2) sworn statements by vendors attesting that Defendants claim their products are made with Vienna’s recipes.

In her Memorandum Opinion, Judge Coleman held that Vienna had predicated its trade secrets claim on RHC’s advertising materials and that RHC effectively rebutted Vienna’s allegations. The Court cited to an affidavit filed by Ladany unequivocally stating that RHC does not use the Vienna recipe developed by Ladany’s grandfather, but instead developed its own recipe as early as 1986 through work with Heller Seasonings & Ingredients, which recipe has been used by RHC in substantially similar form for 25 years.

The Judge concluded that, in any event, Vienna "has shown no evidence that [its] recipes were used in RHC’s business and therefore cannot show that it is likely to succeed on the merits of [its claim for misappropriation of trade secrets]." Likewise, the Court found that Vienna had not shown irreparable harm as, but for one new advertisement, the complained of advertising had been used by RHC "for years", thus negating the need for emergency relief. Accordingly, the Court found that Vienna Beef's application did not pass muster and was denied. Based upon the Court's ruling, it will be interesting to see if there is a round two of the wiener wars in the form a preliminary injunction motion.

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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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