By Robert Milligan and Joshua Salinas

On October 12, 2011, the California Court of Appeal in Nicholas Laboratories, LLC v. Christopher Chen, No. G044105, 2011 WL 4823329 (Cal. Ct. App. Oct. 12, 2011), held that Labor Code section 2802 does not require an employer to reimburse its employee for attorney fees incurred in the employee’s successful defense of the employer’s action against the employee.  While reaffirming the traditional American rule in non-wage related litigation between employees and employers, the decision serves as a reminder to California employers of the implications involved in providing a defense and indemnifying employees in suits brought by third parties, including suits brought by their former employers against employees for trade secret theft.

Labor Code section 2802 provides:

(a) 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, or of his or her obedience to the directions of the employer, even though unlawful, unless the employee, at the time of obeying the directions, believed them to be unlawful.

(b) All awards made by a court or by the Division of Labor Standards Enforcement for reimbursement of necessary expenditures under this section shall carry interest at the same rate as judgments in civil actions. Interest shall accrue from the date on which the employee incurred the necessary expenditure or loss.

(c) For purposes of this section, the term “necessary expenditures or losses” shall include all reasonable costs, including, but not limited to, attorney’s fees incurred by the employee enforcing the rights granted by this section.

Nicholas Laboratories, LLC (Nicholas Labs) filed suit against employee Christopher Chen for alleged theft of company property, misuse of the company credit card, and diverting business opportunities away from Nicholas Labs. The trial court entered judgment for Chen and against Nicholas Labs on the complaint and awarded Chen his costs. Chen then moved for attorney fees per Labor Code section 2802. The issue before the Court of Appeal was whether Nicholas Labs was required to “indemnify” its ex-employee, defendant Christopher Chen, for attorney fees incurred by Chen during his successful defense of the action. 

Chen asserted that various statutory (Lab. Code, § 2802, subd. (a); Corp. Code, § 317, subd. (d)) and/or contractual indemnity provisions obligated Nicholas Labs to reimburse Chen. Additionally, Chen argued that California’s strong public policy favors indemnification of employees by their employers.

The Court of Appeal rejected Chen’s argument and held that Labor Code section 2802 does not require an employer to reimburse its employee for attorney fees incurred in the employee’s successful defense of the employer’s action against the employee. The court stated that indemnification only applies to suits from third-parties and not the employer itself.  The court further concluded that Corporations Code section 317 did not apply because Nicholas Labs was a limited liability company and not a corporation.

This case highlights the situation where a new employer provides a defense for and indemnification for a new employee in a lawsuit brought by his or her former employer. Specifically, the issue may arise in the context of an ex-employee’s alleged trade secret misappropriation on behalf of or for the benefit of the new employer. Under Labor Code section 2802, an employer is required to indemnify employees in defense against third-parties for “all necessary expenditures or losses incurred by the employee in direct consequence of the discharge of his or her duties, or of his or her obedience to the directions of the employer.” The broad language of the statute can make new employers, who have litle knowledge of miscreants’ actions on behalf of their employer, responsible not only for their defense but for indemnification for any money judgment obtained against the employees. Employers need to be particularly vigilant before hiring such high risk employees from competitors to make sure the potential “baggage” in having such employees is worth the risk. Additionally, counsel that represent both the ex-employee and new employer in such suits may have potential conflicts of interest in these joint representation scenarios, which must be constantly monitored.