By Joshua Salinas and Robert Milligan
A California Court of Appeal recently reversed a trial court ruling that found a stipulated injunction preventing the solicitation of customers was invalid and unenforceable under California Business & Professions Code section 16000.
In Wanke, Industrial, Commercial, Residential, Inc. v. Sup. Ct., 2012 WL 4711888 (Cal.App. 4 Dist., October 4, 2012), the Court of Appeal held that since the trial court could not conclude, based on the language of the stipulated injunction, that it does not protect the plaintiff’s trade secrets, the court erred in concluding that it was an unlawful business restraint.
Plaintiff Wanke is a southern California company that installs waterproofing systems. Defendants Scott Keck and Jacob Bozarth are former employees of Wanke that left Wanke to start their own competing waterproofing company, WP Solutions.
Wanke brought action in late 2008 against Keck and Bozarth alleging that they misappropriated and misused Wanke’s trade secrets and confidential information, and used that information to actively target and recruit Wanke’s customers.
The parties ultimately resolved the action in 2009 by entering into a settlement and mutual general release agreement. Pursuant to the settlement agreement, Keck, Bozarth and WP Solutions agreed to a stipulated injunction, in which they would refrain from contacting or soliciting any customers listed on an agreed customer list for five years subject to certain exceptions. The stipulated injunction also provided for liquidated damages in the amount of $50,000 for initial violations of the order, with the amounts increasing in increments of $10,000 for each subsequent violation of the order, plus Wanke’s attorneys’ fees, costs, and expenses.
Proceedings to Enforce the Stipulated Injunction
A dispute arose the following year when the defendants allegedly contacted and/or supplied labor and materials to a customer on the prohibited customer list, Con Am Management. Wanke subsequently filed an application for an order to show cause requesting the trial court to hold the defendants in contempt for having violated the stipulated injunction. Wanke also filed a motion to enforce the settlement agreement related to Con Am Management and requested the court order defendants to pay liquidated damages as provided in the stipulated injunction.
The trial court held a combined trial/hearing on Wanke’s order to show cause for contempt and motion to enforce the settlement agreement. The trial ultimately court found that Wanke failed to establish the “existence of a lawful order,” which is required before a party may be held in contempt of that order.
Specifically, the trial court determined that the stipulated injunction was invalid to the extent it prohibited defendants from soliciting any entity merely because the entity appeared on the customer list attached to the stipulated injunction. Citing Business and Professions Code section 16600, the trial court viewed the stipulated injunction as a non-compete agreement, which could only prohibit customer solicitation if the employee was utilizing trade secret information to solicit those customers.
The trial court found that the identity and location of Con Am Management was easily identifiable and thus, not a trade secret. To avoid striking down the injunction in its entirety, and thereby unwind the entire settlement and resolution between the parties, the trial court narrowed the application of the injunction only to the extent it was used to prohibit defendants from undertaking or proposing to undertake jobs from customers on the customer list while defendants were employed by Wanke. The trial court explained that only on these jobs can defendants be said to be using information they learned while employed at Wanke to identify customers with particular needs or characteristics that would be protectable under California law.
With respect to the motion to enforce the settlement agreement, the trial court ruled that no liquidated damages may be imposed because the alleged violations were not in fact violations of the stipulated injunction as interpreted above by the court. Notwithstanding, the trial court awarded Wanke attorneys’ fees on the motion to enforce the settlement agreement because it obtained a declaratory judgment regarding the scope and enforceability of the stipulated injunction.
A few months later, Wanke filed second motion to enforce the stipulated injunction with respect to a different customer identified in the customer list, AV Builders. This time, the trial court found the defendants violated the stipulated injunction because the AV Builders work involved jobs undertaken or proposed to be undertaken when defendants were employed by Wanke. The trial court awarded Wanke its attorneys’ fees, along with $50,000 in liquidated damages as provided in the settlement agreement.
Court of Appeal
Both parties appealed. Defendants appealed the trial court’s findings that they violated the stipulated injunction as to AV Builders and the award of attorneys’ fees to Wanke regarding the motion to enforce the settlement as to Con Am Management. Wanke appealed the trial court’s order denying its motion to enforce the settlement as to defendants’ work for Con Am Management. Additionally, Wanke filed a petition for writ of mandate challenging the trial court’s order which refused to hold Keck and WP Solutions in contempt for violating the stipulated injunction. Wanke requested the Court of Appeal to enforce the entirety of the settlement agreement and stipulated injunction. Wanke also asked the appellate court to annul the trial court’s order discharging the OSC for contempt and direct the trial court to hold Keck and WP Solutions in contempt.
A. Contempt Ruling
With respect to the contempt issue, the Court of Appeal concluded that the double jeopardy clause of the Fifth Amendment to the federal constitution precluded the court from reviewing the trial court’s acquittal of Keck and WP Solutions on the contempt charges. Wanke argued that double jeopardy did not apply because the government did not prosecute the action. The Court found that there was no language in the binding U.S. Supreme Court decision of United States v. Dixon that limited application of the clause to the contempt proceeding here, which it characterized as a nonsummary criminal contempt proceeding, rather than civil contempt proceeding.
B. Validity of Stipulated Injunction Ruling
Notwithstanding its conclusion on the contempt issue, the Court then analyzed whether the trial court erred in determining the stipulated injunction was invalid and unenforceable. The Court reasoned that a party may successfully defend against the enforcement of an injunction that the trial court issued in excess of jurisdiction. The court, however, found that party may not defend against enforcement of a court order by contending merely that the order is legally erroneous. The Court reasoned that under existing authority an injunctive order enforcing an invalid contract, the invalidity of which is not apparent on its face, is not an injunction issued in excess of jurisdiction.
The Court then reasoned that 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. The Court also discussed Morlife, Inc. v. Perry (1997) 56 Cal.App.4th 1514, in which the court concluded that there was substantial evidence to support the trial court’s finding that the employer’s customer list constituted a protectable trade secret. And as a result, the Morlife court concluded that the trial court had not erred in enjoining former employees from soliciting any business from any entity that did business with Morlife before the former employees stopped working there, provided they obtained knowledge about the customer during the course of their employment at Morlife. The Court also reasoned that under the California Supreme Court’s decision in Edwards v. Arthur Andersen LLP (2008) 44 Cal. 4th 937, section 16600 generally prohibits the enforcement of nonsolictiation agreements in all cases in which the trade secret exception does not apply. The Court also noted that there was a dispute among California appellate courts as to whether such an exception actually exists.
The Court held that Keck and WP failed to make a showing against the enforcement of the injunction on the ground that the injunction was beyond the trial court’s jurisdiction to issue. The Court reasoned that at the time the trial court issued the injunction it had personal and subject matter jurisdiction over the parties. It was also undisputed that Wanke had filed a lawsuit alleging trade secret misappropriation and had requested an order enjoining Keck and WP Solutions from soliciting its customers and the trial court entered the stipulated injunction as part of final resolution of the case. According to the Court, each of these fact supported the validity of the stipulated injunction.
The Court also noted that Keck and WP Solutions did not claim that the Stipulated Injunction was obtained in an unauthorized manner or in violation of statutory procedures. Further, there was nothing on the face of the stipulated injunction that indicated that it was unconstitutional or that it violated a statute. On the contrary, the Court noted that Keck and WP Solutions had conceded that employee non-competition agreements could be enforceable to protect the former employer’s confidential trade secret information and that the misuse of trade secret information may be properly enjoined by agreement. The Court highlighted the fact that defendants failed to oppose the existence of the so called “trade secret exception” to California’s prohibition on the enforcement of non-compete agreements.
The Court held that, because the stipulated injunction was valid to the extent that it protects Wanke’s trade secrets, and one cannot conclude from the face of the stipulated injunction that it does not protect Wanke’s trade secrets, the stipulated injunction was facially valid. The court remarked that even assuming that Keck and WP Solutions could demonstrate that the trial court erred in issuing the stipulated injunction because the customer list attached to the stipulated injunction was not a protected trade secret, such a showing would be insufficient to avoid enforcement of the injunction. That is because the Court reasoned that demonstrating that the trial court erred in issuing the injunction would not be sufficient to demonstrate that it acted in “excess of its jurisdiction” in doing so.
Finally, the Court recognized that common sense and fundamental fairness support its ruling. The Court explained that parties cannot stipulate to injunctions that identify certain customers whom they will not solicit in order to resolve claims that they misappropriated trade secrets, then proceed to violate the injunction and claim that the customer list is not a trade secret. Even assuming that Keck and WP Solutions were permitted to collaterally attack the validity of the stipulated injunction, and that they could prove that the customer list attached to the stipulated injunction was not a trade secret, the Court found that they made no such factual showing in this case.
In short, since the trial court could not conclude, based on the language of the stipulated injunction, that it does not protect Wanke’s trade secrets, the court erred in concluding that the stipulated injunction was an unlawful business restraint.
The defendants’ two claims in their appeal both failed in light of the Court’s conclusion that the trial court erred in determining that the stipulated injunction could not be enforced as drafted.
This case reminds us that California’s general prohibition on noncompetition agreements applies to all agreements that restrain anyone’s engagement in a lawful profession, trade, or business (unless there is an applicable exception); not merely agreements in the employer-employee context. Indeed, even settlement agreements and stipulated injunctions as part of the resolution of a lawsuit are within the ambit of Business and Professions Code section 16600.
While this case does not foreclose the ability to obtain injunctive relief when the settlement agreement and stipulated injunction contain restrictive covenants, it illustrates the difficulties in obtaining relief if the other side enters the agreement in bad faith. Thus, it is important to include language in any settlement agreement, which also contains restrictive covenants, and stipulated injunction references and stipulated findings as to the existence of trade secrets and how and why the agreement and/or injunction is necessary to protect trade secrets.
This case demonstrates that one possibility to increase the effectiveness of a settlement agreement, containing restrictive covenants, is to include a liquidated damages clause for any violations. Another possibility would be to require that money be placed in an escrow account for the life of the restricted period. While these remedies will not guarantee a party will not violate the terms of the agreement or ensure further injunctive relief, they may provide some relief for any damages suffered from a breach.
The case also demonstrates that the California appellate courts are presently split on whether there is a trade secret exception to Business and Professions Code section 16600, which may ultimately necessitate the California Supreme Court’s guidance.
This case is significant as it provides insight for parties that are assessing the enforceability of restrictive covenants contained within settlement agreements, stipulated injunctions, and other agreements. Specifically, parties may attack such agreements on the grounds of the lack of trade secrets and/or language that the restrictive covenants are necessary to protect trade secrets. At least in the case, however, the Court placed some stock in the parties’ agreed resolution to dissuade future collateral attack of the parties’ agreed language. What is clear, however, based on this decision is that non-solicitation of customers provisions that are unnecessary to protect trade secrets or not otherwise subject to an applicable exception are void and unenforceable.