Can You Keep a Secret?

From trade secrets like product recipes and algorithms to confidential details about financing, customers and costs, all businesses have information that could be devastating if it were to fall into a competitor’s hands.

By attending this free seminar presented by our intellectual property experts, you will discover the ways employers must designate and guard proprietary information to ensure legal protection of this most critical asset.

Things You Will Learn

• Steps you can take to protect confidential information
• How to draft and enforce confidentiality agreements
• What “noncompetition protection” is and whether it is available to your business
• What to do when a competitor obtains your protected information
• What policies you must have
• What “venue provisions” are and why they are more important than ever

RSVP TO:

Ramona Carrillo
Email: rcarrillo@weintraub.com
Telephone: (916) 558-6046

Just as employees owe a duty of loyalty to their current employers, partners owe a duty of loyalty to one another. When one partner opens a secret “side business” (that does the same thing as the partnership) that partner breaches the duty of loyalty.  When that happens the breaching partner’s competing business may be valued as an asset of the partnership. Bad news for the guy with the secret business.

Rudy and Richard Corrales formed RC Electronics in 1989.  Rudy ran the business and Richard supplied financing and business know how.  Richard already had a thriving business occupying him full time.  He became involved in RCE because Rudy could not obtain enough financing on his own to start a business. The business was successful for several years. In 2004, however, Richard discovered that Rudy, his wife and their two daughters had formed a competing business, PK Electronics, to perform the same services performed by RCE but without Richard.  When Richard inquired about PKE, Rudy refused to tell him anything and cut off all communications with him.

The trial court held that partnerships must consist of at least two persons and that the partnership was dissolved upon Richard’s withdrawal.  But the trial court declined to award damages resulting from the plaintiff partner’s concealment of a competing business.  The appellate court reversed and found that any funds improperly obtained by the competing business entities were to be included in the assets of the partnership for winding up purposes.

Takeaway:  Although mired in the technicalities of partnership law, this case is at bottom a breach of loyalty case.  It is not at all unlike cases against executive officers, managing employees and the like who violate the duty of loyalty to their current employers by conducting business contrary to the current employer’s interest prior to the termination of their employment.  It is a useful set of facts to keep in mind.  The conduct of business contrary to the interest of a current employer (or partnership) is a breach of the duty of loyalty.

• Unpublished Cases.

The following cases, although not officially published, contain useful insights as to how courts view trade secret unfair competition and breach of duty cases.

• Farmers Insurance Exchange v. Song (February 23, 2012)

 Song was a Farmers insurance agent.  He signed Farmers standard agent appointment agreement which, among other things, provided that: “The agent acknowledges that all manuals, lists and records of any kind (including information pertaining to policy holders and expirations) are the confidential property of [Farmers] and agrees they shall not be used or divulged in any way detrimental to [Farmers] and shall be returned to [Farmers] upon termination of the agency.”  About four years later Farmers terminated its agency relationship with Song.  More than a year after that, Farmers filed a lawsuit after Song repeatedly refused to comply with Farmers request to return all the confidential client information as required by section 1 of the agreement.  The complaint alleged breach of contract, misappropriation of trade secrets, intentional interference with contractual relations, unfair competition and breach of fiduciary duty.  It sought both damages and injunctive relief.

Shortly after filing, Farmers moved for a preliminary injunction to enjoin Song from using Farmers’ trade secrets, including Farmers’ confidential policy holder information for any purpose including but not limited to soliciting insurance business.  Farmers also sought an order requiring Song to immediately surrender to Farmers all copies of the trade secrets and lists.  The trial court issued the preliminary injunction.

Song appealed, claiming that the agreement offended California’s public policy prohibiting restraints on the pursuit of a business or a lawful trade or profession.  (Citing Edwards v. Arthur Andersen LLP, 44 Cal.4^th 937, 945-946.)  The Court of Appeal rejected the argument however, noting that a lengthy line of cases has consistently held former employees may not misappropriate the former employer’s trade secrets to unfairly compete with a former employer.   Song also argued that the policy holder information at issue in the case was not protectable as a trade secret.  The Court of Appeal rejected that argument as well, citing a line of cases that enjoined former insurance agents from soliciting policy holders using customer files that contained the names, addresses and telephone numbers of policy holders.  Although it is a rule notable for its many exceptions, compilations of customer information including customer identity, contact information and some information relating to their customer status (say policy expiration dates, etc.) have long been recognized as trade secret by California courts.

• Ruznak Auto Group v. McTaggert (10/12/2011)

Can a voluntary dismissal of a trade secret case without prejudice support a “bad faith” award of attorney’s fees under the California Uniform Trade Secrets Act?  Not in this case.  In Ruznak, a British automobile sales and service group sued two former employees and their new company for misappropriation of trade secrets, common law unfair competition and unfair competition in violation of Business and Professions Code section 17200.  The complaint also alleged breaches of fiduciary duty.  The complaint alleged that the plaintiff was in the business of automobile sales and service, that it employed defendants as a service manager and service technician and that when their employment was terminated they misappropriated plaintiff’s trade secrets including a customer list, took them to their new business, and used the list to solicit Ruznak’s customers.  After several months of settlement negotiations and when faced with a threat that the defendants would file cross-complaints for wrongful termination, the plaintiff voluntarily dismissed the case without prejudice.

Defendant McTaggert then filed a motion for attorney’s fees under the California Uniform Trade Secrets Act which allows an award of attorneys’ fees for a prevailing defendant when the action alleging misappropriation of trade secrets was filed in “bad faith”.  The defendants’ moving papers included declarations which stated that plaintiff had filed the lawsuit based on fabricated allegations for the purpose of putting defendant out of business.  Plaintiff filed contrary declarations including declarations of persons within the plaintiff group stating they had an objective and reasonable basis for believing that a trade secret list had been taken by the departing employees.  Perhaps the most important holding in the case is that the Court applied the objective/subjective bad faith test required for a determination of fees under the CUTSA.  Although the Court declined to find bad faith (a decision that was upheld by the Court of Appeal), the most important take away may be that a voluntary dismissal without prejudice does not insulate a plaintiff from a claim of bad faith attorney’s fees.

The case of Gabriel Technologies Corporation v. Qualcomm Incorporated (2012 U.S. Dist. LEXIS 33421) reinforces this point.  There, a U.S. District Court threw out plaintiff’s claims for trade secret misappropriation because they were filed more than three years after the plaintiff first suspected misappropriation.

In the late 1990s, two technology companies, Locate (whose assets were acquired by Gabriel) and SnapTrack (later acquired by Qualcomm), entered into a licensing agreement to jointly develop GPS technology. Gabriel later discovered that SnapTrack filed numerous patents using the technology the parties jointly developed.  Gabriel sued Qualcomm in 2008 asserting claims for trade secret misappropriation (among others) and sought more than $1 billion in damages.

Qualcomm moved for summary judgment claiming that the undisputed evidence showed that plaintiff suspected the alleged trade secret misappropriation more than three years before filing the lawsuit and that its trade secret claims were therefore barred by the statute of limitations.  Qualcomm pointed to two pieces of evidence in support of its contention.  First, Locate’s cofounder and chief technology officer sent a January 2003 email in which he stated that SnapTrack’s product was “a direct rip off” of plaintiff’s technology.  The CTO admitted in deposition that he suspected that their trade secrets had been “ripped off” at the time he sent the email.

Defendant also offered evidence that in June 2004, as the parties were renegotiating the licensing agreement, the plaintiff’s CFO grew suspicious because Qualcomm wanted to strike certain language regarding “proprietary rights” that had appeared in an earlier licensing agreement.  The CFO admitted in deposition that he grew suspicious at that time that Qualcomm or SnapTrack had engaged in some type of misconduct concerning Locate’s intellectual property.

In granting summary judgment for Qualcomm as to the trade secret misappropriation claim, the Court noted that “[u]nder California’s discovery rule, suspicion of wrongdoing will trigger the statute of limitations.”  The Court continued by recognizing the well-established California law that “[w]hen there is reason to suspect that a trade secret has been misappropriated, and a reasonable investigation would produce facts sufficient to confirm this suspicion (and justify bringing suit), the limitations period begins, even though the plaintiff has not conducted such an investigation.”   The court concluded: “So long as a suspicion exists, it is clear that the plaintiff must go find the facts; she cannot wait for the facts to find her.”

The Court’s holding in Gabriel Technologies makes clear that if you suspect your trade secret information has been taken, you should immediately conduct an investigation and consult with an attorney concerning the matter.  Waiting to confirm actual misappropriation years after your suspicion first arose may result in your claims for trade secret misappropriation becoming time barred.  Companies are well advised that if they have a suspicion of misappropriation; they must act immediately to protect their rights.

Recently, in Aerotek v. The Johnson Group Staffing Co., the Sacramento Superior Court awarded a successful defendant in a trade secret misappropriation and unfair competition case more than $730,000 in attorney’s fees. In doing so, the Court increased the fees incurred by Defendant by 33%. While that is notable by itself, just as notable is the Court’s analysis that resulted in the award.

In cases brought under the California Uniform Trade Secret Act (“CUTSA”) a Court may award reasonable attorney’s fees and costs to a prevailing defendant “if a claim of misappropriation [of trade secrets] is made in bad faith.” (Cal. Civil Code Section 3426.4) In deciding that the bad faith standard had been met, the trial court examined the plaintiff’s motivations as evidenced by the procedural history of the case, the conduct of plaintiff’s counsel, and the settlement discussions between the parties. The decision (which is very recent and may still be appealed) provides a useful insight into how a party’s litigation tactics may be viewed by a court at the termination of a case.

Aerotek is a staffing agency that recruits and places employees and contract workers with businesses. Michael Ponce (“Ponce”) was an Aerotek employee who served as both a recruiter and a sales person. In the course of his employment, Ponce signed a noncompete agreement where he agreed that he would not divulge Aerotek’s trade secrets which were defined to include Aerotek’s customer list (a section of the Business and Professions Code defines customers of such staffing agencies as trade secrets) and to not solicit any of those customers following the termination of his employment at Aerotek. Chris Johnson was also a former Aerotek employee but had left sometime before the lawsuit was filed to start his own personnel recruiting and placement company, The Johnson Group (“TJG”). Ponce left the employ of Aerotek and eventually went to work for TJG as a recruiter and sales person charged with generating new employer accounts.

Aerotek sued both Ponce and TJG. The case was tried twice. The first jury found misappropriation of Aerotek’s trade secrets but determined that defendants had not caused plaintiff to suffer any damages. It also found that Ponce had breached his contract with Aerotek. All parties filed new trial motions. At the second trial, the jury found no misappropriation of any Aerotek trade secrets. The defendants moved the Court for an award of attorney’s fees under CUTSA.

The “bad faith standard” imposed by CUTSA to award attorney’s fees is a high one. In deciding the motion, the Court relied on a 2009 court of appeals case, FLIR Systems, Inc. v. Parish, 174 Cal.App.4th 1270, 1275-1278 to understand and apply that standard. Citing FLIR, the trial court held that bad faith requires not only that the claim be “objectively specious” but also that the plaintiff brought or maintained the claim in subjective bad faith — that is with an improper motive.

In deciding that the plaintiff’s misappropriation claim was brought in bad faith, the Court noted, among other things, the following:

(1) Aerotek’s failure to seek injunctive relief at the outset of the litigation. In what may usefully serve as a lesson to plaintiffs in trade secret cases, the Court concluded, “if the trade secrets had any significant value, or if [Aerotek] believed such were in imminent danger of loss, Aerotek should have sought immediate protection.”

(2) Lack of customer loss. The Court found it notable that neither Aerotek management nor its counsel sought out the customers in question to inquire as to the exact nature of the contact by defendant Ponce by conducting official interviews, obtaining affidavits, or taking depositions.

(3) Aerotek’s settlement conduct. The Court characterized Aerotek’s settlement conduct as unreasonable. “As Aerotek’s case got weaker, either due to the failure to find favorable evidence or the appearance of adverse evidence, including losing against TJG at the first trial, its settlement demands got larger not smaller.” The Court also found notable Aerotek’s demand to include a “hands off” list as a part of settlement which listed customers that Aerotek had either never done business with or had done business with only distantly, or were TJG’s existing customers.

(4) Maintaining the lawsuit well after Aerotek knew or should have known that the customers it was attempting to exclude from defendants had little or no business of any economic consequence to either Aerotek or TJG – meaning that its damages, assuming it could prove liability, would be insignificant.

(5) The Court concluded that both the merits of the case and the settlement history evidenced that Aerotek had an anti-competitive motive in filing the lawsuit. This conclusion was, in the Court’s view, supported by the lack of the objective merits to the case and Aerotek’s settlement demands. In determining that Aerotek had acted in subjective bad faith, the Court looked at the amount of attorney’s fees incurred in the case, the relative simplicity of the case when considered in light of the litigation history of the case which included “vast numbers of motions brought both in law and motion and in the trial court” largely for “nonsubstantive issues.” The Court concluded that that litigation history “in the absence of the kind of meaningful discovery or other helpful fact gathering, speaks further to a pattern of conducting expensive proceedings for their own sake, without a commensurate effort to pursue productive preparation of the case.”

The Court then applied a lodestar analysis, taking the base amount of attorney’s fees claimed by defendants of more than $553,000 and determined whether or not a multiplier was appropriately applied to that number. The Court applied the multifactor test common to a lodestar analysis which includes, among other things, the novelty and difficulty of the questions involved; the skill displayed in presenting them; the extent to which the nature of the litigation precluded other employment by the attorney; and any risk, contingency or delay in payment of attorney’s fees. These factors weighed against plaintiff. The Court also noted that the fact that one law firm had agreed to take the case on a contingency basis when its client had run out of money was a notable factor in justifying its decision to award a 33% increase in defendants’ attorney’s fees.

It appears that Aerotek has appealed the underlying judgment.

California courts have long held that agreements that prohibit a former employee from hiring a former co-worker are void.  These decisions are based on California’s fundamental public policy (which is codified in Business & Professions Code section 16600) protecting workers’ rights to pursue any lawful trade or profession.  With only a few narrow exceptions, California law prohibits such limitations on employment opportunities.  Simply put, when two
parties agree that they will not hire a particular group of workers, they limit the opportunities of those workers in an impermissible way.

In 1985 however, a California Court of Appeal drew a distinction between agreeing not hire someone and agreeing not to solicit that same worker. In Loral v. Moyes the Court upheld an agreement by a departing employee not to recruit or solicit his former coworkers.  The Court upheld the agreement because, among other things, it restricted only the contracting party’s conduct and did not limit the prospects or employment opportunities of the former co-workers.  While the former employee could not solicit any of his former co-workers to come to work for him or her, any of them were free to seek out the former employee for employment.  The Loral decision has been criticized for improperly drawing a distinction where none was needed.

Flawed or not, the Loral court’s reasoning led to the widespread use of employee non solicitation agreements in California. In 2009, however, in Edwards v. Arthur Andersen, the California Supreme Court unsettled the Loral case when it held — without overruling Loral — that customer non-solicitation agreements violate Business and Professions Code section 16600. The Edwards decision has led many to forecast the demise of Loral, but so far at least, the rule expressed in Loral remains the law.   Where future courts will go on this question remains uncertain.

Loral concerns the enforceability of agreements between an employer and its employees, but what about agreements between competitors that they will not solicit one another’s employees? Recent class action lawsuits alleging that Apple, Inc. and Google, Inc. (among others) violated the law by agreeing not to recruit one another’s employees may answer that question. These lawsuits were filed shortly after the U.S. Department of Justice settled a claim with Google and Apple that agreements not to cold call one another’s workers violated federal anti-trust law.  That settlement does not admit wrongdoing, but does commit the companies to not enter into such agreements in the future.  The civil complaints (which have yet to be certified as class actions) have been consolidated before in the U.S. District Court in San Jose.

Stay tuned.

Probably not.  The case law of many states is littered with what are sometimes referred to as “rolodex” cases.  These cases typically involve a departing employee who takes a rolodex (or other collection of customer or vendor information) that was created while on the former employer’s payroll.  The former employer claims the rolodex is company property.  Customer lists or compilations of customer information (such as rolodexes) have long been recognized as potential trade secrets.  But what happens to those same contacts if they are listed on an individual employee’s LinkedIn or similar website?  Can a recruited employee (who would not be permitted to take their rolodex) rightly consider contacts listed on their LinkedIn page to be theirs rather than their employer’s?  This scenario has been the source of litigation.  (See, for example, TEK Systems, Inc. v. Hammernick, CV00819, filed March 2010, which has since settled.) 

The argument is fairly simple.  Is anything listed on a LinkedIn or similar social media website secret or is it now part of the public domain?  Many companies have responded to this possibility by seeking to prevent employee’s use of LinkedIn or restricting the identification of company customers on the website.  Many commentators fear that such restrictive policies may result in babies going out with the bath water.  Effective sales professionals need to network and barring them from use of evolving social media may hamstring those professionals in doing what they were hired to do – making and establishing a network of contacts that are willing to do business with them.

In Sausko Group, Inc. v. Courtney (WL *3613855), a federal judge in New York found a defendant could not be sued for taking client lists because the information could be collected in just a few minutes on Facebook or LinkedIn.  Information that is readily obtainable through an internet search is, by definition, not secret.  Given the existence of the large volume of customer identity and contact information that is now available on the internet, the idea that lists of customer identity and contact information are trade secret may be obsolete.  Of course, a particular determination that specific customer information constitutes a trade secret will depend on the circumstances.  Where social media messaging systems have been used as part of company policy or where information is linked to more than customer identity and contact information, the claim that the information constitutes a trade secret may be stronger.

One of the former employees is alleged to have emailed Groupon customer and business information to a personal email account on the day he resigned. The lawsuit requests the Court to enjoin the defendants from, among other things, using this information in their new employment.  Further details about this lawsuit can be found at here.

One thing to remember is that the applicable state law is key in a lawsuit such as this one.  Under Illinois law, a court can enforce a restrictive non-compete agreement if its terms are reasonable to protect a legitimate business interest of the employer.  This is not the case in California.  Under California law, a non-compete provision is almost always unenforceable in an employment agreement. Had this lawsuit been filed in California, it is almost certain that the court would dismiss the breach of contract claims arising out of the employment agreement’s non-compete provisions.   (See “Often But Not Always Void” in this blog.)

Also, neither Google nor Google Offers are named as defendants in this lawsuit (yet).  There may be several strategic reasons for this.  First, any injunction issued by a court against the two former Groupon employees will likely contain language enjoining not only them, but “any person acting in concert with them.”  This could bind Google (or at least restrict its ability to employ the two former Groupon employees) without Groupon having to litigate directly against Google.  Second, Groupon could be using the case against its two former employees to conduct discovery to determine whether Google has any potential liability before suing Google.

This lawsuit highlights the pitfalls that can arise when hiring employees from a direct competitor.

In cases where there has been an exportation of employer information or where a large number of employees have departed one employer to join another, a temporary restraining order or preliminary injunction may not be particularly difficult to obtain.  While such applications require great energy by the moving party to prepare a compelling application, the application for such injunctive relief is sometimes the defendant’s first notice that a lawsuit has been filed, and can come as something as a surprise attack.  Defendants are almost always at an immediate disadvantage.  Within a very short time, responding counsel must promptly identify potential conflicts, organize a defense, effectively investigate the facts, and organize and articulate a response to the plaintiff’s application.

 These applications are often accompanied by a request to the court for expedited discovery.  When granted, these applications, plus the short response deadlines to respond to a preliminary injunction application, can keep the defendants on the defense and may slow, and on occasion even prevent, a defendant from timely articulating counter claims or developing a sufficient factual understanding to aggressively defend the complaint.  If it is true that “speed is the essence of attack” then it is certainly true that speed often assists an applicant for a preliminary injunction in these cases.  Nor is speed wholly tactical.  Delay can often work against a preliminary injunction application.  If weeks or months pass from the alleged misconduct, a court is less inclined to find that there is immediate irreparable injury that must be enjoined.

Except in the narrow circumstance where an employee is utilizing confidential or trade secret information to solicit a former employer’s customers, covenants not to solicit customers generally fall under the same prohibition; they are void.  Sometimes referred to as the “trade secret” exception, I don’t view it as an exception to the rule at all.  California law imposes an independent obligation on current and former employees (or for that matter anybody) not to use their employer’s, former employer’s or anybody else’s trade secret information in a way that violates the provisions of the California Uniform Trade Secrets Act.  

But there is a set of circumstances that can arise that will allow a California court to enforce otherwise impermissible covenants not to compete. This “exception” arises as a result of differing law between the states and the federal overlay of constitutional principles that require each state to respect the judgments and law of sister states.  There are circumstances where a California court may find itself helpless to enforce California’s prohibition against covenants not to compete.  This situation can arise when an employer executes agreements with its workers containing choice of law and forum selection provisions requiring any dispute under the employment agreement (and the determination of the enforceability of a covenant not to compete against a California resident) be decided under the law and in the courts of another jurisdiction.  

A chain of state and federal cases shows the struggle over this issue.  In Advanced Bionics v. Medtronics (2002) 29 Cal.4^th 297, the California Supreme Court reversed lower courts, which had enjoined a court proceeding in another state, on the grounds that that state’s law was offensive to California’s fundamental public policy prohibiting covenants not to compete.  Several federal courts are in accord.  Google v. MicroSoft and Swanson v. T Mobile USA, both demonstrate the willingness of federal courts to find that choice of law and choice of forum provisions do not offend a fundamental California public policy.  

In Swanson v. T Mobile, a former employer sought to enjoin competing conduct by a former employee by injunction issued by a Washington State Court.  The former employee sought an injunction in California (where he was resident) based on the invalidity of the covenant.  The former employer removed to federal court and the federal court found that the forum selection provisions were enforceable and inoffensive to California public policy.  Although the Court noted that the former employee could urge the Washington Court to apply California law, there was no basis to enjoin the proceeding in the Washington Court.  At least as to employers with the reach and the resources to litigate in forums outside of California, the choice of law/forum “exception” can, at least practically speaking, swallow the no enforcement of covenants not to compete rule. 

Recently, the California legislative fixes to this “exception” have been proposed.  AB 267 (Swanson) would have made void an unenforceable as against public policy, any provision in an employment contract that requires an employee, as a condition of obtaining or continuing employment, to use a forum other than California, or to agree to a choice of law other than California law to resolve any dispute with an employer regarding employment related issues that arise in California.  While proposed, it appears that bill remains in committee in the California Legislature. 

Provisions of this kind continue to be a significant source of litigation.  Recently the brewers of Sam Adams beer sued a former employee and his new employer.  Both the former employee and the new employer (the Brewers of Anchor Steam Beer) are residents and operate in California.  The lawsuit was filed in Massachusetts and is based on an agreement containing a covenant not to compete and provisions that require that Massachusetts law be applied and that any litigation concerning it take place in Massachusetts.

Trade secrets (especially those relating to customers, pricing, costs and employees) can be a little like love taken for granted:  You don’t notice it until its gone. 

California law often protects such information (sometimes called “soft” trade secrets to distinguish them from product formulas and other “hard” trade secrets) from misuse by former employees or competitors.  But those protections can be forfeited by an employer’s neglect. 

What to Do Before Your Employees Give Notice. 

•  Make clear to your employees what information belongs to the company and specifically, what information you consider to be confidential, proprietary or trade secret. California law protects employers who designate and take reasonable steps to secure their business information as trade secret, confidential and/or proprietary. 

•  Establish a system of reasonable practices to protect this information. Those practices can include proprietary information agreements and other policies that make clear to employees that customer information, customer preferences and indeed the customer relationship itself is the property of the employer. These policies must be carefully drafted so as to not run afoul of California laws protecting employees. You should also take additional security steps such as computer passwords and limiting access, labeling restricted access, utilizing locked file cabinets, etc.

 Portions of this article first appeared in the January/February 2009 issue of Sacramento Lawyer, the bimonthly publication of the Sacramento County Bar Association. Weintraub Genshlea Chediak thanks Sacramento Lawyer for the right to publish the article, in its entirety, on our website. The article is the copyrighted property of the Sacramento County Bar Association.