When employees with access to key company information and knowledge about company practices leave to work for competitors, employers are naturally concerned about protecting themselves. One way employers try to do this is through various types of agreements with employees designed to limit their ability to use confidential information and “trade secrets.”
Employers in California are limited in how far they can go in such agreements, however. Under California’s unfair competition law, found in Business and Professions Code section 16600, employers and employees cannot enter into a “contract by which anyone is restrained from engaging in a lawful profession, trade, or business.” The law is intended to balance the employer’s business interests with the benefits of free competition and the right of individual employees to engage in the occupations of their choosing.
Lately, California courts have take steps to restrict the limitations an employer may legally place on the post-employment activities of former employees. In a 2008 decision, Edwards v. Arthur Andersen LLP, the California Supreme Court decided that in most instances, the unfair competition law does not allow covenants not to compete—that is, agreements that prohibit a former employee from working for a competitor or otherwise competing with a former employer. And in a recent case, The Retirement Group v. Galante, a California appellate court decided that the unfair competition law does not permit a non-solicitation agreement unless it is narrowly tailored to protect trade secrets.
The Retirement Group v. Galante: The Lower Court’s Decision
In Galante, the defendants were former employees of The Retirement Group (TRG). TRG provides broker/dealer services and investment advice. It developed an extensive customer base through marketing strategies including public seminars. TRG maintained a database with the names and contact information of customers and potential customers, and took steps to keep the information in the database confidential. For example, TRG required employees who used the database to sign an agreement to maintain the confidentiality of the information, and the database was configured so users could not make electronic copies of the information. The defendants, who entered into independent contractor relationships with TRG, also signed a “Marketing and License Agreement.” That agreement restricted the contractors from using or disclosing confidential information except in limited circumstances.
When the defendants began working for a competitor, they contacted TRG customers to provide them with information about how to utilize the services of the new company. The defendants generally used contact information they obtained from third-party databases, but at least one defendant had a personal list of his customers’ contact information. TRG claimed the defendants misappropriated its trade secrets and were using that information to solicit TRG customers.
The trial court granted TRG a preliminary injunction that prohibited the defendants from engaging in certain conduct, including indirectly or directly soliciting TRG customers and using information found solely in TRG databases. The defendants appealed the preliminary injunction, claiming the prohibition violated California law.
The Retirement Group v. Galante: The Appellate Court’s Ruling
In evaluating whether to uphold the lower court’s injunction, the appellate court distinguished prohibitions on solicitation under the unfair competition law from prohibitions on the use of trade secrets to solicit customers. Courts have consistently held that employees cannot use trade secret information to solicit customers. Additionally, courts have recognized that customer lists can qualify as trade secrets. Not every list will qualify for such protection, however. The information must not be readily ascertainable from public sources. Instead, customer lists that will qualify as trade secrets must be compiled through the employer’s time and effort and include more than merely customer contact information, such as the likes, needs or characteristics of particular customers. Although TRG claimed the database contained information beyond the names and identities of its customers, TRG did not provide evidence to support that assertion. And TRG did not dispute that the identity of some customers was available from third parties.
Absent trade secrets protection, the court determined that California’s unfair competition law prevents a court from enforcing a contractual non-solicitation clause. To reach this conclusion, the court reviewed the Edwards decision. In that case, Edwards worked for Andersen and signed a non-solicitation and non-competition agreement. When Andersen sold Edwards’s practice group to HSBC, HSBC agreed to hire Edwards if he obtained a “Termination of Non-compete Agreement” (TONC). Among other things, the TONC Andersen offered required Edwards to release any claims against Andersen. If Edwards signed the TONC, Andersen agreed to release him from the agreement. Edwards refused to sign the TONC, Andersen terminated his employment, and HSBC withdrew its offer of employment.
Edwards sued Andersen for intentional interference with prospective economic advantage, claiming Andersen interfered with his potentially economically beneficial relationship with HSBC. The claim required Edwards to show Andersen had engaged in wrongful conduct intended to disrupt his relationship with HSBC. Edwards successfully argued to the appellate court that the non-competition agreement was illegal under the unfair competition law, so requiring him to give up anything released from the illegal agreement violated public policy.
In affirming the appellate court’s ruling, the California Supreme Court rejected the “rule of reasonableness” used by some courts to analyze non-competition agreements. This rule allows a restriction if an employer does not “fully” prohibit a former employee from engaging in his or her profession. The Edwards court also rejected a “narrow restraint” exception found in federal cases, allowing non-competition clauses if they only restrain a portion of a profession, trade, or business.
The Galante court considered the facts before it in light of Edwards and concluded that Edwards prevented the enforcement of a contractual non-solicitation clause. The prohibited solicitation in Galante was very similar to the provision the Edwards court determined violated the unfair competition law.
Also, the Galante court determined that the injunction prohibiting solicitation could not have been designed only to protect misappropriation of trade secrets, because the injunction already prohibited the use of the information found solely in TRG databases. The court therefore ordered the trial court to vacate the preliminary injunction and enter a new injunction without the prohibition on solicitation.
After Galante, trade secrets continued to be protected, while limits on competition continue to be looked upon by California courts with skepticism. To protect legitimate trade secrets, employers ensure they maintain the confidentiality of their confidential information. And courts likely will not enforce agreements to prohibit solicitation unless such agreements prohibit the use of trade secrets.
Of course, because trade secrets themselves are protected under the law, non-solicitation agreements now are arguably redundant and unnecessary. In fact, under Edwards, requiring an employee to sign a non-solicitation agreement that extends beyond protecting trade secrets could be construed as an independently wrongful act subjecting the employer to liability. For this reason, employers should consult competent employment law counsel in this area before proceeding.