Techniques, formulas, client lists and client information are critically important to the success of almost any business. Increasingly, the value, profits, and even the survival of a business are based upon its trade secrets. At the same time, workforce mobility and the ease of copying vast amounts of information with the click of a mouse increase the difficulty of preserving these valuable assets. Businesses must take steps to protect their trade secrets. Conversely, when recruiting employees, businesses must be wary of stepping into litigation with the former employers of new hires.

California trade secret law differs from the law of other states. California-specific issues arise principally in two key areas. First, when California adopted the Uniform Trade Secret Act (UTSA), it did so with some modifications. Second, California law restricts the enforceability and scope of noncompetition agreements.

Understanding California trade secret law is critical to protecting and building a business in this state. The goal of this Letter is to provide analysis and insight into trade secret law as practiced in California. In this first Letter, we briefly introduce California’s trade secret law and its statutory restrictions on covenants not to compete. In subsequent Letters, we will explore the law as it continues to develop and examine specific issues in depth.

Jennifer Brockett, Editor
Davis Wright Tremaine LLP

Under California law, to state a claim for misappropriation, a plaintiff must allege facts showing that the defendant “misappropriated” a “trade secret.”¹ Thus, in order to prevail, the plaintiff must show that (1) the information qualifies as a “trade secret,” and (2) the defendant’s conduct amounts to “misappropriation.”

Under California law, a trade secret is information, including a formula, pattern, compilation, program, device, method, technique or process that meets a two-part test. First, the information must:

Derive independent economic value, actual or potential, from not being generally known to the public or to other persons who can obtain economic value from its disclosure or use.²

This part of the California definition departs from the UTSA. While the UTSA also requires that trade secret information is “not readily ascertainable by proper means,” the California legislature removed this language from the UTSA as enacted in this state.³ Nonetheless, "the assertion that a matter is readily ascertainable by proper means remains available as a defense to a claim of misappropriation."⁴ As a practical matter, if information was readily ascertainable by proper means, it often will not be found to have been “secret.”

Under California’s definition, courts have held that “matters of general knowledge in the trade or of special knowledge of those persons skilled in the trade” are not trade secrets.⁵ For that reason, a competitor does not misappropriate trade secrets merely because it hires employees who are specially qualified to meet a customer’s needs.⁶ But matters of “general knowledge in the trade” may not include customer lists or other compilations of information that is created over time and at significant expense.

To satisfy the second element of the trade secret test, the information must be “the subject of efforts that are reasonable under the circumstances to maintain its secrecy.”⁷ Thus, information loses its status as a trade secret unless reasonable efforts are made to maintain the secrecy of the information, such as advising employees that information available to them is confidential, limiting access to a trade secret on a “need to know basis,” and controlling plant access.⁸ What steps constitute reasonable efforts will vary due to a variety of factors, such as the value of the secrets, the nature of the business and the size of the business that claims to own the secrets.

In general, “misappropriation” means acquisition, disclosure or use of a trade secret of another by a person who knows or has reason to know the secret was acquired by improper means.⁹ The threshold for showing misappropriation is quite low: misappropriation sometimes may be found merely when someone acquires trade secrets through improper means, even if that person neither uses nor discloses such information.¹⁰ On the other hand, in such circumstances the anticipated damages should be nominal.

Whenever a noncompetition or nonsolicitation agreement is involved – as is frequently the case when new or departing employees are implicated in the alleged misappropriation – California trade secret cases must be analyzed through the prism of California’s Business & Professions Code Section 16600. Section 16600 provides:

…every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.

Section 16600 “invalidates provisions in employment contracts that prohibit an employee from working for a competitor after completion of his employment or imposing a penalty if he does so.”¹¹ The statute has also provided the basis for invalidating nonsolicitation covenants as unlawful business restraints.”¹²

“California courts have consistently declared [Section 16600] an expression of public policy to ensure that every citizen shall retain the right to pursue any lawful employment and enterprise of their choice. The interests of the employee in his own mobility and betterment are deemed paramount to the competitive business interests of the employers, where neither the employee nor his new employer has committed any illegal act accompanying the employment change.”¹³ Thus, covenants in the employment setting that restrain a worker’s ability to make a living doing what he or she has experience doing are generally found to be void.¹⁴ Moreover, under California law, “[a] broad covenant not to compete cannot be saved from illegality by narrowed construction.”¹⁵ If a noncompete is found to violate Section 16600, it generally will be stricken in its entirety.

There are only two express statutory exceptions to the restriction on noncompete provisions: Business & Professions Code Section 16601, which applies to the sale of the goodwill of a business, and Section 16602, which applies to the dissolution of partnerships. One federal court interpreting California law has gone so far as to state that covenants not to compete are “absolutely prohibited unless specifically authorized by statute.”¹⁶ However, the law provides at least two other exceptions.

First, noncompete provisions that narrowly restrain competition have been found valid.¹⁷ For example, noncompetes that prohibit a worker from pursuing only a small or limited part of the business, trade or profession (e.g., working with specific clients), have been upheld as valid.¹⁸ Cases recognize this limited carve-out from Section 16600 on the ground that such narrowly-tailored agreements do not restrict the party from engaging in a lawful profession, trade, or business.

But the most important exception provides that restrictive covenants may be enforced when necessary to protect trade secrets. For example, a restrictive covenant may be enforceable where a customer list qualifies as a trade secret and employees are prohibited from soliciting clients on that list.

The interplay between California’s Trade Secret Act and Section 16600 will continue to bedevil employers. Indeed, two cases discussed in this Letter’s Case Notes – ReadyLink Healthcare v. Cotton and Steinberg Moorad & Dunn Inc. v. Dunn – both address this issue and arrive at opposite conclusions. Each case, each migrating employee, and even each potential trade secret must be analyzed in light of the competing interests of protecting trade secrets and protecting employee mobility.

In Digital Envoy, Inc. v. Google, Inc., 370 F. Supp. 2d 1025 (N.D. Cal. 2005), the Northern District of California ruled that California’s Trade Secret Act preempts unfair competition and unjust enrichment claims based on an allegation of misappropriation of trade secrets.

In Digital Envoy, the plaintiff alleged that Google's use of a Digital Envoy technology that allowed Google to make an “educated guess” about the approximate location of site users breached a licensing agreement, and also filed misappropriation, unjust enrichment and unfair competition claims arising from the same conduct. While holding that material questions of fact precluded Google’s motion for summary judgment for breach of the license agreement, the court granted Google’s request for partial summary judgment on Digital Envoy’s remaining claims based upon the preemptive effect of California’s Trade Secret Act.

Google argued that California's UTSA statute preempted the unfair competition and unjust enrichment claims. California’s statute, Google argued, explicitly states that it does not preempt claims that are based upon breach of contract, criminal remedies, or other claims that are not based on trade secret misappropriation, and “there would be no need for inclusion of this provision in California's statutory scheme unless the UTSA preempted other claims based on misappropriation.” The court agreed, finding that because Digital Envoy’s claims of unfair competition and unjust enrichment were based on the same nucleus of fact as its misappropriation of trade secrets claim, those claims were preempted.

Millennium Corporate Solutions v. Peckinpaugh, 126 Cal. App. 4th 352 (2005) provides a cautionary tale to employers too eager to sue departing employees.

There, Millennium Corporate Solutions sued four former employees who had come to Millennium with substantial client lists, claiming unfair business practices and misappropriation of trade secrets. Both sides sought to enjoin the other from using certain client files, but Millennium filed no opposition to the employees’ preliminary injunction application. The trial court enjoined Millennium from reviewing, copying or maintaining copies of information contained in files for specified insurance clients, disclosing or disseminating information in those files, or asserting that any of the employees had stolen any of those files. It also required Millennium to return the files of the specified clients and personal property to the employees.

Millennium appealed, claiming that it had no notice of its duty to show cause beyond the limited scope of an earlier TRO. The Court of Appeal, per Boland, J, disagreed.

The court was highly critical of Millennium’s appeal after failing to object to the employees’ motion below, and imposed $24,045 in sanctions on Millennium on the ground that the appeal was frivolous.

Millennium raises the interesting question of who owns information regarding a client: the employer or the employee. Unfortunately, the issue was not fully explored by the appellate court due to its unusual procedural posture.

The statutory policy favoring the finality of decisions rendered in arbitration went head-to-head against the statutory policy forbidding noncompetes. Arbitration won.

In Jones v. Humanscale, --- Cal.Rptr.3d ---, 2005 WL 1415003 (June 17, 2005), Jones had been employed in California as a regional manager by a company affiliated with Humanscale. Jones’ employment contract contained a noncompetition clause forbidding him from selling products in competition with Humanscale for two years to “any potential purchaser.” The agreement also contained a choice of law clause selecting New Jersey, and an arbitration clause requiring that all disputes be arbitrated in New Jersey. The arbitrator found in Humanscale’s favor, and issued an injunction forbidding Jones from selling competing products to any customer assigned to him while he was at Humanscale.

Humanscale then filed a petition to confirm the arbitration award in California. The California trial court refused to confirm the arbitration award, and instead granted Jones’ request to vacate the award, holding that the award “is not legal on its face, and it violates public policy in California as expressed in Business and Professions Code section 16600.”

The appellate court, however, found that this was “a classic case of the trial court declining to confirm an arbitration award because it disagrees with the merits of the decision.” But California policy and statute strongly favor the enforceability and finality of decisions in arbitration, and the appellate court ruled that “a court may not review the merits of the parties’ controversy or claims that the arbitrator’s decision is either legally or factually erroneous.” Consequently, the appellate court held that the trial court erred in examining the merits of the award, and should simply have confirmed it.

The appellate court also faintly defended the arbitrator’s decision, stating that the arbitrator’s ruling was “not palpably erroneous” because some cases have upheld limited noncompetition clauses.

In ReadyLink Healthcare v. Cotton, 126 Cal. App. 4th 1006 (2005), the California Court of Appeal found that a former employment agency staffer may be preliminarily enjoined from soliciting business contacts of his former employer even if some of the information was publicly available.

The Court of Appeal found that the lower court did not abuse its discretion in enjoining Cotton “from soliciting ReadyLink employees and customers, including ReadyLink's agents, nurses, remote recruiters, hospitals, and other healthcare facilities and professionals under contract with ReadyLink.” Cotton argued that the injunction was improper because it was based on a covenant not to compete that was illegal under California law. The court disagreed, saying that “[w]hile it has been legally recognized that a former employee may use general knowledge, skill, and experience acquired in his or her former employment in competition with a former employer, the former employee may not use confidential information or trade secrets in doing so.”

Noting that Cotton had admitted to misappropriating information and soliciting ReadyLink’s business contacts, the court ruled expansively, holding that Business and Professions Code Section 17200 et seq. authorized enjoining Cotton’s use of information compiled by ReadyLink, such as lists of hospitals and nurses, even if the underlying information in the lists might not be protectable as a trade secret.

It also rejected Cotton’s argument that the injunction was improper because he had changed careers and no longer posed a “threat” to ReadyLink. The court stated that “[i]f it is true that Cotton is not a threat because he is not working in the healthcare staffing business, then the preliminary injunction should have no impact on him.” The court did, however, narrow some language in the injunction that it found to be vague, ambiguous and overbroad.

In an unpublished decision, Steinberg Moorad & Dunn Inc. v. Dunn, No. 03-55953, 2005 WL 712487 (9th Cir. Mar. 30, 2005), the Ninth Circuit affirmed the dismissal of trade secret misappropriation claims based on publicly-known client lists. The court also relied upon Business & Professions Code Section 16600 to reverse a damage award on a related breach of contract claim. In stark contrast to ReadyLink, this decision was protective of the rights of the departed employee.

Sports agency Steinberg Moorad & Dunn, Inc. (SMD) sued a former employee, David Dunn, claiming that the employee’s use of a client list and other information he received while working at SMD constituted misappropriation of trade secrets. The Ninth Circuit affirmed, ruling that whether or not SMD could derive economic value from the client list, the list was publicly known and therefore was not a trade secret. The court also held that SMD failed to show that information Dunn received from clients while working at SMD was not generally known. Finally, it noted that pricing information could only be considered a trade secret if it were not based on commonly used industry formulas.

The Ninth Circuit also reversed an award in SMD’s favor on its breach of contract claim. It found that the lower court had erred in failing to instruct the jury that Section 16600 renders unenforceable noncompetition clauses to the extent that they limit the employee's ability to compete after leaving.

The Federal Northern District of California in Contratto v. Ethicon, Inc. 227 F.R.D. 304 (N.D. Cal. 2005) held that certain documents produced in discovery could not be kept confidential, despite a prior protective order entered to govern discovery.

The defendant argued that a prior protective order allowing the parties to designate documents as confidential during discovery prohibited the disclosure of the documents, that the protective order established a presumption of confidentiality, and that the party seeking the disclosure bore the burden of proving that there was no need for confidentiality.

However, as Magistrate Judge Bernard Zimmerman noted, the “defendants designated all but a few hundred of the three to four hundred thousand documents they produced as confidential.” The court held that, notwithstanding the protective order, the defendant bore the burden of proving that each document was worthy of protection.

The court also summarized the contents of thirteen disputed documents that he reviewed in camera. Some exhibits contained reports of adverse reactions but did not contain any confidential or proprietary information. The designation of another exhibit as confidential “was improper … in light of the fact that the content of the letter concerns publicly available information appearing in defendants' promotional materials and on their website.” Based on this detailed analysis, the court rejected the defendant’s attempt to maintain the confidentiality of the documents.

As this ruling illustrates, parties should be prepared to defend the need for confidentiality of each document, even if the court has already entered a protective order.

In Rombe Corp. v. Allied Ins. Company, 128 Cal. App. 4th 482 (2005), the Court of Appeal ruled that a franchisee who was sued for breach of contract, misappropriation of trade secrets and unfair competition was not entitled to tender its defense to the holder of its commercial general liability policy.

Until 2001, Rombe Corporation was the franchisee of a national temporary employment agency. It then invited clients and employees to a breakfast meeting at which Rombe disclosed that it was becoming independent and invited them to move their business to the new company. When its franchiser sued for breach of contract, misappropriation of trade secrets and unfair competition, Rombe tendered defense to the company which held its commercial general liability policy. The insurer refused tender, claiming that the solicitation that led to the lawsuit could not be considered an advertising offense that would be covered by the policy. The trial court agreed and granted AMCO’s motion for summary judgment.

The Court of Appeal, per Benke, Acting P.J., noted that courts tend to be solicitous of insureds’ expectations regarding the duty to defend. Nevertheless, it agreed with the court below that “[n]either the breakfast meeting Rombe hosted nor any solicitation which occurred there involved the broad dissemination of information which the policy required.” It therefore upheld the grant of summary judgment in favor of AMCO.

In those instances in which litigation is necessary, we draw upon extensive experience among the attorneys in all our offices and in all phases of litigation, including discovery, dispositive motion practice, trials, and appellate proceedings up to and including the U.S. Supreme Court. The depth of our experience has enabled us to successfully resolve many trade secret and employee raiding litigation matters, including litigation in federal and state courts.

Our California trade secret attorneys are routinely at the forefront of legal issues affecting the trade secret litigation and best employment practices. Our team of trade secret lawyers spans DWT’s Intellectual Property, Employment, and Commercial Litigation Departments, to provide the right lawyers for your particular needs.

	Jennifer Brockett, Associate Emilio Gonzalez, Associate Mary Haas, Partner Andrew Hall, Partner John LeCrone, Partner Seth Levy, Of Counsel Henry Tashman, Partner John Tate, Of Counsel Andrew J. Thomas, Partner		Joe Addiego, Partner Tom Cervantez, Partner Sam Dawood, Associate Martin Fineman, Partner Peter Isola, Of Counsel Stu Miller, Partner
			Sheila Fox Morrison, Associate (Admitted to practice in California and Oregon)

¹Civil Code § 3426.1.

²Civil Code § 3426.1(d); see also Civil Code § 3425.1, cmnt.

³The removal of this language has caused several courts to struggle with whether information which is “readily ascertainable” may qualify for trade secret protection. See, e.g., People v. Laiwala, 9 Cal. Rptr. 3d 466, 473-474 (2004) (unpublished opinion); see also ABBA Rubber Co. v. Seaquist, 235 Cal. App. 3d 1, 21 (1991) ("whether a fact is 'readily ascertainable' is not part of the definition of a trade secret in California"); accord, Imax Corp. v. Cinema Technologies, Inc., 152 F.3d 1161, 1168, fn. 10. (9th Cir.1998) (same).

⁴Abba Rubber, 235 Cal. App. 3d at 22 n.9 (quoting Legis. Com., 12A West's Ann. Civ. Code (1997 ed.).

⁵Diodes, Inc. v. Franzen, 260 Cal. App. 2d 244, 253 (1968); see also Imax Corp., 152 F.3d at 1164-65.

⁶See Metro Traffic Control, Inc. v. Shadow Traffic Network, 22 Cal. App. 4th 853, 861-63 (1994) (“[s]imply hiring personnel who possess the requirements specified by a customer does not convert the employee into a “trade secret”).

⁷Civil Code § 3426.1.

⁸Civil Code § 3246.1(d)(2); Morton v. Rank America, Inc., 812 F. Supp. 1062, 1075; see also California Forms of Pleading and Practice, 565 Unfair Competition, pp. 114.1-114.2.

⁹Civil Code § 3426.1(b).

¹⁰Civil Code § 3426.1(b)(1).

¹¹Muggill v. Reuben H. Donelley Corp., 62 Cal. 2d 239, 242 (1965).

¹²Thompson v. Impaxx, Inc., 113 Cal. App. 4th 1425, 1429 (2003).

¹³D’Sa v. Playhut, Inc., 85 Cal. App. 4th 927, 933 (2000) (citations omitted).

¹⁴See, e.g., Kolani v. Gluska, 64 Cal. App. 4th 402, 407 (1998) (contract barring employee from working for competitors was void); Bosley Medical Group v. Abramson, 161 Cal. App. 3d 284, 288 (1984) (same); Chamberlain v. Augustine, 172 Cal. 285, 288 (1916) (same); Walia v. Aetna, 93 Cal. App. 4th 1213, 1221 (2001) (six-month restriction prohibiting employees from working for any competitor in same state violates Section 16600); and Latona v. Aetna US Healthcare, Inc., 82 F. Supp. 2d 1089 (C.D. Cal. 1999) (agreement barring former employee for working for competing company for six months unless new responsibilities excluded the area where she was working violates Section 16600).

¹⁵Kolani, 64 Cal. App. 4th at 405.

¹⁶Campbell, 817 F. 2d at 502.

¹⁷See, e.g., Walia, 93 Cal. App. 4th at 1221; Boughton v. Socony Mobil Oil Co., 231 Cal. App. 2d 188 (1964); King v. Gerald, 109 Cal. App. 2d 316 (1952); General Commercial Packaging v. TPS Package Eng’g, Inc., 126 F. 3d 1131, 1132-33 (9th Cir. 1997); Campbell v. Board of Trustees of Leland Stanford Jr. Univ., 817 F. 2d 499, 502 (9th Cir. 1987); Latona v. Aetna US Healthcare, Inc., 82 F. Supp. 2d 1089 (C.D. Cal. 1999).

¹⁸See, e.g., Campbell, 817 F. 2d at 502, citing Boughton, 231 Cal. App. 2d at 192.

This California Trade Secret & Employee Raiding Law Letter is a publication of the law firm of Davis Wright Tremaine LLP and is prepared by its Commercial Litigation, Intellectual Property and Employment Law Departments.

Our purpose in publishing this Letter is to inform our clients and friends of issues and developments in trade secret and employee raiding law. It is not intended, nor should it be used as a substitute for specific legal advice since legal counsel may be given only in response to inquiries regarding particular factual situations.

DWT thanks Rory Eastburg for his assistance with this Letter.

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