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Are Restrictive Covenants Enforceable in California? It Depends.
In California, it is well established that non-compete provisions are unenforceable, subject to certain statutory exceptions. Nevertheless, some courts have also recognized that non-compete provisions are enforceable if necessary to protect confidential information or trade secrets.
But what about non-compete provisions that are ambiguous as to their protection of confidential information or trade secrets? Recently, when faced with such a provision, one California federal court narrowly construed the provision to find it enforceable.
The Facts in Richmond
In Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158 (N.D. Cal. July 1, 2011), a California federal district court evaluated the following provisions included in the parties’ Confidentiality and Non-Disclosure Agreement (“NDA”):1
Non–Solicitation. During the Term of this Employment (a[s] hereinafter defined), and for a period of one year thereafter, [defendant] [shall not] directly or indirectly, initiate any contact or communication with, solicit or attempt to solicit the employee of, or enter into any agreement with any employee, consultant, sales representative, or account manager of [plaintiff] unless such person has ceased its relationship with [plaintiff] for a period of not less than six months. Similarly [plaintiff] shall not solicit the employment of, or enter into any agreement with any employee, consultant or representative of [defendant].
Non–Interference. During the Term of this Employment, and for a period of one year thereafter, [defendant] will not initiate any contact or communication with, solicit or attempt to solicit, or enter into any agreement with, any account, acquiring bank, merchant, customer, client, or vendor of [plaintiff] in the products created and serviced by [plaintiff], unless (a) such person has ceased its relationship with [plaintiff] for a period of not less than six months, or (b) [defendant]'s relationship and association with such person both (i) pre-existed the date of this Agreement and (ii) does not directly or indirectly conflict with any of the current or reasonably anticipated future business of [plaintiff].
Non Compete and Non Circumvent. [Defendant] will not compete with [plaintiff] with similar product and or Service using its technology for a period of one year thereafter. [Defendant] will not use any of the [plaintiff]'s technical knowhow or Source Code for the personal benefit other than the employment and to meet the customer needs defined by [plaintiff].2
The NDA also contained a provision that barred the defendant from disclosing or using confidential information used in plaintiff's business.3 Confidential information was defined to include “Proprietary Data,” such as “know-how,” contract terms and conditions with merchants, technical data, and source code; “Business and Financial Data;” “Marketing and Developing Operations;” and “Customers, Vendors, Contractors, and Employees,” including their names and identities, data provided by customers, and information on the products and services purchased by customers.4
The Richmond Court’s Analysis
In evaluating plaintiff’s motion for a temporary restraining order, the court assessed plaintiff’s claim that, by teaming up with plaintiff’s former employee to form a competing venture, the defendant had breached the non-compete provisions of the NDA.5 Defendants argued that the plaintiff was not likely to prevail on its contract claims because the non-compete provisions in the NDA are unenforceable under California Business and Professions Code § 16600.6
Within this context, the court first noted that the California Supreme Court had recently confirmed that “‘[t]oday in California, covenants not to compete are void, subject to several exceptions,” and that the California Supreme Court “‘generally condemns noncompetition agreements.’”7
Second, the court also observed that the California Supreme Court had rejected the “narrow-restraints” exception to Section 16600 applied in several Ninth Circuit cases, finding that “‘California courts have been clear in their expression that section 16600 represents a strong public policy of the state which should not be diluted by judicial fiat.’”8 As the court stated, “Section 16600 stands as a broad prohibition on ‘every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind.’”9
Third, the court rejected plaintiff’s argument that Section 16600 applies only to restrictions on employees, concluding that Section 16600 did apply to the facts of the case.10
Fourth, the court acknowledged that, even though Section 16600 applied, a number of California courts have also held that former employees may not misappropriate a former employer’s trade secrets to compete unfairly with the former employer.11
Applying these principles, the court held that the non-solicitation and non-interference provisions of the NDA were likely unenforceable under California law because the provisions were more broadly drafted than necessary to protect plaintiff’s trade secrets and “would have the effect of restraining Defendants from pursuing their chosen business and professions if enforced.”12
In regards to the non-compete provision, the court reasoned that “the scope of the prohibitions on ‘compet[ing] with [plaintiff] with similar product and or Service using its technology” and using ‘technical knowhow’ is not entirely clear.”13 However, the court then concluded that “if the clause is construed to bar only the use of confidential source code, software, or techniques developed for [plaintiff’s] products or clients, it is likely enforceable as necessary to protect [plaintiff]'s trade secrets.”14
To support this construction, the court specifically cited the California Uniform Trade Secrets Act (“UTSA”)’s definition of a “trade secret,” even though plaintiff had not alleged a UTSA claim against the defendants and the UTSA was not briefed.15 The court also found that the provision prohibiting use of confidential information was likely enforceable to the extent that the claimed confidential information is protectable as a trade secret.16
Based on these conclusions regarding the enforceability of the provisions, and facts showing that plaintiff had established at least serious questions going to the merits of its claims, the court issued a narrow temporary restraining order.17
Richmond demonstrates that at least one California federal court may be willing to narrowly construe an ambiguous non-compete provision and find it enforceable to the extent necessary to protect a party’s trade secrets. In so doing, however, the court invites comparisons to California cases where courts have refused to narrowly construe broad non-compete provisions to be protections of trade secrets.18 For example, in D'sa v. Playhut, Inc., 85 Cal. App. 4th 927 (2000), a Court of Appeals refused to reform a non-compete provision that broadly prohibited employees from working in connection with a competing product.19 But D’sa was strictly in the employment context, where courts are more likely to look for over-reaching. Arguably, moreover, the provision at issue in D’Sa was broader than the provision considered in Richmond, which expressly referenced “technology,” “technical knowhow,” and “Source Code” in its language. Nevertheless, even with these references, the Richmond court conceded that the scope of the provision was “not entirely clear,” yet was willing to reform it to find it enforceable.
Furthermore, in enforcing the non-compete provision, the Richmond court also relied on the so-called “trade secret exception” to Section 1660020 — an exception that the California Supreme Court noted but declined to address in Edwards v. Arthur Andersen LLP, 44 Cal. 4th 937, 946 n.4 (2008). This is an exception that other courts, particularly state courts, have questioned.21 This reliance suggests that, in the absence of conclusive guidance from the California Supreme Court on the viability of this exception, federal courts may remain willing to apply this exception to non-compete provisions perhaps as a way to harmonize the two statutes. In doing so, it is possible that the same collision between federal jurisprudence and state jurisprudence that gave rise to the Edwards decision may lie ahead. The California Supreme Court will then have an opportunity to address a key issue that the Supreme Court left unaddressed in a footnote in Edwards.
Finally, even with the uncertainty over the viability of the “trade secret exception” and whether courts will narrowly construe a non-compete provision to find it enforceable, companies should ensure non-compete provisions are drafted to clearly and specifically protect trade secrets, thereby increasing the likelihood that such a provision will be enforced.
1Plaintiff is a company that provides enterprise resource planning software for financial service companies that provide credit card terminals to merchants. Id. at *1. One of the defendants developed and maintained enterprise resource planning software for the plaintiff and, pursuant to this relationship, entered into this NDA with plaintiff’s predecessor-in-interest. Id. at *1-2.
2Id. at *16.
3Id. at *16.
4Id. at *16.
5Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158, at *15-22 (N.D. Cal. July 1, 2011).
6Id. at *16.
7Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158, at *16 (N.D. Cal. July 1, 2011)(quoting Edwards v. Arthur Andersen LLP, 44 Cal. 4th 937, 945-46 (2008)).
8Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158, at *17 (N.D. Cal. July 1, 2011)(quoting Edwards v. Arthur Andersen LLP, 44 Cal. 4th 937, 949 (2008)).
9Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158, at *17 (N.D. Cal. July 1, 2011)(quoting Cal. Bus. & Profs. Code § 16600).
10Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158, at *17 (N.D. Cal. July 1, 2011).
11Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158 at *18 (N.D. Cal. July 1, 2011)(quoting Retirement Group v. Galante, 176 Cal. App. 4th 1226, 1237 (2009)(citing Morlife Inc. v. Perry, 56 Cal. App. 4th 1514, 1519-20 (1997); American Credit Indemnity Co. v. Sacks, 213 Cal. App. 3d 622, 634 (1989); Southern Cal. Disinfecting Co. v. Lomkin, 183 Cal. App. 2d 431, 442–448 (1960); Hollingsworth Solderless Terminal Co. v. Turley, 622 F.2d 1324, 1338 (9th Cir. 1980); Gordon v. Landau, 49 Cal. 2d 690 (1958); Gordon v. Schwartz, 147 Cal. App. 2d 213 (1956); Gordon v. Wasserman, 153 Cal. App. 2d 328 (1957)).
12Id. at *18.
13Id. at *19.
14Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158, at *19 (N.D. Cal. July 1, 2011)(citing Whyte v. Schlage Lock Co., 101 Cal. App. 4th 1443, 1456 (2002)). Interestingly, there is theoretically no temporal limit to a trade secret, so the one year limit of the non-compete provision actually undercut the plaintiff's protection!
15See Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158, at *19 (N.D. Cal. July 1, 2011)(citing Cal. Civ.Code § 3426.1(defining “trade secret” to include programs, methods, and techniques that derive independent economic value from not being generally known to the public, provided they are subject to reasonable efforts to maintain their secrecy)).
16Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158, at *19 (N.D. Cal. July 1, 2011)
17Id. at *23.
18Perhaps this decision also signals a willingness among California federal courts to protect employer’s interests by reforming or severing provisions that may not comply with Section 16600. See also Thomas Weisel Partners LLC v. BNP Paribas, No. C 07–6198 MHP, 2010 WL 1267744 (N.D. Cal. Feb. 10, 2010)(holding that a former employee’s non-solicitation provision was void to the extent it restricted the former employee’s ability to hire the employer’s employees after the former employee transitioned to another company, but upholding the rest of the employment agreement). These decisions may renew forum shopping, the ill that the California Supreme Court’s decision in Edwards v. Arthur Andersen LLP, 44 Cal. 4th 937 (2008) was implicitly designed to address.
19The provision stated: “Employee will not render services, directly or indirectly, for a period of one year after separation of employment with Playhut, Inc. to any person or entity in connection with any Competing Product. A 'Competing Product' shall mean any products, processes or services of any person or entity other than Playhut, Inc. in existence or under development, which are substantially the same, may be substituted for, or applied to substantially that same end use as the products, processes or services with which I work during the time of my employment with Playhut, Inc. or about which I work during the time of my employment with Playhut Inc. or about which I acquire Confidential Information through my work with Playhut, Inc. Employee agrees that, upon accepting employment with any organization in competition with the Company or its affiliates during a period of five year(s) following employment separation, Employee shall notify the Company in writing within thirty days of the name and address of such new employer.” D'sa v. Playhut, Inc., 85 Cal. App. 4th 927, 930 -31(2000).
20Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158 at *18 (N.D. Cal. July 1, 2011).
21As an example of the trend, see, e.g., Dowell v. Biosense Webster, Inc., 179 Cal. App. 4th 564, 577 (2009)(“Although we doubt the continued viability of the common law trade secret exception to covenants not to compete, we need not resolve the issue here.”); Robinson v. U-Haul Co. of California, Nos. A124070, A124097, A124096, 2010 WL 4113578, at *10 (Cal. Ct. App. Oct. 20, 2010)(“the so-called ‘trade secrets’ exception to Business and Professions Code section 16600 . . .rests on shaky legal grounds”)(citing Edwards v. Arthur Andersen LLP, 44 Cal. 4th 937, 946 n.4 (2008); Dowell v. Biosense Webster, Inc., 179 Cal. App. 4th 564, 578 (2009); Retirement Group v. Galante, 176 Cal. App. 4th 1226, 1238 (2009)). When the apparent conflict in this area is addressed, perhaps the California Supreme Court will defuse it entirely, by agreeing with the way the court in Retirement Group v. Galante, 176 Cal. App. 4th 1226 (2009) reconciled it: “the conduct is enjoinable not because it falls within a judicially-created ‘exception’ to section 16600's ban on contractual nonsolicitation clauses, but is instead enjoinable because it is wrongful independent of any contractual undertaking.” Retirement Group v. Galante, 176 Cal. App. 4th at 1238.