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Recent court rulings about employee confidentiality make noncompetition agreements more important than ever.

Joel D. Covelman

If a trusted employee leaves a company to take a similar position with a competing firm, can the first company bring a lawsuit to stop it? The answer

 depends upon several factors. However, a recent California appellate court decision narrows the scope of remedies available to the former employer when the departing employee has a confidentiality agreement, but not a noncompetition agreement, with that employer.

A Schlage Lock Co. vice president named Whyte, who possessed detailed knowledge of Schlage’s manufacturing and lock sales to large home-improvement-store chains, quit and went to work for a major Schlage competitor, Kwikset Corp., in a similar executive position. Shortly before, Schlage had increased its business with a key customer, Home Depot, at the expense of Kwikset. Whyte had signed a confidentiality pledge as part of his employment agreement with Schlage, but not a noncompetition agreement. In the case of Schlage Lock Co. v. Whyte, the trial court found for the defendant, a decision that was upheld on appeal.1

Although Schlage gave the trial judge some evidence that Whyte had not fully honored the terms of his confidentiality agreement, no evidence was produced to show that his new employer had obtained any Schlage business secrets from Whyte, or that Whyte was about to disclose such secrets. Schlage argued that, given his job duties, it was inevitable that Whyte would disclose Schlage business secrets to Kwikset. 

Schlage initially sought an injunction that would prohibit Whyte from working for the lock division of Kwikset at all.2 The plaintiff later narrowed its request, asking that Whyte be enjoined only from attempting to make door-lock sales to Home Depot on behalf of his new employer. But the California Court of Appeal sided with the employee, taking a stance being adopted by a growing minority of state courts. It held that, in the absence of evidence unequivocally showing actual or imminent disclosure of the former employer’s business secrets, it would not resort to the legal fiction known as inevitable disclosure to bar the employee from working for the competitor.

Other courts have rejected the so-called inevitable disclosure doctrine, among them state courts in Virginia and federal courts in California, Florida,

 and New York. Nevertheless, federal courts in Connecticut, Illinois, Minnesota, Missouri, North Carolina, Texas, and Utah and state courts in Arkansas, Delaware, Illinois, New Jersey, and Ohio have gone the other way, accepting versions of the doctrine as valid (see sidebar, this page).

What Is a Trade Secret?

Most states have enacted some form of the Uniform Trade Secrets Act, a model law drafted by legal scholars, that defines a trade secret and sets forth remedies for the actual or threatened disclosure of such secrets. In California’s version of the law, a trade secret is defined as 

information, including a formula, pattern, compilation, program, device, method, technique, or process that: (1) Derives 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; and (2) Is the subject of efforts that are reasonable under the circumstances to maintain its secrecy. 

As the California court observed in Schlage, “‘know-how’ is the quintessential trade secret.”4 Manufacturing and production methods and processes, as well as research results that may lead to new or improved product manufacturing techniques or to wholly new products, are the paradigmatic trade secrets protected by law. Court fights often revolve around the departure of employees who are engaged in cutting-edge scientific research or new-product development in the fields of biotechnology and electronics. However, these are not the only types of business secrets the law protects against being disclosed, or being used by a departing employee’s new employer.

In the Schlage case, the defendant, Whyte, held a sales position with the plaintiff company. The trade secrets Whyte possessed concerned primarily sales and marketing, such as information about Schlage’s new products, its customers, profits, pricing structures, and marketing plans. Payment terms offered by Schlage to its customers and the terms offered by suppliers to Schlage, as well as the lock maker’s advertising and promotional plans and budgets, also traveled with him. Because this kind of business information could have competitive value to Kwikset if disclosed by Whyte, it also fits the legal definition of a trade secret cited above. 

In the biotechnology field, therefore, not only can employees in research and development hold trade-secret information, but sales and marketing staff—and even outside advertising and marketing consultants or OEM manufacturers—may be privy to business secrets.

The Importance of Keeping Secrets Protected

The second element of the definition of a protectable trade secret in California, as well as in most other states, is that the business must show that it has always taken reasonable steps to maintain the secrecy of its information. This is simply a way of preventing a court from issuing an overly restrictive injunction, one that would cover information generally known within the industry or that entities outside the company already know.
Examples of nonconfidential information that is often wrongly taken for confidential are pricing information and instances of product purchases by customers. Any product purchaser knows what it has bought and the price paid. Unless the buyer has pledged to keep that information confidential, it is free to disclose such terms to any competitor of the seller.

The defendant in Schlage was accused of giving a line review document to Kwikset. This was a proposal to the customer (Home Depot) containing pricing arrangements—including discounts—and marketing and advertising incentives, along with notice of product changes and new product introductions. Of course, if Whyte had disclosed a secret line review document to Kwikset, the information it contained would have allowed Kwikset to compete more effectively with Schlage, not only for Home Depot’s business but for that of other home improvement chains. But the California appellate court ruled that the information in question did not qualify as a protectable trade secret. The court explained that there was no evidence before it to show that Home Depot was required to keep the line review document confidential. Thus, Schlage’s customer was free to disclose this information to Kwikset or to any other Schlage competitor.

Injunction Not Necessarily Warranted

The Uniform Trade Secrets Act allows a court to prohibit “actual or threatened misappropriation” of a trade secret. In California, then, the court must inquire after such misappropriation, and the former employer must provide evidence that business secrets were actually, or threatened to be, misappropriated.

The trade secrets law defines misappropriation generally as improper acquisition or unconsented use or disclosure of the secret information. Because most former employees were permitted users or possessors of their employer’s business secrets while they were working at the company, their acquisition of such business information usually is not improper. If they are spying for a commercial competitor, the situation is different. Former employees usually run afoul of the trade secrets law by virtue of subsequently disclosing, not initially acquiring, secret company information.

The California Court of Appeal observed that Whyte’s new employer cautioned Whyte not to disclose any of Schlage’s business secrets, and that only conflicting circumstantial evidence touched on whether Whyte might disclose, or might have already disclosed, Schlage’s secrets to Kwikset. The trial court, as a result of the judge’s firsthand examination of this evidence, had refused to grant an injunction prohibiting Whyte from working for Kwikset’s lock division, and the appellate court was unwilling to overturn the trial judge’s decision not to enjoin.

The appellate court also pointed out that another California law, Business and Profession Code section 16600, favors employee job mobility, noting that judicial decisions applying that law have required any noncompetition covenant made by an employee to be clear and circumscribed.6 Here, the so-called inevitable disclosure doctrine would convert an employee’s confidentiality agreement into a covenant not to compete that was never agreed upon (see sidebar). Said the court:

The covenant [not to compete] is imposed [by the inevitable disclosure doctrine] after the employment contract is made and therefore alters the employment relationship without the employee’s consent. When, as here, a confidentiality agreement is in place, the inevitable disclosure doctrine ‘in effect convert[s] the confidentiality agreement into such a covenant [not to compete].’7

Thus, inevitable disclosure is not the law in California.

Conclusion

The interaction of trade secret law with covenants not to compete is still unsettled. It is a creature of state-by-state legislation and judicial decisions. Nevertheless, some courts are questioning the wisdom of the inevitable disclosure doctrine. With one California appellate court now having rejected the inevitable disclosure doctrine, the tide may be turning against this legal fiction.

References 

1. Schlage Lock Co. v. Whyte, (September 12, 2002), Cal. App. 4th.
2. Schlage Lock Co. v. Whyte, (September 12, 2002), Cal. App. 4th, slip op. at p. 22.
3. California Civil Code, sec. 3426.1(d).
4. Schlage Lock Co. v.. Whyte, (September 12, 2002), Cal. App. 4th, slip op. at p. 14.
5. California Civil Code, sec. 3426.2(a).
6. California Civil Code, sec. 3426.1(b).
7. Schlage Lock Co. v. Whyte, (September 12, 2002), Cal. App. 4th, slip op. at p. 22, quoting PSC Inc. v. Reiss, supra, 111 F. Supp. 2d, 257.

Joel D. Covelman, JD, is Of Counsel to the law firm of Levin & Hawes LLP (Laguna Beach, CA), which limits its practice to intellectual property, patent, trademark, copyright, trade dress, and related litigation, both domestic and international. 

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