Trade Secret / Noncompete : Business, Employment, Intellectual Property, and Litigation Attorneys Focused on Trade Secret/Noncompete Issues

Subsequently, in November, 2007, Creteguard’s CEO informed Silguero in writing that although Creteguard believed that “non-compete clauses are not legally enforceable here in California,” Creteguard desired “to keep the same respect and understanding with colleagues in the same industry” – and therefore – that Silguero was being terminated effective November 14, 2007.

Silguero sued both FST and Creteguard advancing a number of theories including interference with contract, state antitrust law violations – and as against Creteguard – wrongful termination in violation of public policy.

Creteguard moved to dismiss Silguero’s wrongful termination claim, arguing among other things, that there was “no clearly-delineated public policy prohibiting a subsequent employer from honoring a putatively valid non-compete / confidentiality agreement entered into by an employee and a former employer.”

The trial court agreed and dismissed the wrongful claim against Creteguard. On July 30, 2010, however, the Court of Appeal reversed.

Observing that under California Business and Professions Code 16600, the “interests of the employee in his own mobility and betterment are deemed paramount to the competitive business interests of employers, where neither the employee nor his new employer has committed any illegal act accompanying the employment change,” the Court of Appeal likened the understanding reached between FST and Creteguard to a “no hire agreement” previously disapproved of by the California Court of Appeal in in VL Systems, Inc. v. Unisen, Inc. (2007) 152 Cal.App.4th 708. To enforce the agreement between FST and Creteguard, the Court of Appeal found, would allow employers “to accomplish by indirection that which” they could not accomplish directly.

The result in Silguero is not entirely surprising, particularly given how broadly the California Courts – including the California Supreme Court – have recently been interpreting California Business and Professions Code section 16600.

The decision should serve as a cautionary reminder that when a California employer sends or receives a letter threatening litigation based on a confidentiality or competition agreement a current or former employee has signed, careful attention to the enforceability of the agreement under California law is required. Particularly if you conclude that the agreement the employee has signed with a former employer is not enforceable, even a threat of litigation by that former employer will not necessarily insulate you, as the current employer, from liability if you choose to “take a pass” purely to avoid litigation. 

For this reason as well, it is critically important during any interview and selection process to inquire about and require disclosure of any confidentiality or competition agreements to which an employee may be subject so that you go into a new employment relationship with eyes wide open to the potential risks associated with selecting any particular candidate.

With that background, even though nonsolicitation agreements are not permitted in California (and thus, that might be considered to be the end of the case), the court nevertheless found that it was proper to prevent a former employee from soliciting customers based on trade secret misappropriation law and/or unfair competition law - as opposed to based on some contractual obligations.  The court explained that "a former employee may be barred from soliciting existing customers to redirect their business away from the former employer and to the employee's new business if the employee is utilizing trade secret information to solicit those customers."  The court further explained, "[I]t is not the solicitation of the former employer's customers, but is instead the misuse of trade secret information, that may be enjoined." 

What is true in California in this regard is true elsewhere:  An employee's solicitation of an employer's customers may not only jeopardize the employer's goodwill, it may implicate the employer's trade secrets and confidential information, thus providing the employer with another arrow in its quiver to prevent such conduct.

Application of the "inevitable disclosure" doctrine is neither universal nor automatic, however.  For example, in states that have not adopted the UTSA, some courts have construed the absence of an express statutory provision allowing for claims based on threatened (as opposed to actual) misappropriation as precluding the use of the doctrine.    

Even in those states where the UTSA has been adopted, the applicability of the doctrine remains an open question.  For example, in some UTSA states, courts have expressly rejected the doctrine, holding that it "cannot be used as a substitute for proving actual or threatened misappropriation of trade secrets."  See, e.g., Whyte v. Schlage Lock Co., 125 Cal. Rptr. 2d 277 294 (Cal. Ct. App. 2002).  In other states, despite the fact that the doctrine has been recognized for at least 40 years, the state appellate courts have simply not addressed the issue, leaving the federal courts to predict what is likely to happen in those jurisdictions.  Compare, e.g., Clorox Co. v.  S.C. Johnson & Son, ___ F.Supp.2d ___, No. 09-CV-408, 2009 WL 1615522 (E.D. Wis. June 9, 2009) (noting lack of Wisconsin decisions addressing the viability of the inevitable disclosure doctrine) with Square D Co. v. Van Handel, No 04-C-775, 2005 WL 2076720 (E.D. Wis. Aug. 25, 2005) (assuming, without deciding, that even without an enforceable noncompete agreement, the inevitable disclosure doctrine would justify injunctive relief under Wisconsin law, if the information allegedly possessed by the former employer were a trade secret).  

Finally, even where the state courts have adopted the doctrine, it will not "inevitably" lead to the granting of injunctive relief for the former employer.  As the Square D court noted, there is still a threshold issue of whether the information the former employer seeks to protect is a trade secret.  And, even if a trade secret is involved, to determine whether disclosure is truly inevitable, courts will often look closely at just how much overlap there is between the employee's former and current positions or whether other actions can be taken to protect against disclosure short of enjoining the employee from working for the competitor.  See, e.g., Bridgestone/Firestone, Inc. v. Lockhart, 5 F. Supp. 2d 667 (S.D. Ind. 1998) (where sales executive had been assigned to work in a non-competitive division and "ethical walls" would be used to isolate him from decisions where his trade secret knowledge could be used, no inevitable disclosure threat existed).  Courts also continue to look closely at the balance of harms.  Thus, even while recognizing that you can't put toothpaste back in a tube and, similarly, a trade secret once disclosed is, by definition, no longer a trade secret, courts remain very concerned about limiting the mobility of employees, especially those with highly specialized knowledge.   

In short, despite the long-standing nature of the doctrine, courts continue to struggle to balance the legitimate needs of both employees and employers and, even where prior case law indicates that the doctrine is viable, where a particular court will strike the balance remains an open question. 

Illinois: Marty Bishop of our Chicago office writes:

The general rule in Illinois is that "parties may freely assign rights and duties under a contract."  Automed Technologies, Inc. v. Eller, 160 F. Supp. 2d 915, 923 (N.D. Ill. 2001) (citing Patrick Media Group, Inc. v. DuPage Water Comm'n, 630 N.E.2d 958, 965 (Ill. App. Ct. 1994)).  Accordingly, in stark contrast to Nevada, Illinois courts have recognized the assignability of noncompete agreements.  See Hexacomb Corp. v. GTW Enterprises, 875 F. Supp. 457, 464 (N.D. Ill. 1993); Hamer Holding Group v. Elmore, 560 N.E.2d 907, 917 (Ill. App. Ct. 1990).  Even where an employment contract is silent as to assignability, "courts generally permit assignment of restrictive covenants to a corporate acquirer."  Automed, 160 F. Supp. 2d at 924; see Hexacomb, 875 F. Supp. At 464 ("A successor corporation in an asset purchase can enforce confidentiality agreements and covenants not to compete that an employee signed with its predecessor corporation.") (citing A. Fink & Sons v. Goldberg, 139 A. 408 (N.J. Ct. Chan. 1927)).  The assignability rule applies equally in the context of mergers, see, e.g., Unisource Worldwide, Inc. v. Carrara, 244 F. Supp. 2d 977, 981 (C.D. Ill. 2003) (holding that merged entity could enforce restrictive covenants against former employees even though employment agreements were silent as to assignments), and asset purchase agreements, see, e.g., Hamer, 560 N.E.2d at 919 (holding that buyer in asset purchase agreement had standing to enforce restrictive covenant assigned as part of that agreement, concluding that "the trial court's determination that plaintiff failed to establish a protectable interest in the restrictive covenant was against the manifest weight of the evidence and contrary to law.").

Maryland: David Sanders of our Washington office writes:

In a merger of entities where the CEO and stakeholders of the predecessor and successor were the same, and where nothing about the operations of the business changed, the court found that the successor was entitled to enforce a noncompete between the predecessor entity and an employee. National Instrument, LLC v. Braithwaite, 2006 MDBT 11; 2006 WL 2405831; 2006 Md. Cir. Ct. LEXIS 12 (Md. Cir. Ct. 2006). The court noted further that "even if the Covenant had been assigned from [the predecessor] to [the successor], [the successor] can still enforce it," because a person contracting with a corporation should assume that the corporation and its personnel could change, there had been no change in the employee's duties and obligations, and the employee did not object to the merger and continued to accept the benefits of employment after the merger.  Id. (relying, in part, on cases from Missouri and New Hampshire: Alexander & Alexander, Inc. v. Koelz, 722 S.W.2d 311 (Mo. Ct. App. 1986) and Town of Hampton v. Hampton Beach Improvement Co., 107 N.H. 89, 218 A.2d 442 (N.H. 1966)). It should be noted, however, that the court did leave the door open for a different result if two unrelated entities were to merge. Id.

Massachusetts: Russell Beck of our Boston office writes as follows at pages 134-36 of his book entitled, Negotiating, Drafting and Enforcing Noncompetition Agreements & Related Restricted Covenants (3^rd Edition 2009):

No appellate level court has directly addressed the issue of whether a successor in interest or assignee of a noncompetition agreement may enforce the agreement in the absence of express consent from the restricted party (in the noncompetition agreement or otherwise). See Chiswick, Inc. v. Constas, 2004 WL 1895044, at *2 (Mass. Super. Ct. June 17, 2004) (Kane, J.) (finding no likelihood of success on the merits because issue is unresolved). There are, however, several trial court decisions suggesting that consent is in fact required. Next Generation Vending v. Bruno, C.A. No. 08-0365-G, at *5 (May 20, 2008) (Quinlan, J.) ("noncompete clauses are not assignable unless specifically assented to by the employee"); Getman & Cleary Schultz Ins., LLC v. USI Holdings Corp., 2005 WL 2183159, at *2 (Mass. Super. Ct. Sept. 1, 2005) (Gants, J.) (refusing to enforce noncompetition agreement-albeit enforcing other restrictive covenants-where employer merged into larger company and employee's noncompetition agreement could not be viewed as contemplating restrictions that would inhere with respect to much larger company); Securitas Sec. Servs. USA, Inc. v. Jenkins, 2003 WL 21781385, at *5 (Mass. Super. Ct. July 18, 2003) (van Gestel, J.) (noncompetition agreement is not assignable without express consent). But see Banc of Am. Corporate Ins. Agency, LLC v. Verille, C.A. No. CV2007-01099, at *5 (Mass. Super. Ct. Aug. 6, 2007) (Connors, J.) (ignoring issue, except to question to whom any goodwill belonged, predecessor company or employee). Consistent with these decisions, the Appeals Court observed in Middlesex Neurological Associates, Inc. v. Cohen, 3 Mass. App. Ct. 126, 127-28 (1975), that the defendant had not argued that he did not consent to the assignment, thus implying that consent is in fact required. Even if an agreement states that it will apply to a successor entity, courts will review the nature of the transactions involved to determine whether, in fact, the new employer fits within the strict construction of "successor," as defined in the agreement. If the noncompetition agreement is with a parent company, for example, and the subsidiary - through which the employee worked - is sold, the noncompetition agreement might not apply after the sale. See, e.g., L-3 Communications Corp. v. Reveal Imaging Techs., Inc., No. 035810-BLS, at *11 (Dec. 2, 2004) (van Gestel, J.) (court narrowly construed agreement to find that agreement did not cover post-sale employment). The reason for the courts' resistance to permitting unbridled assignment of noncompetition agreements was explained by Judge van Gestel in Securitas Security Services USA as follows:

"[E]very one has a right to select and determine with whom he will contract, and cannot have another person thrust upon him without his consent." New England Cabinet Works v. Morris, 226 Mass. 246, 250 (1917).

. . .

[W]hen rights arising out of a contract are coupled with obligations to be performed by the contractor, and involve such relation of personal confidence that it must have been intended that the rights should be exercised and the obligations performed by him along, the contract, including both his rights and his obligations, cannot be assigned without the consent of the other party to the contract. Id.

. . .

Yet another, and possibly quite significant, reason for not permitting assignments of these kinds of agreements without assent is the fact that [the employee], knowing the character and personality of [the employer], might be ready and willing to safeguard the trust which it imposed in him by granting restrictive covenant against leaving his employment. This does not mean, however, that [the employee] would have been willing to suffer this same restraint for the benefit of a stranger to the original undertaking. Certainly [the employee] could not assign his contract with [the employer] . . . without [the employer's] consent. For similar reasons [the employer] could not assign [the employee's] employment agreement to another corporate entity with [the employee's] assent.

Securitas Sec. Servs. USA, Inc. v. Jenkins, 2003 WL 21781385, at *5.

Michigan: Jeffrey Kopp of our Detroit office writes:

Michigan, like many other states, recognizes that contracts are generally assignable, unless forbidden by public policy or the contract itself, or its provisions are personal in nature.  Michigan courts also recognize that noncompetition clauses are favored as long as they are reasonable in geographic scope and duration. Although there is a dearth of case law regarding the issue of whether noncompete agreements may be assigned in Michigan, a few cases suggest that a successor company can enforce noncompete agreements against the predecessor's former employee. For instance, in Logical Networks, Inc. v Murdock, No. 239779, 2002 Mich. App. LEXIS 1374, **10-11 (Mich. Ct. App., Oct 1, 2002) and Virchow Krause & Co v. Schmidt, 2006 WL 1751835 (Mich. Ct. App., June 27, 2006) (both unpublished cases), courts enforced noncompete agreements by the successor company following asset sales. The court rejected the employee's arguments that the contracts were personal in nature and therefore unassignable.  Thus, given the broad enforceability of restrictive covenants in Michigan, which has been very employer-favorable in recent years, assignment clauses that are well-drafted and included in noncompete agreements are likely to be upheld by Michigan courts.  

New York: Kim Shur of our Washington office (and formerly of our New York office) writes:

Under New York law, a contract containing a noncompete agreement generally is assignable in a merger or sale of assets, even if the agreement in question is silent as to the issue of assignability, so long as the original parties to the contract so intended and the agreement was not one for personal services.  See e.g., Eisner Computer Solutions, LLC v. Gluckstern, 293 A.d.2d 289, 741 N.Y.S.2d 511 (1st Dep't 2002); Special Prods. Mfg. v. Douglass, 159 A.d.2d 847, 553 N.Y.S.2d 506 (3d Dep't 1990).  New York courts long have held that executory contracts, which do not involve exceptional personal skills and which the assignee can perform without adversely affecting the rights and interests of the adverse party, are freely assignable absent a contractual, statutory or public policy prohibition.  Special Prods. Mfg., 553 N.Y.S.2d at 509.  New York courts also have held that where the intent to create a covenant not to compete is unmistakably evident in an agreement between the parties, it benefits the successors and assigns of an employer so long as a second agreement does not specifically forbid such an assignment. Id.; see also Abalene Pest Control Service, Inc. v. Powell, 8 A.D.2d 734, 187 N.Y.S.2d 381 (2d Dep't 1959) (a subsequent sale of a business will pass the covenant not to compete as an incident of the goodwill of the business even though it is not expressly assigned so long as the original contract was not one involving personal credit or confidence).  In sum, in determining whether a noncompete agreement can be assigned in the context of a merger or sale of assets, New York courts will focus on the intention of the parties and try to determine whether assignability was contemplated in the first instance, whether assignability is necessary to protect the goodwill of the business being sold, and whether the contract was for personal services.    

Virginia: David Sanders of our Washington office writes:

Virginia courts will not permit the assignment of a noncompete contained in an employment contract in the context of an asset acquisition, unless both parties agree to the assignment. The Reynolds and Reynolds Company v. Hardee, 932 F. Supp. 149 (E.D. Va. 1996), affirmed, 133 F. 3d 916 (4^th Cir. 1997) (unpublished).

Wisconsin: Sharon Mollman Elliott of our Madison office writes:

Because Wisconsin courts deem that the parties to a merger have become one, the surviving company automatically assumes the noncompete agreements of each party that is merged into it.  Unless the covenant not to compete specifically provides that it does not survive a merger, the surviving company can enforce the covenant as if it were its own.  See Farm Credit Services v. Wysocki, 627 N.W.2d 444 n.2 (Wis. 2001).