EXCLUSIVITY OF SERVICES, NONCOMPETITION

AGREEMENTS AND THE DEMAND FOR HIGHLY

SKILLED EMPLOYEES

by

Scott H. Dunham

Presented to

Institute for Corporate Counsel

Seventh Annual Seminar

March 1998

© 1998 O’Melveny & Myers LLP

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TABLE OF CONTENTS

Page

I. During Employment.......................................................................................................3A. Conduct not associated with preparing to compete.......................................3B. Preparing to leave..............................................................................................7C. Unfair competition restrictions......................................................................13

II. Post-Termination.........................................................................................................14A. An employee's contract contains a covenant not to compete......................14B. Former employee has misappropriated trade secrets..................................19C. Former employees are soliciting the employer's customers........................19D. Competitors are soliciting employer's former employees...........................22E. Former employee is soliciting the employer's employees............................22F. Unfair competition...........................................................................................24

III. Remedies.....................................................................................................................24A. Generally..........................................................................................................24B. Damages...........................................................................................................24

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I. During Employment.1

A. Conduct not associated with preparing to compete.

1. As a general matter, covenants not to compete during employment are enforceable. See Bach v. Curry, 258 Cal. App. 2d 676 (1968).

a. Since such a covenant only limits behavior during employment, it survives Cal. Bus. & Prof. Code § 16600, which states “any contract by which anyone is restrained from engaging in a lawful profession, trade or business of any kind is to that extent void.”

b. If the covenant is not expressly stated, employee’s activities will be limited under the unfair competition law. See “unfair competition,” page 27.

c. In addition to any covenant not to compete, an implied covenant of good faith and fair dealing exists in every contract, which can establish the basis for a contract action. Bleecher v. Conte, 29 Cal. 3d 345, 350 (1981).

(1) In the context of employment contracts, an implied covenant of good faith and fair dealing does not give rise to a tort action in addition to a contract action. Foley v. Interactive Data Corp., 47 Cal. 3d 654 (1988); see also Hunter v. Up-Right, Inc., 6 Cal. 4th 1174 (1993).

d. For remedies available, see page 27.

2. Employee has breached the contract.

a. An affirmative covenant to perform personal services will not be specifically enforced unless “special circumstances” exist. Cal. Civ. Code § 2390.

(1) “Special circumstances” will be found to exist where:

(a) there is a written contract for personal services;

(b) with a minimum compensation of at least $9,000 for the first year of the contract2, $12,000 for the second year of the contract, $30,000 for the fourth and fifth years of the contract and $45,000 for the sixth and seventh years of the contract;3 and

1 This outline focuses on California law.2 For contracts entered into on or before December 31, 1993, the compensation minimum is $6,000 per year. Cal. Civ. Code § 3423(e)(1).LA3:804066.1LA3:804066.1 3

(c) “where the promised service is of special, unique, unusual, extraordinary or intellectual character, which gives it peculiar value the loss of which cannot be reasonably or adequately compensated in damages in an action at law . . . .” Cal. Civ. Code § 3423.

(2) The rationale for such a provision is the “difficulty of supervision, the proscription of the Thirteenth Amendment of the Constitution against involuntary servitude, [and the] lack of mutual remedy."4

(3) Case law is unclear whether an injunction should only be granted to prevent breach of a negative covenant in a contract, leaving open the option for an employee to breach the contract and become idle. Briody, supra note 4, at 353.

(4) Case law is also ambiguous in defining “unique, unusual, extraordinary or intellectual services.” Briody, supra note 4, at 353.

(a) California cases seem to focus on degree of skill and replaceability of the employee. Id. at 353-54.

i) Examples include singers, ball players or actors. Id. at 354.

(b) A showing of irreparable damage may also be required. Id.

(5) Examples.

(a) A 10 year unilateral employment agreement, where, in the event of termination for any reason, the employee agreed not to become employed by any company in the same business, was unenforceable since it bound the employee for the 10 years, while the employer had no corresponding obligation to compensate him. Thompson v. Fish, 152 F. Supp. 779 (S.D. Cal. 1957).

3 If the contract does not satisfy these criteria for each and every year, Section 3423 could still apply if the aggregate compensation actually received through the year in which injunctive relief is being sought is at least 10 times the aggregate of the year-to-year minimum compensation specified by this provision. Cal. Civ. Code § 3423(e)(2)(B).4 Thomas Briody, “Employment Agreements Not To Compete In California,” 47 Cal. St. B.J. 318, 353 (1972) (“Briody”).LA3:804066.1LA3:804066.1 4

(b) An employment contract where the employee was entitled to “service fees” for “so long as the contract remains in force” was valid since it tended to regulate the employee’s conduct only during the employment, not after termination. Bach v. Curry, 258 Cal. App. 2d 676 (1968).

(6) In Practice.

(a) Cal. Lab. Code § 2855 limits enforcement of a personal services contract to seven years from the commencement of service5;

(b) employee’s unique services should be carefully defined and stipulated;

(c) agreement should be individually negotiated on a separate and independent basis; and

(d) side effects on other employment agreements already in force should be considered. Briody, supra note 4, at 355.

3. An employee has misappropriated trade secrets.6

a. A trade secret is defined as “information, including a formula, pattern, compilation, program, devise, 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;"7 and

5 One case implies that Section 2855 does not apply to agreements for the services of independent contractors. Foxx v. Williams, 244 Cal. App. 2d 223 (1966).6 The law governing misappropriation of trade secrets is consistent whether during employment, preparing to leave employment, or post termination. Although misappropriation arises most frequently while an employee is preparing to leave or post termination, an employee may misappropriate trade secrets while not necessarily competing. Examples of such situations include: doing favors for family members; cultivating favor; receiving monetary benefit; or acting out of spite. 7 Under California law, information can be a trade secret even though it is readily ascertainable, so long as it has not yet been ascertained by others in the industry. ABBA Rubber Co. v. Seaquist, 235 Cal. App. 3d 1, 18 (1991).LA3:804066.1LA3:804066.1 5

“(2) Is the subject of efforts that are reasonable under the circumstances to maintain its secrecy."8 Cal. Civ. Code § 3426.1(d).9

b. Either in the absence of an express agreement or in addition to one, a three year statute of limitations applies for misappropriation and misuse of trade secrets by a former employee. Id. § 3426.1(b)(2).

(1) This statute only applies where actual trade secrets are involved. Ingrassia v. Bailey, 172 Cal. App. 2d 117, 123 (1959) (“An agreement between the parties that something is a trade secret will not make of it a trade secret if in fact it is not”).

(2) Remedies available include injunctive relief and damages, including attorneys fees’ and exemplary damages. See remedies available, page 27.

(3) The court is to take reasonable steps to preserve the confidential nature of trade secrets. Cal. Civ. Code § 3426.5.

c. Sanctions can also be imposed against those who induce, bribe, or reward an employer’s former employees to procure and turn over a trade secret that the employee obtained while working for that employer. Cal. Penal Code § 499c(c).

d. A contract provision not to use trade secrets in competition with an employer is valid. Muggill v. Reuben H. Donnelly Corp., 62 Cal. 2d 239, 242 (1965).

(1) In the absence of a contract provision, trade secret law still protects the employer, but control over misappropriation is simpler if a contract establishes by agreement the definition of trade secrets and explicitly prohibits their use.

(2) Examples.

(a) “[A customer list] built up by ingenuity, time, labor and expense of the owner over a period of many years is property of the employer ... [and] [k]nowledge of such a list, acquired by an employee by reason of his employment, may not be used by

8 Reasonable efforts to maintain secrecy have been held to include advising employees of the existence of a trade secret, limiting access to a trade secret on a “need-to-know” basis, and controlling access to the company’s facilities. Courtesy Temporary Service, Inc. v. Camacho, 222 Cal. App. 3d 1278, 1288 (1990). 9 In addition, criminal sanctions exist that have a more difficult burden of proof and elements beyond the civil definition for misappropriation of trade secrets. See Cal. Penal Code § 499c(b)(1).LA3:804066.1LA3:804066.1 6

the employee as his own property or to his employer’s prejudice."10 Greenly v. Cooper, 77 Cal. App. 3d 382, 392 (1978); Morlife v. Perry, 66 Cal. Rptr. 2d 731, 735 (1997) (a list of prospective customers that took considerable time and expense to develop which was kept confidential, and which gave the employer an advantage over its competitors, is a trade secret that cannot be used by former employees to solicit customers). Accord Courtesy Temporary Service, Inc. v. Camacho, 222 Cal. App. 3d 1278, 288 (1990) (customer list that took a substantial amount of time and expense to create and which was kept reasonably confidential was a trade secret).

i) Computer programs and data compilations stored in computers are trade secrets. Cal. Penal Code § 499c.

(3) Drafting suggestions.11

(a) “Any employment agreement should itemize all confidential trade secrets and processes to which the employee will be exposed so that the employee is placed on notice that these matters are deemed to be confidential and the proprietary information of the company."12

(b) The agreement should also include a provision that allows for “the addition of new trade secrets and processes during the contract period."13

B. Preparing to leave.14

1. An employee is competitively soliciting employer’s customers.

10 Notwithstanding the existence of a trade secret customer list, California courts have acknowledged a former employee’s right to announce a new affiliation (as contrasted with solicitation of patronage). American Credit Indemnity Co. v. Sacks, 213 Cal. App. 3d 622, 634 (1989). See infra, page 7.11 If an employer specifies trade secrets by contract, it must ensure that it does not diminish its statutory rights. The examples listed should not appear to be exhaustive. In addition, the contract should survive the duration of the contract period.12 Allan Browne, “Guarding Against Unfair Competition and Business Piracy Through Preventative Law,” 51 Los Angeles Bar J. 153 (1975) (“Browne”).13 Allan Browne et al., Competitive Business Practices 101 (2d ed. 1991) (“Browne”).14 These situations generally arise when one is preparing to compete or leave. Analytically, the discussion is equally applicable to the situations where the employee is not preparing to leave but has other outside interests.LA3:804066.1LA3:804066.1 7

a. Whether the employer is trying to restrain the solicitation under a tort or contract theory, one must first define “solicitation.”

(1) Solicitation “implies personal petition and importunity addressed to a particular individual to do some particular thing.” Aetna Bldg. Maintenance Co. v. West, 39 Cal. 2d 198, 203.

(a) Merely announcing to the employer’s customers that he/she is changing employment does not constitute improper solicitation. Id.

(b) An employee may also willingly discuss business at the invitation of another person without violating a prohibition against solicitation. Id.

(2) The difference between a solicitation and an announcement is not always clear.

(a) Mailed announcement comparing employee’s products or services and prices to the employer’s constituted improper solicitation and unfair competition since the employees had used the employer’s confidential customer list in connection with the mailings. Klamath-Orleans Lumber, Inc. v. Miller, 87 Cal. App. 3d 458, 466 (1978).

(b) Where employees, however, use customer names and addresses in the employer’s files, which were held not to be trade secrets, to mail announcements in violation of the employees’ employment agreements, the actions did not constitute improper solicitation. Moss, Adams & Co. v. Shilling, 179 Cal. App. 3d 124 (1986).

(c) Query: Is a single personal visit or a phone call a solicitation?

b. A typical nonsolicitation covenant15 is valid during employment because it just requires an employee not to act to the employer’s detriment. Id.

(1) An antisolicitation clause of this type does not violate Cal. Bus. & Prof. Code § 16600.

15 Courts are not as hostile toward nonsolicitation agreements as noncompetition agreements. Browne, supra note 13, at 99. LA3:804066.1LA3:804066.1 8

c. In the absence of an express covenant, unfair competition laws dictate. See “unfair competition,” page 27.

d. For remedies available, see page 27.

2. Competitors or employees are soliciting employer’s employees.

a. Competitors are soliciting employer’s employees.

(1) Generally a business does not commit an actionable wrong by soliciting a competitor’s employees, or hiring away one or more of the competitor’s noncontractual employees, so long as neither the defecting employee nor the new employer uses deceptive or unfair methods. Diodes, Inc. v. Franzen, 260 Cal. App. 2d 244 (1968); Metro Traffic Control v. Shadow Traffic Network, 22 Cal. App. 4th 853, 859-60 (1992) (employer commits no actionable wrong by soliciting or hiring his or her competitor’s employees who are not under contract to the competitor so long as the inducement to leave is not accompanied by unlawful action).

(2) A competitor is also limited from soliciting employer’s employees under contract.

(a) The tort of interference with a contractual relationship has five elements: existence of valid contract; defendant’s knowledge of that contract; defendant’s intentional inducement of breach of that contract; actual breach or disruption of that contract; and damages. Pacific Gas & Elec. v. Bear Stearns, 50 Cal. 3d. 1118, 1125 (1990).

(3) For remedies available, see page 27.

b. An employee is soliciting fellow employees for a competing company.

(1) An employee cannot solicit fellow employees to leave the employer and work for a competitor. Such action would constitute unfair competition16 or a breach of fiduciary duty.17 Breach of a confidential relationship or breach of an implied obligation may also be added to support the primary claims. Bancroft-Whitney Co. v. Glen, 64 Cal. 2d 327 (1966).

16 See page 14.17 See page 11.LA3:804066.1LA3:804066.1 9

(a) See Bancroft-Whitney below, page 12.

(b) Laundry driver who solicited fellow employees to work for a competing laundry was terminated from employment for good cause. Puritan Laundry Co. v. Green, 15 Cal. App. 654 (1911).

(c) For remedies available, see page 27.

3. Otherwise preparing to compete.

a. An employee is setting up a competing business.

(1) California law permits an employee to seek other employment and to take steps in preparation to compete before resigning, but the employee may not transfer his or her loyalty to a competitor during the employment period. Fowler v. Varian Assoc., Inc., 196 Cal. App. 3d 34, 41 (1987); Stokes v. Dole Nut Co., 41 Cal. App. 4th 285, 293-96 (1995) (employer can terminate employee who was preparing to establish a competing business).

(a) Examples.

i) An employer can terminate an employee who refuses to disclose information about his or her knowledge regarding prospective competition and claims an obligation to the competitor to remain silent. Fowler v. Varian Assoc., Inc, 196 Cal. App. 3d 34, 41 (1987).

ii) Writing announcements of future employment or the establishment of a new company, or leasing the necessary premises, have been held to be permissible preparatory actions.18 See Sarkes Tarzian v. Audio Devices, Inc., 166 F. Supp. 250 (S.D. Cal. 1958); Southern California Disinfecting Co. v. Lomkin, 183 Cal. App. 2d 431 (1960).

(2) When a transfer of loyalty occurs.

(a) Statutory. See “unfair competition,” page 14.

(b) Contracts.18 These activities may only be permissible when the employee’s employment contract is terminable at will.LA3:804066.1LA3:804066.1 10

i) “An employee may agree in advance not to take any preliminary steps to set up a competing business until after his employment expires. Thus, the employee may waive by contract his common law right to make preparation for a competing business as long as he stays on the payroll of his employer.” Browne, supra note 13 at 75.

ii) An agreement can be entered into which requires an employee to divulge any competitive plans “which he may have under consideration whether or not he intends to act upon them.” Browne, supra note 12, at 157.

(c) A breach of fiduciary duty may be asserted.

i) A fiduciary relationship must exist between the employee and the employer. Generally, this means that at the time of the misappropriation of confidential information the employee must have been a director or officer of the employer’s company. Diodes, Inc. v. Franzen, 260 Cal. App. 2d 244, 255-56 (1968).

ii) In the leading case on fiduciary duty, corporate officers were found to have no general obligation to disclose prospective competitive plans unless the nondisclosure could result in harm to the corporation.19 Bancroft-Whitney Co. v. Glen, 64 Cal. 2d 327 (1966).

iii) Examples of breaches of fiduciary duty.

a) President of a corporation breached his fiduciary duty by disclosing confidential salary information to a competitor, and by further assisting the competitor in negotiations to hire away some of the corporation’s best employees. Id. at 350-54.

19 Other special rules may exist in partnership situations.LA3:804066.1LA3:804066.1 11

b) An employee violated his fiduciary duty by setting up his own warehouse business, thereby interfering with his employer’s renewal of a business lease. Gower v. Andrew, 59 Cal. 119 (1881).

c) A corporate director, who also designed the company’s main product, gave design drawings of the custom-made components of the system to a competitor. This saved the competitor a great deal of time and expense that would otherwise be required to develop the system on its own. Subsequently, the director became a major stockholder in the competing company. Thus, the court held that he breached his fiduciary duty to his employer by using his position of trust and confidence to advance his private interests at his employer’s expense. Sequoia Vacuum Systems v. Stransky, 229 Cal. App. 2d 281, 287-88 (1969).

d) An employee who set up a business of selling new books was not in competition with employer’s secondhand bookstore. Charles T. Power Co. v. Smith, 91 Cal. App. 101 (1928).

iv) Employees that are not officers or directors MAY have a duty of loyalty that parallels a fiduciary duty, where the employee is not a director or officer but the employee has a position of trust and confidence in the employer’s organization. American Republic Ins. Co. v. Union Fidelity Life Ins. Co., 470 F.2d 820 (9th Cir. 1972). See, e.g., Intermedics, Inc. v. Ventritex, Inc., 822 F. Supp. 634 (N.D. Cal. 1993); Imi-Tech Corp. v. Gagliani, 691 F. Supp. 214, 230 (S.D. Cal. 1986).

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(3) For remedies available, see page 27.

b. The employer wants to prevent an employee from accepting employment with a competitor.

(1) The “interests of the employee in his own mobility and betterment are deemed paramount to the competitive business interests of the employers” so long as the employee does not use unfair means to obtain the new job. Diodes, Inc. v. Franzen, 260 Cal. App. 2d 244, 255 (1968).

(a) An employee may accept employment with employer’s competitors and use the general knowledge and skill and experience that the employee developed while working for the employer. Morlife v. Perry, 66 Cal. Rptr. 731, 734 (1997).

(b) The employee may not, however, use trade secrets from the former employer in his or her new employment. Id.

(2) “An employer may not use (or threaten to use) a contractual provision that restricts an employee from using or disclosing trade secrets or confidential information to prevent the employee from obtaining or accepting employment with a competitor.” Browne, supra note 13, at 83.

(a) Accepting employment with a competitor does not automatically mean that the employee will violate the [employment] agreement and disclose trade secrets. Herzog v. “A” Co., 138 Cal. App. 3d 656 (1982).

4. An employee misappropriates trade secrets, see page 4.C. Unfair competition restrictions.

a. Cal. Bus. & Prof. Code § 17200 defines unfair competition, in pertinent part, as an “unlawful, unfair20 or fraudulent business act.”

(1) Such activities include solicitation of customers, solicitation of employees, accepting competitive employment, organizing a competing business,

20 “An ‘unfair’ business practice occurs when it offends an established public policy or when the practice is immoral, unethical, oppressive, unscrupulous or substantially injurious to consumers.” People v. Casa Blanca Convalescent Homes, Inc., 159 Cal. App. 3d 509, 530 (1984). LA3:804066.1LA3:804066.1 13

concealment of competitive plans and divulging confidential matters.21

(2) The unfair competition law governs in addition to the applicable specific statutes and contract provisions.

b. For remedies available, see page 27.

II. Post-Termination.

A. An employee’s contract contains a covenant not to compete.

1. At common law, covenants in restraint of trade were enforceable when reasonable as a matter of law.

a. Factors to be considered to determine “reasonableness” include: (1) whether or not the covenant is ancillary to an otherwise lawful contract; (2) whether or not it is necessary to protect the parties and effectuate the main contract; (3) whether it is a general or partial restraint as regards to territory and duration; and (4) the effect of the contract on the general public.22

2. Under California law, however, unless a statutory exception applies, “any contract by which anyone is restrained from engaging in a lawful profession, trade or business of any kind is to that extent void.” Cal. Bus. & Prof. Code § 16600.

a. California courts have been hostile toward covenants not to compete requiring the covenant to be strictly construed against the employer and in favor of the employee.

(1) A clown performing in a chicken suit after his employment by a radio station as a chicken-suited clown had been terminated is “not unfair competition in violation of the employment agreement, because the clown neither wore the station’s call letters nor represented that he was performing for the station.” Bosley Medical Group v. Abramson, 161 Cal. App. 3d 284 (1984).

(2) A pension plan provision that terminates retirement benefits if the former employee works for a competitor is an invalid restraint under Section 16600. Muggill v. Reuben H. Donnelley Corp., 62 Cal. 2d 239, 242 (1965);

21 These activities constitute unfair competition when conducted in the manner discussed in this outline.22 Joseph D. Mullender, Jr., Case Note: “Contracts--Legality--Contracts in Restraint of Trade,” 26 S. Cal. L. Rev. 208 (1953).LA3:804066.1LA3:804066.1 14

(a) Compare Smith v. CMTA-IAM Pension Trust, 654 F.2d 650 (9th Cir. 1981), where a pension plan that merely suspended benefits during employment in the same industry or by another who participated in the same pension plan was a valid partial restraint.

(b) But Section 16600 may be preempted in the context of a

pension plan under the broad preemptive effect of the Employee Retirement and Income Security Act

of 1974 (“ERISA”), 29 U.S.C. §§ 1001 et seq.

b. Section 16600 may not apply “where one is barred from pursuing only a small or limited part of the business, trade or profession.” Boughton v. Socony Mobil Oil Co., 231 Cal. App. 2d 188 (1964).

(1) An agreement that barred a person from the orchard heater business is invalid as restraining a lawful profession, trade or business. Summerhays v. Scheu, 10 Cal. App. 2d 574 (1936).

(2) An agreement by an insurance agent to forfeit commissions if agent interfered with pre-existing business relationships is a valid partial restraint. Bushkuhl v. Family Life Ins. Co., 271 Cal. App. 2d 514 (1969).

(3) An agreement not to produce a specific trailer model is a valid partial restraint. King v. Gerold, 109 Cal. App. 2d 316 (1952).

(4) A psychologist barred from the preparation of aptitude tests could invalidate the agreement by showing that his “profession, trade or business” was the preparation of aptitude tests and not psychology generally. Campbell v. Board of Trustees, 817 F.2d 499 (9th Cir. 1987).

c. Customer lists or trade secrets rather than partial restraints may actually be the main factor considered to determine whether a particular restraint is valid. See Morris v. Harris, 127 Cal. App. 2d 476 (1954) (partial restraint was illegal since no customer lists or trade secrets were involved). See also Muggill v. Donnelly, 62 Cal. 2d 239 (1965); Buskuhl v. Family Life Ins. Co., 271 Cal. App. 2d 514 (1969) (it is acceptable to not pay commission accrued to an employee after the end of his or her employment if the employee injures the employer by inducing customers not to

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patronize the employer when a preexisting restrictive covenant restricted the employee’s ability to deal with the customers for only a limited time).

(1) In the absence of a protectable trade secret, the right to compete fairly seems to outweigh the employer’s right to protect clients against competition from former employees. American Credit Indemnity Co. v. Sacks, 213 Cal. App. 3d 622, 634 (1989).

d. Cal. Bus. & Prof. Code §§ 16601-16602 create four statutory exceptions to the general prohibition against covenants not to compete.23

(1) Under Section 16601, a covenant not to compete is valid if it is made in connection with the sale of the goodwill of a business.

(a) A sole proprietor must sell goodwill to make an enforceable covenant not to compete. Browne, supra, note 13, at 70.

i) A gift will not satisfy to meet the statutory requirements. Id.

ii) “[A] sale of goodwill without the transfer of tangible assets” will satisfy the statutory requirements. Id.

(b) A covenant not to compete will be held to exist despite the absence of a contract provision where the court finds it necessary in order to protect the buyer from suffering a decrease in the value of its purchase. Monogram Indus. v. Sar Indus., 64 Cal. App. 3d 692 (1976).

(2) Under Section 16601, a covenant not to compete will be enforced if it is made in connection with the sale or other disposition of all the covenantor’s shares in a corporation.

(a) A shareholder must sell or otherwise dispose of all of his/her shares to support a covenant not to compete. Radiant Indus. v. Skirvin, 33 Cal. App. 3d 401 (1973).

23 Covenants under these provisions must be limited to the city or county where the business is located and to the duration of the period in which the coventee carries on a like business.LA3:804066.1LA3:804066.1 16

i) A gift of shares by shareholder would satisfy the statutory requirements. Browne, supra note 12, at 70.

ii) A covenant not to compete is invalid if the stockholder retains even one share. Radiant Industries, Inc.v. Skirvin, 26 Cal. App. 3d 72 (1972).

iii) Where an employment agreement conditions employment on the purchase of stock and also requires the employee to sell the stock back upon termination, a covenant not to compete is invalid. Bosley Medical Group v. Abramson, 161 Cal. App. 3d 284 (1984).

a) Such an agreement is considered a “sham” in order to obtain an enforceable covenant not to compete under Section 16601; covenant will not be enforced under this exception unless the sale of stock is of a significant amount so as to be a transfer of the corporation’s goodwill. Id.

(3) Under Section 16601, a covenant not to compete in connection with the sale of all or substantially all the operating assets, together with the goodwill of a corporation or its subsidiary or division, is enforceable.

(a) A corporation needs to sell substantially all but not all of its operating assets to support a covenant not to compete. Fleming v. Ray-Suzuki, Inc., 225 Cal. App. 3d 574 (1990).

(4) A covenant not to compete will be upheld if it is made in connection with the dissolution of a partnership. Howard v. Babcock, 6 Cal. 4th 409, 425 (1993); Haight, Brown & Bonesteel v. Superior Court, 234 Cal. App. 3d 963, 969 (1991).

(a) A “sale” does not need to take place for a partner to agree not to compete. Browne, supra, note 13, at 71.

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(b) An agreement not to compete by a partner may precede any transaction or “dissolution.” Id.

e. Public policy.

(1) California courts have consistently held that Section 16600 is an expression of strong California public policy, ensuring the retention of every citizen’s right to pursue any lawful employment and enterprise of their choice. Metro Traffic Control, Inc. v. Shadow Traffic Network, 22 Cal. App. 4th 853, 859 (1994); KGB, Inc. v. Giannoulas, 104 Cal. App. 3d 844 (1980).

(2) Other concerns include the effects of restraints on the individual employee’s bargaining position, reduced competition in the market, and the slowing of the dissemination of ideas, processes, and methods. Briody, supra note 4, at 320.

f. A permanent injunction to prevent competition by a former employee may be granted to enforce a valid covenant not to compete. Morlife v. Perry, 66 Cal. Rptr. 2d 731 (1997).

3. “If the employer retains an option in the employment contract to hire the employee as a consultant after the expiration of his contract, the employee may be restrained from working for competitors during the term of the consulting agreement.” Browne, supra note 13, at 159.

(1) A contract, however, that does not require performance of actual services and provides for nominal compensation may be read as a “sham.” Id. at 99.

4. The employer can enjoin an employee from breaching an employment contract. See page 1.

5. In the absence of a covenant not to compete, unfair competition law applies. See page 27.

6. For discussion of available remedies, see page 27.

B. Former employee has misappropriated trade secrets.

1. “An agreement [that] protects merely a propriety or property right of the employer recognized as entitled to protection under the general principles of unfair competition"24 survives the Section 16600 ban as a valid partial restraint. Metro Traffic, 22 Cal. App. 4th at 861.

24 See “unfair competition,” page 27. LA3:804066.1LA3:804066.1 18

a. Accordingly, an employee’s agreement not to disclose a former employer’s confidential customer lists or solicit the customers specified on that list is a valid agreement.

b. All that an employee acquires by virtue of employment belongs to the employer, whether acquired lawfully or unlawfully, or during or after the expiration of the term of employment.25 Cal. Lab. Code § 2860.

(1) A contractual provision may negate the application of Section 2860. Browne, supra note 13, at 157.

(2) An employer cannot require an employee to assign rights to certain inventions developed by the employee, on the employee’s own time without the use of the employer’s resources. See Cal. Lab. Code §§ 2870-2872.

2. In the absence of an express agreement or in addition to one, the misappropriation of trade secrets is prohibited. See “Uniform Trade Secrets Act,” page 4.

C. Former employees are soliciting the employer’s customers.

1. Where no valid nonsolicitation agreement exists, a former employee may solicit the employer’s customers so long as it is carried out fairly and legally. Rigging Int’l Maintenance Co. v. Gwin, 128 Cal. App. 3d 594 (1982); A.B.C. Distrib. Co. v. Distillers Distrib. Corp., 154 Cal. App. 2d 175, 192 (1957); John F. Mattul Assoc., Inc. v. Cloutier, 194 Cal. App. 3d 1049, 1054 (1987); Continental CAR-NA-VAR Corp. v. Mosely, 24 Cal. 2d 104, 111 (1944).

a. Under the unfair competition law, whether a former employee’s competition is conducted fairly and legally is determined on a case-by-case basis. Browne, supra note 13, at page 79.

(1) Example: Use of confidential customer list to solicit customers is unfair and illegal competition. See page 27.

b. Common law tort theories of recovery that could also be added to an unfair competition claim include breach of confidential relationship and interference with prospective economic advantages.

2. A post-termination nonsolicitation covenant may be allowed. Browne, supra note 13, at page 81.

a. See “solicitation” discussion, page 7.

25 This rule only applies to property that belongs to the employer, which does not include skills acquired by the employee during employment. King v. Pacific Vitamin Corp., 256 Cal. App. 2d 841 (1967).LA3:804066.1LA3:804066.1 19

b. An employer cannot prohibit mere solicitation without combining the prohibition with another fact like the use of a trade secret, in which the combination would result in “unfair competition.” See Klamath-Orleans Lumber, Inc. v. Miller, 87 Cal. App. 3d 458 (1978).

(1) The validity of a nonsolicitation agreement could turn on whether or not the employee used confidential information to solicit the customers.

(a) “[I]t is well settled that although a former employee who joins or establishes a competing enterprise may properly solicit business from those he served in his previous employment, ‘an employee ... should not be allowed to exploit information which his employer compiled at great expense and which represents a valuable business asset.’” Klamath-Orleans Lumber, Inc. v. Miller, 87 Cal. App. 3d 458 (1978); Morlife v. Perry, 66 Cal. Rptr. 731 (1997) (employee cannot use former employer’s potential customer list that took great expense and time to generate, which was confidential and which provided employer with advantage over other competitors).

i) If the identity of the customers are not confidential, a covenant not to solicit customers is invalid. See, e.g., Forna v. Martin, 158 Cal. App. 2d 634 (1958).

ii) Where names and addresses are accessible to all, customer identities are not confidential. Id. at 63.

(2) Where trade secrets or confidential information are involved, “a covenant, if reasonable, should be enforced as a permissible partial restraint. Gordon v. Wasserman, 153 Cal. App. 2d 328 (1957).

(a) The subsequent use of that information to solicit the former employer’s customers has been found to be an unfair and deceptive practice for purposes of Section 17200 and, thus, enjoined. See, e.g., Courtesy Temporary Service, Inc. v. Camacho, 222 Cal. App. 3d 1278, 1291-92 (1990).

i) A nonsolicitation agreement for one year after termination is valid because one is not

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prevented from engaging in a similar business, one was just prevented from using employer’s customer list to solicit employer’s customers for his own benefit. Gordon v. Wasserman, 153 Cal. App. 2d 328 (1957). See also Weissensee v. Chronicle Publishing Co., 59 Cal. App. 3d 723, 728 (1976) (“a reasonable agreement not to use confidential [customer] lists is valid and enforceable”).

ii) There is a limit on what is reasonable because a post termination, nonsolicitation agreement for 10 years after termination is unreasonable. Morris. v Harris, 127 Cal. App. 2d 476 (1954).

(b) But other cases demonstrate a lack of cohesiveness in this area.

i) An employment contract that provided that the employees “will not ... solicit, divert or take away, directly or indirectly, any of the customers, business or patronage of [employer]” during and after the employees’ term of employment for as long as employer carries on its business was valid and enforceable. Golden State Linen Serv. v. Vidalin, 69 Cal. App. 3d 1, 6, 9 (1977).

ii) An agreement that the employee would not solicit employer’s customer “at any time in the future” and that, if the employee breaches this agreement, he would pay $50.00 per breach was an invalid covenant not to compete that unduly restrained the employee from exercising a “lawful profession, trade, or business.” Gordon Termite Control v. Terrones, 84 Cal. App. 3d 176 (1978).

iii) In Hollingsworth Solderless Terminal Co. v. Turley, 622 F.2d 1325, 1338 (9th Cir. 1980), the court held that “the applicable California law is that the employer will be able to restrain by contract only that conduct of the former employee that would have been

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subject to judicial restraint under the law of unfair competition, absent the contract.” If the employees did not engage in any unfair competition, the contract would be unenforceable as violative of Cal. Bus & Prof. Code § 16600. Id.

3. For remedies available, see page 27.

D. Competitors are soliciting employer’s former employees.

1. Competitors are free to solicit former employees so long as no deceptive or unfair methods are used.26

E. Former employee is soliciting the employer’s employees.

1. A nonsolicitation clause is in place.

a. A former employee’s agreement not to disrupt, damage, impair or interfere with his or her former employer by “raiding” its work staff is enforceable. See Loral v. Moyes, 174 Cal. App. 3d 268, 279-80 (1985).

(1) Within a termination agreement, the potential impact on trade must be considered before invalidating a noninterference agreement. Id. at 278.

(a) A restraint on “raiding” employees “does not appear to be any more of a significant restraint on his engaging in his profession, trade or business than a restraint on solicitation of customers or on disclosure of confidential information. Id. at 279.

(b) A restraint clause should “be limited in scope as to geography, duration, and the job descriptions covered by the non-solicitation provision.” Browne, supra note 12, at 157.

(c) Nonetheless, the former employee could always receive and accept applications from employees of a former employer; only the solicitation of their applications was prohibited under the contract and Section 16600. Loral, 174 Cal. App. 3d at 279-80.

(2) An employer is entitled to some protection against the business piracy by former employees aimed at the

26 ? See “unfair competition” page 27, and remedies available, page 27.LA3:804066.1LA3:804066.1 22

destruction of its business. Klamath-Orleans Lumber, Inc. v. Miller, 87 Cal. App. 3d 458 (1978).

b. “Some employment contracts provide that, for a specified period (e.g., one year) after termination of the employee’s full-time employment with the company, he or she will not enter business or work with anyone who was employed with the company during the last (e.g., six) months of his own employment in any business enterprise in competition with the employer.” Browne, supra note 13, at 100.

(1) An employer may also limit the application of such a provision to employees that earn over a specified amount. Id.

(2) It may be argued that an employee’s right to work is violated by such a provision. Id.

(a) However, it can be said that such a provision merely limits those with whom the former employee can associate. Id.

(3) This type of provision has not yet been litigated in California. Id.

2. Breach of fiduciary duty. See page 11.

a. The duty does not continue once the employee-director is no longer employed as such.

(1) An attorney who was a former officer and employee of the corporation was allowed to use the corporations confidential customer list to announce her new employment, but not to solicit the customers’ business. John F. Matull & Assoc., Inc. v. Cloutier, 194 Cal. App. 3d 1049, 1052 (1987). The court found that the former employee, who was also a director, had no fiduciary duties to her former employer after she was fired or resigned. Therefore, the court held that the employer’s claim that she breached her fiduciary duty by using a confidential customer list to solicit business was without merit. Id. at 1052-53 n.3.

3. For remedies available, see below.

F. Unfair competition.

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1. Former employee’s activities can be regulated under the unfair competition law, Business and Professions Code §§ 17200-17209, which applies to “unlawful, unfair or fraudulent business practices.”

a. See “unfair competition” discussion, page 15.

(1) Example: A former employee’s use of confidential information obtained from his or her former employer to compete with and solicit business from said employer is regarded as unfair competition. Cloutier, 194 Cal. App. 3d at 1054-55. See also Continental Car-Na-Var Corp. v. Moseley, 24 Cal. 2d 104, 110 (1944) (court enjoined former employee from using employer’s confidential business secrets to engage in competition with employer).

2. For remedies available, see below.

III. Remedies.

A. Generally.

1. Statutory remedies generally consist of injunctive relief, civil penalties, and civil penalties for violating an injunction.

a. Any action can be brought by the Attorney General, by other specified public officers, “or by any person acting in the interests of itself, its members, or the general public.” Cal. Bus. & Prof. Code § 17204.

B. Damages.

1. A party may recover damages in unfair competition cases if a satisfactory basis exists for estimating probable earnings if the wrongful conduct had not occurred. See Natural Soda Prods. Co. v. City of Los Angeles, 23 Cal. 2d 193 (1943); Guntert v. City of Stockton, 55 Cal. App. 3d 131 (1976); Dulien Steel Prods. v. A.J. Indus., 264 Cal. App. 2d 540 (1968).

a. An award may be proper where there is sufficient operating experience to allow for a reasonable estimate of probable income and expense. Id.

b. Lost profits can be established by defendants’ profit from the diverted sale where defendants competed unfairly by soliciting plaintiff’s customers. Klamath-Orleans Lumber, Inc. v. Miller, 87 Cal. App. 3d 458, 466 (1978).

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c. Variable costs, but not fixed costs, are deducted from profits to arrive at net lost profits. Seaboard Music Co. v. Germano, 24 Cal. App. 3d 618 (1972).

d. The Uniform Trade Secrets Act, Cal. Civ. Code §§ 3426-3426.11, allows actual pecuniary loss and unjust enrichment27 to be considered in calculating damages for misappropriation of trade secrets. Morlife v. Perry, 66 Cal. Rptr. 2d 731, 740 (1997).

2. In addition to the damages for probable earnings, courts may award damages for initial expenses that are incurred in connection with the business. Aronowicz v. Nalley’s, Inc., 30 Cal. App. 3d 27 (1972).

3. Diminution in the value of goodwill can also be awarded. Donleavey v. Johnston, 24 Cal. App. 319 (1914).

4. Punitive damages may be awarded when the defendant is found guilty of fraud, malice, or oppression in an unfair competition case, where the claim sounds in tort. Southern Cal. Disinfecting Co. v. Lomkin, 183 Cal. App. 2d 431 (1960).

a. The Uniform Trade Secrets Act has a similar provision allowing for punitives where there is a “willful and malicious misappropriation” of trade secrets, but the maximum punitive damages award is limited to twice the amount of compensatory damages awarded under the Uniform Trade Secrets Act. Cal. Civ. Code § 3426.3(c).

5. Attorneys’ fees will be awarded only if provided for by statute or agreement of the parties. Cal. Civ. Proc. Code § 1021.

a. Where an agreement seems only to allow for attorneys’ fees unilaterally, reciprocity will be read into the agreement. Cal. Civ. Code § 1717.

b. An exception allows for attorneys’ fees where a plaintiff was protecting his or her interests by bringing or defending an action against a third person, which was necessitated by the defendant’s tort. See, e.g., Prentice v. North Am. Title Guar. Corp., 59 Cal. 2d 618 (1963).

c. Another exception exists where the court feels that “overriding considerations indicate the need for such a recovery” and particularly if one party has “acted in bad faith, vexatiously, wantonly, or for oppressive reasons.” K-2 Ski Co. v. Head Ski Co., 506 F.2d 471, 476 (9th Cir. 1974).

27 ? One may not receive duplicative recovery. Cal. Civ. Code § 3426.3.LA3:804066.1LA3:804066.1 25

6. Civil penalties may arise in actions brought by the Attorney General or by a local district attorney. Cal. Bus. & Prof. Code § 17206.

a. The maximum penalty is $2,500 for each violation of the unfair competition law.

(1) Some courts have held that a separate penalty must be imposed for each violation. People v. Custom Craft Carpets, Inc., 159 Cal. App. 3d 676, 686 (1984); People v. National Ass’n of Realtors, 155 Cal. App. 3d 578, 585 (1984). But see People v. Casa Blanca Convalescent Homes, Inc., 159 Cal. App. 3d 509, 535 (1984).

7. The California Supreme Court has left undecided if a non-business competitor plaintiff can recover damages on an unfair competition cause of action. Committee on Children’s Tel., Inc. v. General Foods Corp., 35 Cal. 3d 197, 215 (1983).

C. Permanent injunctive relief.

1. “Any person who engages, has engaged, or proposes to engage in unfair competition may be enjoined.” Cal. Bus. & Prof. Code § 17203.

a. Under Cal. Bus. & Prof. Code § 17203, a court may order restitution and/or disgorgement of profits to the state, as a type of ancillary relief to an injunction. People v. Thomas Shelton Powers, M.D., Inc., 2 Cal. App. 4th 330 (1992).

2. Permanent injunctive relief can be awarded where Bus. & Prof. Code § 17203 applies, where unfair competition arises from the misappropriation of trade secrets, where money damages are inadequate28, where money damages are difficult to ascertain29, where it is necessary to prevent multiple court actions30, or where the obligation arises from a trust.31

a. Courts have held that the legislature “intended to permit tribunals to enjoin on-going wrongful business conduct in whatever context such activity might occur.” Barquis v. Merchants’ Collection Ass’n, 7 Cal. 3d 94 (1972).

3. As a catch-all, Cal. Civ. Code § 3368 authorizes injunctive relief where necessary to prevent “a party from doing that which ought not to be done.”

28 ? Cal. Civ. Code § 3422(1).29 ? Cal. Civ. Code § 3422(2).30 ? Cal. Civ. Code § 3422(3).31 ? Cal. Civ. Code § 3422(4).LA3:804066.1LA3:804066.1 26

4. An injunction can continue until the commercial advantage obtained from the misappropriation of the trade secret no longer exists. Morlife v. Perry, 66 Cal.

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