While star employees may be well-compensated at established Valley companies, many embark on their own start up ventures in hopes of becoming the next Larry and Sergey.1
A departing employee may have heard that a California court won’t enforce that “non-competition” covenant signed upon joining the company. Conventional wisdom would lead the one time employee, now master of her own destiny, to believe only funding and that nagging issue of execution stands between her and that new house in Woodside. In practice, however, you can rarely entirely escape your past, and starting a new company is no different – unless the new venture has zero in common with the old day job, a rarity indeed, the ex-employer has at its disposal California trade secret law as a tool to keep the “rogue” employee, or more pointedly, future potential competitor harassed, distracted or even unfunded and out of business.
First, a little background on non-compete clauses in California. California public policy tends to favor a person being able to work where and for whom he or she chooses. Indeed, you could argue that without this policy, the Valley’s knack for inventing and reinventing (and often just improving) may never really have come into its own. A non-compete limits the freedom of an employee to leave her current employer and work for a competitive venture for some stated duration and within a defined territory after termination of employment – a purported limitation directly in contravention to California’s stated public policy. Section 16600 of the California Business and Professions Code, which governs noncompetition covenants made between a California resident employee and her employer, embodies this policy by stating that “every contract by which anyone is restrained from engaging in a lawful profession, trade or business of any kind is to that extent void.” Thus when taken alone, a California court generally finds noncompetition clauses to be void and therefore unenforceable.
Yet freedom to move is one thing. The ideas you carry with you are another. Great ideas, that is, great intellectual property, are often the backbone of most technology companies.
So, it’s not hard to understand why California law tends to often slant in favor of protecting and promoting this all important asset. Specifically, California essentially follows the Uniform Trade Secret Act.2 Under the California UTSA, a trade secret is 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 other persons who can obtain economic value from its disclosure or use, and (2) is the subject of reasonable efforts to maintain its secrecy.3
And, hence, California’s policy of protecting a person’s right to work collides with its other policy of protecting the results, the fruits, of one’s work. Doing their best to reconcile the two, seemingly equally compelling goals, California courts have explained that a covenant restraining competition may be enforced when subsequent competition constitutes unfair competition – that is, where the competitor (let’s say, a departed employee) uses or discloses to his new employer (which, can be his own start up company) the trade secrets or confidential information of his previous employer.4
Ultimately proving this unfair competition has or will occur is not easy – but for a cash strapped entrepreneur, trying to get both other talent and outside money to rally around her vision, allegations of trade secret infringement, of “unfairness” can be just enough to derail the entrepreneur’s efforts. Sometimes, just the overlap in business plans or similar target customer base can be just enough to spur the former employer on and spook other, potential allies (investors, potential co-founders, strategic partners).
A recent example that pushes the envelope of what can be thought of as confidential and inherently valuable intellectual property illustrates how far a California court can go, and how wary a departed employee, ought to be. In the 2005 California case, ReadyLink Healthcare v. Cotton, the court ruled that soliciting ReadyLink’s business contacts was inadmissible, explaining that “while it has been legally recognized that a former employee may use general knowledge, skill and experience acquired in his or her former employment in competition with a former employer, the former employee may not use confidential information or trade secrets in doing so.”5
Some states have adopted the “inevitable disclosure doctrine,” which assumes that if a former employee has knowledge of particular trade secret of her former employer and obtains a similar job with a direct competitor in a highly competitive industry, he or she will “inevitably” disclose the trade secret while working for the new competitor.
A California Court of Appeal in Schlage Lock v. Whyte expressly rejected the application of the inevitable disclosure doctrine in California. In Schlage Lock, Schlage Lock Company employed J. Douglas Whyte as its vice president of sales, making him responsible for sales to The Home Depot, Sears, Lowe’s and other large retailers. Whyte signed a proprietary information and confidentiality agreement as part of his employment. Whyte subsequently accepted employment with Kwikset Corporation, a competitor of Schlage as its vice president of sales for national accounts. His duties at Kwikset substantially replicated those at Schlage, including handling the Home Depot account. Among other causes of action, Schlage brought a misappropriation of trade secrets claim against Whyte based on the inevitable disclosure doctrine.
The court rejected the inevitable disclosure doctrine and held that it was incompatible with Section 16600 because the doctrine “creates a de facto covenant not to compete” and “run[s] counter to the strong public policy in California favoring employee mobility.”6 Although the Schlage Lock court completely rejected the inevitable disclosure doctrine, it recognized that the California USTA does not permit trade secret misappropriation.
While “actual” misappropriation is comparatively straightforward, the Schlage Lock court failed to definitively draw the line between “threatened” and “inevitable” disclosure. Such distinction was blurred since the court identified similar factors to show “threatened” misappropriation that is also used to establish inevitable disclosure, such as the similarity of former and current job duties, degree of competition between the former and current employers, current employer’s efforts to safeguard the former’s trade secrets, “lack of candor” by the departing employee and his current employer, and “their willingness to misuse” the former’s trade secrets. An employee ought to be wary of such factors when departing his or her employer and moving to start his new venture.
As noted above, and a point that requires emphasis . . . a lawsuit, even serious dispute in advance of a lawsuit, arising out of an alleged trade secret violation can occupy such a significant portion of the entrepreneur’s time and resources, and give enough pause to either other strong possible team members or investors, that it can sink the start-up. Given, however, that most founders either were happily employed somewhere else prior to a parting of the ways over pay, responsibility, vision, or simply had a day job to learn their art or pay the bills, a former employer often lurks in the background of many young companies. As such, there are some basic rules of disengagement an employee ought to follow while joining or founding a new company. They can be found here.
James Huie, a former associate at Greenberg Traurig, assisted with this article.
1Larry Page and Sergei Brin, founders of Google.
2Cal. Civ. Code Â§ 3426.
3Cal. Civ. Code Â§ 3426.1(d).
4See Schlage Lock Co. v. Whyte, 101 Cal. App. 4th 1443, 1462 (2002) (quoting Muggill v. Reuben H. Donnelley Corp., 62 Cal. 2d 239, 242 (1965)); see also Scott v. Snelling and Snelling, Inc., 732 F.Supp. 1034, 1038 (1990); see also American Paper & Packaging Products, Inc. v. Kirgan, 183 Cal. App. 3d 1318 (1986); see also Moss, Adams & Co. v. Shilling, 179 Cal. App. 3d 124 (1986).
5ReadyLink Healthcare v. Cotton, 126 Cal. App. 4th 1006 (2005).
6Schlage Lock, 101 Cal. App. 4th at 1462 (quoting Bayer Corp. v. Roche Molecular Sys., Inc., 72 F. Supp. 2d 1111, 1120 (N.D. Cal. 1999).