United States: Trade Secret Litigation -- New Challenges when Using the Employment Contract to Protect Trade Secrets, Confidential Information, and Competitive Advantage

Originally published in IP Litigator, April 2001

Two recent California decisions invite caution when implementing contractual postemployment restrictions with existing employees. Twin rulings in D'Sa v. Playhut, Inc. [2000 Cal. App. LEXIS 982 (2000)] and Latona v. Aetna U.S. Healthcare, Inc. [82 F.Supp. 2d 1089 (C.D. Cal. 1999) forewarn that hardball negotiating tactics over legally suspect covenants not to compete may not only defeat the intended contractual protection of trade secrets, but also expose employers to liability for wrongful termination.

Employers pursue aggressive postemployment restrictions in the hope that their trade secrets will be protected and their competitive advantage will be preserved. A typical package agreement will include a covenant not to compete, a promise not to solicit customers, and a promise not to use or disclose confidential information and trade secrets.

The promises are typically secured from new employees as part of a take-it-or-leave-it job offer, and the new hires rarely question or challenge the trade secret and confidentiality contracts imposed by their employers. As Roger Milgrim reports in his treatise, "[w]here an enterprise has an established employment contract program its continued implementation is likely to proceed smoothly" [Milgrim on Trade Secrets § 6.01[3][a] (1998)]. However, Milgrim warns that a host of complications may arise when an employer approaches its existing, less compliant employees with a new secrecy agreement. In this type of situation,

  • The contracts may be viewed as an assault on the integrity and loyalty of long-time employees.
  • The contracts may inspire "larcenous thoughts" in otherwise loyal employees.
  • The contracts must be bargained for with creative consideration such as a new benefits package or additional leave time [Id.].

Additionally, employers are now facing a significant hurdle to instituting the package agreements: employees who simply refuse to sign the agreements. The Latona and D'Sa decisions demonstrate that spurned employers would do well to temper their reaction to such refusals, even with at-will employees who decline the contract. The employers in both cases fired an existing at-will employee who had refused to sign package agreements containing a covenant not to compete. The aggrieved employees responded with lawsuits for wrongful termination, alleging that the noncompete provisions of the agreements were void against public policy and that they could not be legally terminated for declining a void contract. Both employers attempted to define the covenant not to compete as necessary to protect trade secrets--a type of covenant valid even under California's stringent standards. The employers also advocated the operation of the contracts' severability provisions to demonstrate the validity of other provisions, even if the covenants not to compete were invalid.

The courts sided with the fired workers on both issues. In each case, the defendant argued that the severability clause allowed the court to disregard the illegal covenant not to compete and find the remainder of the contract valid. The D'Sa court, for example, was not persuaded that an employer could fire an employee for refusing a covenant not to compete that offends public policy on the ground that other clauses in the contract were "inoffensive." The court characterized that argument as "circular and unintelligible" [D'Sa at 500.]. Rather, the D'Sa court construed the entire contract as illegal and unenforceable, despite the severability provision.

Both courts were equally unpersuaded by the employers' construction of the covenant not to compete as "necessary to protect the employers' trade secrets." Such a construction would have allowed the covenants to fall under a narrow exception to California's general prohibition on such covenants. The D'Sa court explained that the employer's construction was inappropriate because (1) other provisions of the agreement targeted trade secret protection, and (2) the covenant contained a time limitation absent in the other provisions of the agreement [D'Sa at 501.].

The holdings of these wrongful termination cases illustrate that employees wishing to institute a protection program by forcing existing employees to sign package agreements should do so with care and finesse. Furthermore, in dicta, the D'Sa ruling even suggests that the same concerns would apply when hiring new employees. These concerns are particularly important for employers using boilerplate packages in multiple jurisdictions. The Latona court explicitly denounced such a practice: "Aetna took the contract it uses in other states and, without regard to [California's general prohibition of covenants not to compete] compelled its California employees to sign it or be fired" [Latona at 1098.]. Although the need to protect intellectual property and competitive advantage may suggest a heavy handed take-it-or-leave-it bargaining technique, the D'Sa and Latona opinions indicate that such an approach carries substantial risks. When changing the rules in the middle of the employment relationship, those risks may even include liability for wrongful termination.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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