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California Misappropriation/Misuse of Trade Secrets

California Law on Enjoining a Former Employee from Competing Unfairly

In a misguided effort to catch up to a competitor, a business may hire a competitor’s key employees for the purpose of using the trade secret information known to the employee. Or, an employee may quit and go into competition with the former employer, using the confidential, proprietary and trade secret information learned while on the job. Whether characterized as misappropriation or theft of trade secrets, or as unfair competition, the bottom line is that such conduct represents an unfair business practice that can be enjoined under California law.

In a separate article, we explored the enforceability of non-compete agreements in California in light of the statutory prohibition against such agreements set forth in Business & Professions Code section 16600. We noted there that broad exceptions exist to the statutory prohibition, centering around an employer’s legitimate need to protect confidential and proprietary information. We address here the quantum of proof required to enjoin a former employee from using trade secrets in the service of a competitor.

We first address the validity of the “inevitable discovery” rule in California. The inevitable disclosure doctrine permits an employer to enjoin a former employee from working for a competitor “by demonstrating the employee’s new job duties will inevitably cause the employee to rely upon knowledge of the former employer’s trade secrets.” Whyte v. Schlage Lock Co., 101 Cal.App.4th 1443, 1446 (2002). Prior to Whyte, “[n]o published California decision ha[d] accepted or rejected the inevitable disclosure doctrine.” Id. Whyte unambiguously rejected it. Id., at 1447. Thus, California court decisions upholding non-compete agreements have not done so based on the inevitable discovery rule.

However, these decisions have not always required actual proof of use, either. It may be sufficient if the company can demonstrate the actual “threat” that confidential information will be used by the former employee to benefit a competitor.

While the cases do not say this, in my opinion there is a “sliding scale” much like the “irreparable harm/probability of success” scale a court uses in determining whether to grant injunctive relief such that the more important the misappropriated trade secret information at issue, the less strong need be the evidence of actual use. Put another way, the more “unfair” the competition based on the use of trade secrets, the more likely it is that a court will enjoin a former employee from competing.

The injunctive relief sliding scale has been explained as follows:

In order to prevail on its motion for a preliminary injunction, the moving party must demonstrate either (1) a likelihood of success on the merits and the possibility of irreparable injury or (2) the existence of serious questions going to the merits and that the balance of hardships tips sharply in its favor. Metro Publishing, Ltd. v. San Jose Mercury News, 987 F.2d 637 (9th Cir.1993). “These two formulations represent two points on a sliding scale in which the required degree of irreparable harm increases as the probability of success decreases.” MAI Systems Corp. v. Peak Computer, Inc., 991 F.2d 511, 516 (9th Cir.1993) (quoting Diamontiney v. Borg, 918 F.2d 793, 795 (9th Cir.1990)). In other words, “[w]here a party can show a strong chance of success on the merits, he need only show a possibility of irreparable harm. Where, on the other hand, a party can show only that serious questions are raised, he must show that the balance of hardships tips sharply in his favor.Id. at 517.

Bayer Corp. v. Roche Molecular Systems, Inc., 72 F.Supp.2d 1111, 1116 (N.D. Cal. 1999) (italics added).

A summary of Bayer v. Roche Molecular is illustrative. Bayer brought a motion for preliminary injunction against Roche Molecular and Pete Betzelos, a former employee that served as Bayer’s “HIV Marketing Manager,” after Betzelos joined Roche as its “International Marketing Manager, HIV”; the district court found that “[t]here is a clear overlap in job responsibilities.” Id., at 1112-13. The district court explained at page 1112,

This motion for a preliminary injunction presents a conflict between two strong public policies of California the policy favoring employee mobility free of encumbering restriction and the policy favoring protection of genuine trade secrets.

The court rejected the inevitable discovery doctrine, and explained that Bayer “will have to demonstrate actual use or disclosure, or actual threat thereof.” Id.

The factual summary foreshadowed the court’s ultimate decision not to grant injunctive relief. First, Roche controlled 70% of the market in HIV blood tests, while Bayer controlled only 20-25% of the market. Bayer, at 1113. (The Court apparently was impressed by the fact that Roche Molecular controlled a substantially larger market share because it later quoted from a letter by Roche’s general counsel that “RUMS is the market leader in developing nucleic acid diagnostic tests for infectious diseases; in fact RMS’ PCR HIV and HCV tests have become the gold standard in the industry.” Bayer, at 1115.)

Second, “Bayer’s tests use bDNA technology. Roche’s tests use PCR technology. They are completely different approaches to competing products.Id. (italics added). Third, Betzelos was “was responsible for the development and execution of marketing strategies, product launches, and marketing support activities” and “for the overall success of Bayer’s HIV products,” and he “developed Bayer’s worldwide marketing strategy for Bayer’s HIV 3.0 assay.” Id. At Roche, Betzelos would be “responsible only for marketing existing Amplicor HIV-1 viral-load assays, and not for launching new products.” Id., at 1114.

Perhaps most importantly, when Betzelos joined Roche “he signed a contract in which he agreed not to disclose or use confidential information,” and later (in connection with the motion for preliminary injunction) Betzelos “signed a further undertaking for his employers at Roche in which he re-affirmed his agreement that he would not use or disclose any confidential or proprietary information of Chiron Diagnostics [Bayer] in his performance of his position as the International HIV Marketing Manager for Roche.” Bayer, at 1114.

The district court’s detailed analysis led it to deny injunctive relief because “the Court finds that Bayer’s specific evidence of actual use fails, either because the information was not really private or because it was already known by Roche.” Bayer, at 1117 (italics added). However, the district court ordered “periodic and targeted discovery” permitting Bayer to monitor Betzelos’ conduct for Roche and permitting Bayer to renew its motion “[s]hould the discovery reveal evidence of use or disclosure of Bayer’s confidential or proprietary information.” Id., at 1121.

The same problem existed for the former employer in Whyte v. Schlage Lock Co., 101 Cal.App.4th 1443 (2002). Even though the opinion rejects the inevitable disclosure doctrine and affirms the denial of injunctive relief, it contains very favorable language for employers as to the type of information that can be protected as “trade secret.” For that reason, we discuss it at length.

The lawsuit involved a bitter fight between archrivals, Schlage and Kwikset when a former employee, Schlage’s Vice President of Sales, J. Douglas Whyte, joined Kwikset. Kwikset affirmatively courted Whyte because, in the words of Kwikset’s president, he “was killing my team.” Id., at 1448. Skipping the interim legal battles, the trial court ultimately denied injunctive relief because it did not believe the information Schlage sought to protect were trade secrets. Id., at 1449.

The appellate court first set forth the standard of review:

Injunctions in the area of trade secrets are governed by the principles applicable to injunctions in general. [Citation.] “In deciding whether to issue a preliminary injunction, a trial court weighs two interrelated factors: the likelihood the moving party ultimately will prevail on the merits, and the relative interim harm to the parties from the issuance or nonissuance of the injunction.”

101 Cal.App.4th at 1449-50 (quoting Hunt v. Superior Court, 21 Cal.4th 984, 999 (1999).

Schlage sought to protect 19 categories of information. As noted above, the trial court believed that the information was not trade secret; the appellate court in large part disagreed. Specifically, Schlage sought to enjoin the use of the following:

a. Information about Schlage’s new products;

b. Pricing of Schlage’s products sold to its customers;

c. Profit margins on Schlage’s products sold to its customers;

d. Schlage’s costs in producing the products it sells to its customers;

e. The Home Depot Line Review Documents;

f. Pricing concessions made by Schlage to its customers;

g. Promotional discounts made by Schlage to its customers;

h. Advertising allowances made by Schlage to its customers;

i. Volume rebates made by Schlage on its products to its customers;

j. Marketing concessions made by Schlage to its customers;

k. Schlage’s market research data;

l. Advertising strategy plans for calendar year 2000;

m. Trade Discounts made by Schlage to its customers;

n. Payment terms offered by Schlage to its customers and offered by Schlage’s vendors/suppliers to Schlage;

o. Rebate Incentives made by Schlage to its customers;

p. Schlage’s advertising, sales and promotion budgets;

q. Finishing processes for new and existing Schlage products;

r. Composite material process technologies (i.e., the unique composite materials used by Schlage in its products and the processes applied to those composite materials);

s. Schlage’s 1, 3 and 5 year strategic plan documents;

t. Schlage’s personnel information….”

101 Cal.App.4th at 1452 (italics added).

For purposes of determining whether misuse of this information may be enjoined, the appellate court held that, “With the exception of category [a] (Schlage’s new product information), we conclude Schlage identified its trade secrets with the requisite specificity.” Id., at 1453. This is because all a party seeking injunctive relief need do is

“describe the subject matter of the trade secret with sufficient particularity to separate it from matters of general knowledge in the trade or of special knowledge of those persons who are skilled in the trade, and to permit the defendant to ascertain at least the boundaries within which the secret lies.”

Id., at 1452 (quoting Diodes, Inc. v. Franzen, 260 Cal.App.2d 244, 253 (1968)). Whyte rejected the “new product” category because Schlage failed to “differentiate between truly secret information (such as formulas and product designs) and new product information which has been publicly disclosed.” Id. at 1454. The appellate court also rejected the “personnel information” category on the ground that Schlage failed to address it, and so it was deemed waived. Id.

“The test for trade secrets is whether the matter sought to be protected is information (1) which is valuable because it is unknown to others and (2) which the owner has attempted to keep secret.” Whyte, at 1454 (citation omitted). The court then applied this test to the various categories Schlage sought to protect.

With respect to Schlage’s “competitive pricing and marketing of products” categories b through d, f through j and m through o the court explained at page 1455:

These categories identify Schlage’s pricing, profit margins, costs of production, pricing concessions, promotional discounts, advertising allowances, volume rebates, marketing concessions, payment terms and rebate incentives. These categories . . . [are] used by Schlage to price its products competitively. The information in these categories has independent economic value because Schlage’s pricing policies would be valuable to a competitor to set prices which meet or undercut Schlage’s.

Cases have recognized that information related to cost and pricing can be trade secret. (See Courtesy Temporary Service, Inc. v. Camacho, supra, 222 Cal.App.3d at p. 1288, 272 Cal.Rptr. 352 [billing and markup rates “irrefutably” of commercial value]; SI Handling Systems, Inc. v. Heisley (3d Cir.1985) 753 F.2d 1244, 1260 [cost and pricing information trade secret]; Lumex, Inc. v. Highsmith (E.D.N.Y.1996) 919 F.Supp. 624, 628-630 [pricing, costs, and profit margins treated as trade secrets].)

The court rejected a claim that this type of information “is merely ‘general methods of doing business,’ which cannot be protected as trade secret.” Whyte, at 1455. As the appellate court explained at pages 1455 and 1456, there is a difference between pricing unique to a company versus pricing based on industry formulas:

Whyte fails to distinguish between cost and pricing data unique to Schlage (which may qualify as trade secrets) and commonly used industry formulas for setting prices (which do not). The court in SI Handling Systems, Inc. v. Heisley, supra, 753 F.2d at page 1260, drew this distinction to conclude that cost and pricing information not readily known in the industry–information such as the cost of materials, labor, overhead, and profit margins–was trade secret.

With respect to Schlage’s “strategic and marketing plans and marketing research” categories k, l, p and s the court explained:

These categories refer to the results of confidential marketing research; advertising and marketing strategy, plans, and techniques; and Schlage’s five-year strategic plan. This information would be valuable if known by a competitor because it would allow the competitor to predict and counter Schlage’s advertising and marketing. Schlage’s marketing strategy and plans (including its five-year strategic plan) constitute trade secrets under California law. (See Duncan v. Stuetzle (9th Cir.1996) 76 F.3d 1480, 1488, fn. 11.)

Whyte, at 1456 (italics added). However, market research does not “enjoy such blanket trade secret protection.” Id. Market research must be general to be protected:

Marketing research can be trade secret if it “explores the needs of numerous, diverse buyers,” but is not protectable if it “relates to a single prominent buyer that is presumably aware of its own needs….” (SI Handling Systems, Inc. v. Heisley, supra, 753 F.2d at p. 1259; see also Metro Traffic Control, Inc. v. Shadow Traffic Network, supra, 22 Cal.App.4th at pp. 863-864, 27 Cal.Rptr.2d 573 [customer’s preferences and requirements not trade secret].) Thus, Schlage’s marketing research is not trade secret if it relates solely to The Home Depot’s, or any one prominent customer’s, needs.

Whyte, at 1456 italics added).

Finally, with respect to Schlage’s “process technologies” categories q and r the court held that the technical “know-how” inherent in process technologies is “the quintessential trade secret.” Whyte, at 1456 (italics added) (citing Civ. Code, § 3426.1, subd. (d) [trade secrets include formulas, methods, techniques, or processes]; Vacco Industries, Inc. v. Van Den Berg, 5 Cal.App.4th 34, 49-51 (1992); Surgidev Corp. v. Eye Technology, Inc., 648 F.Supp. 661, 687 (D.Minn. 1986) and cases cited at n.8; 1 Milgrim, Trade Secrets, § 1.09[1][b], [2][c], [3] (2002)).

In the end, however, the appellate court was restrained by principles of judicial review: “we must interpret the facts favorably to the order denying a preliminary injunction, and therefore conclude the evidence established Whyte did not threaten to or actually misappropriate Schlage’s trade secrets.” Whyte, at 1458. The court hastened to emphasize, however, that “our decision is not a final adjudication of the issue of actual or threatened misappropriation,” and expressly noted that it had “serious concerns over evidence in the record suggesting Whyte took Schlage’s trade secrets or destroyed evidence.” Id. Nonetheless, the court found it was “constrained . . . by the applicable standard of review and our limited role as a reviewing court to view the facts in favor of the trial court’s order.” Id.

In sum, the cases discussed above provide a roadmap for the employer who seeks to enjoin a former employee from working for a competitor. The types of trade secrets that can be protected, and the proof required to establish the threat of such misuse, must be examined on a case-by-case basis. The bottom line, however, is that an employee’s claim that he or she may leave a company to work wherever they want, and to utilize whatever knowledge and information they may from their former employer, is an overly broad reading of California Business & Professions Code section 16600.