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Avoiding Trade Secret Liability when Hiring and Losing Employees

Trade secret protection policy is rooted in the simple belief that a company should be able to keep what it has paid for.

Employers typically spend substantial sums hiring, training, and retaining their most productive employees. Successful companies recognize that a business’ employees are an integral component of the company’s success and value. This awareness and the company’s ability to protect its property and business goodwill, drive the desire to keep key employees from working for a competitor who did not pay for the training they received and who may ask the employees to use that specialized knowledge against the company that provided the training.1

This desire to protect what a company has paid for must be balanced against an employee’s right to work for any employer that will hire him or her. California, in particular, has a clear and strong public policy favouring “open competition and the right of its citizens to pursue the enterprise of their choice.”2 This public policy is rooted in California Business and Professions Code Section 16600 (hereinafter “§16600”) which provides as follows: “[E]xcept as provided in this chapter, every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.”3 As a consequence, this public policy makes non-compete agreements unenforceable for California employees.4 It also voids any other restrictive covenant that effectively acts as a non-compete.5

I. Maximizing Trade Secret Protection When an Employee Leaves.

It is beyond the scope of this article to discuss in detail all of the elements of trade secret law. Rather, its focus is on how to protect trade secrets when an employee leaves and what steps the hiring employer can take to avoid liability. Thus, it is worth identifying what is being protected. In California, which has adopted the greater part of the Uniform Trade Secret Act, a trade secret is defined as follows: “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 to other persons who can obtain economic value from its disclosure or use, and (2) is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.”6

What efforts are “reasonable under the circumstances” that a company must take to protect those secrets? First, the company must define the information to be protected. The confidential information that a company wishes to protect often includes matters such as customer lists; marketing strategy and plans; cost and pricing information; profit margins; operational methods and product development information; technical know-how, including formulas, methods, techniques or processes; and other intellectual property of the company.7 Next, the company must treat the information as a secret internally. The information should be accessible only to those who have a need to know and use it in performing their responsibilities for the company. Those individuals must be instructed and agree to keep the information confidential. The company should lock up hard copies and password-protect electronic copies of such information. In addition, the holder of the trade secret should have employees sign a written agreement (or include terms in an employee handbook) restricting the use and disclosure of the information.8 The typical non-disclosure covenant requires the employee to keep identified information confidential in perpetuity.

II. Non-Solicitation Covenants

When an employee who has had access to the company’s confidential information and customers departs, the company will often send the employee a termination letter, reminding the employee of his/her continuing obligation to treat the company’s confidential information with appropriate care. In addition, when the new employer’s identity becomes known, many companies will send a letter to the new employer stating that the employee has, in his or her possession, trade secret and other confidential information of the former employer, and admonishing the new employer to see that the employee does not use that information in the new position. Most employers, however, conclude that these steps, while basic, are insufficient to protect the unauthorized disclosure of critical business information. As a result companies, even in California, have recently turned to creative ways to draft restrictive post-employment covenants that bind the employee from disclosing or using confidential information at the next job. As noted above, California has a declared public policy limiting, if not outright prohibiting, many post-employment restrictions. The following cases provide a discussion of recent developments in this area, and examine how courts have responded to creative efforts to get around the basic premise articulated in §16600.

California courts have viewed with varying levels of approval the two most common restrictive covenants used to protect trade secrets and other confidential information: agreements not to solicit former customers and covenants not to solicit employees of the prior employer. Generally, non-solicitation covenants regarding former customers have been viewed with skepticism by California courts, as they often act as a restraint on competition, however limited, in violation of §16600. Covenants restricting the ability to solicit former employees, however, have been approved provided they are not “non-hire” agreements.

Covenants not to solicit former customers will be upheld only if the employer can demonstrate that the restriction is necessary to protect trade secrets. Thus, in Latona v. Aetna U.S. Health Care, Inc.,9 the plaintiff refused to sign a non-compete and confidentiality agreement, and was terminated by her employer, Aetna. In addition to a non-compete clause (which the court refused to enforce), the agreement contained a clause purporting to restrict the solicitation of any Aetna customer in the health care service industry for a period of one year. The court invalidated the non-solicitation clause because it was not necessary for the protection of Aetna’s trade secrets. Another factor cited by the court was the fact that the non-solicitation clause was not “narrowly tailored,” as Aetna required all of its employees to sign it.10

A court may uphold a non-solicitation clause on the grounds that a customer list constitutes a trade secret and the former employee actively solicited his former employer’s customers.11 However, where the customer list does not meet the definition of a trade secret, i.e. the names of the customers are generally known to the public or the plaintiff has not taken steps to protect their confidentiality, the court will not enforce the covenant.12 The cases frequently hinge on whether the activities of the former employee amounted to solicitation, which can be restricted, or a mere announcement of his/her change of employment, which can not be restricted. If the former employee’s conduct consists of a simple announcement, then a restrictive covenant will not be enforced, even if customers of the former employer decide to change their business to the new company for which the former employee now works.13 These cases follow from the leading California Supreme Court case of Aetna Building Maintenance Co. v. West.14 In that case the Supreme Court held that: “[M]erely informing customers of one’s change of employment, without more, is not solicitation. Neither does the willingness to discuss business upon invitation of another party constitute solicitation on the part of the invitee. Equity will not enjoin a former employee from receiving business from the customers of his former employer, even though the circumstances be such that he should be prohibited from soliciting such business.”15

California courts also carefully scrutinize clauses attempting to restrict solicitation of the employees of one’s former employer. Courts hesitate to rule that non-solicitation covenants are necessary to protect trade secrets where they effectively preclude the new employer from hiring employees of the former employer simply because an employee has jumped from one ship to another, absent some additional showing.16

California courts are consistent in voiding non-hire covenants. A non-hire covenant would preclude the former employee or his/her new employer from hiring any of the employees of his former employer, even if those employees initiated the contact. California case law clearly holds that such non-hire covenants are unenforceable in California.17

III. The Rise and Fall of Narrow Restraints

Having been rebuffed by the California courts on the general enforceability of non-compete clauses, creative lawyers have crafted narrow or “partial” restraints in an effort to circumvent the restrictions of §16600. Initially, these efforts met with some success in California courts. More recent decisions suggest that such efforts are doomed to failure in California state courts, but federal courts in the Ninth Circuit have been more receptive. A corollary of this approach has been the suggestion that the California courts should follow the lead of the majority of other jurisdictions by “blue penciling” overly restrictive covenants to rewrite them with narrower, more acceptable language. This suggestion has been rejected as well.

The leading case applying the narrow/partial restraint doctrine, and purporting to apply California law, is the Ninth Circuit decision in IBM v. Bajorek.18 That decision refused to construe §16600 as barring every restraint on an employee’s right to work for a competitor, and held that a former employee may be “barred from pursuing only a small or limited part of [his] business, trade or profession….”19 Bajorek was a California resident who had worked for IBM for 25 years, mostly in California. He signed a stock option agreement (containing a New York choice of law provision) which required him to return to IBM the profits from any options that he exercised if he went to work for an IBM competitor within six months of exercising the option. When he went to work for a competitor, IBM advised him that his stock options were cancelled. Bajorek sued IBM in California for declaratory relief, and IBM, in turn, sued him in New York for breach of contract. The cases were consolidated in federal court in California, which granted Bajorek judgment on the pleadings on the ground that the “clawback” provision of the stock option agreement was unenforceable under California law.

The Ninth Circuit reversed the district court. The decision should be viewed most accurately as a choice of law determination. The court found that applying New York law, as provided in the stock option agreement, would not violate a fundamental public policy of California, and that there was no significant difference between the laws of the two states. The court then applied the narrow restraint exception in finding that Bajorek was only excluded from a small corner of the marketplace for his services: “Bajorek… was free to work in his profession and in the same industry and keep the money, so long as he did not work for a competitor. And he could work for a competitor if he gave up what was paid in part for his promise not to.”20 Significantly, the court relied on its earlier decision in Campbell v. Bd. of Trustees,21 holding that an otherwise legitimate restraint places the burden on the former employee to “prove that the contract completely restrained him from pursuing his profession.”22

Bajorek can fairly be described as stating Ninth Circuit law on “partial restraints” under California law, but not California state law on the subject. No California case has endorsed this partial restraint exception to §16600. The statute is quite explicit in 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.” (Emphasis added.) As noted above, the statute contains specific exceptions for the sale of a business, and for the disassociation of a partner or dissolution of a partnership. The “presence of express exceptions ordinarily implies that additional exceptions are not contemplated…other exceptions are not to be implied or presumed unless a contrary legislative intent is evident.”23 As the California legislature created express statutory exceptions to §16600, it is reasonable to conclude that it did not intend there to be a fourth, implied exception for “partial or narrow restraints.”24

This issue may soon be decided by the California Supreme Court. The Court has granted review in two cases that examine and specifically reject the Bajorek conclusion that a partial restraint exception is valid under California law.25 The Court in Edwards v. Arthur Andersen was quite explicit in rejecting the Bajorek reasoning: “[I]n sum, we conclude the ‘narrow restraint’ doctrine is a misapplication of California law. Non-competition agreements are invalid under §16600, even if narrowly drawn, unless they fall within the statutory or trade secret exceptions.”26 Hopefully, the California Supreme Court will soon provide the definitive word on this subject.

California courts also have considered but rejected the argument that a court can narrow an overly-broad non-compete provision to a point of reasonableness by a process known as “blue penciling.”27 In Kolani v. Gluska, the court specifically confronted the request to “blue pencil” the non-compete clause in the contract. The court found the non-compete clause unenforceable and refused to “blue pencil” out the provision because it would undermine the purpose of §16600. The court supported its reasoning by noting that, if it were to rule otherwise, employers would feel free to include overly broad non-compete provisions in employment contracts with employees, knowing that they had a safety net; if the employee ever challenged the clause, a court would simply “blue pencil” the offensive provisions.28 Most recently, this issue was raised in Strategix, Ltd. v. Infocrossing West, Inc.29 In that case, a non-solicitation covenant precluded the seller from soliciting the purchaser’s employees and customers for one year after the termination of a consulting relationship. The court found that the non-solicitation covenant wrongly barred the seller from soliciting the employees and customers of the purchaser, rather than the former employees and customers of the seller. The court specifically declined to rewrite the overbroad covenant into narrow restrictions against soliciting the seller’s former employees and customers, on the grounds that had the parties so intended, they could have included that language in their agreement. The court stated that it would not “rewrite overbroad covenants not to solicit Infocrossing’s employees and customers into narrow bars against soliciting Strategix’s former employees and customers.”30

The more interesting question is whether the “narrow restraint” federal cases that have followed the Bajorek decision, contrasted with the unwillingness of California state courts to interpret a restraint narrowly or to “blue pencil” it into a zone of approval, have resulted in race-to-the-courthouse for cases involving restrictive covenants governed by California law. Companies seeking to enforce such restraints unquestionably find a friendlier reception in the federal courts of the Ninth Circuit than they do in California state courts. Indeed, in Bajorek, the Ninth Circuit expressly found the interpretations of §16600 made by California state courts to be less persuasive than its own earlier decisions construing §16600, declaring that “we are bound” by earlier Ninth Circuit precedent.31 At least until the California Supreme Court weighs in on the debate in the Alliance Payment Systems and Edwards v. Arthur Andersen cases, this federal-state dichotomy is likely to continue.32

IV. “Inevitable Disclosure” is Dead in California.

It should be clear by now that the “inevitable disclosure” doctrine has no life in California, despite its vibrancy in some other jurisdictions.

The inevitable disclosure doctrine has judicial roots in the case of PepsiCo, Inc. v. Redmond.33 The facts of the case are unremarkable. A former PepsiCo general manager obtained a similar position with a competitor. The district court granted PepsiCo an injunction which prevented the former manager from assuming the new position for a period of six months, and also permanently enjoined him from revealing PepsiCo trade secrets or confidential information, primarily regarding marketing plans for “sports drinks.” Upholding the district court’s grant of the injunction, the Seventh Circuit Court of Appeals identified the central issue as follows: “the question of threatened or inevitable misappropriation in this case lies at the heart of a basic tension in trade secret law.” The Court perceived a tension between a worker’s right to pursue his livelihood when leaving his current employment, with the purpose of trade secret law, which “serves to protect internal ‘standards of commercial morality’ and ‘encourage invention and innovation’ while maintaining ‘the public interest in having free and open competition in the manufacture and sale of unpatented goods’.”34 Although there had not been any actual misappropriation, and the misappropriation was only threatened, the Seventh Circuit concluded that the injunction should stand, as “a plaintiff may prove a claim of trade secret misappropriation by demonstrating that defendant’s new employment will inevitably lead him to rely on the plaintiff’s trade secrets.”35 (Emphasis added.)

The inevitable disclosure doctrine showed a brief glimmer of life in California, primarily in a handful of federal court cases.36 The doctrine was explicitly rejected, however, in the case of Whyte v. Schlage Lock Co.37 In that case, Whyte, Schlage’s Vice President of Sales, signed a confidentiality agreement to protect Schlage’s proprietary information and agreed not to disclose confidential information for personal or non-company uses; however, Whyte did not sign a covenant not to compete. Whyte left Schlage to accept a similar position with its fiercest competitor, Kwikset. Schlage initiated litigation in Colorado which was dismissed. Whyte sued Schlage in California for interference with contract, and Schlage counterclaimed seeking, among other things, a preliminary injunction against Whyte’s disclosure or use of Schlage’s trade secrets. After the trial court ultimately denied this request, Schlage appealed. The appellate court agreed with Schlage that some of the information that it sought to restrain Whyte from using qualified for trade secret status. After confirming that the evidence in the trial court did not demonstrate that Whyte either threatened to or had actually misappropriated Schlage’s trade secrets,38 the court considered Schlage’s request that the injunction be upheld on the grounds that Whyte would “inevitably” disclose trade secrets.

Relying on the PepsiCo case, Schlage argued that “unless the employee has an uncanny ability to compartmentalize information, he will necessarily rely, consciously or subconsciously, upon knowledge of his former employer’s trade secrets in performing his new job duties.”39 The court agreed with Schlage that the facts underlying its claim against Whyte were “strikingly similar” to the facts in the PepsiCo case, noting that Schlage and Kwikset were fierce competitors; Whyte’s new job duties were virtually identical to those he had at Schlage; Whyte knew Schlage’s trade secrets; Whyte had signed a confidentiality agreement; and Whyte was not entirely forthright with Schlage at the time of departure.40 Nevertheless, after noting that the majority of jurisdictions addressing the issue have adopted some form of the inevitable disclosure doctrine, the Whyte court specifically rejected that doctrine as contrary to California law. The court concluded that the inevitable disclosure doctrine, by permitting an employer to enjoin a former employee without proof of actual or threatened use of trade secrets, resulted in an injunction not merely against the use of trade secrets, but an injunction restricting employment. This created “a de facto covenant not to compete” which was contrary to California’s strong public policy favoring employee mobility pursuant to §16600.41 The court noted that covenants not to compete are enforceable in California notwithstanding §16600 only if “necessary to protect the employer’s trade secrets.” The court concluded that the inevitable disclosure doctrine, if applied where a confidentiality agreement was in place, in effect converted the confidentiality agreement into an after-the-fact covenant not to compete.42 The court was clear in stating the rejection of the doctrine in California: “[L]est there be any doubt of our holding, our rejection of the inevitable disclosure doctrine is complete. . . .The inevitable disclosure doctrine can not be used as a substitute for proving actual or threatened misappropriation of trade secrets.”43 The Whyte decision remains good law in California.

V. Drafting Restrictive Covenants That Do Not Violate California Law.

Companies with multi-state activities should tread carefully when including non-compete provisions in employment agreements or other documents when some of their employees work in California. Companies sometimes decide to include an unenforceable restrictive covenant in an agreement with the belief that most employees will honor it, a few will challenge it, and for those few who challenge it, the offending provisions of the agreement can be modified or stricken.44 In California, employers do this at their peril. The California Court of Appeal has held that knowingly taking such action not only supports a judgment for an injunction and compensatory damages, but also provides a sufficient basis for punitive damages.45

Aware of this trend, more companies are including restrictive covenants in employment or stock option agreements with California-based employees that include numerous recitals and clauses that attempt to incorporate the exceptions to §16600 to the maximum extent possible. However, an employer must not be seduced by the prospect, nor let counsel persuade him or her, that making a restrictive covenant enforceable is simply a matter of good drafting. The fundamental hostility of California courts to restrictive covenants of any nature, and in particular to those that look, feel or smell like non-competes, should not be ignored.

What follows are suggestions for an employer to consider in attempting to draft restrictive covenants that may survive scrutiny in California. Two general suggestions should be kept in mind in each instance. First, an employer must decide what is trade secret information and what is not. This means limiting the restrictive covenant to information that will withstand trade secret scrutiny (i.e. it is a secret, its confidential status provides value that gives the holder a competitive advantage, and reasonable steps have been taken to protect its secrecy). Second, the restrictive covenant should be tailored to the particular individual(s) who will be asked to sign it. Broadly worded restrictive covenants applied to all or a large segment of an employer’s work force are more likely to be stricken.46 Covenants tailored to the particular skills and knowledge base of a specific individual, and drafted to include the risks to the company if that individual leaves to work for a competitor, are more likely to be enforced.47 With these guidelines in mind, an agreement containing restrictive covenants should include some or all of the following points:

  • If the employee owns or will own stock in the company, the agreement should recite that he/she is a substantial shareholder in the company. This may place the restriction within one of the exceptions to §16600.
  • The agreement should state that the individual is a significant and vital member of the technical or managerial work force of the company.
  • The restrictive covenant should state that the employee will be given access to the company’s confidential and proprietary business information, including trade secrets.
  • Any restrictive covenant should contain a confidentiality clause stating that the employee agrees to keep confidential and not disclose to any person or entity, or use for any purpose other than the company’s business, the company’s confidential and trade secret information. The confidential information should be identified as precisely and specifically as possible without actually disclosing the trade secret, i.e. categories such as pricing and marketing plans, details of client contracts, price lists, customer lists, new business plans, etc. This covenant should state explicitly that the employee’s obligation of confidentiality survives the termination of the employment relationship.
  • The agreement should recite that the employee agrees that the restrictive covenant is necessary for the protection of the company’s legitimate business interests in its trade secrets, that the employee has no intention of competing with the company at any time by using those trade secrets, and that the employer is relying on that understanding in entering into the employment relationship.
  • The employee should affirm that his/her expertise and abilities are sufficiently strong and well-developed such that the neither the restrictive covenant nor the enforcement of its remedies by an injunction, will prevent the employee from earning a livelihood in his/her chosen area of work.
  • The employee should acknowledge that a breach of the restrictive covenant will leave the employer with no adequate remedy at law, and thus the employer should be entitled to seek an injunction against any conduct by the employee which would breach the agreement.
  • The agreement should contain a severability clause preserving the remaining terms of the agreement in case one portion of it is stricken by a court. The agreement should also specifically authorize the court to “blue pencil” the agreement if necessary to make it enforceable under applicable law. (E.g. the parties should acknowledge that the agreement is reasonable in scope, but that if a court of competent jurisdiction should subsequently conclude that some portion of the agreement is not reasonable or otherwise violates local law, then the parties intend for the court to construe the agreement as imposing only those limitations on the employee that are reasonable under applicable law, and which will ensure that the employer receives the intended benefit of the agreement.)

Employers doing business in California should keep in mind that California courts will be hostile to a true non-compete agreement regardless of how cleverly the overall agreement is drafted. An employer is safer if it drafts the agreement to preclude the employee from using or disclosing any trade secret information in any subsequent employment, or accepting any subsequent employment which requires him or her to use or disclose the company’s trade secret information.

If the employer wishes to include a clause restricting solicitation of its workers by departing employees, the clause should be limited to employees who have access to the company’s confidential information during their employment. It is critical to tie this restriction to protecting the employer’s trade secrets. For example, the restrictive covenant may preclude the departing employee from using the employer’s customer list to solicit business from those customers, provided reasonable steps have been taken to protect the customer list as a trade secret. At a minimum, the non-solicitation covenant should not be worded as a “non-hire” agreement.

Multi-state employers soon may no longer be able to use two common tools for avoiding California employment law, i.e., choice-of-law and forum-selection clauses. In 2007 the California legislature passed AB 1043, which would prohibit employers from including in an employment application, contract or handbook, any requirement that a California employee agree to a forum outside California, or agree to a choice of law other than California law, to resolve any employment-related issue that arises in California.48 Governor Schwarzenegger vetoed the bill.49 Given the direction taken by California employment law in recent years, however, eventual enactment of this or similar legislation would not be surprising.

VI. Protection for the Hiring Company, or How to Keep New Employees From Dragging You Into Court.

While there are no-bullet proof steps that any company can take to prevent the former employer of a new hire from filing a lawsuit, the hiring company can adopt measures making it a very uninviting and uneconomic target for that type of litigation. What can a hiring company do to reduce the chance that it will be hauled into court based on a claim that the hot new engineer that it has just hired is revealing his former employer’s trade secrets?

The first thing that the company should do is have a clear policy against hiring individuals for the purpose of acquiring the confidential knowledge that they possess from working for a competitor. This policy should be articulated and widely disseminated within the company. Before extending an offer to a potential hire, the company should advise the candidate to consult with counsel, or at least make him/her aware of the things that they must not do (e.g. copy files of the old employer or contact key clients to let them know of the change of employment before it has occurred). New hires should be informed in writing that they are not to disclose any trade secret information that they learned in their prior employment. In addition, the new employee should be required to identify any restrictive covenant that he/she may have signed with a prior employer. If there are any such restrictive covenants, the company should involve counsel to review the covenants and advise the company regarding their enforceability and how best to approach the prior employer, if necessary.

When the new employee first comes to work, he/she should be counselled not to use or disclose the prior company’s trade secrets. It is important to create a record of this meeting with the new employee. This should be followed by a letter to the new employee with a copy to his/her personnel file, advising the employee not to use or disclose trade secrets of the former employer. The employee should also be required to sign a brief statement that he/she is not violating the terms of any restrictive covenant signed with the prior employer, by taking on the new position.

If the company receives a letter or call from the former employer or its attorney claiming that the new employee is using that company’s trade secrets, the company should take the charge seriously. It should insist that the representative of the former employer be very specific in identifying the type of information that allegedly is being improperly used or disclosed. It should investigate the claim and confirm the conclusion of the investigation in writing. There may be instances when it is advisable to put the new hire in a different job position for a limited period of time, one that may involve less client contact or limit opportunities to use the prior employer’s confidential information. However the company decides to resolve this claim, it is important to document each step it takes.

VII. Garden Leave

Another possible tool for protecting trade secrets and other confidential information can be found not in California, or in its adjoining states, but across the Atlantic in England. “Garden leave” has become a common tool in English employment contracts for curtailing a departing employee’s ability to work for the competition.50 Anecdotal evidence suggests that American employers, primarily on the East Coast, have begun inserting garden leave clauses into employment agreements. The enforceability of the garden leave clauses, however, remains untested in California courts.51

As it has developed in England, “garden leave” describes a situation where an employee must give notice of termination a significant period of time prior to the effective date of termination. The employee then is required to spend the time between the date of notice and the termination date away from the office, i.e., at home “in the garden.” The employee receives full payment of salary and benefits, but is precluded from contact with customers or the employer’s confidential information; most importantly, the employee is precluded from beginning employment with a new employer until the garden leave expires. The length of the garden leave varies, but in the reported English cases generally runs from six to eighteen months in length.

The obvious benefit to the employer from a garden leave provision is that it prevents the employee from working for a competitor until such time as his/her current technical knowledge has become less useful to a competitor, the contacts with customers have become dated, or the employee is otherwise rendered less valuable to a competitor. The cost to the employer may be significant in paying the full salary and benefits to an employee for a lengthy period of time while the employee is not engaged in any productive activity on behalf of the employer. Thus, such clauses may be appropriate only for senior executives, key technical employees or others who have access to truly confidential information and/or key clients. This necessarily sparing use of the garden leave tool may, in fact, make it more palatable to a California court than boilerplate clauses intended to restrict the post-employment activities of all, or a substantial part of, an employer’s workforce. The garden leave provision can be tailored to specific workers in whom the employer has invested substantial training and exposure to trade secret information. Also, it is in the employer’s interest to make the duration of the garden leave as short as possible in order to minimize the payment of salary and benefits during the leave.

Any garden leave provision should contain certain specific terms in order to increase the likelihood of its enforceability. First, there must be an express garden leave provision in the employment contract.52 Second, the garden leave provision must explicitly preclude the employee from working for anyone else for the term of the contract and recite that he/she remains an employee during the notice period. Additionally, the garden leave clause should contain a term relieving the employer of an obligation to provide the employee with work during the garden leave period.53 The clause must explicitly state the employer’s right to exclude the employee from the office or workplace, and preclude the employee from contact with customers, clients, or confidential information, e.g., a home computer that has access to a company network or database.

A garden leave provision could be a successful alternative in those jurisdictions where courts permit but limit non-compete agreements. Whether garden leave provisions would succeed in California courts is another question entirely, and very problematic. California decisional law, as noted above, is not interested in the “reasonableness” of a restrictive covenant. Rather, the courts of California examine a restrictive covenant based on its impact on employee mobility and the broad and firm public policy favoring open competition, i.e., 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.” The Court might look no further than this analysis and conclude that because the garden leave provision restricts the particular employee’s ability to take another job, it is void.

On the other hand, garden leave clauses, unlike traditional non-compete agreements, do not offend several of the principles underlying the argument for California’s public policy stance against enforcing non-competition agreements. For example, the garden leave clause does not interfere with the employee’s ability to earn a living, as he/she is paid in full with benefits during the term of the garden leave. Also, if the garden leave clause is used effectively with key management, sales, and technical employees, who theoretically are more sophisticated and have greater bargaining power than regular employees generally, then the argument that the restrictive covenant is a product of unequal bargaining powers becomes less forceful. Moreover, the employer is motivated to keep the garden leave term as short as possible because of its cost, which runs contrary to the motivation for non-competition agreements, which is to extend them for as long as possible. 54

At this point in time, it appears unlikely that a garden leave clause would overcome the public policy concerns of California courts. Nevertheless, one will never know for sure whether this innovative approach to preserving the employer’s investment in training certain knowledge-based employees might be successful, until such time as a court examines it against the background of a specific fact situation.

* William C. Wilka is a partner in the San Francisco firm of Dudnick, Detwiler, Rivin & Stikker. Mr. Wilka’s practice focuses on complex business litigation, trade secrets, and employment law counselling and litigation. He received his B.A. from the University of Notre Dame in 1972 and his J.D. from Georgetown University Law Center in 1975.

Copyright © 2008 by William C. Wilka. All Rights Reserved.

1 Norman D. Bishara, “Covenants Not to Compete in a Knowledge Economy: Balancing Innovation from Employee Mobility Against Legal Protection for Human Capital Investment,” 27 Berkeley J. Emp. & Lab. Law 287, 295-296 (2006).

2 Hill Medical Corp. v. Wycoff, 86 Cal.App.4th 895, 900-01 (2001); Metro Traffic Control, Inc. v. Shadow Traffic Network, 22 Cal.App.4th 853, 859 (1994).

3 Cal. Bus. & Prof. Code §16600. All further statutory citations will be to this code unless otherwise noted.

4 Advanced Bionics Corp. v. Medtronic, Inc., 29 Cal.4th 697, 706 (2002); Application Group, Inc. v. Hunter Group, Inc., 61 Cal.App.4th 881, 900 (1998); Metro Traffic Control, Inc. v. Shadow Traffic Network, 22 Cal.App.4th 853 (1994); see Latona v. Aetna U.S. Healthcare, Inc., 82 F.Supp.2d 1089, 1093-94 (1999).

5 The term “restrictive covenants” includes agreements not to solicit customers or other employees, as well as the various types of non-compete agreements.

6 Cal. Civ. Code § 3426.1(d).

7 Whyte v. Schlage Lock Co., 101 Cal.App.4th 1443, 1455-56 (2002).

8 Id. At 1454.

9 82 F.Supp.2d 1089 (C.D. Cal. 1989).

10 Contrast this with the holding in Lorel v. Moyes, 174 Cal.App.3d 268 (1985), where the court upheld as valid a narrow anti-solicitation provision whereby a departing executive agreed not to interfere with, disrupt or impair the company’s relationships “with customers, agents, representatives, or vendors.” This term was in a negotiated termination agreement with the former President and member of the Board of Directors; no other employees were asked to sign it. The Court of Appeal found it significant that the agreement prohibited a single individual from contacting other customers, and thus the agreement had little or no impact on competition.

11 See Morlife v. Perry, 56 Cal.App.4th 1514 (1997) (plaintiff roof maintenance company’s customer list was a trade secret and defendant’s use of that list in constructing his own customer base was properly enjoined); MAI Systems Corp. v. Peak Computer, Inc., 991 F.2d 511 (9th Cir. 1993) (customer list a trade secret and defendant enjoined from using that list in constructing its own customer base); but see MGM Studios v. Grokster, Ltd., 2007 U.S.Dist.LEXIS 79726 (C.D.Cal.2007) suggesting that the test for a permanent injunction applied in MAI (past infringement coupled with likelihood of future infringement) likely does not survive eBay, Inc., v. MercExchange, L.L.C., 126 S.Ct.1837 (2006), which requires the application of a more stringent four-part test before issuing a permanent injunction.

12 See Thompson v. Impaxx, Inc., 113 Cal.App.4th 1425 (2003) (Thompson was terminated for refusing to sign an agreement not to solicit any of Impaxx’s customers. The court refused to enforce a non-solicitation of customers covenant unless the employer could prove that the identity of the customers satisfied all the requirements of a trade secret.).

13 Hilb, Rogal & Hamilton Insur. Serv. of Orange Cty., Inc. v. Robb, 33 Cal.App.4th 1812 (1995) (a simple announcement, including responding to questions from former customers who then transferred their business, did not amount to “solicitation”); see also American Paper & Packaging Products v. Kirgan, 183 Cal.App.3rd 1318 (1986) (the former employer’s customer list was not a trade secret as the list of customers “certainly would be known or readily ascertainable to other persons in the shipping business” and the “compilation process in this case was neither sophisticated, nor difficult nor particularly time-consuming”); Gordon v. Landau, 49 Cal.2d 690, 694 (1958) (refusing to enforce an agreement prohibiting an employee from calling on the accounts of his former employer, because the identity of the accounts was not a trade secret).

14 39 Cal.2d 198, 204 (1952).

15 Id. at 204.

16 See Metro Traffic Control, 22 Cal.App.4th at 859; Moss Adams & Co. v. Shilling, 179 Cal.App.3d 124, 130 (1986).

17 See VL Systems, Inc. v. Unisen, Inc., 152 Cal.App.4th 708 (2007).

18 191 F.3d 1033 (9th Cir. 1999).

19 Quoting Boughton v. Socony Mobil Co., 231 Cal.App.2d 188 (1964).

20 Id. at 1041.

21 817 F.2d 499, 502 (9th Cir. 1987).

22 See also Gen. Commercial Packaging, Inc. v. TPS Package Engineering., Inc., 126 F.3d 1131 (9th Cir. 1997).

23 People v. Standish, 38 Cal.4th 858, 870 (2006).

24 Kolani v. Gluska, 64 Cal.App.4th 402, 407 (1998).

25 Alliance Payment Systems, Inc. v. Walczer, 152 Cal.App.4th 620, rev. granted, depublished by 2007 Cal. Lexis 11659 (Oct. 17, 2007); Edwards v. Arthur Andersen, LLP, 142 Cal.App.4th 603, rev. granted, depublished by 52 Cal.Rptr.3d 86 (Nov. 29, 2006).

26 Edwards at 624.

27 Bosley Medical Group v. Abramson, 161 Cal.App.3d 284, 288 (1984); Muggill v. Reuben H. Donnelley Corp., 62 Cal.2d 239 (1965).

28 Kolani, 64 Cal.App.4th at 408.

29 142 Cal.App.4th 1068 (2006).

30 Id. at 1074.

31 Bajorek, 191 F.3d at 1040.

32 See Google, Inc. v. Microsoft Corp., 415 F.Supp.2d 1018 (N.D. Cal. 2005); but see Davis v. Adv. Care Techs, Inc., 2007 U.S. DIST LEXIS 57783 (E.D. Cal. 2007) (where the employee had lived and worked in California, and continued to do so with his new employer, the court applied a choice of law analysis to select California law rather than Connecticut law as stated in the employment contract, to invalidate a non-compete provision).

33 54 F.3d 1262 (7th Cir. 1995).

34 Id. at 1268.

35 Id. at 1269.

36 See Bayer Corp. v. Roche Molecular Sys., 72 F.Supp.2d 1111 (N.D. Cal. 1999); Globespan v. O’Neil, 151 F.Supp.2d 1229 (C.D. Cal. 2001).

37 101 Cal.App.4th 1443 (2002).

38 Id. at 1457.

39 Id. at 1458-59.

40 Id. at 1460.

41 Id at 1462.

42 Id. at 1463.

43 Id. at 1463-64.

44 Kolani, 64 Cal.App.4th at 408.

45 Walia v. Aetna, Inc., 93 Cal.App.4th 1213, rev. granted, depublished by 117 Cal. Rptr. 2d 541 (2002), rev. dismissed by 132 Cal.Rptr.2nd 712 (2003). The First District Court of Appeal in Walia upheld a jury award of $1,080,000 in punitive damages against Aetna, which had included a non-compete clause in an employment contract that all sales people at a certain level nationwide were required to sign, despite the knowledge that such covenants were unenforceable in California. This case was taken for review by the California Supreme Court as a companion case to Advanced Bionics Corp. v. Medtronic, Inc., 29 Cal.4th 697 (2002). The decision of the court of appeal in Walia was affirmed by the dismissal of the grant of review, following the Supreme Court’s decision in Medtronic. Cal. Rules of Court §8.528.

46 See Latona, 82 F.Supp. 1089

47 See Lorel, 174 Cal.App.3d 268.

48 Assem. Bill No. AB 1043, (2007-08 Reg.Sess.) passed September 7, 2007, intended to add § 924 to the Cal.Lab.Code.

49 2007 Legis. Bill. Hist. CA, A.B. 1043 (October 13, 2007).

50 See Greg T. Lembrich, “Garden Leave: A Possible Solution to the Uncertain Enforceability of Restrictive Employment Covenants,” 102 Colum. L. Rev. 2291 (2002).

51 A Lexis search of American cases performed by the author at the time of preparation of this article revealed no California decisions regarding the enforceability of a garden leave provision. See Lembrich, supra, at 2315.

52 This principle has been clearly established in English law by the case of William Hill v. Tucker (1999) I.C.R. 291 [998 I.R.L.R. 313].

53 The purpose of this clause is to address a potential claim that the employee’s skills will atrophy or become obsolete if he or she is precluded from exercising those skills for any extended period of time. This concern could make a garden leave clause difficult to enforce in the case of an actor, musician, or an athlete, but is less likely to be an issue in the case of a technical or management employee. Nevertheless, such a clause is advised in order to avoid this objection.

54 See Lembrich, supra note 50, at 2315-2319.