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Attorneys

Non-Competes and the “Trade Secret Exception” Revisited

June 3 2014

By James Kachmar

We periodically discuss California law regarding non-compete provisions in this Blog. The California Supreme Court has made clear that non-compete provisions are unenforceable unless they fall within one of the statutory exceptions set out in sections 16601 et seq. (i.e., in connection with the sale of a business, goodwill, etc.).  Over the years, courts have observed a so-called “trade secret exception” to the general rule that non-competes are unenforceable, holding that non-compete provisions may be enforced to the extent necessary to protect a company’s trade secret information.  The U.S. District Court for the Northern District of California recently revisited this issue in, Arthur J. Gallagher & Co. v. Lang.  Its ruling suggests that the “trade secret exception” is on shakier ground.

Arthur J. Gallagher & Co. (“Gallagher”) is an insurance brokerage firm headquartered in Illinois that acquired a California insurance broker in September 2008.  The employees of the California agency signed employment agreements in connection with the acquisition that contained various non-compete and non-solicitation provisions.  These provisions included: (1) a provision barring employees from soliciting any “insurance related business with any individual partnership, corporation, association or other entity … about which [the employee] received trade secrets of [Gallagher] or any of its affiliates;” and (2) a provision that the employees would not “directly solicit, induce or recruit any employee of [Gallagher] or its affiliates to leave the employ of [Gallagher] or its affiliates.”

Defendant Lang submitted his resignation in January 2014 so that he could start a new insurance brokerage firm with two of his former coworkers.  Shortly thereafter, Gallagher clients began taking their business to Lang’s new company.   Gallagher sued Lang and claimed he breached the non-competition and non-solicitation provisions of his employment agreement, among other claims. Long moved to dismiss the breach of contract claims.  Although the employment contract had a choice of law provision identifying Illinois law as applying, the Court agreed with Lang that California law would apply to the interpretation of the non-competition provisions because of California’s “strong interest in protecting its employees from non-competition agreements under [Business and Professions Code] section 16600.”

The Court next recognized the well-established rule that “[u]nder California law, to the extent that the provisions of the agreement preclude Lang from soliciting business from Gallagher’s clients, they are void,” citing the California Supreme Court’s decision in Edwards v. Arthur Andersen, LLP.  During argument on Lang’s motion to dismiss, Gallagher argued that the non-compete provision should be enforceable because it protected its trade secret information.  The court seemingly rejected this argument and noted that the so-called “trade secret exception” to section 16600 was of doubtful “continued viability.”  The Court concluded that even if the exception was viable, it would not save the provision at issue  because it was simply too broad because it barred Lang from soliciting Gallagher’s customers regardless of whether or not he used Gallagher’s trade secret information.

Although the Court concluded that the non-compete provision was unenforceable under section 16600, it held that the non-solicitation of former employee’s provision was enforceable.  The Court reasoned: “Although California courts recognize that an employer may not prohibit its former employee’s from hiring the employer’s current employees, an employer may lawfully prohibit its former employees from actively recruiting or soliciting its current employees.”

The Court granted Lang’s motion to dismiss in part but allowed Gallagher to file an amended complaint to see if it could allege facts that Lang breached the non-compete provision in a manner consistent with section 16600 [unlikely given the fact pattern] and assert a trade secret misappropriation claim if possible.

The Gallagher decision is a reminder to employers that non-compete provisions will be heavily scrutinized by courts and likely to be struck down unless they fall within the narrow confines of the statutory exceptions.  Although the Gallagher Court was leery of the so-called “trade secret exception” to section 16600, it is possible that had the employment agreement been more narrowly drafted to tie the solicitation to the actual use of Gallagher’s trade secrets, it is possible the Court could have been persuaded to reach a different conclusion.  Employers should consult with legal counsel to see whether a non-compete provision can be crafted in a manner to comply with California law.