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What to Do When an Employee Becomes a Competitor

A Guide for Businesses Large and Small.

Immediate First Steps

When key personnel leave to start or to join a competing business, there is often a scramble to save clients and to focus on damage control.  The company should also immediately undertake two measures to preserve its legal rights.

First, the company should take steps to preserve all the data on the employee’s computers and other devices.  An in-house IT professional can usually perform this function, although a computer forensics specialist should perform the analysis when it is time to do so.

Second, the company should engage counsel to evaluate litigation options.  Counsel will likely recommend that the company conduct a factual investigation with the assistance of the law firm.  A thorough investigation usually includes a forensic analysis of the employee’s computer, including gathering emails and analyzing whether and to what extent the employee downloaded company data.

Discretion is the better part of valor, and it may not always be worthwhile to file a lawsuit.  In some cases, the investigation may reveal that the employee did nothing wrong.  But it is important to address the crisis immediately and assess the company’s position right away.

Rights[1]

Loyalty

An employee owes an employer an undivided duty of loyalty.[2]  An employee will be liable for the breach of the duty of loyalty if the company can prove that the employee:

  • actively competed with the company while still employed; or
  • acquired a material benefit from a third party in connection with actions taken through the employee’s use of his position; or
  • communicated confidential information of the principal for the employee’s own purpose or those of a third party; or
  • otherwise engaged in conduct “inimical to the best interests of the employer.”[3]

Importantly, however, an employee may “prepare” to leave the company for a competitor (including a company that he creates) while still at the company.[4]   For example, it is permissible for an employee to incorporate a shell corporation or to make similar ministerial preparations, as long as he does so on his own time and using his own resources.[5]

It is also worth noting that covenants not to compete are void under California law, except in connection with the sale of a business or partnership dissolution or dissociation.[6]  Courts generally view this public policy in favor of an employee’s freedom to make a living as sacrosanct.  Even where a California employee agrees that his employment would be governed by the laws of a state that permits non-compete contracts, courts still will not enforce such non-compete agreements.[7]

But while employees enjoy rights to leave and compete with their former employer, and even the right to prepare to start a competing business, employees do not have the right to use company time and resources to “feather their nest.”  Employees who secretly solicit company clients for the benefit of their new firm, or who send confidential information to competitors to curry favor, to cite two examples, are liable in tort for breach of the duty of loyalty.

Trade secret protection

The California Uniform Trade Secrets Act (“CUTSA”) prohibits the misappropriation of trade secrets.[8]  While it is not always easy to discern what information qualifies as a “trade secret” under CUTSA,[9] courts have afforded trade secret protection to, for example, customer lists that required significant resources to develop,[10] plans and designs of products,[11] project binders,[12] technical data not generally known to the industry[13] and software source code.[14] In general, an employee who takes an employer’s trade secret information with him when she leaves — whether by stuffing papers into her briefcase or, more likely, downloading data on to some electronic medium — is liable for trade secret misappropriation under CUTSA.

Notably, however, CUTSA imposes important requirements.To prevail on a trade secret misappropriation claim, the employer must prove that it took reasonable steps to protect the secrecy of its proprietary information.[15]  The employer must also establish that the secret information rises to the level of a “trade secret,” as opposed to merely confidential or commercially sensitive.  Courts, for instance, have found that general methods for determining pricing[16] or custom training materials[17] did not qualify for trade secret protection.  Because CUTSA provides the exclusive remedy for the misappropriation of trade secrets, an employer may have no recourse against an employee for the theft of confidential information that falls short of CUTSA’s definition of “trade secret.”[18]  But if the employer can clear these hurdles and prove that the employee stole valuable, secret and closely guarded information, the company can assert a viable CUTSA claim.

Preservation of data

Gone are the days where a company’s “top secret” documents were kept in a filing cabinet under lock and key.  Typically, a company’s most valuable data is stored on its secure servers.  An employee planning to leave will often download company files or send data to a personal email account.  The employee will then often seek to cover his tracks by wiping clean his company-issued computers and devices, sometimes destroying valuable data in the process.

An employee’s electronic burglary implicates at least two potential causes of action that the employer may assert.  First, the destruction of data constitutes a breach of the duty of loyalty insofar as the conduct is “inimical to the best interests of the employer.”[19]  Second, the destruction, or unauthorized access, of data violates Penal Code section 502, which affords civil litigants a private right of action.[20]  Generally, this claim will have the greatest chance of success when the employee accessed restricted data that had no connection to his job function, or when the employee accessed the data after his separation from the company but before the company cut off his access to the server.

Fair competition

Claims for unfair competition in violation of California Business and Professions Code section 17200 (the “UCL”) usually arise in the context of consumer class actions or in disputes between competitor companies, but an employer may sue a former employee for unfair competition for her wrongful conduct during the course of employment.[21]  Specifically, the UCL prohibits “unlawful, unfair or fraudulent” conduct.[22]  Because the UCL is broad, almost any tortious conduct, or even simply underhanded behavior, falls within the UCL’s scope.  Wrongful acts giving rise to the breach of the duty of loyalty, for example, will satisfy the “unlawful” prong of the UCL.

Notably, UCL claims are decided by the judge, not the jury.  This can be an equalizing factor since juries are sometimes reluctant to award damages against the “little guy,” even when the law and the facts compel such an outcome.

Remedies

Injunctive relief

An injunction is typically an order entered by a judge directed at a litigant to stop doing something.  In the context of the turncoat employee, an injunction could be entered to stop him from using a stolen customer list or to bar him from launching a copycat product.[23]  Injunctions may be obtained in connection with each of the causes of action discussed above — breach of the duty of loyalty, CUTSA, Penal Code § 502 and the UCL.  CUTSA[24] and the UCL[25] explicitly provide that injunctive relief is available, which may help persuade a judge to enter an injunction in aid of either of those claims.

Injunctive relief comes in three basic varieties — as a temporary restraining order (“TRO”), a preliminary injunction or a permanent injunction.

When a rogue employee’s wrongful conduct is causing, or will cause, “irreparable harm,” the employer can file a complaint and immediately seek a TRO.[26]  TROs are a useful mechanism to resolve the immediate crisis, but they are difficult to obtain.  In addition to proving that the company’s injury is irreparable (difficult to measure in monetary harm), the employer must persuade the judge — with declarations and other evidence — that the company will ultimately prevail on the merits.  Because a TROs is an emergency, stopgap measure, it “dissolves” after a short duration, usually on the day of the preliminary injunction hearing.

The criteria to obtain a preliminary injunction is similar to what is required for a TRO, but the parties are afforded more opportunity to develop and present the evidence.[27]  If the preliminary injunction is granted, it usually will be in effect until the final adjudication of the case.

A permanent injunction is, as its name suggests, permanent.  If the employer prevails, a judge may enjoin the employee from, for example, soliciting certain clients ever again.  As noted, however, injunctions are difficult to obtain; but they are also often more valuable than monetary damages, especially when the former employee may not be able to satisfy a judgment.

Tort damages

At common law, the standard recourse for tortious conduct is monetary damages.  Tort damages are measured as “the amount which will compensate for all the detriment proximately caused thereby, whether it could have been anticipated or not.”[28]  As courts have observed, there is “no fixed rule for the measure of tort damages,”[29] which is another way of saying that the jury can award what it pleases.  Punitive damages are also available where the party acts with “oppression, fraud, or malice.”[30]  Such exemplary damages are rarely awarded against individual employees.

Disgorgement of salary

Although it does not happen frequently, judges can order employees to reimburse the employer for salary and benefits paid during the time that the employee was acting contrary to the interests of the company.[31]  This disgorgement remedy may not make the company whole by the damages wrought by the traitorous employee, but it may serve as a powerful deterrent for other employees inclined to act against the interests of the company.

Conclusion

It is often said that California law favors employees over their employers.  While there is truth to that general statement, employers have rights, too.  Although litigation can be expensive, time consuming and unpleasant, litigation is sometimes the best and only way to prevent an employee from stealing the company’s hard-won clients and assets.

[1] The causes of action discussed herein is not an exhaustive list.  Rather, the article identifies the claims that are most commonly asserted in a scenario in which a former employee has left to start a competing business.  Other causes of action that may lie include breach of fiduciary duty, conversion, interference with contractual relations, interference with prospective economic relations and breach of contract.

[2] See, e.g., Angelica Textile Services, Inc. v. Park, 220 Cal. App. 4th 495, 509 (2013); Huong Que, Inc. v. Luu, 150 Cal. App. 4th 400, 410 (2007); Stokes v. Dole Nut Co., 41 Cal. App. 4th 285, 295 (1995)

[3] Huong Que, Inc., 150 Cal. App. 4th 400 at 416.

[4] See Mamou v. Trendwest Resorts, Inc., 165 Cal. App. 4th 686, 719 (2008).

[5] See Mamou, 165 Cal. App. 4th at 719.

[6] Cal. Bus. & Prof. Code §§ 16600-16602; Edwards v. Arthur Andersen, 94 Cal. 4th 937, 945-46 (2008.)

[7] See, e.g., Application Group, Inc. v. Hunter Group, Inc., 61 Cal. App. 4th 881, 902 (1998); Frame v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 20 Cal. App. 3d 668, 673 (1971).

[8] Cal. Civ. Code § 3426, et seq.

[9] CUTSA defines a “trade secret” as a formula, pattern, compilation, program, device, method, technique, or process, that…[d]erives 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 [i]s the subject of efforts that are reasonable under the circumstances to maintain its secrecy.  Cal. Civ. Code § 3426.1(d).

[10] Morlife, Inc. v. Perry, 56 Cal. App. 4th 1514, 1522 (1997).

[11] Vacco Industries, Inc. v. Van Den Berg, 5 Cal. App. 4th 34, 50 (1992).

[12] San Jose Const., Inc. v. S.B.C.C., Inc. 155 Cal. App. 4th 1528, 1538-1539 (2007).

[13] MAI Systems Corp. v. Peak Computer, Inc. 991 F. 2d 511, 522 (9th Cir. 1993).

[14] Kwikset Corp. v. Superior Court (Benson), 51 Cal. 4th 310, 337 (2011).

[15] Cal. Civ. Code § 3426.1(d).

[16] Aetna Bldg. Maint. Co. v. West, 39 Cal. 2d 198, 206 (1952).

[17] Metro Traffic Control, Inc. v. Shadow Traffic Network, 22 Cal. App. 4th 853, 861-863 (1994).

[18] See Civil Code § 3426.7(b); Silvaco Data Systems v. Intel Corp., 184 Cal. App. 4th 210, 239 (2010).

[19] Huong Que, Inc., 150 Cal. App. 4th 400 at 416.

[20] Cal. Penal Code § 502(e).

[21] See, e.g., Service Employees Intn’l Union, Local 250 v. Colcord (“SEIU”), 160 Cal. App. 4th 362 (2008).

[22] Cal. Bus. & Prof. Code § 17200.

[24] Cal. Civ. Code § 3426.2.

[25] Cal. Bus. & Prof. Code § 17203.

[26] Cal. Civ. Proc. Code § 526 (a)(2).

[27] See id.

[28] Cal. Civ. Code § 3333.

[29] Metz v. Soares, 142 Cal. App. 4th 1250, 1255 (2006).

[30] Cal. Civ. Code § 3294.

[31] SEIU, 160 Cal. App. 4th at 371.