The International Enforceability of Trade Secret Protections, Non-Compete Agreements and Stock Ownership Restrictions in the Context of Global High-Tech Professionals, Researchers, Intellectual Capital Workers and Executives – a California Example

Non-Compete Agreements and Stock Ownership Restrictions in California

INTRODUCTION

A client recently retained our firm who is a highly qualified specialist and current executive in the pharmaceutical industry originally from China but over the past decade engaged in extensive work for one of the largest pharmaceutical companies in the U.S. here in California.

The client asked us to review his current factual predicament in regards to his current executive position and the law in California as it relates. After client’s extensive work with the U.S. based multinational (hereinafter, “Company A”), he later joined a Chinese biotech company as an executive after leaving Company A. Currently, the biotech company where he works is in the process of conducting an auditing and accounting analysis. Basically, the company would like to assure prospective investors there are no problems with his previous employment Company A and his current employment in the biotech industry with his current Chinese company where he is taking on the role of an executive.

COVENANTS NOT TO COMPETE UNDER CALIFORNIA LAW

California businesses face a tough task by trying to prevent its employees from leaving the company and going to work for the company’s competitor or starting their own competing business.  In order to protect the company’s business, many employers consider covenants not to compete (non-compete clauses) in employment agreements essential to protecting the company.  However, most employers do not realize that non-compete clauses are generally invalid in California unless the non-compete clause falls within an exception.

California Business and Professions Code section 16600 (Section 16600) states 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.”  In addition, California has a strong, fundamental public policy that promotes freedom of competition between an employee and an employer, allowing the employee the ability to freely pursue any lawful employment provided that certain exceptions do not apply.  Thus, California courts typically interpret Section 16600 broadly and continually refuse to enforce non-compete clauses.

There are a limited number of statutory exceptions to the prohibitions of Business and Professions Code section 16600. They involve sale of a business or ownership interest in a business, the dissolution of a partnership or dissociation of the partner from the partnership, and the termination of an interest in a closely held LLC. See, Cal. Bus. & Prof. Code §§16601-16602.5. Again, in these circumstances, the person who is leaving the existing entity agrees that he or she will not carry on a similar business within a specified geographic area where the existing partnership or limited liability company is located.  (See, California Business and Corporations Code Section 16600 – 16602).

Section 16601 allows covenants not to compete where a “person sells the goodwill of a business, or any owner of a business entity [sells] or otherwise [disposes] of all of his or her ownership in the business entity’. However, cases interpret this section to require that the price of the business entity or shares sold therein account for goodwill. See, Alliant Ins. Service, Inc. v. Gaddy (2008) 159 Cal. App. 4th 1292, 1300-1306, 72 Cal. Rptr. 3d 259.

Lastly, in terms of affirmative limitations on employers, an employer who places unfair covenants in an employment contract may be liable for engaging in unfair competition and violating Business and Professions Code section 17200 for using an illegal covenant not to compete in an employee contract. Dowell v. Biosense Webster, Inc. (2009) 179 Cal. App. 4th 564, 575 102 Cal. Rptr. 3d 1.

Furthermore, an employer cannot lawfully make the signing of an employment agreement containing an unenforceable covenant not to compete a condition of employment or continued employment. Termination of an employee who refuses to sign such an agreement constitutes a wrongful termination in violation of public policy. D’Sa v. Playhut, Inc. (2000) 85 Cal. App. 4th 927, 929, 102 Cal. Rptr. 2d 495.

Thus, the issue presented is moot in his case since Company A (in good judgment) has enough legal good sense not to coerce their employee (he) to sign what amounts to an unfair covenant in a contract. Otherwise, he would likely have a right to sue them on two (2) grounds under California law.

Finally, it is further a non-issue because even if he did sign such an agreement, it would not be enforceable as the client wasa a research employee and did not sell the goodwill of Company A in any way by leaving their employ, nor was the client in any way in a closely-held relationship with such a large global corporation.

EMPLOYER STOCK OWNERSHIP RESTRICTIONS UNDER CALIFORNIA LAW

As generally discussed above, public policy in California supports the right of an individual to the unhampered pursuit of the livelihood of his or her choice. Futurecraft Corp. v. Clary Corp. (1962) 205 Cal. App. 2d 279, 285-296, 23 Cal. Rptr. 198. Thus, as a general rule, a former employee has the right to engage in a competitive business and may enter into competition with the former employer, even for the business of those who were customers of the former employer, provided such competition is fairly conducted. Continental Car-Na-Var Corp. v. Moseley (1944) 24 Cal. 2d 104, 110, 148 P. 2d 9.

I’m not certain that I understand what the rationale would be for prohibiting one’s employees from owning stock in a competitor that is a large public company. Employees often move from one company to a competitor, and retain stock they may have acquired while working in the first, so it’s not at all unusual for an employee to own stock in a competitor, particularly a large publically traded company.

Once again, as with covenants not to compete, in California, an employer who places unfair restrictions on an employee may be liable for engaging in unfair competition and violating Business and Professions Code section 17200 for using an illegal covenant not to compete in an employee contract. Dowell v. Biosense Webster, Inc. (2009) 179 Cal. App. 4th 564, 575 102 Cal. Rptr. 3d 1. I think it is very likely a court in California would find that prohibiting an employee from holding stock in a large publically traded company where the employee worked previously would be such an unfair restriction.

CONCLUSION / DIVULGENCE OF TRADE SECRETS (UTSA)

Trade secrets are protected by statute under the California Uniform Trade Secrets Act (UTSA). Civ. Code §3426 et seq. However, these are limited to cases where the employee acts improperly by intentionally disclosing or misappropriating a “trade secret” to a competitor. Examples of this would be secrets that involve special machines, formulas, or designs for the productions of goods. Cal. Francisco Inv. Corp. v. Vrionis (1971) 14 Cal. App. 3d. 318, 322, 92 Cal. Rptr. 201.

Another example would be disclosing customer lists. Although this term of art is very restrictively defined in California law as to employers. For example, in Moss, Adams & Co. v. Shilling, the court of appeal held that the names of customers of an accounting firm that were known by the employees because they had provided services for those customers did not constitute a trade secret. Moss, Adams & Co. v. Shilling (1986) 179 Cal. App. 3d 124, 128-129, 224 Cal. Rptr. 456.

In this client’s circumstance, there is no evidence of the divulgence of trade secrets. But even if the client had used company customer lists, etc. in his future employment, under California public policy even the definition of trade secrets is rather broadly construed in the employee’s favor.

Thus, in conclusion, under California law there is no problem that in that the client previously worked for Company A and currently works for as an executive for another biotech company in the absence of a non-compete agreement that would never be enforced anyway. Nor is there any legal problem under California law with the client holding an equity position in his previous very large publically traded company and working for another company in that business field. Lastly, any attempts to limit his rights in these regards may subject any unreasonably limiting employer to the legally justifiable risk of litigation.

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