INEVITABLE DISCLOSURE OF TRADE SECRETS

IVAN HOFFMAN, B.A., J.D.



        Here is the situation:  an employee is leaving or has left his or her job (voluntarily or otherwise) and seeks to go to work for a competitor of the former employer.  The employee has a great deal of knowledge about certain trade secrets and confidential information of the former employer but there is no evidence establishing that the employee intends to use or has used those trade secrets in his or her new job.  The employee may or may not have previously signed an agreement promising not to compete with the previous employer for some period of time.

        Question:  can the former employer prevent the employee from taking the new job (or prevent the new employer from hiring the employee) merely because of that employee’s knowledge about such trade secrets and confidential information if there is no evidence of actual or threatened use of those secrets?

        Answer: like all good legal answers, it depends.  It depends on which state in the United States has jurisdiction over the dispute and where the employment agreement, if there was one, containing the non-compete provision was entered into and under which law it is to be governed.  The reader is strongly cautioned to consult an attorney experienced in these matters in the reader’s state since the law varies from state to state.

Covenants Not To Compete

        The law around the country varies as to the validity and enforceability of provisions in contracts that restrict the ability of an employee to compete with the former employer.  Some states allow such restrictions provided they are reasonable in time and geography and other factors.  However, California law specifically makes such provisions invalid and unenforceable except in certain narrow situations not the subject of this article.  California Business and Professions Code, section 16600 provides:

Except 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.
        However, as indicated above, the issues presented in this article are in many senses independent of the existence or not of a covenant not to compete.  (For a further discussion read “The Non-Disclosure Agreement” and “Trade Secrets”)  The rights of the parties are determined more on the basis of whether or not the past employer has protectable trade secrets and the issues surrounding the new employment.  The issues in that regard are the possession of knowledge that, if used, would violate clearly established and protectable rights of the former employer in and to trade secrets.

        Many states have adopted the Uniform Trade Secrets Act.  In California, it is included in Civil Code section 3426.2, which states, in part:

(a) Actual or threatened misappropriation may be enjoined.
        Thus, there is no argument that a court can prevent such actual or threatened actions on the part of the former employee and/or the new employer.

        The issue, for the sake of this article, is what are the parameters of “threatened misappropriation?” And again, for the sake of this article, that issue is further refined in situations in which there is no evidence of any actual or threatened use of such trade secrets but only the employees’ possession of such information.  Those situations are often present in the context of whether or not a court could then prevent that employee with such knowledge from taking a job (or preventing a new employer from hiring that party) in which such trade secrets might be used at some time in the future.

        To deal with such a contingency, the courts have developed the policy of “inevitable disclosure.”

Inevitable Disclosure

        The principle behind this doctrine is that an employee with knowledge of a former employer’s trade secrets would “inevitably” disclose the same to the new employer since the nature of the new job would lead to such disclosures, given that the new and old employers were competitors.  And given the inevitability of such disclosures, the former employer was not limited to sitting around and waiting until there was an actual or even threatened use of those trade secrets before the former employer could seek legal redress.  Under this doctrine, that former employer could prevent the employee from taking that job and prevent the new employer from hiring the employee merely because the employee had such knowledge that would “inevitably” be disclosed.

        The doctrine, which has been adopted in some, but not all states, finds a coherent expression in a case out of the 7th Circuit, PepsiCo, Inc. vs. Redmond.  That case involved a former PepsiCo employee, William Redmond, who left that employ to go to work for the Quaker Oats Company (also sued), manufacturer of Gatorade, a competitor to Pepsi’s “All Sport.”  The case also involved other drink beverages in which the 2 companies competed.  Redmond, in his employ with PepsiCo, had access to many company trade secrets and confidential information.  There was no allegation, however, that he or Quaker used or intended to use that knowledge.  The appellate Court cited the trial court’s finding as follows:

The court found that PepsiCo’s fears about Redmond were based upon a mistaken understanding of his new position at Quaker and that the likelihood that Redmond would improperly reveal any confidential information did not “rise above mere speculation.”
        The appellate Court then summarized the PepsiCo position as follows:
… PepsiCo argued that Redmond would inevitably disclose that information to Quaker in his new position, at which he would have substantial input as to Gatorade and Snapple pricing, costs, margins, distribution systems, products, packaging and marketing, and could give Quaker an unfair advantage in its upcoming skirmishes with PepsiCo.
        Both Redmond and Quaker denied these allegations.

        The Court cited the Illinois version of the Uniform Trade Secrets Act section cited above about actual or threatened misappropriation and decided that the case turned on what constituted this “threatened or inevitable misappropriation” under the facts of that case.  The reader should be clear that these, like many other legal issues, turn and are dependent on the specific facts in the given case.

        The Court held that:

…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. See also 1 Jager, supra, sec. 7.02[2][a] at 7-20 (noting claims where “the allegation is based on the fact that the disclosure of trade secrets in the new employment is inevitable, whether or not the former employee acts conciously [sic] or unconsciously”).
        The Court stated further:
Again, the danger of misappropriation in the present case is not that Quaker threatens to use PCNA’s secrets to create distribution systems or coopt PCNA’s advertising and marketing ideas. Rather, PepsiCo believes that Quaker, unfairly armed with knowledge of PCNA’s plans, will be able to anticipate its distribution, packaging, pricing, and marketing moves. Redmond and Quaker even concede that Redmond might be faced with a decision that could be influenced by certain confidential information that he obtained while at PepsiCo. In other words, PepsiCo finds itself in the position of a coach, one of whose players has left, playbook in hand, to join the opposing team before the big game.
The California View

        As indicated above, California law does not allow covenants not to compete in situations such as might apply to facts similar to those discussed in this article.

        In Schlage Lock Co. vs. Whyte, the California Court of Appeals decided a case in which the issue of “inevitable disclosure” was squarely faced.

        The Court cited the PepsiCo case above as well as the above discussed California code sections.  The Court said:

The chief ill in the covenant not to compete imposed by the inevitable disclosure doctrine is its after-the-fact nature: The covenant is imposed after the employment contract is made and therefore alters the employment relationship without the employee's consent. When, as here, a confidentiality agreement is in place, the inevitable disclosure doctrine “in effect convert[s] the confidentiality agreement into such a covenant [not to compete].” (PSC, Inc. v. Reiss, supra, 111 F.Supp.2d at p. 257.) Or, as another federal court put it, “[a] court should not allow a plaintiff to use inevitable disclosure as an after-the-fact noncompete agreement to enjoin an employee from working for the employer of his or her choice.” (Del Monte Fresh Produce Co. v. Dole Food Co., Inc., supra, 148 F.Supp.2d at p. 1337; see also Matheson, Employee Beware: The Irreparable Damage of the Inevitable Disclosure Doctrine (1998) 10 Loyola Consumer L.Rev. 145, 162 [“the inevitable disclosure doctrine transforms employee access to trade secrets into a de facto non-competition agreement”].)

The doctrine of inevitable disclosure thus rewrites the employment agreement and “such retroactive alterations distort the terms of the employment relationship and upset the balance which courts have attempted to achieve in construing non-compete agreements.” (EarthWeb, Inc. v. Schlack, supra, 71 F.Supp.2d at p. 311.) The result, as the EarthWeb court explained, is “the imperceptible shift in bargaining power that necessarily occurs upon the commencement of an employment relationship marked by the execution of a confidentiality agreement. When that relationship eventually ends, the parties' confidentiality agreement may be wielded as a restrictive covenant, depending on how the employer views the new job its former employee has accepted. This can be a powerful weapon in the hands of an employer; the risk of litigation alone may have a chilling effect on the employee.” (Id. at p. 310.) As a result of the inevitable disclosure doctrine, the employer obtains the benefit of a contractual provision it did not pay for, while the employee is bound by a court-imposed contract provision with no opportunity to negotiate terms or consideration. (Matheson, supra, 10 Loyola Consumer L.Rev. at p. 160.)

Schlage and Whyte did not agree upon a covenant not to compete. We decline to impose one, however restricted in scope, by adopting the inevitable disclosure doctrine.

Lest there be any doubt about our holding, our rejection of the inevitable disclosure doctrine is complete. [emphasis added]  If a covenant not to compete (which would include, for example, a nonsolicitation clause), is part of the employment agreement, the inevitable disclosure doctrine cannot be invoked to supplement the covenant, alter its meaning, or make an otherwise unenforceable covenant enforceable. California law concerning enforcement of noncompetition agreements, not the inevitable disclosure doctrine, would measure the covenant's scope, meaning, and validity. Our opinion does not change that law. Under the circumstances presented in this case, an employer might prevent disclosure of trade secrets through, for example, an agreed-upon and reasonable nonsolicitation clause that is narrowly drafted for the purpose of protecting trade secrets. Thus, regardless whether a covenant not to compete is part of the employment agreement, the inevitable disclosure doctrine cannot be used as a substitute for proving actual or threatened misappropriation of trade secrets.

        The Court also stated:
In this opinion, we reject the inevitable disclosure doctrine. We hold this doctrine is contrary to California law and policy because it creates an after-the-fact covenant not to compete restricting employee mobility.
Conclusion

        Where you stand on these issues depends on where you sit.  If you sit at the table of the employer with trade secrets to protect, you may favor the expansion of the doctrine.  Of course, that same employer seeking to prevent its employees from leaving to a competitor may also find itself, in another situation, in the position of the hiring company and thus may have to argue against the doctrine.  If you sit at the table of the employees, you would oppose such expansion.

        It is worthwhile repeating: these are very fact-based situations and outcomes can often turn on the subtleties of those facts.

© 2002 Ivan Hoffman

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This article is not intended as legal advice.  The specific facts that apply to your matter may make the outcome different than would be anticipated by you.  You should consult with an attorney familiar with the issues and the laws.  This article does not create any attorney client relationship.

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No portion of this article may be copied, retransmitted, reposted, duplicated or otherwise used without the express written approval of the author.


 

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