In its 2008 landmark decision Edwards v. Arthur Andersen LLP (2008) 44 Cal. 4th 937, the California Supreme Court set forth a broad prohibition against non-compete provisions, but it left open whether or to what extent employee non-solicit provisions were enforceable. Since Edwards, no California appellate court has addressed that issue in a published opinion – until recently. On November 1, the California Court of Appeal in AMN Healthcare, Inc. v. Aya Healthcare Services, Inc., ruled that a broadly worded contractual clause that prohibited solicitation of employees for one year after employment was void under California Business and Professions Code section 16600, which 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.” The decision calls into question the continuing viability of employee non-solicitation provisions in the employment context, and employers who regularly include such provisions in their agreements should reassess their use and enforcement of those provisions.

AMN and Aya are competing healthcare staffing companies that provide travel nurses, to medical care facilities throughout the country. The individual defendants were former travel nurse recruiters of AMN who left AMN and joined Aya, where they also worked as travel nurse recruiters.

The individual defendants each signed a confidentiality and nondisclosure agreement (CNDA) with AMN, which included a provision preventing them from soliciting any employee of AMN to leave AMN for a one-year period. Section 3.2 of the CDNA provided:

Employee covenants and agrees that during Employee’s employment with the Company and for a period of [one year or] eighteen months after the termination of the employment relationship with the Company, Employee shall not directly or indirectly solicit or induce, or cause others to solicit or induce, any employee of the Company or any Company Affiliate to leave the service of the Company or such Company Affiliate.

Because AMN’s travel nurses were employees of AMN, section 3.2 of the CNDA applied to prevent a former AMN employee from recruiting a travel nurse on a temporary assignment for AMN.

After the individual defendants resigned, AMN sued them, asserting various causes of action, including breach of the non-solicitation provision in the CNDA. Defendants filed a cross-complaint, requesting the court declare the non-solicitation provision in the CNDA void and enjoining AMN from enforcing the provision against other former AMN employees.

The defendants moved for summary judgment of AMN’s complaint and of their own cross-complaint. Defendants claimed that the non-solicitation provision in the CNDA was an improper restraint on individual defendants’ ability to engage in their profession – soliciting and recruiting travel nurses – in violation of Business and Professions Code section 16600. The trial court agreed, and granted defendants summary judgment on AMN’s complaint and granted summary adjudication of defendants’ declaratory relief cause of action. Then the court enjoined AMN from enforcing the employee non-solicitation provision in the CNDA as to any former California employee and awarded defendants attorney’s fees.

The Fourth District Court of Appeal affirmed the trial court’s grant of summary judgment. In doing so, the court concluded that the non-solicitation provision in the CNDA was void under section 16600. “Indeed, the broadly worded provision prevents individual defendants, for a period of at least one year after termination of employment with AMN, from either ‘directly or indirectly’ soliciting or recruiting, or causing others to solicit or induce, any employee of AMN. This provision clearly restrained individual defendants from practicing with Aya their chosen profession—recruiting travel nurses on 13-week assignments with AMN.” The court further found that a one-year, post-termination restriction preventing a former AMN recruiter from contacting and recruiting a travel nurse on a 13-week assignment with AMN “at a minimum equates to a period of four such assignments for a given nurse. The undisputed evidence thus shows section 3.2 of the CNDA restricted individual defendants’ ability to engage in their ‘profession, trade, or business.'”

In granting summary adjudication, the court rejected AMN’s reliance on Loral Corp. v. Moyes (1985) 174 Cal. App. 3d 268 for the argument that the CNDA was valid because it only prevented non-solicitation of employees (here, travel nurses). Moyes involved the validity of a contractual clause restricting a former executive officer from “raiding” the plaintiffs’ employees. In determining the provision was more like a permissible non-solicitation or nondisclosure agreement and not an invalid non-competition agreement, the court observed that the agreement “restrained [defendant] from disrupting, damaging, impairing or interfering with his former employer by raiding [the plaintiffs’] employees …. This does not appear to be any more of a significant restraint on his engaging in his profession, trade or business than a restraint on solicitation of customers or on disclosure of confidential information.”

 The court concluded that Moyes‘s use of a reasonableness standard in analyzing the non-solicitation clause conflicted with Edwards – decided over twenty years later – where the California Supreme Court interpreted Section 16600 to be a “settled public policy in favor of open competition,” and rejected the common law “rule of reasonableness.” Because the Edwards court found section 16600 “unambiguous,” and noted that “if the Legislature intended the statute to apply only to restraints that were unreasonable or overbroad, it could have included language to that effect,” the court expressed “doubt [as to] the continuing viability of Moyes post-Edwards.”

The court also affirmed the injunction, which prevented AMN and its employees and agents “from using, enforcing, or attempting to enforce any contract or employment agreement in the State of California which purports to restrain its former employees from directly or indirectly soliciting or inducing, or causing others to solicit or induce, any employee of AMN to leave the service of AMN.” In connection with the injunction, the court approved an award of attorney’s fees to defendants under Code of Civil Procedure section 1021.5, which permits fees to be awarded “in any action which has resulted in the enforcement of an important right affecting the public interest if: (a) a significant benefit … has been conferred on the general public or a large class of persons, (b) the necessity and financial burden of private enforcement … are such as to make the award appropriate, and (c) such fees should not in the interest of justice be paid out of the recovery, if any.”

In affirming the award of attorney’s fees, the court concluded that “Defendants clearly were successful parties within the meaning of the statute … the instant action involved an important issue affecting the public interest, namely the enforceability of section 3.2 [of the CNDA, which], if enforced, prevented former AMN employees from recruiting travel nurses and similar professionals who were on temporary assignment with AMN, even if those same travel nurses had applied to, were known by, and/or had previously been placed by, a competitor of AMN, as the instant case aptly shows.” The court further concluded that “instant action conferred a significant benefit on the public … [and] a large class of persons … namely, all current and former AMN California employees who had signed a CNDA containing a non-solicitation of employee provision similar to section 3.2 of the CNDA.”

The AMN Healthcare decision is significant for several reasons. The court’s expressed doubt as to the viability of Loral Corp. v. Moyes should give pause to both employers who regularly include such provisions in employment agreements and practitioners who advise employers as to the inclusion or enforceability of such provisions. While it could be argued the appellate court’s ruling should be limited to its facts because an employee non-solicitation clause easily restrains a recruiter from engaging in their “profession, trade, or business,” the AMN Healthcare court’s reasoning could be extended to other situations. Further, the court’s award of attorney’s fees under Code of Civil Procedure section 1021.5 provides a cautionary tale for employers attempting to enforce contractual provisions that run afoul of Business & Professions Code section 16600. Well-informed defendants will bring a cross-complaint seeking injunctive relief, and, if they prevail, could be entitled their attorney’s fees in doing so.

NuScience Corporation is a California corporation that researches, develops and distributes health and beauty products, including nutritional supplements. In 2009, NuScience obtained by default a permanent injunction in a California federal court against Robert and Michael Henkel, the nephew of a woman from whom NuScience purchased the formula for a nutritional supplement, prohibiting them from selling or marketing NuScience’s trade secrets. Before the federal court injunction was entered, NuScience terminated the employment of David McKinney, NuScience Vice President of sales and marketing. McKinney signed a separation agreement wherein he agreed to maintain the confidentiality of certain NuScience-related matters. What followed might be good book material.

In June 2010, NuScience received an email from a third-party which included an email string between Robert Henkel and McKinney that caused NuScience to conclude Robert Henkel was violating the federal court injunction. Based on the emails, NuScience sued McKinney and Robert Henkel in California Superior Court for misappropriation of trade secrets, among other claims. (“NuScience I”) Robert Henkel again did not appear and the court entered a default against him in March 2011.

McKinney appeared in the state court action and was represented by Stephen E. Abraham. McKinney filed a motion to compel further discovery responses from NuScience and a motion for sanctions against NuScience which NuScience initially opposed. But before the motion was heard, NuScience filed a request for dismissal without prejudice. McKinney responded to the NuScience voluntary dismissal with a motion for attorney’s fees and costs under the Uniform Trade Secrets Act, California Civil Code Section 3426 et seq. (“UTSA”). The trial court granted the motion for attorney’s fees, concluded the record showed subjective bad faith on NuScience’s part, and awarded McKinney the $32,842.81 he requested.

NuScience moved for reconsideration contending that after it took Henkel’s default, Henkel called NuScience’s attorney and said NuScience “better back off and leave [them] alone” and that Henkels thereafter began posting threats to publish NuScience’s trade secret formula on the Internet. NuScience’s attorney reported the threat to the FBI, which informed him that it had assigned an agent to investigate and the pending investigation should remain confidential. NuScience asserted that Henkel then told NuScience’s attorney that he “would release NuScience’s formula to the world unless [NuScience] dismissed this lawsuit” and “cease all enforcement of the federal judgment against the Henkels.” NuScience asserted that only later did the FBI “reluctantly acquiesce[ ]” and allowed NuScience to discuss the investigation.

The court denied the motion for reconsideration.

NuScience appealed the attorney’s fees award and the Court of Appeal reversed the decision of the lower court. The Appellate Court found that the email exchange between McKinney and Henkel on which NuScience I was premised was evidence that they were engaged in internal experimentation with NuScience’s trade secret formula and further stated McKinney had been using the samples. The court found this was sufficient evidence of actual or threatened misappropriation under the UTSA. The court further found that the email exchange was evidence that McKinney intended to use the NuScience customer list to market to buyers in Asia and that since McKinney was unlikely to have derived information about customers interested in the formula other than through his employment with NuScience, a trier of fact could conclude McKinney intended to use the information he derived from NuScience’s customer list to compete.

The day after the trial court awarded fees under the UTSA in NuScience I, McKinney filed a malicious prosecution action against NuScience and was represented again by Stephen Abraham (“NuScience II”). NuScience filed a motion to strike under California’s Anti-SLAPP (Strategic Litigation Against Public Policy) statute. The trial court granted the motion, and rejected McKinney’s claim that the dismissal prior to the hearing on the discovery motion was a favorable determination on the merits, noting “undisputed evidence… that the case was dismissed in response to extortionist threats.” The court awarded NuScience attorney’s fees of $129,938.75. The order was affirmed on appeal.

NuScience then filed an action against McKinney, Abraham and his law firm, and two other individuals in March 2014 alleging malicious prosecution and intentional interference with contractual relations against Abraham. Abraham responded with special motions to strike the causes of action.

Abraham attacked the intentional interference cause of action under the California Anti-SLAPP statute on the grounds that the conduct Abraham was alleged to have engaged in – the filing of declarations in federal and state court lawsuits that were signed by McKinney – is protected conduct. The trial court, and subsequently the Court of Appeal, concluded there could be no breach of contract absent a disclosure or public disparagement and the disclosure/disparagement NuScience alleged was Abraham’s public filing of McKinney’s declarations. As such, it was protected activity.

The trial court also granted Abraham’s SLAPP back action in the malicious prosecution claim. The Court of Appeal agreed, finding that NuScience had not demonstrated that the underlying malicious prosecution claim was initiated with malice because, in part, the malicious prosecution was alleged against a former adversary’s attorney, and not the former adversary. The court held that malice harbored by an adversary may not be attributed to its attorney. NuScience tried to identify additional evidence of Abraham’s own malice on appeal asserting, in part, that Abraham “told NuScience that he intends to destroy NuScience,” but the court pointed out that the actual evidence stated “NuScience will be out of business in six months” and “NuScience will be done in six months,” which the court stated suggested, at most, that Abraham believed that litigation would be successful and that NuScience’s demise was imminent, “not that he intended to cause its demise.” The Court of Appeal affirmed the order dismissing the claims against Abraham and affirmed the award of Abraham’s attorney’s fees of $99,595.00.

While the initial trade secret dispute between the parties here was relatively straightforward, this case is worth highlighting because of the extensive litigation that followed. Despite the company’s legitimate interest in protecting its threatened trade secrets, there were certainly unintended consequences as a result of the company’s vigorous advocacy to protect its interests. NuScience became embroiled in litigation spanning the course of the next eight years, itself even becoming the defendant to a lawsuit. This serves as a cautionary tale and a reminder of the inherent risk to engaging in litigation.

The case is NuScience Corp. v. Abraham, B264334 (Ca. Ct. of App. 2/1/17).

High-stakes trade secret cases are typically aggressively prosecuted. But plaintiffs (and their attorneys) who prosecute these claims face substantial risks if the evidence does not support the contention that a trade secret has been misappropriated. Even a plaintiff who may have initiated a misappropriation action in good faith risks attorneys’ fees and malicious prosecution liability by continuing to prosecute the matter after it learns that the case is not substantiated.

Section 4 of the Uniform Trade Secrets Act authorizes a court to award costs and attorneys’ fees if the court determines that a claim for misappropriation is made in bad faith, and most jurisdictions include this provision. For example, California Civil Code § 3426.4 provides that “[i]f a claim of misappropriation is made in bad faith, a motion to terminate an injunction is made or resisted in bad faith, or willful and malicious misappropriation exists, the court may award reasonable attorney’s fees and costs to the prevailing party.”

SASCO v. Rosendin Electric, Inc.

Several recent California cases highlight that the risk to employers (and the law firms representing them) is not simply in initiating actions for misappropriation but also for continuing to pursue them when the facts of the claim are not borne out in litigation.

In SASCO v. Rosendin Electric, Inc., 207 Cal.App.4th 837 (2012), the California Court of Appeal affirmed a trial court’s order awarding the defendants almost $485,000 in attorneys’ fees and costs pursuant to California Civil Code § 3426.4. SASCO sued Rosendin Electric, Inc.; another licensed electrical contractor; and three individual defendants for misappropriation of trade secrets, among other things. The trial court accepted for the sake of argument that SASCO’s computer program was a trade secret. The court concluded, however, that there was no evidence of misappropriation and that SASCO had sued the defendants based on the suspicion that they must have misappropriated trade secrets because the individual defendants went to work for a competitor, which subsequently secured a contract for which both companies were competing. The trial court concluded that the plaintiff engaged in bad faith pursuant to Section 3426.4, which consisted of both objective speciousness and subjective bad faith. The appellate court agreed with the trial court that continuing to prosecute the action without evidence of actual misappropriation constituted subjective bad faith.

FLIR Systems, Inc. v. Parrish

The risk to plaintiff employers (and their law firms) in pursuing claims in bad faith is not limited to attorneys’ fees and costs under the statute. On April 6, 2012, Latham & Watkins was sued for malicious prosecution in Los Angeles Superior Court. The plaintiffs, William Parrish and Timothy Fitzgibbons, were former officers and shareholders of Indigo Systems Corporation, which was purchased by FLIR Systems, Inc., in 2004. From 2004 to 2006, the plaintiffs worked for FLIR, leaving in 2006 to start their own business. FLIR retained Latham and sued the plaintiffs for, among other things, misappropriation of trade secrets. After a summary judgment motion was denied, the case proceeded to trial on FLIR’s claim for injunctive relief. The trial court denied FLIR’s request for a permanent injunction, found that FLIR brought the trade secrets action in bad faith, and awarded attorneys’ fees and costs of $1,641,216.78. The trial court’s decision was affirmed on appeal.[1]

In the subsequent malicious prosecution suit, Latham & Watkins filed a motion contending that the plaintiffs’ claims were barred by the statute of limitations and on their merits, contending that (i) a one-year statute of limitations applied to the plaintiffs’ claims and the claims were untimely under that limitations period and (ii) the trial court’s denial of summary judgment for the plaintiffs on the claims brought against them by FLIR established that the underlying action was brought with probable cause as a matter of law. The trial court granted Latham’s motion on statute of limitations grounds and did not expressly address Latham’s argument that the claims against the law firm were without probable cause.

On August 27, 2014, the Court of Appeal issued an opinion reversing the trial court. The Court of Appeal held that the applicable statute of limitations for malicious prosecution claims was not the one-year, but rather the two-year, limitation period set forth in Cal. Code Civ. Proc. Section 335.1.

The Court of Appeal then considered Latham’s argument disputing the merits of the plaintiffs’ malicious prosecution complaint. Key to Latham’s argument was the fact that the plaintiffs had moved for summary judgment in the underlying case and that motion had been denied. Latham argued that the “interim adverse judgment rule” applied, under which claims that have succeeded at a hearing on the merits are deemed not so lacking in potential merit to serve as the basis for a malicious prosecution claim (unless such ruling is obtained by fraud or perjury). Prior courts had routinely applied the interim adverse judgment rule to bar claims for malicious prosecution where there had been a denial of a defendant’s motion for summary judgment in the underlying action.

The Court of Appeal noted that the plaintiffs had evidence that:

  1. Latham filed a complaint alleging actual misappropriation of a business plan, disregarding a claim that the plaintiffs had created the business plan prior to their employment with FLIR;
  2. when plaintiffs presented that evidence to Latham, Latham changed the theory of the case to pursue a claim that the plaintiffs could not effectuate the business plan without inevitably using FLIR’s intellectual property;
  3. Latham knew that inevitable disclosure is not a viable legal theory in California and, therefore, knew that this theory lacked legal basis;
  4. the factual basis for Latham’s theory was expert testimony that considered only publicly available technology when Latham knew that the plaintiffs’ business plan would be using non-public technology obtained lawfully from third parties; and
  5. FLIR’s president testified that he had no factual basis to assert that the plaintiffs would use FLIR’s intellectual property, strongly implying that the claim against them was a preemptive strike.

Critically, the Court of Appeal found that Latham had “sought an obviously anti-competitive injunction based on the speculative possibility that the [plaintiffs’] product might violate its client’s trade secrets . . . .” The Court of Appeal held that these circumstances supported the conclusion that “no reasonable attorney would have believed [the] case had merit,” and it reinstated plaintiffs’ claim.

Latham filed a petition for re-hearing, which was denied on September 19, 2014, and then, on the court’s own motion, was granted on September 25, 2014. On June 26, 2015, the Court of Appeal issued its decision, this time, affirming the trial court’s order granting Latham’s motion on the ground that the “interim adverse judgment rule” established Latham had probable cause to bring the action. The court held that exceptions to the interim adverse judgment rule did not apply in this case because (i) the summary judgment motion was not denied on procedural or technical grounds and (ii) the summary judgment motion was not obtained by fraud or perjury.[2]

But this ruling did not conclude the matter. On October 14, 2015, the California Supreme Court granted the plaintiffs’ Petition for Review, and the case is pending.

Understand the Risk Before Prosecuting

There are substantial risks in pursuing trade secret actions if it appears that plaintiffs are using the Trade Secrets Act to mask an anti-competitive intent. If, during the course of the litigation, there is no evidence that a trade secret has been misappropriated or it does not look like a trade secret can be proven, plaintiffs and their attorneys must understand this risk in assessing whether, or to what extent, to continue to pursue the action.

A version of this article originally appeared in the Take 5 newsletter “Restrictive Covenants: Do Yours Meet a Changing Landscape?

[1] FLIR Systems, Inc. v. William Parrish, et al., 174 Cal.App.4th 1270 (2009).

[2] Parrish v. Latham & Watkins, 238 Cal.App.4th 81, 97 (2015).