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Spring 2014

Achieving Success Together

Trade Secrets, Confidential Information and Employee Mobility
By: Richard E. Blasco, Esq

Increasingly today, the value of a company is measured not by its physical assets, but by the talents of its employees and the value of its intellectual property. Because of their knowledge and experience, talented employees are constantly being approached by competitors. However, as employees leave, or as they come to your company, many take with them, mentally and sometimes physically, intellectual property belonging to their employer.

The general term "intellectual property" is used to describe basically 5 types of information: copyrights, patents, trademarks, trade secrets, and other confidential business information ("IP"). Unlike copyrights, patents and trademarks, there is no formal system in which trade secrets or other confidential business information are defined or registered.

The Difference Between "Trade Secrets" and "Confidential Information"

Many companies regard all business information as "trade secrets." This would include business information which meets the statutory requirements of a "trade secret", as well as "confidential information" which does not meet the statutory requirements of a "trade secret." Under the California Uniform Trade Secrets Act (CUTSA), the only information that is protectable as a trade secret is that which meets the statutory definition of a trade secret. In California a "trade secret" is defined by statute generally as information that: (i) is not generally known in the industry, to the public, or to others; (ii) who can realize economic value from its disclosure or use; (iii) has independent economic value that derives from its secrecy; and (iv) is subject to reasonable efforts to maintain its secrecy.

"Confidential Information" is that which does not meet the 4 requirements listed above to attain status as a trade secret. However, because no statutory definition of "confidential information" exists, if legal protection of such information is sought, it must be included in a Non-Disclosure Agreement or a non-disclosure provision an employment agreement (collectively "NDA".)

However, the protection afforded a company's "confidential information" is not unlimited in California, because of the application of Business and Professions Code ยง16600. Unlike most other jurisdictions, California has a settled legislative policy in favor of open competition and employee mobility. As a result, there is a fine line between provisions which seek to protect a company's "confidential information," and a California employee's right to mobility of employment.

Employees Joining or Leaving Your Company

When employees join or leave your company, the protection of "trade secrets" and "confidential information" (collectively "secret information") can present special challenges. Although misappropriation of a trade secret is actionable, even in the absence of a contract, many companies require employees who in their course of employment will gain knowledge of the company's secret information to sign a NDA.

It is important to distinguish between contract provisions in which the employee agrees not to compete, and a promise not to use or disclose secret information. A non-competition provision in an employment agreement in California will usually be regarded by a court as void, unless the provision is given in connection with a sale of the employee's ownership interest in the company. However, a thoughtfully drafted employment contract can protect both the employee's interest in mobility and the employer's interest in its secret information.

Identification of Secret Information

In many secret information disputes, considerable time and resources are expended to identify the alleged secret information. It is important for the company to identify ahead of time all of its secret information. Claiming that company's information was secret after an employee leaves the company, is likely to lead a court to the conclusion that the employee did not know that the information was a company secret.

Identification of secret information needs to be done on an on-going basis as new information is developed, or as more often occurs, old secret information is further developed into new secret information. The more precisely a company identifies its secret information the more likely the company will be able to successfully protect such information when a dispute arises.

Protection of Trade Secrets and Confidential Information

Secret information must be the subject of efforts by the company that are "reasonable under the circumstances to maintain its secrecy." This is where the efforts of the company become extremely important. No matter how broad a contract provision is drafted defining what constitutes a "trade secret" or "confidential information" a company still needs to have in place policies that attempt to prevent the disclose of such information to others, and when disclosure is necessary, to make the employee aware that the information is a secret.

These types of procedures would include disclosing such information only to employees who need the information to perform their respective duties. Other procedures would include labeling such material "trade secret" or "confidential information," and, storing the secret information in a secure location not accessible by anyone who does not need such information to perform their respective jobs.

Employment Agreements

It is important when an employee is hired, that they be required in an addendum to their employment agreement to disclose all secret information that the employee is bringing to your company. This includes attaching an addendum, signed or initialed by the employee, which discloses the secret information that is being brought to the company, or, indicates that no secret information is being brought by the employee to the company. The use of the addendum serves three purposes:

First, the addendum provides information to the employer about secret information which the new employee is possibly bringing to the company from a past employer. A disclosure of secret information should prompt the company to investigate whether or not the secret information was misappropriated, and will be inadvertently used by the company, thereby opening it up to potential liability.

Second, the addendum signed by the new employee who fails to disclose that he is bring secret information from a prior employer provides some protection to the company from liability for intentional acts, if the company conducts an investigation and promptly ceases using the prior employer's secret information.

Third, if the employee fails to disclose the secret information in the addendum, it precludes the employee from claims that he or she developed the secret information on their own prior to employment with the company, coupled with a demand for compensation (e.g. royalties) for use of the secret information by the company. Any IP that was developed by an employee prior to his employment with your company does not qualify as a "work for hire" entitling the company to claim ownership of such property.

Experience has shown that most employees with just complete the addendum by inserting "none." This response will assist the company in preliminarily resolving the three types of potential claims discussed above.

The Relief Available in Secret Information Disputes

Unlike other litigation in which monetary damages are the primary relief sought, because of the speed at which technology is changing, injunctive relief is an important remedy in secret information disputes. When a Court issues an injunction against the new employer, in most cases issuance of the injunction leads to a prompt settlement and ends the litigation.

Protective Orders

Whether or not a court grants injunctive relief, it will have to review the secret information, to determine whether it is a trade secret or confidential information, and whether or not it has economic value. This is where protective orders are needed, so that the disclosure of the secret information necessary for the court to make a decision on the request for injunctive relief, or later for monetary damages, is still protected from disclosure to others.

The judicial system is generally open to the public, and all pleadings and evidence are subject to public review. As a result, courts are reluctant to conduct closed sessions or order the sealing of papers filed in court proceedings, even when the parties to the dispute stipulate that certain information is secret information. With most Courts changing to electronic filing systems which provide access via the internet, it is much easier for the public to have access to documents filed with the courts.

As a result, a protective order is essential remove secret information from the electronic filing requirements, and thereby preclude access to the public and others. In some cases, upon stipulation of the parties, courts have gone so far as issue protective orders which limit access to secret information to only counsel and a party's experts.

Coordination of Indemnification Provisions With the Other Provisions in a Contract
By: Richard E. Blasco, Esq.

Indemnification provisions are widely used in contracts by parties that wish to allocate risk. The most common contract of indemnity is an insurance policy, whereby a licensed insurer agrees to indemnify its insured from various risks in exchange for the payment of a premium. Indemnity provisions are also frequently included in non-insurance contracts, such as construction, manufacturing, etc. agreements, whereby one party agrees to indemnify another party from losses associated with various risks, in consideration for being allowed to enter into the contract. Aside from the lack of any underwriting analysis of the potential cost to you of assuming liability for the risks associated with indemnity provisions in non-insurance contracts, the lack of coordination of such indemnity provisions with the other provisions in a non-insurance contract frequently lead to ambiguities which result in duties to defend and indemnify the other party which can bankrupt a company.

Indemnity Against First and Third Party Claims Arising from a Breach of Contract

Contracts frequently contain indemnity provisions, stating that a party will pay for the other party's losses related to: (a) third-party claims related to a breach of contract by the indemnitor; (b) first party claims for breach of contract against the indemnitor; and/or (c) both. If an indemnity provision does not clearly address the issue of first and third party indemnification for breaches of contract, the parties may be left arguing in court about the scope of the indemnity provision.

For example, an indemnity provision may expressly provide for coverage for any and all losses, including reasonable attorney's fees, arising from the other party's breach of the contract. This indemnity provision would appear on its face to be an unambiguous first and third party indemnity provision, providing coverage for both: (a) third party claims against the other party arising out of the indemnitor's breach of the parties' contract; and, (b) first party claims by the other party arising from a breach of contract by the indemnitor. However, these types of provisions, without further clarification, have been held to be ambiguous and are generally interpreted as only providing coverage for third party claims against the other party arising out of the indemnitor's breach of the parties' contract. Obviously, careful drafting of the indemnity provision needs to eliminate this ambiguity, so that the parties' intent as to the scope of the indemnity provision for breach of contract is clear (i.e. covers third party claims only, or covers both first and third party claims.)

The Effect of Limitation of Damages Provision

Another ambiguity can arise when a contract also contains a limitation of damages provision (e.g. a liquidated damages provision.) Note that a limitation of damages provision that limits the amount of damages recoverable to $0, or another unreasonable amount, is unenforceable as it makes the contract illusory.

Such a provision usually provides a reasonable dollar limit, whether in a specific dollar amount or by application of a formula that results in a specific dollar limit, on the amount of damages recoverable by the non-breaching party. However, when an indemnity provision and a limitation of damages provision are contained in the parties' contract, what may appear to be a clear unlimited obligation in the indemnity provision to indemnify the non-breaching party, becomes ambiguous when it conflicts with the limitation of damages provision, unless the parties have included clear language to address the two conflicting provisions.

A limitation of damages provision that does not clearly eliminate it application to the indemnity provision runs the risk of being found applicable to both third party as well as first party indemnity claims. A prudent party should seek to draft the indemnity provision to expressly provide for the scope of the indemnity obligation, and, to make sure that the indemnity provision does not conflict with other provisions in the contract such as the limitation of damages provision, exclusion of types of damages provision, etc.

The Effect of Exclusionary Damages Provisions

In addition to the limitation of the amount of damages provisions discussed, contracts commonly contain provisions which limit the types of damages (e.g., consequential, punitive, etc.) recoverable by a party to the contract. As with a limitation of the amount of damages provision, issues can also arise regarding the interaction of the types of damages that are recoverable. Again note that unless the exclusion as to the types of damages provision excludes all types of damages, they are generally enforceable it reasonable.

For example, a contract may contain: (i) a first and/or third party indemnity provision against breaches of the contract; (ii) a limitation of liability as to the amount of damages recoverable; and, (iii) an exclusion of the recovery of indirect, consequential, incidental, special (including lost profits, savings, competitive advantage, goodwill or business interruption) and punitive damages, whether arising out of contract, tort or other claims, from the universe of potentially recoverable damages. Again, the contract is silent as to the interaction of the indemnity provision, be it first or third party, and the limitation of liability provisions as to both the amount and the type of damage recoverable. The indemnified party under the contract receives a third-party claim for which that party is entitled to indemnification. The indemnified party is found to owe damages to the third party, some of which are indirect, consequential, incidental and special damages (collectively "indirect damages.")

In this situation, the question is whether the third party limitation of damages provision capping the amount of damages recoverable, and the provision excluding consequential damages, apply to the indemnification provision? Simply stated: Does the limitation of the type of damages provision operate to limit the indemnified party's right to indemnification with respect to the "indirect damages" that it owes to the third party?

Again, a contract that is silent regarding whether the exclusion of indirect damages applies to a third-party indemnity provision runs the risk of an indemnity that is not as broad, or as limited, as the parties intended.

When drafting a provision that excludes certain damages, a prudent party should seek to make the contract clear as to whether any limitation or exclusion of damages applies to any indemnity provisions, first or third party, under the contract. Those drafting contracts that include indemnity provisions need to address whether: (i) the indemnity provision applies to first-party claims, third-party claims, or both; (ii) the scope of the indemnity provision is limited by a limitation of the amount of damages recoverable; and, (iii) the scope of the indemnity provision is further limited by an exclusion of certain types of damages recoverable.

© Blasco & Hawekotte General Counsel Services LLP 2014. All rights reserved.
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This article is not legal advice and is not intended as legal advice. This article is intended to provide only general, non-specific legal information. This article is not intended to cover all the issues related to the topic addressed. The specific facts that apply to your matter may make the outcome different. This article is based on United States and California law. You should consult with an attorney familiar with the issues and the laws of your state. This article does not create any attorney client relationship.