Protecting Customer Lists – Why Have Confidentiality Agreements With Employees?

By Brad D. Bosomworth, Esq.

It can be argued that having confidentiality agreements with employees is a useless exercise because such agreements cannot prevent an employee from doing anything the law does not already prevent them from doing. While partially true, confidentiality agreements are a vital tool that greatly aid an employer’s efforts to preserve its proprietary assets.

While some employers have trade secrets in the technical sense such as secret formulas which they do not want their former employees to disclose or use, most do not. Most employers do have customer bases that they, equally, do not want former employees to pursue. Indeed, from many employers their customer relationships are their principal asset.

Ideally, in such situations employers would want to prevent former employees from competing following termination of employment and, thus, preserve their customer relationships with certainty. Outside of California, employee non-competition covenants are common but in California, non-competition covenants with employees are not valid. Cal. B & P Code §16600.

California employers should never have non-competition covenants with their employees. Including such provisions would be a violation of Labor Code Section § 432.5 which reads:

No employer, or agent, manager, superintendent, or officer thereof, shall require any employee or applicant for employment to agree, in writing, to any term or condition which is known by such employer, or agent, manager, superintendent, or officer thereof to be prohibited by law.

Note that under Labor Code § 433. “Any person violating this article is guilty of a misdemeanor.” Termination of an employee for refusing to sign an agreement containing such a non-compete provision constitutes wrongful termination. D‘Sa v. Playhut, Inc. (2000) 85 Cal.App.4th 927, 929. Use of a non-compete provision in an employment agreement has been held to constitute a form of unfair competition under Business & Professions Code §17200. Dowell v. Biosensor Webster, Inc. (2009) 179 Cal. App. 4th 564, 575. And, in Silguero v. Creteguard (2010) 187 Cal. App. 4th 60, an employee was permitted to pursue his new employer for wrongful termination for firing him after finding out he had a non-compete covenant with his former employer!
Less than perfect are “non-solicitation” covenants. Under non-solicitation covenants former employees can compete and accept business from the former employer’s customers. They just cannot affirmatively solicit those customers. California case law once supported such covenants. Recent California decisions are now treating non-solicitation covenants, at least covenants labeled “non-solicitation,” as though they are non-competition covenants and striking them down. In The Retirement Group v. Galante (2009) 176 Cal. App. 4th 1226, 1238, the Court stated:

We distill from the foregoing cases that section 16600 bars a court from specifically enforcing (by way of injunctive relief) a contractual clause purporting to ban a former employee from soliciting former customers to transfer their business away from the former employer to the employee’s new business

With the potential for the same parade of horribles as may flow from use of non-competition covenants, California employers are well advised to be extremely careful in use of non-solicitation covenants if they use them at all.

That leaves California employers with basic confidentiality agreements to protect what the employer asserts is a confidential customers list. In simple terms, the agreement restricts the employee from disclosing, or using, the employer’s confidential or trade secret information. The agreement typically identifies and defines what the employer considers secret and invariably includes customer lists and information. But, California Courts are clear that through such agreements an employer cannot convert information which is not a trade secret into a trade secret. The agreement can only apply to what the law already defines as confidential or trade secret and which the employee is prohibited from disclosing or using by their common law fiduciary duties and the Uniform Trade Secret Act. Civil Code Section 3426 et. seq. (“UTSA”). That is, while customer lists and information may very well constitute a trade secret, confidentiality agreements cannot impose restrictions on a former employee that do not already exist.

So, what is the point? There are three reasons to have confidentiality agreements with employees. 

First, most obviously they provide notice to the employee that the employer considers information confidential or trade secret. Employers can point to the agreements to remind the employees of that fact upon termination of employment.

Second, they are potentially essential to having information found to be trade secret. Under the UTSA, to maintain trade secrets an employer must use reasonable efforts to maintain the secrecy of the information. Civil Code Section 3426.1(d)(2). The first thing a Court will look to in determining whether the employer used reasonable efforts is whether they required confidentiality agreements from the employees. That is, failure to have confidentiality agreements, as a basic secrecy effort, could lead to valuable information being held not to be a protectable trade secret.

Third, they can provide a bit more of a threat to employees who might otherwise seek to misappropriate protected information. With a written agreement, an aggrieved employer can threaten to pursue punitive damages against the employee. And, under the UTSA the employer might recover attorney’s fees incurred in enforcing its rights if the misappropriation is “willful and malicious.” But, that is a fairly high standard to prove. In a written agreement, however, the employer can include an attorney’s fees provision pursuant to which it need only be the prevailing party to be entitled to recover its attorney’s fees. Such a provision could, thus, provide the employer with a substantial advantage in trying to prevent a former employee from misappropriating its valuable information.

Brad D. Bosomworth is an attorney specialize in General Corporate and Business Law, and Intellectual Property. For additional information about Corporate and Business Law, please contact Brad D. Bosomworth at (408) 356-3000, or the contact information on the right of this page.

SWEENEY, MASON, WILSON & BOSOMWORTH is a Professional Law Corporation located at 983 University Avenue, Suite 104C, Los Gatos, California, 95032, telephone (408) 356-3000. This “Legal Notice” is designed to assist our clients and other business owners in spotting issues which may result in costly litigation and court awarded damages if allowed to continue unaddressed. SWEENEY, MASON, WILSON & BOSOMWORTH’s philosophy is that by educating our clients, and other businesses, about their legal obligations, including changes in the law, we best serve our legal goal of minimizing or preventing expensive litigation.