A Rare Occurrence: California Court Overturns Arbitrator’s Award

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California’s statutory ban on post-employment covenants, which are enforceable in most other states, has bedeviled employers trying to protect confidential information and trade secrets. The state’s Business and Professions Code section 16600 provides 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.”  Due to this prohibition, employers in California have few options in terms of preventing post-employment competition and solicitation. 

The one avenue available to California employers is the ability to prevent former employees from using confidential information to compete and solicit customers and employees.  Thus, having an enforceable non-disclosure agreement (NDA) preventing the use of confidential information is essential.  A recent decision from the California Court of Appeal, Fourth Appellate District, however, has taken the unprecedented step of applying section 16600 to void the scope of non-disclosure provisions on confidential information and set aside an arbitration award that found a former employee has breached the confidential information provisions of his NDA.  While this decision should be limited to its unique facts, particularly the fact that it applied to the highly specialized field of statistical arbitrage, employers should review their NDA agreements to ensure the definition of “confidential information” is not so broad that it become a restraint on practicing a chosen profession, trade or business in violation of section 16600.

Background

In Richard Hale Brown v. TGS Management Company, LLC, No. G058323 (Cal. Ct. App. October 13, 2020), the court reversed an arbitrator’s decision finding that a former employee had violated his NDA when he attached and filed confidential information regarding his employer, including its profits and bonus calculations, with his petition to compel arbitration.  The appellant worked for TGS Management Company, LLC (TGS), a company that engages in a highly computerized form of equities trading known as statistical arbitrage.  As a condition of his employment, the appellant signed an NDA, which included confidentiality provisions.1  “Confidential Information” was defined as “information, in whatever form, used or usable in, or originated, developed or acquired for use in, or about or relating to, the Business” and “Business” was defined as “without limitation analyzing, executing, trading and/or hedging in securities and financial instruments and derivatives thereon, securities-related research, and trade processing and related administration . . . .” 

After his job termination from TGS, the appellant filed a claim for declaratory relief, seeking a declaration that he “could compete with TGS without risking a damages claim for breaching the Employment Agreement or jeopardizing his two deferred bonuses.” He also sought an injunction against enforcement of the covenant not to compete in the agreement.  TGS responded by stating it would not seek to enforce the non-compete, but counterclaimed for breach of contract, claiming that the appellant forfeited two deferred bonuses when he violated the confidentiality provisions of the Employment Agreement by filing a copy of the Draft Separation Agreement, which disclosed the identity of TGS’s clients and its “bonus formula” for computing employee bonuses.

Arbitration Decision

The arbitrator found that the appellant forfeited his right to about $950,000 in deferred bonuses by breaching the confidentiality provisions of the Employment Agreement. The appellant claimed that the definition of “Confidential Information” was not just the actual business of TGS, but also all aspects of working in the securities industry, and therefore, the provision was so expansive that he could never trade securities again.  The arbitrator rejected that claim, stating that “not being able to foresee the nature of Claimant[’]s conduct in the context of his anticipated future employment, cannot make such a finding.”  The arbitrator also concluded that the appellant “made no showing that the confidentiality provisions….are unreasonably restrictive in the context of the nature of [his] employment and the business which TGS was engaged.”  The arbitrator further denied the appellant’s request for equitable relief on the grounds that he had stolen TGS’s confidential information about its “historical earnings” by copying the electronically-stored information onto his cell phone and retaining the information “after his employment was terminated and by providing ‘intentionally’ false testimony at the hearing regarding how he obtained this confidential information.”

Court Decision

The trial court had denied the appellant’s petition to vacate the arbitration award and had entered judgment on the award.  The appellate court reversed the trial court’s decision and set aside the arbitration award, stating that the arbitrator’s “refusal to decide his facial challenge to the legality of the confidentiality provisions under section 16600” violated the appellant’s statutory rights and exceeded his authority as an arbitrator. In setting aside the award, the court held that the NDA was void because the definition of “Confidential Information” was overbroad and violated Business and Professions Code section 16600. 

The Court’s findings are concerning for two reasons. First, arbitration decisions are not generally reviewable for errors of fact or law, and therefore usually overturned in rare circumstances.  Here, the court decided to conduct judicial review of the arbitrator’s decision under the exception that review is available if the award is inconsistent with an individual’s statutory rights and conflicts with public policy, citing to the California Supreme Court’s decision in Moncharsh v. Heily & Blase, 3 Cal.4th 1 (1992).  The court reasoned that because the trial court’s confirmation of the arbitration award conflicts with the appellant’s rights under section 16600 to pursue lawful employment, the decision was subject to judicial review de novo.  The court’s finding may have been based on the fact that the arbitrator did not decide the appellant’s request for a decision on the validity of the confidentiality provisions. The Brown decision opens up the possibility that arbitration awards involving the adjudication of an individual’s statutory rights will be subject to greater judicial review. 

Second, the court analyzed the definition of “Confidential Information” and held that it was drafted too broadly, which should give employers pause when drafting their NDAs.2  While TGS had two exceptions to the definition of “Confidential Information,” the court felt the exceptions were insufficient to allow the appellant to continue to work in the securities industry.  The first exception stated “Confidential Information” did not include “information which is or becomes generally known in the securities industry through legal means without fault by” the appellant.  The second exception stated that information which “was known by [the appellant] on a non-confidential basis prior to his initial engagement or employment with [TGS] as evidenced by [his] written records.”  The court concluded these exceptions were not meaningful because: (1) the methods behind statistical arbitrage are not generally known to the public; and (2) requiring the appellant to have written records to confirm his prior knowledge was absurd.  The court concluded:

[T]he confidentiality provisions in the Employment Agreement on their face patently violate section 16600.  Collectively, these overly restrictive provisions operate as a de facto noncompete provision; they plainly bar [appellant] in perpetuity from doing any work in securities field, much less in his chosen profession of statistical arbitrage..  Consequently, we conclude the confidentiality provisions are void ab initio and unenforceable.

Implications for Employers

This case involved a unique set of facts, and may fall into the category of decisions described as “bad facts create bad law.” This is not a case where an employer tried to seek damages for misappropriation of trade secrets used to compete against it.  While unstated, the court may have reached the result it did because it thought a forfeiture of almost $1 million in compensation for attaching an agreement to a declaratory claim was overreaching.  In addition, given the NDA pertained to a field where the methods are not widely known and the definition of “Confidential Information” was not limited to just the business of TGS, but the securities industry in general, it may be possible to distinguish this case. However, the court’s setting aside an award based on a facial challenge to the scope of the confidentiality provision is a new development. Given the court’s decision, employers drafting confidentiality provisions should keep the Brown decision in mind and limit the definition of confidential information so that it does not over-reach and prohibit post-employment competitive activity that is protected by Cal. Bus. & Prof. Code 16600.

 

Footnotes

1 The NDA also included a two-year non-competition clause, but TGS did not seek to enforce that clause given it is void under section 16600.

2 It should be noted that TGS did not try to defend the legality of the confidentiality provisions on appeal, and instead argued that the arbitrator had not exceed his powers under Moncharsh

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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