California Court Affirms that Customer Lists Can Qualify as Trade Secrets

by Ogletree, Deakins, Nash, Smoak & Stewart, P.C.

Under California’s trade secret laws, a trade secret is information that (a) is not generally known in the industry, to the public, or to others who can realize economic value from its disclosure or use; (b) has independent economic value that derives from its secrecy; and (c) is subject to reasonable efforts to maintain its secrecy. In a recent decision by the Fourth Appellate District of California, Wanke, Industrial, Commercial, Residential, Inc. v. Superior Court, 2012 WL 4711888 (Cal. App. 4 Dist., Oct. 4, 2012) the court affirmed that under some circumstances, a company’s customer list can qualify as a trade secret.

Material Facts of the Case

Wanke, Industrial, Commercial, Residential, Inc. (Wanke) is a company that installs waterproofing systems in southern California. The defendants, Scott Keck and Jacob Bozarth, are former employees of Wanke. The defendants signed confidentiality agreements with Wanke as a condition of their employment. In early 2008, they left Wanke’s employ and formed their own competing waterproofing company called WP Solutions, Inc. (WP Solutions).

In December 2008, Wanke sued the defendants, alleging that Wanke had spent a significant amount of time, effort, and money in the acquisition, development, compilation, and maintenance of confidential information concerning its customers. This confidential information included the identity of Wanke’s existing and prospective customers, customer objectives, the strategies developed for each customer, the identities of key personnel at those customers, the special needs and characteristics of existing and potential customers, and the histories and account balances of existing customers. Wanke also alleged that the defendants had misused and misappropriated Wanke’s confidential information to improperly target and recruit Wanke’s customers.

In October 2009, the parties resolved the action by entering into a settlement agreement. The settlement agreement included a stipulated injunction to enforce its terms. The injunction prohibited the defendants and their new company, WP Solutions, from contacting or soliciting any person on Wanke’s customer list for the purpose of gaining any of their business.

In May 2010, Wanke filed an application with the trial court requesting that the court hold Keck, Bozarth, and WP Solutions (the defendants) in contempt for having violated the injunction. According to Wanke, the defendants improperly contacted and/or supplied labor and/or materials to Con Am Management Corporation (Con Am Management), a Wanke customer that appeared on Wanke’s customer list as set forth in the injunction.

On August 11, after a hearing, the trial court found that the defendants failed to comply with the injunction. However, the court also concluded that the injunction was invalid to the extent that it prohibited defendants from soliciting Con Am Management because its identity and location could not qualify as Wanke’s trade secrets. The court emphasized that pursuant to California Business and Professions Code section 16600, a former employee may be barred from soliciting the former employer’s customers only if the employee was utilizing trade secret information to solicit those customers, but awarded attorney’s fees to Wanke. Specifically, section 16600 provides as follows: “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.”

In September 2010, Wanke filed another motion to enforce the settlement agreement with regard to another customer on the list. This time the trial court found that the injunction applied to jobs that were undertaken while the defendants worked for Wanke and awarded damages and attorneys’ fees to Wanke. Both sides appealed.

The Court’s Analysis

The appellate court upheld the trial court’s decision, in part, and reversed it, in part, emphasizing that the injunction could apply only to jobs undertaken or proposed to be undertaken for Con Am while defendants Keck and/or Bozarth were employed by Wanke. Only on those jobs could the defendants be said to be using information that they learned while employed at Wanke to identify customers with particular needs or characteristics that would qualify as trade secrets. To that extent, the injunction was overly broad and unenforceable.

The court’s analysis also included an examination of Edwards v. Arthur Andersen LLP, 44 Cal. 4th 937, 948 (2008). In Edwards, the Supreme Court of California considered whether section 16600 rendered invalid sections of a noncompetition agreement that prohibited an employee from soliciting the clients of his former employer for one year after the termination of his employment. (As noted above, section 16600—generally speaking—codifies California’s public policy against restraints on employment.) In holding that the noncompetition agreement was invalid, the Edwards court stated that a no-solicitation provision that precluded the former employee from performing work for Arthur Andersen’s Los Angeles clients unlawfully restricted his ability to practice his accounting profession. Thus, under Edwards, Section 16600 generally prohibits the enforcement of a nonsolicitation of customer agreement unless the customer information qualifies as a trade secret.

How This Case Impacts California Businesses

In determining whether a customer list qualifies as a trade secret, a court will consider factors such as whether the list was compiled with substantial effort and expense, whether the customer identities are public or commonly known, and the sophistication of the customer information, including whether it includes key contacts, special customer requirements, ordering history, billing rates, and payment terms.

Employers must also make reasonable efforts to maintain the secrecy of their customer information by limiting its disclosure, restricting public and employee access to the information, and labeling the information as confidential. An employer’s primary means of protecting customer information is to require employees to sign confidentiality agreements that obligate them to maintain the confidentiality of customer information that is expressly described in the agreement. Employers should also notify departing executives of their ongoing obligations to refrain from any use or disclosure of confidential customer information.

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.

© Ogletree, Deakins, Nash, Smoak & Stewart, P.C. | Attorney Advertising

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