Section 16600 and the Fate of Trade Secret Exception

03.18.2024

Following the Legislature’s 2024 amendments to Section 16600, a new spotlight has been shown down on the so-called Trade Secret Exception and the rift that has emerged over the past few years between California courts about its continued application. Ultimately, the California Supreme Court will likely be called upon in the near future to address whether—and to what extent—an employer may include restrictive covenants in an employment agreement as necessary to protect the employer’s trade secrets. Until it does, litigants may credibly argue that the legislature’s recent amendments to Section 16600 abrogated the exception, diminished the exception, or had no effect on it at all.

The California Supreme Court specifically declined to address the Trade Secret Exception in Edwards, but following the Legislature’s further amendments this year, in part to codify Edwards, the question regarding the fate of the judicially created Trade Secret Exception is likely to return to the Court soon. This is significant because if such provisions are found void under California Business and Professions Code Section 16600 (“Section 16600”), employers relying on the Trade Secret Exception may unwittingly expose themselves to liability.

On January 1, 2024, California enacted California Business and Professions Code Section 16600.5 (“Section 16600.5”).[1] Under Section 16600.5, “[a]n employee, former employee, or prospective employee may bring a private action to enforce this chapter for injunctive relief or the recovery of actual damages, or both.” This means an employer may be held liable for simply including a void provision in its employment agreement, even if the employer never attempts to enforce the agreement. Critically, the Legislature also amended Section 16600 to state 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 . . . . no matter how narrowly tailored, that does not satisfy an exception in this chapter.” Because the trade secret exception is judicially created—and therefore not one of the statutory exceptions in the “chapter”[2]—a plain reading of the recent amendment to Section 16600 suggests that employers may not use nonsolicitation or noncompete language in their employment agreements, even when narrowly tailored to protect trade secrets. On the other hand, the Legislature emphasized that the recent amendment was intended to bring Section 16600 “in[to] accordance with Edwards,” which expressly declines to address the Trade Secret Exception. Its therefore plausible that the Legislature did not intend to disturb the exception at all.

If the courts ultimately rule that the Trade Secret Exception to Section 16600 did not survive the Legislature’s recent amendment to the statute, it is important to note that this interpretation does not mean employers have no recourse for trade secret misappropriation. To the contrary, federal and state trade secret law would still provide independent bases to protect and prohibit current and former employees from using or disclosing company trade secrets. But the protection and enforcement mechanism for employers would be confidentiality agreements narrowly tailored to the protection of trade secrets restricting use or disclosure of bona fide trade secrets (rather than more general restrictive covenants purportedly tied to trade secrets) and lawsuits for misappropriation under the California Uniform Trade Secrets Act (“CUTSA”) and/or the federal Defend Trade Secrets Act (“DTSA”). This interpretation would, however, preclude employers from simultaneously seeking damages based on breach of contract for violation of a nonsolicitation or noncompete clause based on the misuse of the employer’s trade secrets and limit the relief to breach of a confidentiality clause with respect to trade secrets only. The practical import of this being that the employer would likely need to prove the underlying protectability of its trade secrets as bona fide trade secrets and evidence of misappropriation to prevail.

It should also be noted that California courts have made clear that the Trade Secret Exception only applies to trade secrets. California courts generally prohibit employers from restricting former employees from using non-trade secret confidential information post-employment, unless the employer can prove some other property right in the information by some positive operation of law, such as copyright or other recognized intellectual property rights. In other words, a confidentiality provision may only restrict a former employee’s use of information if the employer can prove such information meets the strict statutory definition of a “trade secret.” CUTSA defines “trade secrets” as comprising information that (1) “[d]erives independent economic value, actual or potential, from not being generally known to the public or to other persons who can obtain economic value from its disclosure or use;” and (2) “[i]s the subject of efforts that are reasonable under the circumstances to maintain its secrecy.”[3] The federal DTSA defines trade secrets similarly. Employers have wider latitude to restrict and prohibit current employees from the unauthorized use or disclosure of confidential information that may not meet the statutory definition of trade secrets because of the duty of loyalty and other statutory or common law duties current employees may owe to their employers with respect to such confidential and proprietary information.

History of the Trade Secret Exception – Inception through Edwards v. Arthur Andersen

The history of the Trade Secret Exception further demonstrates its fragility in view of the Legislature’s recent amendment to Section 16600. The Trade Secret Exception was conceived as early as 1939, when the California Court of Appeals suggested that—although not applicable to the case at hand—an exception to Section 16600 might be necessary to enjoin persons who gained knowledge of trade secrets while in a position of confidence from “divulging them to third persons or from taking advantage of them himself to the injury of the owner.”[4] A subsequent case that considered the validity of alleged restraints of trade under Section 16600 similarly recognized the need for a Trade Secret Exception, but did not apply one. [5]

The first two cases to apply a Trade Secret Exception to Section 16600 justified the decision using the same reasoning applied in the now-defunct “narrow restraint” doctrine. Under the narrow restraint doctrine, a narrowly tailored covenant that does not have the effect of “restrain[ing] [the former employee] from engaging in a lawful profession, trade or business within the meaning of section 16600” may be enforced without violating Section 16600.[6] Courts apply a rule of reasonableness in evaluating whether a competitive restraint is sufficiently narrow or unduly broad, i.e. a restraints that prevent a former employee from engaging in their chosen business, trade, or profession. Subsequent cases applying the Trade Secret Exception inherently relied on these cases and/or the “narrow restraint” principle articulated therein.[7] In 1965, the Supreme Court of California—relying on the same principle and citing many of the cases noted above—articulated the Trade Secret Exception as it currently exists: “[t]his section invalidates provisions in employment contracts prohibiting an employee from working for a competitor after completion of his employment or imposing a penalty if he does so, unless they are necessary to protect the employer's trade secrets.”[8]

Contemporary case law applying the Trade Secret Exception can be traced back to Muggill. The exception is therefore deeply rooted in the “narrow restraint” doctrine, which was squarely rejected by the California Supreme Court’s 2008 Edwards v. Arthur Anderson opinion. In Edwards, however, the Supreme Court was careful not to “address the applicability of the so-called Trade Secret Exception,” even though it explicitly rejected the “‘narrow-restraint’ exception to section 16600,” and the notion that “section 16600 ‘only makes illegal those restraints which preclude one from engaging in a lawful profession, trade, or business.’” Puzzlingly, the Court struck down the rationale underlying the Trade Secret Exception while specifically declining to address the exception itself. This hesitation may suggest that the Court recognized some worthy rationale underlying Trade Secret Exception—separate from the “narrow restraint” rationale—that justified sparing it. It may, alternatively, reflect the Court’s apprehension at overturning any long-held precedent unless absolutely necessary to resolution of the case at hand.

Post-Edwards Cases Applying the Trade Secret Exception

Since Edwards, California Courts have understandably struggled to articulate how the Trade Secret Exception can remain intact if the rationale that justified its creation has been squarely rejected by the Supreme Court. Predictably, these courts have become emboldened to chip away at the Trade Secret Exception. For example, in 2009, the Court of Appeals for the Second District of California expressed “doubt [at] the continued viability of the common law Trade Secret Exception to covenants not to compete” in light of Edwards. Although the court ultimately found that it was unnecessary to address the Trade Secret Exception head-on because it did not apply to the overbroad covenant at issue in the case, the court’s opinion echoed Plaintiff’s concerns about continuing to rely on Muggill as justification for a Trade Secret Exception to Section 16600:

Plaintiffs argue that the Trade Secret Exception rests on shaky ground in the first place. They point out that many of the cases recognizing a Trade Secret Exception cite to Muggill and that the language in Muggill regarding a trade secret was dicta, as no trade secrets were at issue in that case. Plaintiffs also point out that Muggill, in turn, relied on Gordon v. Landau (1958) 49 Cal.2d 690, 321 P.2d 456, a “trade route” case in which the employee was a door-to-door salesman, whose employment agreement prevented him from divulging the names of his prior customers or soliciting their business for one year following termination of employment. The Gordon court concluded that the agreement was valid under section 16600 because it did not restrain the employee from engaging in his profession. (Gordon v. Landau, supra, at p. 694, 321 P.2d 456.)

Similarly, in the 2009 case, Galante, the Court of Appeals for the Fourth District of California held that to the extent the Trade Secret Exception does exist, it offers no protection in addition to enjoining misuse of trade secrets. The Court found that the trial court had erred by enjoining Defendant from soliciting Plaintiff’s customers in addition to using Plaintiff’s trade secrets because the nonsolicitation injunction “add[ed] nothing to further the legitimate scope of protections (e.g. protection of [plaintiff’s] trade secrets) to which [plaintiff] is entitled, and [could] only operate to preclude the precise type of competition Edwards declares is otherwise permissible.” The Court further explained that “Edwards did not approve the enforcement of noncompetition clauses whenever the employer showed the employee had access to information purporting to be trade secrets.” Numerous other more recent cases have also cast doubt on the continued viability of the Trade Secret Exception without explicitly striking it down.

To be sure, there are other cases that still support the notion that the Trade Secret Exception is alive and well, even after Edwards. However, a critical observer might argue that the restrictive covenants upheld are so narrow that they are more so reminders of employees’ ongoing duty not to misappropriate trade secrets than they are “nonsolicitation” and “noncompete” provisions. For example, in Wanke, the Court of Appeals for the Fourth District of California held that Section 16600 did not prohibit an employer from enforcing a court-approved stipulated injunction against a former employee that, for a term of five years, prevented the former employee from soliciting customers listed on Plaintiff’s trade secret protected customer list. However, because the nonsolicitation provision applied only to customers whose identity—because of the unique circumstances surrounding that case—were admittedly the employer’s trade secrets, Wanke is consistent with Galante in holding that employers may use nonsolicitation provisions to preclude misappropriation of trade secrets, but nothing more.

To the extent the Trade Secret Exception remains, any such restriction must be “narrowly tailored or carefully limited to the protection of trade secrets” and “[not] so broadly worded as to restrain competition.” Practically speaking, this means former employees can be prohibited from using trade secret information to gain an illicit or unfair advantage through the use of that trade secret information or otherwise unfairly compete with their former employer. Former employees cannot, however, be subjected to a broad nonsolicitation provision simply because they had some exposure to the company’s confidential and trade secret information. Consequently, aside from providing an additional cause of action for breach of contract, it is unclear whether the Trade Secret Exception is actually an exception that allows employers to include restrictive covenants in their employee agreements that would otherwise be deemed void by Section 16600. Rather, the exception appears to be an acknowledgement that trade secret misappropriation constitutes an independent wrong that may, at times, causes friction with Section 16600. To the extent that it does, California Courts have made clear that Section 16600 does not divest trade secret owners of the protections afforded by Federal and State law.

Impact of New Laws

Given the uncertainty of the Trade Secret Exception, and its limited value to employers even if it does exist, California’s new Section 16600.5 may tip the scales in favor of omitting any mention of nonsolicitation and noncompetes, even if they are “necessary to protect trade secrets.” Indeed, if and when a court determines that the Trade Secret Exception does not save an otherwise void nonsolicitation or noncompete provision, the company attempting to enforce it will almost certainly face liability under Section 16600.5.

If you have questions or are wondering whether the restrictive covenants in your employment agreements comply with the requirements of Section 16600 as amended, please contact the authors of this Alert or your usual AALRR attorney and trusted advisor. If you find yourself or your company in a dispute related to these new laws, our Intellectual Property Team is uniquely positioned to advocate on your behalf. California’s strong policies in favor of employee mobility have significantly diminished the recourse employers can obtain against former employees. Despite these changes, intellectual property remains a steadfast tool for keeping your company’s valuable assets and goodwill intact during times of high employee turnover. AALRR’s Intellectual Property Team consists of experts in trade secret, patent, copyright, trademark, and trade dress law supported by a robust employment law group that has served all types of companies and organizations in myriad industries in California for decades.

[1] Read the authors’ previous article explaining California’s January 1, 2024, updates to Section 16600 (https://www.aalrr.com/newsroom-alerts-4013).

[2] The Chapter refers to Chapter 1 of Part 2, Division 7, of the Business and Professions Code. The statutory exceptions included in Chapter 1 referenced in Section 16600 include Sections 16601, 16602, and 16602.5 of the California Business and Professions Code (summarized here with some nuance omitted for clarity). See Section 16601 (any person who sells the goodwill of a business, including all or substantially of its operating asserts, may agree with the buyer to refrain from carrying on a similar business within a specified geographic area for so long as the buyer carries on a like business therein); Section 16602 (partners may, in anticipation of dissolution of the partnership or dissolution of a partner from the partnership, agree that the departing partner(s) will not carry on a similar business within a specified geographic area for so long as the partnership carries on a like business therein); and Section 16602.5 (Any member, in anticipation of dissolution of, or the termination of their interest in, a limited liability company, may agree that they will not carry on a similar business within a specified geographic area where the limited liability company has been transacted so long as any other member of the limited liability company carries on a like business therein).

[3] Ca. Civ. Code § 3426.1.

[4] Hunter v. Superior Ct. of Riverside Cnty., 36 Cal. App. 2d 100, 111–112 (1939).

[5] Morris v. Harris, 127 Cal. App. 2d 476, 478, 274 P.2d 22, 23 (1954) (“Equity recognizes a fiduciary duty of an employee after leaving employer's service not to take an unfair advantage of trade secrets and customers' lists. It seems reasonable that to the extent of this rule the parties may implement it by contract. But the rule does not cover the services of a janitor who after leaving the employer's service accepts employment from the employer's customers without solicitation on his part.”).

[6] Gordon v. Wasserman, 153 Cal. App. 2d 328, 330, 314 P.2d 759, 761 (1957) (enjoining former employee’s use of confidential list of plaintiffs’ customers for one year after termination did not run afoul of Section 16600 because the restraint did not prevent former employee “from conducting the same or any other business for himself and hence was not void as having an unlawful object.”); Gordon v. Landau, 49 Cal. 2d 690, 694–95 (1958) (employment contract that prohibited salesman from soliciting certain customers for one year after termination, was valid and enforceable because it did not restrain salesman from engaging in a lawful profession, trade or business; he could still carry on a weekly credit business or any other business so long as he did not use employers' confidential lists to solicit customers).

[7] See, e.g., Ingrassia v. Bailey, 172 Cal. App. 2d 117, 124 (1959) (citing Gordon v. Wasserman and Gordon v. Landau in finding that “contract [which] merely provided that defendant would not solicit those customers made known to him in confidence” did not violate Section 16600); State Farm Mut. Auto. Ins. Co. v. Dempster, 174 Cal. App. 2d 418, 426–427 (1959) (citing Morris v. Harris, Gordon v. Wasserman, Gordon v. Landau, and Ingrassia v. Bailey in upholding portion of contract that could be construed as limiting nonsolicitation provision to instances where former employee improperly used trade secrets to solicit).

[8] Muggill v. Reuben H. Donnelley Corp., 62 Cal. 2d 239, 242, 398 P.2d 147, 149 (1965) (emphasis added) (citing Morris v. Harris and Gordon v. Landau).