Customer Non-Solicitation Provisions Are Unenforceable Unless No More Restrictive Than Necessary to Protect Legitimate Trade Secrets


The California Court of Appeal's published opinion in Thompson v. Impaxx, Inc., 113 Cal.App.4th 1425, 7 Cal.Rptr.3d 427 (2003), is important because it concludes that customer non-solicitation provisions are enforceable only to the extent necessary to protect an employer's legitimate trade secrets. The plaintiff in Thompson sued his former employer for wrongful termination after the employer terminated the plaintiff's employment for refusing to sign an agreement containing a customer non-solicitation provision. The employee in Thompson sought to build upon the decision in D'Sa v. Playhut, Inc., 85 Cal.App.4th 927, 102 Cal. Rptr.2d 495 (2000), in which a former employee refused to sign a covenant not to compete and sued his former employer for wrongful termination. The former employee prevailed because the covenant not to compete was not limited to the protection of the employer's property, trade secrets, or other proprietary information and was therefore unenforceable under section 16600 of the California Business and Professions Code.

Unlike D'Sa, Thompson involved a customer non-solicitation provision restricting the employee for one year from "calling on, soliciting, or taking away" any of the employer's customers or potential customers with whom plaintiff had had contact during his employment. The employer prevailed in the trial court, which found that the covenant was narrowly drawn and restricted to protecting the employer's "legitimate proprietary interest in customer information."

The appellate court in Thompson agreed that the customer non-solicitation provision was narrowly drafted and did not unreasonably impair the employee's ability to seek future employment. It permitted the employee to continue his profession or trade, to work for an employer's former customer or competitor, to accept business from his employer's former customers or competitors if they solicited him, and to do business with his former employer's customers as long as he had not had contact with them while he was an employee. Nonetheless, the court found that the customer non-solicitation clause was unenforceable because it violated section 16600's general prohibition on restraints of trade in the employment context. The reason: it was not restricted solely to protection of the employer's legitimate trade secrets, and the parties in Thompson had agreed that the identities of the employer's customers and potential customers were not trade secrets. Reversing the lower court's decision, the court in Thompson effectively opened the door to expanding the holding in D'Sa to encompass employee non-solicitation provisions in addition to restrictive covenants.

Recommendation to Employers.

In light of Thompson, we recommend that employers not require employees to sign customer non-solicitation provisions unless the identities of actual or potential customers actually rise to the level of being protected as a trade secret under the Uniform Trade Secrets Act (Civil Code sections 3426.1-11), or if the particular employee has access to trade secret information (i.e., cost and pricing information) which could be used to solicit business away from the employer. The corollary is that employers who cannot legitimately claim that the identities of their actual or prospective customers are trade secrets, or who cannot legitimately assert that their employees will have access to other trade secret information, should not require that employees sign such provisions.

Thompson leaves unanswered the question whether information that is used to solicit customers and which is not a trade secret under the Uniform Trade Secrets Act may still be entitled to protection as "confidential information" under a non-disclosure agreement.

Risks to Employers In Light of Thompson v. Impaxx.

If, in fact, courts will enforce non-solicitation provisions only to the extent necessary to protect rights already protected under the Uniform Trade Secrets Act, is it worth the risk of wrongful termination lawsuits to include customer non-solicitation provisions in employee contracts? Employers should consider their appetite for risk on a case-by-case basis. When employees solicit business away from their former employer, they commonly use knowledge of their former employer's customers and/or knowledge of their former employer's pricing. A meaningful assessment of the risk involved in requiring employees to sign customer non-solicitation provisions should be made with reference to these factual scenarios and the level of protection that the Uniform Trade Secrets Act is likely to provide in each scenario.

Customer Lists or Customer Identities as Trade Secrets.

The Uniform Trade Secrets Act can protect the identities of certain customers if the identities are not readily ascertainable and the employer has taken reasonable technical and legal measures to protect that information. Whether the Uniform Trade Secrets Act will protect the identities of customers turns on the nature of an employer's business and is different in each situation. As a general rule, if an employer provides a particularized type of goods or services and has invested time and effort to cultivate its customer base, then the identity of those actual or potential customers is more likely to be protected. If the identities of customers can legitimately be considered a trade secret, employers should consider amending any customer non-solicitation provisions to include language expressing their intent to enforce such a provision only to the extent necessary to protect trade secrets.

California's courts are also more likely to enforce confidentiality agreements that prohibit the use or disclosure of information such as customer lists, customer identities, or customer profiles. In cases in which an employee has signed an employment agreement containing a confidentiality clause applicable to customer information, California's courts have commonly relied on the Uniform Trade Secrets Act to prohibit former employees from soliciting customers even when the former employee did not sign a non-solicitation agreement. See Morlife, Inc. v. Perry, 56 Cal.App.4th 1514, 1526, 66 Cal. Rptr.2d 731, 738-739 (1977); Merrill Lynch, Pierce, Fenner & Smith, Inc v. Garcia, 127 F. Supp.2d 1305, 1307 (2000). In light of Thompson, we suggest that employers are better served by increasing the protections of their confidentiality agreements to specify that the use or disclosure of customer information, identities, preferences and contacts shall be prohibited rather than relying on customer non-solicitation provisions.

Pricing Information as a Protected Trade Secret.

Likewise, the Uniform Trade Secrets Act can protect certain pricing information and preclude its use to solicit business away from the former employer. Courts have consistently held that such pricing information can qualify for protection under the Uniform Trade Secrets Act. Courtesy Temporary Service, Inc. v. Camacho, 222 Cal.App.3d 1278, 1288, 272 Cal. Rptr. 352, 358 (1990) [billing and markup rates "irrefutably" of commercial value]; SI Handling Systems, Inc v. Heisley, 753 F.2d 1244, 1260 (3rd Cir. 1985) [cost and pricing information are a trade secret]; Lumex, Inc. v. Highsmith, 919 F.Supp. 624, 628-630 (E.D.N.Y. 1996) [pricing, costs, and profit margins treated as trade secrets]. If the employee will have access to cost or pricing information, and that type information is not generally known to a company's competitors, then it may be appropriate to present an employee with a non-solicitation provision to address those issues. Nonetheless, the employer would still be well-served by a confidentiality agreement expressly applicable to pricing information.

Conclusion

Thompson is not a decision by the California Supreme Court and its reach is therefore limited. Nevertheless, it is an important case because it permits wrongful termination claims based on the signing of an unenforceable non-solicitation agreement, and because it limits enforceable non-solicitation agreements to those which protect the employer's trade secrets. In doing so, it suggests that non-solicitation agreements may be of little practical use and that employers may be better served by strong, well-drafted confidentiality agreements.