California Court of Appeal Extends the Reach of Section 16600 to Upset Arbitration Award Because of Alleged Overly Broad Confidentiality Provisions

In an expansive recent ruling, the California Court of Appeal in Brown v. TGS Management Co., LLC reversed a judgment confirming an arbitration award, examining the arbitrator’s findings, and ultimately invalidating confidentiality provisions in an employment agreement under Business and Professions Code section 16600 on the grounds that they operated as a “de facto non-compete provision” and were “void ab initio and unenforceable.” The court’s decision, upholding the state’s long-standing policy in favor of employee mobility, offered a harsh word of caution for employers that use overly broad confidentiality provisions and other restrictive covenants with their California employees.

Brown’s original action

Upon joining TGS in 2005, and as a condition of his employment with TGS, Brown entered into a confidentiality, non-competition, assignment, and notice agreement. The “confidentiality” provisions of the employment agreement barred Brown in perpetuity from disclosing or using “confidential information” for his own benefit or the benefit of any party other than TGS or a TGS client. The employment agreement contained, in addition to a number of restrictive covenants, an arbitration clause requiring that all disputes arising under or out of the agreement be resolved in “binding dispute resolution.” In 2015, Brown executed a “2014 bonus agreement” rewarding his performance for the previous year. The bonus agreement contained forfeiture provisions referencing the obligations set forth in the employment agreement, as well as a similar arbitration clause.

Brown was terminated without cause in 2016. The parties were unable to agree on the terms of a separation agreement, but the termination was listed as “without cause” to allow Brown to receive two bonus payments he had earned but not yet received. Months later, Brown filed a complaint against TGS, asserting claims for declaratory relief, injunctive relief, and reformation of the arbitrator-selection process in the employment agreement. More specifically, Brown sought a declaration that he could compete with TGS without risking a claim for breach of the employment agreement or jeopardizing his two deferred bonuses, and an injunction against enforcement of the non-competition provisions. Brown subsequently filed a petition to compel arbitration, with the draft separation agreement attached as an exhibit.

The arbitration

TGS consented to arbitration, and the trial court referred the matter to JAMS. Brown later filed a Demand in Arbitration, adding allegations of wrongful termination, whistleblowing, and regulatory compliance violations. TGS answered and asserted counterclaims against Brown for breach of contract and declaratory relief, seeking, among other things, to recover the deferred bonus it had already paid, and to be relieved of its obligation to pay the remaining bonus. According to TGS, Brown had forfeited both bonuses by violating the confidentiality provisions of his employment agreement when he filed a copy of the draft separation agreement the parties were negotiating. The draft separation agreement purportedly disclosed the identities of TGS clients and the “formula” TGS used to calculate employee bonuses.

The arbitrator granted in part TGS’s motion for summary disposition, leaving only the claims for declaratory relief, payment of the second deferred bonus, violations of Business and Professions Code section 17200, and violation of Labor Code section 1102.5(a). The arbitrator later ruled in favor of TGS on all of Brown’s claims and TGS’s counterclaims. Notably, the arbitrator found that (1) Brown had breached the confidentiality provisions of his employment agreement, causing the forfeiture of both deferred bonuses which, at the time of the breach, were vested but unpaid; (2) Brown was not entitled to a declaration invalidating the non-competition and confidentiality provisions of his employment agreement under Business and Professions Code section 16600, and was ineligible for equitable relief more generally due to his theft of TGS’s confidential information; (3) the UCL claim was “derivative” of the failed declaratory relief claim; and (4) Brown had not established the underlying facts necessary to sustain a claim under Labor Code section 1102.5(a). Finally, the arbitrator found several instances of bad faith conduct by Brown and ordered him to pay TGS $2,462,721 for its attorneys’ fees, plus $172,682 in costs, a refund of the deferred bonus he had received, and interest on the bonus and the award overall.

Both parties petitioned for review of the award by the trial court. The trial court denied Brown’s petition to vacate the award and granted TGS’s petition to confirm it. The trial court rejected Brown’s argument that the arbitrator had exceeded his power by issuing an award in violation of public policy.

The appeal

On appeal, Brown contended that the Court of Appeal must reverse the judgment because the trial court’s confirmation of the arbitration award conflicted with Brown’s right under section 16600 to pursue lawful employment. Reviewing de novo the trial court’s denial of the petition to vacate, the Court of Appeal ultimately found that the arbitrator had exceeded his power “by issuing an award that violates a party’s unwaivable statutory rights or that contravenes an explicit legislative expression of public policy” and reached the merits of the decision supporting the award. A key contention of Brown’s appeal argued that the employment agreement defines “confidential information” so broadly as to prevent him from ever working again in securities trading, much less in his chosen specialty of statistical arbitrage.

The Court first agreed with Brown’s contention that the trial court’s confirmation of the arbitration award conflicted with his “right to work in his chosen profession” under Section 16600. See Dowell v. Biosense Webster, Inc., 179 Cal. App. 4th 564, 575 (2009) (“The interests of the employee in his own mobility and betterment are deemed paramount to the competitive business interests of the employers . . .”); Edwards v. Arthur Andersen LLP, 44 Cal. 4th 937, 946 (2008) (California courts “have consistently affirmed that section 16600 evinces a settled legislative policy in favor of open competition and employee mobility.”).

Primed to enforce California’s notorious Section 16600, even against the findings of an arbitrator after a 5-day trial and extensive discovery, the Court went on to conduct an analysis of the confidentiality provisions in Brown’s employment agreement. The Court concluded that the definition of “confidential information” was “strikingly broad,” such that enforcing the provisions could prevent Brown from trading in securities at all (not just statistical arbitrage) for the remainder of his life.

The arbitrator declined to reach a determination on the issues of the legality of the covenants. The Court of Appeal found that a court or arbitrator must decide the merits of a facial challenge to contracts allegedly containing provisions that violate section 16600. Consequently, the arbitrator erred here in concluding he “cannot make a finding” on the legality of the confidentiality provisions because the arbitrator is unable to “foresee the nature of [Brown’s] conduct in the context of his anticipated future employment[.]” The Court addressed Brown’s facial challenge to the confidentiality provisions, holding that the “overly restrictive” provisions “operate as a de facto non-compete provision” and were “void ab initio and unenforceable.” See Dowell, 179 Cal. App. 4th at 564 (a facial challenge is a sufficient basis for determining whether a clause or provision violates Section 16600); Ritchey, 60 Cal. 4th at 917-18 (an arbitrator’s legal error is reviewable if the error prevented the plaintiff from getting a hearing on the merits of his claim for violation of unwaivable statutory rights). The Court also referred to AMN Healthcare, Inc. v. Aya Healthcare Services, Inc., 28 Cal App. 5th 923, 940, 948 (2018), another case in which confidential information was defined in a way that interfered with an employee’s right to compete, rendering provisions of an employment agreement invalid under Section 16600.

The Court found that the confidentiality provisions in the employment agreement on their face patently violated section 16600. The Court reasoned that these “overly restrictive provisions” plainly bar Brown “in perpetuity from doing any work in the securities field, much less in his chosen profession of statistical arbitrage.” Despite the facial invalidity of these provisions, the Court found that the arbitrator did not declare them void and unenforceable and instead the arbitration award allowed the provisions to stand as a perpetual restriction on Brown’s right to compete with TGS. The Court concluded that because “the arbitration award is inconsistent with the protection of Brown’s rights under section 16600, the award exceeded the arbitrator’s powers” and consequently, the trial court erred in denying the petition to vacate the arbitration award and in entering judgment on the award.

By extension, the arbitrator’s finding of forfeiture of bonuses was also subject to reversal. The arbitrator had explicitly tied Brown’s forfeiture of the deferred bonuses to his breach of the unenforceable confidentiality provisions, thereby enforcing “illegal anticompetitive provisions” in Brown’s employment agreement. On remand, the Court found that TGS can attempt to prove Brown forfeited the deferred bonuses by committing “a fraudulent, illegal or deliberately deceptive act in connection with [his] employment” as set forth in the bonus agreement. The Court noted that Brown, for his part, may assert, as he does on appeal, forfeiture based on the conduct in question would constitute the improper enforcement of an invalid liquidated damages provision.

Takeaways

The Brown decision is yet another illustration of California courts’ willingness to scrutinize employment agreements through the lens of Section 16600. In light of ever-increasing hostility to perceived restraints on trade, businesses should revisit the scope of their employment agreements and, more specifically, confidentiality, solicitation and invention assignment provisions and any forfeitures based on breaches of such provisions, to ensure they do not run afoul of similar challenges under Section 16600. In particular, businesses should carefully consider the level of inclusiveness when defining “confidential information,” and avoid provisions barring employees from using or disclosing such information “in perpetuity.”

 

                        author

Robert Milligan

Robert represents clients in state and federal courts in complex commercial litigation and employment litigation.   Robert's practice encompasses a wide variety of commercial litigation and employment matters, including general business and contract disputes, unfair competition, trade secret misappropriation, and other intellectual property theft, franchise litigation, real estate litigation, insurance… MORE >

                        author

Sierra Chinn-Liu

Sierra advises clients on their complex commercial disputes, helps them protect their assets, and supports their business goals.   Businesses facing disputes regarding their trade secrets and restrictive covenants turn to Sierra to protect their valuable assets. She assists clients in complex commercial disputes regarding contract, business tort, unfair competition,… MORE >

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