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Overbroad Confidentiality Agreement Found to Illegally Restrict an Employee’s Right to Work

By Katherine S. Bowles, Esq. and Keith Collins, law clerk of Shustak Reynolds & Partners, P.C. posted on Monday, December 28, 2020.

California courts routinely refuse to enforce employment agreements that have non-compete provisions, and more frequently are rejecting certain non-solicitation provisions, based on California’s strong public policy favoring an employee’s right to work that is enumerated in California Business and Professions Code § 16600. However, courts have been cautious about expanding this right-to-work policy beyond explicit agreements that restrict an employee’s right to work after leaving the company.

In response, employers have expanded their use of broad “confidentiality agreements” to restrict their employees’ future employment opportunities without explicitly including a non-compete provision. These agreements implicitly function as noncompete agreements and prevent employees from seeking employment in their chosen field without fear of litigation. These broad confidentially agreements generally say an employee cannot use any of the company’s “confidential material” after they leave. The definition of “confidential” usually covers, in effect, anything the employee receives or learns during their employment. Many times, employers selectively enforce these provisions and only pursue enforcement after high-valued employees leave to work for a competitor.

Although a 2009 California Court of Appeal case recognized employers can only restrain an employee’s right to compete with them to the extent the former employee is infringing on the employer’s trade secrets, courts have shied away from broadly apply this rationale to other portions of employment agreements outside of explicit non-competes or non-solicitation provisions. The Retirement Group v. Galante, 176 Cal. App. 4th 1226, 1241 (2009).

A recent California Court of Appeal decision took up the issue of an overbroad confidentiality agreement in Brown v. TGS Management Company, LLC, 57 Cal. App. 5th 303 (Oct. 13, 2020). In this case, Richard Brown worked for TGS Management Company, LLC, for 10 years. TGS specialized in statistical arbitrage, which is a highly computerized form of equities trading. During his employment, Brown signed a confidentiality agreement that, in part, prohibited him from disclosing or using any of TGS’s “confidential information” for his own benefit or for the benefit of any party other than TGS, both during his employment with TGS and after he left the company. Brown also signed similar agreements tied to his annual TGS bonus compensation, which required him to repay or forfeit the bonus if he was found in the future to be in breach of any portion of the agreement, including the confidentiality provision.

TGS ultimately terminated Brown and the parties ended up in arbitration regarding whether the bonus agreement forfeiture provisions were enforceable. The arbitrator upheld the agreement and ordered Brown to repay over $650,000 in bonus money that he previously received and held Brown had forfeited his right to an additional $300,000 in deferred bonus compensation. The arbitrator also awarded TGS approximately $2.5 million in attorneys’ fees. Brown sought to have the arbitration award vacated, and he appealed after the award was confirmed by the trial court.

Brown sought to vacate the award on multiple grounds, including that the arbitrator exceeded his powers by enforcing an agreement that violated Brown’s right to be free from anticompetitive contracts. The Court of Appeal ultimately agreed with Brown, finding the arbitrator exceeded his powers by issuing an award that violated Brown’s unwaivable statutory rights granted to him by Business and Professions Code § 16600. The court held that the broad confidentiality provisions covered essentially all information that is used in, or relates to, the security industry, and the only exceptions were publicly known information or information known to Brown before he started working at TGS. Basically, Brown would be prohibited from using any information he learned while working at TGS in the future, unless that information had become public knowledge.

The court held this broad confidentiality provision acted as a de facto noncompete agreement, because it essentially barred Brown in perpetuity from working in the securities industry, much less from working in his chosen field of statistical arbitrage. The court overturned the order confirming the arbitration award and sent the case back to the trial court for review. In response to arguments by TGS that the court’s ruling would strip companies of their ability to protect confidential information and trade secrets, the court said “properly drawn” confidentiality agreements that preserve an employee’s right to compete with their former employer could be enforced, and that the ruling did not prevent companies from pursuing trade secret claims.

The Brown decision underscores the importance of a properly drafted and narrowly tailored agreement that preserves an employee’s right to compete within the protections of California law. It is yet to be seen how this opinion will be applied to other similar confidentiality provisions, that although may not be as egregious as the TGS agreement, also have the effect of stifling an employee’s right to compete without fear of litigation. It is unlikely, however, that companies will affirmatively remove or modify these provisions until there is more case law striking down overbroad confidentiality agreements.

If you have questions about confidentiality agreements, transitioning jobs, or your right to work, contact Shustak Reynolds today for a confidential and complimentary consultation.

Shustak Reynolds & Partners, P.C. focuses its practice on securities and financial services law and complex business disputes. 
We represent many broker-dealers, registered representatives, investment advisors, investors and businesses. 
Attorney Katherine Bowles can be reached in the firm’s San Diego office at (619) 696-9500. 

 

 

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