Appellate Court Invalidates Confidential Information Agreement as an Unlawful Non-Compete

Using a confidential information or confidentiality agreement in California? Tread carefully, and consult with qualified counsel. A recent California Court of Appeal held that an overbroad confidentiality agreement functioned as an illegal non-compete agreement.

A Strict Reading of Section 16600

While it is widely understood that California Business and Professions Code section 16600 prohibits most types of non-compete agreements, employers doing business in California also should be aware of the possibility that other forms of restrictive covenants may be invalid if they operate as a de facto non-compete agreement, even if labeled as something else.* This reading of section 16600 is seen in Brown v. TGS Mgmt. Co., LLC, 57 Cal. App. 5th 303 (2020). In that case, the Court of Appeal for the Fourth Appellate District reviewed TGS’s “Confidential Information” provision as applied to a former employee. TGS is a firm engaged in a form of equities trading known as statistical arbitrage, and required its employees to enter into a confidentiality agreement that barred employees—like the plaintiff—“in perpetuity from disclosing or using ‘Confidential Information’ for his own benefit or the benefit of any other party.” Confidential Information was broadly defined to include “information, in whatever form, used or usable in, or originated, developed or acquired for use in, or about or relating to ... trading and/or hedging in securities and financial instruments and derivatives thereon, securities-related research, and trade processing and related administration[.]”

After TGS terminated his employment, the plaintiff filed a complaint alleging California Labor Code violations and unfair competition claims, and seeking declaratory relief under section 16600. The case ultimately was moved to arbitration, where the arbitrator denied the plaintiff’s claims and found in favor of TGS, awarding repayment of a deferred bonus payment made to the plaintiff and attorneys’ fees and costs. A California Superior Court denied the plaintiff’s petition to vacate the arbitrator’s decision, and the matter was appealed.

Relying heavily on section 16600 and the California Supreme Court’s decision in Edwards v. Arthur Anderson, 44 Cal. 4th 937 (2008), the Court of Appeal overturned the lower court’s decision and held in the plaintiff’s favor. The Court found that TGS’s confidentiality provision was “strikingly broad” and effectively claimed “for itself, without limitation, all information that is ‘usable in’ of that ‘relates to’ the securities industry.” The court took particular issue with the fact that the confidentiality provision encompassed not only “statistical arbitrage—the actual business of TGS—but, instead, refer[ed] to all aspects of working in the securities industry at large.” The court held that “these overly restrictive provisions operate as a de facto noncompete provision” because “they plainly bar[red] Brown in perpetuity from doing any work in the securities field, much less in his chosen profession[.]”

At the same time, the court noted that the plaintiff’s claims were “not easy to resolve” because of evidence that the plaintiff had “abused the discovery process by knowingly failing to disclose material and relevant information and documents that would have exposed his theft of TGS documents and data” and also “knowingly testified falsely under oath [at the arbitration hearing] as to the manner in which he obtained [that] information[.]” Given the plaintiff’s unclean hands, the court was reluctant to grant equitable relief in his favor, but ultimately held that the “importance of the public policies at stake in the declaratory relief” required invalidation of the Confidential Information provision.

Take-Aways and Next Steps

Although not binding on other California Courts of Appeal or federal district courts, the Court of Appeal’s decision in Brown offers important guidance for employers seeking to ensure enforceability of their confidentiality agreements. Employers should work with qualified counsel to ensure restrictive covenants are appropriately drafted to protect confidential information—rather than publicly available information or matters of general knowledge—and are not written in a way that prevents an employee from working in his or her chosen field.

*   For further reading on the developing issue, please see: Employers Take Note: A Third California Court Invalidates Employee Non-Solicitation Agreement.