December 07, 2020 Practice Points

Arbitrators, Litigants, and Companies Beware: Overbroad NDA May Violate Statutory Rights

Companies should examine their employee confidentiality agreements to ensure they do not run afoul of any state statute, and litigants in trade secret disputes should note that the scope of the agreements will be fertile ground for challenge.

By Dana Welch

It is the rare occasion indeed when a court overturns an arbitration award. But in a decision that arbitrators, litigators, and companies alike should take careful note of, the California Court of Appeal did exactly that. The court vacated an award on the basis that the arbitrator exceeded his authority by refusing “to decide [Claimant’s] facial challenge to the legality of the confidentiality provisions” which the court, on a de novo review, found violated California’s statutory ban on post-employment covenants not to compete. Richard Hale Brown v. TGS Management Company, LLC, 2020 Cal. App. LEXIS (Cal. Ct. App. Oct. 13, 2020), certified for publication, Nov. 12, 2020. 

Unlike most states, California bans post-employment covenants not to compete. Cal. Bus. & Prof. Code § 16600 prohibits “every contract” that restrains “anyone . . .  from engaging in a lawful profession, trade, or business of any kind . . . .” As a result, California technology companies routinely require that their employees sign non-disclosure agreements, which provide virtually the only means for companies to protect their confidential information and trade secrets. 

Although Brown may be limited to its (bad) facts, its holding serves as a warning to companies that they should carefully evaluate their employee confidentiality agreements to ensure that they will survive a challenge. Arbitrators should take note of Brown as well; trade secret disputes routinely require facial scrutiny of confidentiality agreements. 

Background

Brown worked for TGS, a trading firm specializing in statistical arbitrage. His employment agreement contained a confidentiality provision, which prohibited him from using “Confidential Information,” defined as “information, in whatever form, used or usable in, or originated, developed, or acquired for use in, or about or related to, the Business.” The “Business” was in turn defined extremely broadly.

After TGS terminated his employment, Brown filed a declaratory relief action in court, seeking a declaration that he could compete with TGS without risking a damages claim for breaching the employment agreement or jeopardizing two deferred bonuses. He subsequently filed a petition for arbitration, attaching a draft separation agreement which contained information arguably within the parameters of the employment agreement’s confidentiality provision.

TGS agreed to arbitration and then filed a counterclaim that included a claim for forfeiture of the two deferred bonuses based on Brown’s public filing (in the arbitration petition) of TGS’s confidential information. After a five-day hearing, the arbitrator granted all of TGS’ counterclaims and denied all of Brown’s claims. With respect to the declaratory relief action, the arbitrator ruled that he could not foresee the nature of Brown’s conduct in anticipated employment, further finding that the employment agreement’s definition of confidential information was not unreasonably restrictive.

The trial court confirmed the award. On appeal, the court of appeal reversed the trial court and vacated the award.

The Court’s Opinion

The court concluded that the arbitrator had exceeded his powers “by issuing an award that violates a party’s unwaivable statutory rights or that contravenes an explicit legislative public policy.” In so doing, it cited to the California Supreme Court’s decision in Moncharsh v. Heily & Blasé, 3 Cal.4th 1 (1992), which established that basis for vacatur.

First, the Brown court found that the arbitrator erred by not considering the facial challenge to the confidentiality provisions, rejecting the arbitrator’s finding that he could not consider Brown’s anticipated employment. Second, the Brown court conducted a de novo review of the employment agreement’s confidentiality provisions, finding the definition of “Confidential Information” “strikingly broad” and thus violative of Cal. Bus. & Prof. Code § 16600. 

Implications

The Federal Arbitration Act does not include as one of its grounds for vacatur that an award is violative of public policy or statutory rights. California has added that judicial gloss. Arbitrators practicing in California, and in any other state that has adopted this ground for vacatur, must take care that their awards do not violate that state’s public policy or an unwaivable statutory right.   

Companies should examine their employee confidentiality provisions to ensure that they do not run afoul of any state statute, especially statutes, like section 16600, that prohibit post-employment covenants not to compete.  

And litigants in trade secret disputes should take note that the scope of employee confidentiality agreements will be fertile ground for challenge.

Dana Welch is an experienced arbitrator at Welch ADR in San Francisco, California.


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