• Corrales v. Corrales, 198 Cal.App.4th 221 (August 10, 2011)

Just as employees owe a duty of loyalty to their current employers, partners owe a duty of loyalty to one another. When one partner opens a secret “side business” (that does the same thing as the partnership) that partner breaches the duty of loyalty.  When that happens the breaching partner’s competing business may be valued as an asset of the partnership. Bad news for the guy with the secret business.

Rudy and Richard Corrales formed RC Electronics in 1989.  Rudy ran the business and Richard supplied financing and business know how.  Richard already had a thriving business occupying him full time.  He became involved in RCE because Rudy could not obtain enough financing on his own to start a business. The business was successful for several years. In 2004, however, Richard discovered that Rudy, his wife and their two daughters had formed a competing business, PK Electronics, to perform the same services performed by RCE but without Richard.  When Richard inquired about PKE, Rudy refused to tell him anything and cut off all communications with him.

The trial court held that partnerships must consist of at least two persons and that the partnership was dissolved upon Richard’s withdrawal.  But the trial court declined to award damages resulting from the plaintiff partner’s concealment of a competing business.  The appellate court reversed and found that any funds improperly obtained by the competing business entities were to be included in the assets of the partnership for winding up purposes.

Takeaway:  Although mired in the technicalities of partnership law, this case is at bottom a breach of loyalty case.  It is not at all unlike cases against executive officers, managing employees and the like who violate the duty of loyalty to their current employers by conducting business contrary to the current employer’s interest prior to the termination of their employment.  It is a useful set of facts to keep in mind.  The conduct of business contrary to the interest of a current employer (or partnership) is a breach of the duty of loyalty.

  • Unpublished Cases.

The following cases, although not officially published, contain useful insights as to how courts view trade secret unfair competition and breach of duty cases.

  • Farmers Insurance Exchange v. Song (February 23, 2012)

 Song was a Farmers insurance agent.  He signed Farmers standard agent appointment agreement which, among other things, provided that: “The agent acknowledges that all manuals, lists and records of any kind (including information pertaining to policy holders and expirations) are the confidential property of [Farmers] and agrees they shall not be used or divulged in any way detrimental to [Farmers] and shall be returned to [Farmers] upon termination of the agency.”  About four years later Farmers terminated its agency relationship with Song.  More than a year after that, Farmers filed a lawsuit after Song repeatedly refused to comply with Farmers request to return all the confidential client information as required by section 1 of the agreement.  The complaint alleged breach of contract, misappropriation of trade secrets, intentional interference with contractual relations, unfair competition and breach of fiduciary duty.  It sought both damages and injunctive relief.

Shortly after filing, Farmers moved for a preliminary injunction to enjoin Song from using Farmers’ trade secrets, including Farmers’ confidential policy holder information for any purpose including but not limited to soliciting insurance business.  Farmers also sought an order requiring Song to immediately surrender to Farmers all copies of the trade secrets and lists.  The trial court issued the preliminary injunction.

Song appealed, claiming that the agreement offended California’s public policy prohibiting restraints on the pursuit of a business or a lawful trade or profession.  (Citing Edwards v. Arthur Andersen LLP, 44 Cal.4th 937, 945-946.)  The Court of Appeal rejected the argument however, noting that a lengthy line of cases has consistently held former employees may not misappropriate the former employer’s trade secrets to unfairly compete with a former employer.   Song also argued that the policy holder information at issue in the case was not protectable as a trade secret.  The Court of Appeal rejected that argument as well, citing a line of cases that enjoined former insurance agents from soliciting policy holders using customer files that contained the names, addresses and telephone numbers of policy holders.  Although it is a rule notable for its many exceptions, compilations of customer information including customer identity, contact information and some information relating to their customer status (say policy expiration dates, etc.) have long been recognized as trade secret by California courts.

  • Ruznak Auto Group v. McTaggert (10/12/2011)

Can a voluntary dismissal of a trade secret case without prejudice support a “bad faith” award of attorney’s fees under the California Uniform Trade Secrets Act?  Not in this case.  In Ruznak, a British automobile sales and service group sued two former employees and their new company for misappropriation of trade secrets, common law unfair competition and unfair competition in violation of Business and Professions Code section 17200.  The complaint also alleged breaches of fiduciary duty.  The complaint alleged that the plaintiff was in the business of automobile sales and service, that it employed defendants as a service manager and service technician and that when their employment was terminated they misappropriated plaintiff’s trade secrets including a customer list, took them to their new business, and used the list to solicit Ruznak’s customers.  After several months of settlement negotiations and when faced with a threat that the defendants would file cross-complaints for wrongful termination, the plaintiff voluntarily dismissed the case without prejudice.

Defendant McTaggert then filed a motion for attorney’s fees under the California Uniform Trade Secrets Act which allows an award of attorneys’ fees for a prevailing defendant when the action alleging misappropriation of trade secrets was filed in “bad faith”.  The defendants’ moving papers included declarations which stated that plaintiff had filed the lawsuit based on fabricated allegations for the purpose of putting defendant out of business.  Plaintiff filed contrary declarations including declarations of persons within the plaintiff group stating they had an objective and reasonable basis for believing that a trade secret list had been taken by the departing employees.  Perhaps the most important holding in the case is that the Court applied the objective/subjective bad faith test required for a determination of fees under the CUTSA.  Although the Court declined to find bad faith (a decision that was upheld by the Court of Appeal), the most important take away may be that a voluntary dismissal without prejudice does not insulate a plaintiff from a claim of bad faith attorney’s fees.