Amicus Brief Professors Supporting Edwards

Case No. S147190

IN THE SUPREME COURT OF THE STATE OF CALIFORNIA RAYMOND EDWARDS II, Petitioner and Appellant,

v. ARTHUR ANDERSEN LLP, Defendant and Respondent.

BRIEF OF AMICI CURIAE LAW PROFESSORS AND WRITERS OF LEARNED TREATISES After a Decision by the Court of Appeal, Second Appellate District, Division Three Case No. B 178246 Los Angeles Superior Court Case No. BC 255796 Honorable Andria K. Richey, Judge

JAMES POOLEY (SBN 58041) MORRISON & FOERSTER LLP 755 Page Mill Road Palo Alto, California 94304-1018 Telephone: (650) 813-5600 Facsimile: (650) 494-0794 [email protected]

MARK A. LEMLEY (SBN 155830) Stanford Law School Crown Quadrangle 559 Nathan Abbott Way Stanford, CA 94305-8610 Telephone: (650) 723.2465 Facsimile: (650) 725.0253 [email protected]

Counsel ofRecord

ATTORNEYS FOR AMICI PROFESSORS AND WRITERS OF LEARNED TREATISES

pa-1163924

TABLE OF CONTENTS

Page APPLICATION FOR LEAVE TO FILE BRIEF AMICI CURIAE

1

I.

INTRODUCTION AND SUMMARY OF ARGUMENT

3

II.

SECTION 16600 EMBODIES CALIFORNIA'S FUNDAMENTAL PUBLIC POLICY AGAINST COVENANTS NOT TO COMPETE

3

CALIFORNIA HAS NEVER ADOPTED A "PARTIAL" OR "NARROW" RESTRAINT EXCEPTION TO THE STATUTORY RULE

6

III.

A. B.

IV.

V.

California Cases Make Clear There Is No Partial Restraint Exception The Ninth Circuit Cases Creating a "Narrow Restraint" Exception Are Ill-Founded and Should Not Be Followed

6 10

THE SO-CALLED "TRADE SECRET EXCEPTION" APPLIES TO INDEPENDENTLY WRONGFUL CONDUCT BUT DOES NOT PERMIT CONTRACTUAL RESTRAINTS ON THE USE OF PUBLIC INFORMATION OR ON LAWFUL COMPETITION

12

CALIFORNIA'S BAN ON EMPLOYEE COVENANTS NOT TO COMPETE SERVES CRITICAL STATE INTERESTS

16

TABLE OF AUTHORITIES CASES

Advanced Bionics v. Medtronic, Inc., 29 Cal.4th 697,59 P.3d 231 (2002)

4

Application Group, Inc. v. Hunter Group, Inc., 61 Cal.AppAth 881 (1998)

4,5

Bosley Med. Group v. Abramson, 161 Cal.App.3d 284 (1984)

4,5

Boughton v. Socony Mobil Oil Co., 231 Cal.App.2d 188 (1964)

10, 11

Campbell v. Trustees ofLeland Stanford Jr. Univ., 817 F.2d499 (9thCir. 1987)

10, 11

Chamberlain v. Augustine, 172 Cal. 285 (1916)

5,6, 7, 8, 10, 11

D'Sa v. Playhut, Inc., 85 Cal.AppAth 927 (2000)

5

Davis v. Jointless Fire Brick Co., 300 F. 1 (9th Cir. 1924)

10

Fortna v. Martin, 158 Cal.App.2d 634 (1958)

5

Fowler v. Varian Assoc., Inc., 196 Cal.App.3d 34 (1987)

13

Frame v. Merrill Lynch, 20 Cal.App.3d 668 (1971)

4,5, 8

General Commercial Packaging, Inc. v. TPS Package Engineering, Inc., 126F.3d 1131 (9thCir. 1997) Golden State Linen Service, Inc. v. Vidalin, 69 Cal.App.3d 1 (1977) Gordon Termite Control v. Terrones, 84 Cal.App.3d 176 (1978)

11 5, 14 5, 8, 9

Gordon v. Landau, 49 Ca1.2d 690 (1958)

7, 12, 13

Hill Med. Corp. v. Wycoff, 86 Cal.AppAth 895 (200 1)

4, 5

Hollingsworth Solderless Terminal Co. v. Turley, 622 F.2d 1324 (9th Cir. 1980)

111

14

Hunter v. Superior Court, 36 Cal.App.2d 100 (1939)

5

International Business Machines Corp. v. Bajorek, 191 F.3d 1033 (9th Cir. 1998)

11

John F. Matull & Assoc., Inc. v. Cloutier, 194 Cal.App.3d 1049 (1987)

14

King v. Gerold, 109 Cal.App.2d 316 (1952)

~

10, 11

Kolani v. Gluska, 64 Cal.AppAth 402 (1998)

5, 13

Loral Corp. v. Moyes, 174 Cal.App.3d 268 (1985)

14

Merrill Lynch v. Ware, 414 U.S. 117 (1973)

4

Metro Traffic Control, Inc. v. Shadow Traffic Network, 22 Cal.AppAth 853 (1994) Morey v. Paladini, 187 Cal. 727 (1922)

5, 14 5,6, 7, 10, 11

Morris v. Harris, 127 Cal.App.2d 476 (1954)

5, 8

Muggill v. Reuben H. Donnelley Corp., 62 Cal.2d 239 (1965)

5,8,9, 12, 13

Readylink Healthcare v. Cotton, 126 Cal.AppAth 1006 (2005)

13

Scott v. Snelling and Snelling, Inc., 732 F.Supp. 1034 (N.D. Cal. 1990)

4, 13

Thompson v. Impaxx, Inc., 113 Cal.AppAth 1425 (2003)

5

Thompson v. Impaxx, Inc., supra, 113 Cal.AppAth at 429-430

14

Ware v. Merrill Lynch, 24 Cal.App.3d 35 (1972)

4

Warner and Co. v. Solberg, 634 N.W.2d 65 (N.D. 2001)

15

Winston Research Corp. v. Minnesota Mining & Mig. Co., 350 F.2d 134 (9th Cir. 1965)

15

IV

STATUTES Cal. Bus. & Prof. Code § 16600

passim

Cal. Civ. Code § 3426 (Uniform Trade Secrets Act)

13, 15, 18

MISCELLANEOUS CEB, Trade Secrets Practice in California § 2.32

6

Restatement (Third) of Unfair Competition § 39

15

Acs et al., The Knowledge Spillover Theory ofEntrepreneurship 23 (Ctr. for Econ. Policy Research, Discussion Paper No. 5326, 2005)

20

Andersson et al., The Effect ofHRM Practices and R&D Investment on Work Productivity. http://web.mit.edu/ipc/sloan05/HRM_R&D_Andersson_et_al.pdf..

17

Baumol, The Free Market Innovation Machine 121-23 (2002)

19

Fallick et al., Job Hopping in Silicon Valley, 88 Rev. Econ. Stat. 472 (2006)

17

Frischmann & Lemley, Spillovers, 107 Colum. L. Rev. 257 (2007)

18, 19

Gilson, The Legal Infrastructure ofHigh Technology Industrial Districts: Silicon Valley, Route 128, and Covenants Not to Compete, 74 N.Y.U. L. Rev. 575 (1999)

17,21

Gorg & Hijzen, Multinationals and Productivity Spillovers 1-2 (Univ. of Nottingham, Research Paper 2004/41,2004), in Globalisation and Productivity Growth (David Greenaway et al. eds., forthcoming 2006)

19

Harhoff, R&D Spillovers, Technological Proximity, and Productivity Growth -Evidence from German Panel Data, 52 Schmalenbach Bus. Rev. 238 (2000)

20

Hays, Unfair Competition -Another Decade, 51 Cal.L.Rev. 51

14

Hyde, Working in Silicon Valley: Economic and Legal Analysis of a High-Velocity Labor Market (2003) 16, 17, 18,21 Keller &Yeaple, Multinational Enterprises, International Trade, and Productivity Growth: Firm-Level Evidence from the United States 26-28 (Leverhulme Ctr., Research Paper No. 03, 2003)

v

19

Malsberger ed., Covenants Not to Compete: A State-by-State Survey (BNA Books 2d ed. 1996)

21

Pooley, Restrictive Employee Covenants in California, 4 Santa Clara Compo & High Tech. L.J. 251 (1988)

14

Pooley, Trade Secrets, § 8.02[2]

13

Paul M. Romer, The Origins ofEndogenous Growth, 8 J. Econ. Persp. 3 (1994)

18

Saxenian, Regional Advantage: Culture and Competition in Silicon Valley and Route 128 (1994)

17,21

Schmidt, An Empirical Analysis ofthe Effects ofPatent and Secrecy on Knowledge Spillovers 1 (Ctr. for Eur. Econ. Res., Discussion Paper No. 06-048, 2006)

20

Valleta, On the Move: California Employment Law and High-Tech Development, Fed. Res. Bank of San Francisco Econ. Ltr. No. 200224 (Aug. 16, 2002)

17

VI

APPLICATION FOR LEAVE TO FILE BRIEF AMICI CURIAE Pursuant to Calif. Rule of Court 8.520(f), the undersigned request leave to file the attached brief as amici curiae in support of respondent Raymond Edwards II. This application is timely made. Amici are 26 professors and writers of learned treatises in the areas of intellectual property, trade secret law, and innovation policy. They include law, business, and innovation professors at leading academic institutions throughout California and the country. Among them are several who have made the effects of Cal. Bus. & Prof. Code § 16600 a primary area of study for many years. Amici have no personal or financial stake in the outcome of this case, but as scholars are vitally interested in seeing that the rules governing employee mobility encourage rather than retard innovation. No party or other organization has paid for or authored any part of this brief. A full list of amici is attached as Appendix A. This amicus briefwill assist the court in two respects. First, it offers the consensus of unbiased leading scholars in the field about the way the law of section 16600 has developed. Second, it offers abundant economic and empirical evidence on the effects ofthe various possible interpretations of section 16600 offered by the parties to this case. We believe that additional briefmg is necessary in this case in order to highlight for the Court both the history of how section 16600 has been interpreted and the dramatic consequences should this Court undo that long-standing interpretation.

1

Accordingly, we respectfully request that the Court accept and file the attached brief amici curiae. Dated: May 14,2007 Respectfully submitted, JAMES POOLEY MORRISON & FOERSTER LLP

By --+----1.------~~-=-~~.,..e_ames ooley Att s for amici professors of learned treatises

2

writers

I.

INTRODUCTION AND SUMMARY OF ARGUMENT

The Court of Appeal's interpretation of Cal. Bus. & Prof. Code

§ 16600 was correct as a matter of both law and policy, and should be affirmed.} As a matter of law, the Court of Appeal correctly read section 16600 literally, to bar all covenants not to compete imposed on employees. That reading was consistent with a long line of California decisions interpreting section 16600. There is not now, and never has been, a "narrow restraint" exception to section 16600 in California. Despite its name, adopting such an exception would have the effect ofjudicially overruling the statute. And the so-called ''trade secret exception" cannot support contractual restraints on lawful competition that does not involve misappropriation of trade secrets. As a matter of policy, this state's longstanding interpretation of section 16600 serves a vital state interest. California's strong innovation economy depends critically on the free movement of employees. Judicial creation of an exception that swallows the statutory rule would risk serious harm to California's position as a leader in the technology industry. II.

SECTION 16600 EMBODIES CALIFORNIA'S FUNDAMENTAL PUBLIC POLICY AGAINST COVENANTS NOT TO COMPETE

Section 16600 voids contracts to the extent they operate to restrain anyone from engaging in a lawful profession, trade or business. 2 The

1

Amici express no opinion on the second question before the Court.

The statute contains certain express exceptions for sales of interests in a corporation or partnership. 2

3

statute represents a clear choice by California to reject the "rule of reason" standard applied in many other jurisdictions. Bosley Med. Group v.

Abramson, 161 Cal.App.3d 284,288 (1984); Hill Med. Corp. v. Wycoff, 86 Cal.AppAth 895, 900-901 (2001) ("Section 16600 presently sets out the general rule in California -

covenants not to compete are void.,,).3 It

reflects a public policy so profound that courts of this state consistently override contractual choice of law provisions that would allow enforcement under the law of a sister state. See, e.g., Frame v. Merrill Lynch, 20 Cal.App.3d 668, 673 (1971); Ware v. Merrill Lynch, 24 Cal.App.3d 35, 43 (1972), aff'd sub nom. Merrill Lynch v. Ware, 414 U.S. 117, 139-140 (1973) ("California has manifested a strong policy of protecting its wage earners from what it regards as undesirable economic pressures affecting the employment relationship."); Application Group, Inc. v. Hunter Group,

Inc., 61 Cal.AppAth 881,902 (1998).4 California courts have applied the law to condemn a wide variety of contractual restrictions that affect an

3 See also Scott v. Snelling and Snelling, Inc., 732 F.Supp. 1034, 1042 (N.D. Cal. 1990) (although "a number of states have abandoned the common law prohibition of covenants restraining competition in the employment agreement context, adopting instead a balancing approach even in the face of statutes like 16600 ... [,] California courts have been clear in their expression that section 16600 represents a strong public policy of the state which should not be diluted by judicial fiat."). 4 In Advanced Bionics v. Medtronic, Inc., 29 Cal.4th 697, 59 P.3d 231 (2002), this Court overturned an injunction against Medtronic proceeding with a suit in Minnesota to enforce a noncompetition agreement. It did so for reasons of interstate comity, however, not because it questioned the public policy behind section 16600. Indeed, the Advanced Bionics Court "agree[d] that California has a strong interest in protecting its employees from noncompetition agreements under section 16600." Id. at 706,59 P.3d at 237.

4

individual's ability to move freely from job to job. See, e.g., Application

Group, supra; Bosley, supra; Chamberlain v. Augustine, 172 Cal. 285, 288289 (1916); Fortna v. Martin, 158 Cal.App.2d 634,638 (1958); Frame,

supra; Golden State Linen Service, Inc. v. Vidalin, 69 Cal.App.3d 1, 12 (1977); Gordon Termite Control v. Terrones, 84 Cal.App.3d 176, 179 (1978); Hill Med. Corp., supra; Hunter v. Superior Court, 36 Cal.App.2d 100, 114 (1939); Kolani v. Gluska, 64 Cal.App.4th 402,407 (1998); Metro

Traffic Control, Inc. v. Shadow Traffic Network, 22 Cal.App.4th 853, 859860 (1994); Morey v. Paladini, 187 Cal. 727, 736 (1922); Morris v. Harris, 127 Cal.App.2d 476,478 (1954); Muggill v. Reuben H Donnelley Corp., 62 Cal.2d 239,242-243 (1965). For similar policy-based reasons, California courts have held that an employer commits an act of wrongful discharge when firing an employee for refusing to sign a non-competition agreement. See, e.g., D'Sa v. Playhut, Inc., 85 Cal.App.4th 927,933 (2000) and Thompson v. Impaxx, Inc., 113 Cal.App.4th 1425 (2003). This Court should reject Andersen's strained argument that a restriction on competition cannot be a "restraint" unless someone is entirely barred from employment. (Op. Br. at n.4). That is not the ordinary meaning of the term "restraint." Someone can be restrained without abandoning any action at all. A leash is a "restraining device" even though it permits some limited freedom of movement, for example. Nor is Andersen's "complete prohibition" the meaning California courts have given the term. Tellingly, none of the voided contracts just cited sought to prevent the individual from an entire field of endeavor, but merely from aspects of it, such as serving certain customers or competing with a certain company. The legislature has amended various portions of the statute in 1945, 1963 and 2002, and at no time has it seen fit to change or even question its

5

interpretation by California courts as a broad prohibition against all fonns of restraints which are not expressly allowed. Andersen (Op. Br. at 28, Rply. Br. at 13) makes the bizarre argument that this legislative silence infers approval of the Ninth Circuit's "narrow restraint exception", which we address below, and implicit rejection of the more than 15 California appellate decisions that contain no such exception. But there is no logical basis for concluding that the legislature was ignorant of the decisions of our own state courts, including this Court, and was tuned in instead exclusively to the contrary interpretation offered by a handful of federal cases. 5

Ill.

CALIFORNIA HAS NEVER ADOPTED A "PARTIAL" OR "NARROW" RESTRAINT EXCEPTION TO THE STATUTORY RULE

Section 16600 is simple and straightforward: to the extent any contract restrains otherwise lawful competition, it is void. The plain meaning of "restraint" is reason enough to conclude that the covenant involved in this case is unenforceable. But Andersen would have this Court sanction a "narrow restraint exception" that not only relies on a misreading of our state's precedents, but that would if adopted swamp the rule in a wave of "partial" restraints.

A.

California Cases Make Clear There Is No Partial Restraint Exception

In Chamberlain v. Augustine, supra, 172 Cal. at 289, and again in

Morey v. Paladini, supra, 187 Cal. at 738, this Court declared that there is no such thing as a "partial restraint" under the predecessor to section

Commentators have noted the conflict. See, e.g., CEB, Trade Secrets Practice in California § 2.32, p. 54 ("The federal cases appear inconsistent with California law."). 5

6

16600. In Chamberlain, the covenant barred defendant for three years from any involvement in a business "similar" to the foundry whose stock he had sold. The plaintiff argued that the restriction was limited to the states of California, Washington, and Oregon; that the defendant could work as a "laborer or molder" in certain designated foundries; and that the covenant was therefore "only a partial restraint". The argument was easily rejected: "The statute makes no exception in favor of contracts only in partial restraint of trade." 172 Cal. at 289. In Morey, the alleged agreement was with a lobster fishery to sell only to a single purchaser in northern California, Oregon, Washington and Nevada, who in return promised to buy a large amount of lobsters on a continuing basis. When sued for failure to buy, the purchaser argued the contract was illegal. Observing that "the contract was one which would result in at least a partial restraint of trade", 187 Cal. at 736, this Court agreed it was unlawful, since "[t]he statute (Civ. Code, sec. 1673) makes no exception in favor of contracts only in partial restraint of trade." Andersen never discusses Morey, and mischaracterizes Chamberlain as involving a "complete restriction on the seller's ability to engage in the foundry business ...." (Op. Br. at 22; emphasis in original)6

6Andersen attempts (Op. Br. at 19-20) to contrast this misleading picture of Chamberlain with Gordon v. Landau, 49 Cal.2d 690 (1958), which it argues involved a non-compete agreement comparable to the one imposed here by Andersen. But this ignores the very important characterization by this Court of the agreement in that case: the defendant "merely agreed not to use plaintiff s confidential lists to solicit customers for himself for a period of one year following termination of employment". 49 Cal.2d at 694. This language was the genesis of the "trade secret exception", discussed infra in section V.

7

Clearly, any covenant not to work for a competitor is a "partial" restraint, since the typical employee can ply his or her skills in other ways.7 Yet as noted above, California courts have repeatedly held that postemployment non-competition agreements run afoul of section 16600. In the leading case of Muggill v. Reuben H Donnelley Corp., supra, 62 Ca1.2d at 243 (1965), Justice Traynor explained that section 16600 "invalidates provisions in employment contracts prohibiting an employee from working for a competitor after completion of his employment ...." Citing Muggill, as well as Chamberlain, the court in Gordon Termite Control v. Terrones,

supra, 84 Cal.App.3d at 179, voided a contract that required an employee to pay $50 each time he called on a customer that he worked with at a former employer. 8 Andersen (Op. Br. at 26-27) waves off these cases as part ofa supposedly anomalous "handful" that in any event "do not support an

7 Consider a carpenter barred by contract from competing with a homebuilding company; he could be employed building sets for a movie studio. A stockbroker leaving a brokerage (cf. Frame v. Merrill Lynch, supra) can become an investment advisor. These examples (and many more which come to mind) expose the fallacy of arguing "partial restraint": almost any restraint can be described as substantially less than the whole of a trade, profession or business.

Gordon Termite Control also relied on Morris v. Harris, supra, another case involving post-employment payments for calling on previously-serviced customers. Citing Chamberlain, the Morris decision rejected an argument that the contract was "only a restriction and not a restraint". 127 Cal.App.2d at 478. Ironically, Andersen uses a similar semantic argument (prohibition versus restriction) in trying to distinguish Morris. (Op. Br. at 43) 8

8

absolute prohibition on non-competition agreements". 9 This observation is curious, since each of these decisions considered, and found wanting, a non-competition agreement. (Muggill at 240 n.l: payments will terminate if employee "enters any occupation or does any act which ... is in competition with ... Employer"; Gordon Termite: employee agreed "that should he terminate . . . he will not call on any accounts called on" while working for his former employer.). Andersen calls for "clarity" in application of section 16600. (Op. Br. at 14). California courts have in fact established a perfectly clear rule: the statute means what it says -

that restraints on competition are

invalid. It is Andersen's approach that would generate profound uncertainty. How could one determine what is a "narrow" restraint, other than by post hoc conclusions? Indeed, in practice this "exception" would certainly swallow the rule. What would be left to prohibit, if the statute allowed restraints up to, but some indeterminate amount short of, a comprehensive bar on pursuing a trade? What employee would have the resources to litigate whether the line was drawn properly in his or her case? What employer would readily hire an employee subject to such an uncertain potential restraint? Where the "partial" or "narrow" restraint inevitably leads is to some version of the "rule of reason" approach, one which this state's legislature soundly rejected over a century ago. See section III,

supra. As implemented in a jurisdiction like California with no developed jurisprudence on what are "reasonable" post-employment restraints, this

Andersen strangely criticizes Gordon Termite Control for "unquestioningly" following Muggill, which is presumably what courts of appeal are supposed to do with this Court's precedent. 9

9

new regime would dramatically discourage employee mobility and put at risk one of the world's most vibrant economies (see section VI infra).

B.

The Ninth Circuit Cases Creating a "Narrow Restraint" Exception Are Ill-Founded and Should Not Be Followed

Andersen relies on a trio of Ninth Circuit cases beginning with

Campbell v. Trustees ofLeland Stanford Jr. Univ., 817 F.2d 499 (9th Cir. 1987). Those cases rely on a strained reading of California precedent, and this Court should not abandon the statutory language and the consistent reading given it by California courts merely to blindly follow cases decided by a court that was itself supposedly following this Court's rule in the fIrst place. Campbell, while recognizing that California had rejected the rule of reason in enacting section 16600, chose nonetheless to import such a rule into California law under a diffetent name. Campbell's basis for that decision was dubious. It relied on a single appellate court opinion,

Boughton v. SoconyMobil Oil Co., 231 Cal.App.2d 188 (1964), for the proposition that the statute did not apply "where one is barred from pursuing only a small part of [a] business, trade or profession." 817 F.2d at 502. Inexplicably, Campbell did not address this Court's unmistakable holdings to the contrary in Chamberlain and Morey, or its own precedent in

Davis v. Jointless Fire Brick Co., 300 F. 1,3 (9th Cir. 1924), which had expressly followed Chamberlain in rejecting a "partial restraint" argument. But in any event its reliance on the Boughton dictum lO was misplaced, since

Boughton had relied for its "small or limited part" exception on King v.

Boughton, as the Court of Appeal noted below, involved a restriction on the use of land, a very specifIc circumstance that only obliquely involved section 16600. 10

10

Gerold, 109 Cal.App.2d 316 (1952), a case that even the Campbell court found to hold no such thing. 11 See Boughton, 231 Cal.App.2d at 192. From this inauspicious beginning the "narrow restraint exception" took root in Ninth Circuit jurisprudence with an unusual deference to its questionable provenance. In General Commercial Packaging, Inc. v. TPS Package Engineering, Inc., 126 F.3d 1131, 1133 (9th Cir. 1997), the court cited to the "rule of Campbell" as if it were the pronouncement of this Court, rather than a flawed interpretation of two appellate opinions. Once again, the Ninth Circuit inexplicably ignored this Court's rulings in Chamberlain and Morey. It did so again in International Business Machines Corp. v. Bajorek, 191 F.3d 1033, 1041 (9th Cir. 1998), concluding that Ninth Circuit, not California, precedent bound the court to follow the "narrow restraint" exception it had created: "We are not free to read California law without deferring to our own precedent on how to construe it. . . . Because of the limited scope of the restriction [against working for a competitor], we are bound to hold, under Campbell, General Commercial Packaging, and Smith, that the covenant did not violate section 16600." 191 F.3d at 1041. It is past time to address and correct the Ninth Circuit's creation of the "narrow restraint exception". It was based originally on unreliable analysis that ignored this Court's rulings and the Ninth Circuit's own precedent, and it grew primarily through circular reasoning and self-

King did not involve a restraint against producing "competing models" of the licensed product, but only the specific product licensed. 11

11

citation. There is no reason to adopt, and many compelling reasons not to adopt, this jurisprudential aberration. 12

IV.

THE SO-CALLED "TRADE SECRET EXCEPTION" APPLIES TO INDEPENDENTLY WRONGFUL CONDUCT BUT DOES NOT PERMIT CONTRACTUAL RESTRAINTS ON THE USE OF PUBLIC INFORMATION OR ON LAWFUL COMPETITION

As noted above, in Gordon v. Landau this Court considered a covenant directed at misuse of a route salesman's account cards, which carried detailed information about each customer and their buying habits. The Court noted that the restriction did not prevent lawful competition, but was directed at use of these "confidential lists to solicit customers" after leaving employment. This decision was cited in Muggill, creating the socalled ''trade secret exception". 62 Ca1.2d at 242 (section 16600 invalidates non-competition agreements "unless they are necessary to protect the employer's trade secrets"). We say "so-called", because the concept is mis-named. It is not an exception at all, since it only applies to activity, such as misuse of trade secrets or breach of fiduciary duty, that the law would prohibit in the absence of a contract. It follows that any contract that also prohibits such

Andersen argues (Op. Br. at 15-18, Rep. Br. at 7 n.8) that the decision of the Court of Appeal below improperly found an exception for contracts other than those with employees. This is a straw man. Section 16600 by its terms is meant to regulate restrictions on individuals' work. Apart from agreements with employers, the only other sort of contract that could be implicated is one between organizations that restrains someone's rights to work (for example, an agreement between competitors not to hire each other's engineers for a period of time). The Court of Appeal had no reason to venture beyond the fact situation presented to it; but there is also no reason to apply a different analysis to contracts between entities. 12

12

activity is not a "restraint" of a "lawful profession, trade or business.,,13 These cases, in other words, stand for nothing more than the straightforward proposition that section 16600 doesn't void or preempt the operation of California trade secret law. The dictum from Muggill, however, has been repeated without much analysis in a number of subsequent cases. 14 Although the Court of Appeal below concluded that the record was insufficiently developed to address the "trade secret exception", 47 Cal.Rptr.3d at 796, its conclusion seems to have been based on an assumption that proof of an interest in trade secrets might provide legitimacy to the non-competition covenant. But that assumption is incorrect. If there is any "trade secret exception" in modem law, it means only that non-disclosure agreements are valid under section 16600. See Kolani v. Gluska, 64 Cal.App.4th 402,407 (1998) ("Narrower contractual restraints on a departing employee, which prohibit him/her from using confidential information taken from the former employer, have been held to be lawful." [citing Gordon v. Landau, 49 Cal.2d at 694]); Readylink

Healthcare v. Cotton, 126 Cal.App.4th 1006, 1022 (2005)

This does not mean that such contracts are entirely superfluous, since they serve important collateral purposes, such as establishing a confidential relationship, defining its subject matter, and proving reasonable efforts to protect trade secrets. See Pooley, Trade Secrets, § 8.02[2] (Law Journal Press). Moreover, contracts can specify additional remedies for misappropriation. See also Uniform Trade Secrets Act, Civ. Code § 3426.7(b) (contractual remedies not displaced). 13

14 See, for example, Scott v. Snelling & Snelling, Inc., 732 F.Supp. 1034, 1043 (N.D. Cal. 1990) (declining to enforce non-competition agreement); and Fowler v. Varian Assoc., Inc., 196 Cal.App.3d 34, 43-44 (1987) (no non-competition covenant involved).

13

("Misappropriation of trade secret information constitutes an exception to section 16600.,,)].15 That the statute does not void promises of confidentiality should not be surprising. No California case has ever overthrown a nondisclosure agreement as a restraint of trade; but just as importantly, none has ever upheld a non-competition agreement because of a ''trade secret exception." In effect, the "exception" merely reflects the well-accepted notion that "'the

employer will be able to restrain by contract only that conduct of the former employee that would have been subject to judicial restraint under the law of unfair competition, absent the contract.'" Metro Traffic Control, Inc. v.

Shadow Traffic Network, 22 Cal.App.4th 853, 861 (1994) (quoting Hays, Unfair Competition -Another Decade, 51 Cal.L.Rev. 51, 69); see also Hollingsworth Solderless Terminal Co. v. Turley, 622 F.2d 1324, 1338 (9th Cir. 1980) (same). In any event, any trade secret "exception" in modem parlance must take account of the more robust protection afforded secret information

15 Dictum from one case, Loral Corp. v. Moyes, 174 Cal.App.3d 268,275 (1985), suggests that "contractual restrictions may have more impact in a non-solicitation case than a nondisclosure case." But the analysis in Loral (and in a case that cited it, John F. Matull & Assoc., Inc. v. Cloutier, 194 Cal.App.3d 1049 (1987)) was flawed; see Pooley, Restrictive Employee Covenants in California, 4 Santa Clara Compo & High Tech. LJ. 251,264-276 (1988). A more recent case, Thompson v. Impaxx, Inc., supra, 113 Cal.App.4th at 429-430, reaffirms that nonsolicitation covenants are enforceable only to the extent that misuse of trade secrets is involved. Andersen (Op. Br. at 24) criticizes the Court of Appeal for not considering Loral, or dictum from another nonsolicitation case, Golden State Linen Servo v. Vidalin, 69 Cal.App.3d 1,9 (1977); but there was no particular reason for the court to do so, since Edwards had not challenged that part of the agreement. 47 Cal.Rptr.3d at 797 n.4.

14

under the Uniform Trade Secrets Act, Civil Code § 3426. Before enactment of that statute, California common law on trade secrets was based largely on the Restatement (First) of Torts, which defined trade secrets relatively narrowly, excluding "emphemeral" information such as unpublished bids, and "negative" information such as the results of unsuccessful experiments. 16 Even if one might have argued the need for supplemental contractual protection of information when trade secret law was narrower, such arguments have no force at all today, when the extremely broad statutory definition of a trade secret covers virtually all nonpublic information that a business may want to protect. 17 The important conclusion from this development is that there is no justification for seeking contractual protection for information that does not qualify as a trade secret under the UTSA, since such information is undeserving of any protection at all. The trade secret "exception," in short, cannot be used to justify a non-competition covenant that restricts an employee from competing in a way that would not use a trade secret; the "exception" merely explains why non-disclosure agreements are valid when used to protect real trade secrets.

See Restatement (Third) of Unfair Competition § 39, comment d. Cf. Winston Research Corp. v. Minnesota Mining & MIg. Co., 350 F.2d 134, 144 (9th Cir. 1965) (in pre-UTSA decision, held information about problems with company's machine cannot qualify as trade secret). 16

17 See Warner and Co. v. Solberg, 634 N.W.2d 65, 72 (N.D. 2001) (applying North Dakota statute similar to section 16600, and in reference to California decisional law, finding that since enactment of the UTSA the "need to create a judicial exception ... may now be questioned.").

15

v.

CALIFORNIA'S BAN ON EMPLOYEE COVENANTS NOT TO COMPETE SERVES CRITICAL STATE INTERESTS

Reading Andersen's briefs, one might have the impression that section 16600 is a poorly-drafted accident that was never intended to mean what it says. Nothing could be further from the truth. California's longstanding ban on employee covenants not to compete is a centerpiece of state innovation policy, and it is perhaps the most important reason why California has enjoyed its leading position in the technology industries over the past 25 years. Most states other than California enforce employee covenants not to compete. The fact that California does not enforce them has led to what Alan Hyde has called a "high-velocity labor market": one in which employees can and do change jobs with some frequency. Alan Hyde, Working in Silicon Valley: Economic and Legal Analysis of a HighVelocity Labor Market (2003). The ability to leave ajob and continue to work in one's chosen profession -

something taken for granted in

California but subject to significant restrictions elsewhere -

obviously

benefits employees, who are not bound to bad jobs by fear that they will be unemployable or at least underemployed if they choose to leave. But less obviously, it also benefits employers and the economy as a whole. While employers whose employees want to leave may have a short-term, selfish interest in making it hard for them to do so, those same employers benefit in the long run by being able to hire new employees away from competitors without fear of legal sanction. And perhaps most important, California's rule protecting the freedom of departing employees to compete encourages employees who think they can build a better mousetrap (or a better computer chip or search engine) to start a new company to do just that.

16

Those start-ups have contributed enormously to the California economy, to such an extent that regions all over the world have sought to emulate Silicon Valley. But as a number of legal and economic studies have shown, those efforts to be like Silicon Valley have failed. Annalee Saxenian, Regional Advantage: Culture and Competition in Silicon Valley and Route 128 (1994). Notably, work by legal scholars and social scientists suggest that Silicon Valley has succeeded where others have failed in significant part because of California's rule prohibiting employee covenants not to compete, which led to high rates of employee mobility. See, e.g., Saxenian, supra, at 34-35, 161-68 (documenting the high rates of employee mobility in Silicon Valley, and attributing the success of innovation in the Valley in part to that difference); Ronald J. Gilson, The

Legal Infrastructure ofHigh Technology Industrial Districts: Silicon Valley, Route 128, and Covenants Not to Compete, 74 N.Y.U. L. Rev. 575, 577-78 (1999); Bruce C. Fallick et aI., Job Hopping in Silicon Valley, 88 Rev. Econ. Stat. 472 (2006) (providing empirical support for the Saxenian-Gilson argument); Fredrik Andersson et aI., The Effect ofHRM

Practices and R&D Investment on Work Productivity. http://web.mit.edu/ipc/sloan05/HRM_R&D_Andersson_et_aI.pdf; Rob Valleta, On the Move: California Employment Law and High-Tech

Development, Fed. Res. Bank of San Francisco Econ. Ltr. No. 2002-24 (Aug. 16, 2002). The explanation is straightforward: start-ups drive new innovation. The biggest source of start-ups is employees who depart from existing companies. See Hyde, supra, at 31-32 (reporting a study of hard-drive manufacturing, in which departing-employee start-ups accounted for over 99% of start-up revenue). Those new companies grow, employing workers,

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developing better products, and contributing to the state's economic growth. They in tum spawn new companies as employees depart the companies that were once start-ups and develop their own new companies and products. The economy as a whole benefits from this cycle of innovation. Those who argue for restrictions on employee mobility and the development of start-ups generally worry that existing companies will lose incentives to innovate if departing employees can take their know-how and compete with them. There are three answers to this objection. First, as we have seen, section 16600 does nothing to prevent the enforcement of trade secret law. Companies who choose to do so can enforce their statutory rights under Cal. Civ. Code § 3426 to ensure that departing employees cannot use a former employer's trade secrets. What they cannot do is prevent employees from competing even when those employees do not use any trade secrets. It is that freedom that has made Silicon Valley possible. Second, it is not corporations per se but the individuals who work for them who come up with new ideas. An employee who cannot start a new business cannot profit from an entrepreneurial idea, and so has less incentive to try to develop new ideas for an existing employer. An important benefit of a high-velocity labor market like California's is that it provides the maximum incentive to individuals to invent and pursue new ideas. See Hyde, supra, at 52. Those incentives are likely more important than corporate investment incentives in many cases. This is particularly true since, as Paul Romer has explained, corporations will continue to invest in innovation even if they cannot capture all the benefits from that innovation, as long as they make enough money to turn a profit. Paul M. Romer, The

Origins o/Endogenous Growth, 8 J. Econ. Persp. 3 (1994); Brett M.

18

Frischmann & Mark A. Lemley, Spillovers, 107 Colum. L. Rev. 257 (2007). Third, the benefits of the "spillovers" of ideas that come with employee mobility are large enough to outweigh any harm to former employers, and indeed so great that even the fortner employers themselves benefit from California's high-velocity labor market. A wealth of economic evidence teaches us that these spillovers are good for society. There is no question that inventions create significant social benefits beyond those captured in a market transaction. Statistical evidence repeatedly demonstrates that innovators capture only a small proportion of the social value of their inventions. See, e.g., Frischmann & Lemley, supra, at fn. 5 (collecting the dozens of economic studies proving this point). These spillovers benefit not only consumers but also third parties, including competitors and potential competitors. Employees at an innovative company acquire knowledge about innovative products and processes that they can put to use elsewhere. 18 The public as a whole also benefits from new sources of innovative products. See William J. Baumol, The Free Market Innovation Machine 121 ..23 (2002).

See, e.g., Holger Gorg & Alexander Hijzen, Multinationals and Productivity Spillovers 1-2 (Univ. of Nottingham, Research Paper 2004/41, 2004), in Globalisation and Productivity Growth (David Greenaway et al. eds., forthcoming 2006) (noting ways in which spillovers to competitors occur); W. Keller & S. Yeaple, Multinational Enterprises, International Trade, and Productivity Growth: Firm-Level Evidence from the United States 26-28 (Leverhulme Ctr., Research Paper No. 03,2003), available at http://www.nottingham.ac.ukleconomics/leverhulme/research-papers/03_ 03.pdf (documenting their significance). 18

19

Far from interfering with incentives, empirical evidence suggests that these spillovers actually drive further innovation. Industries with significant spillovers generally experience more and faster innovation than industries with fewer spillovers. 19 Dietmar Harhoff fmds empirical evidence that firms in high-technology industries (the most innovationintensive ones) are likely to increase rather than decrease their investment in research and development in the face of significant intra-industry spillovers. Harhoff, supra, at 258. Acs et al. argue that this is because the spillovers are creating opportunities to be exploited by entrepreneurs such as departing employees. Zoltan J. Acs et aI., The Knowledge Spillover

Theory ofEntrepreneurship 23 (Ctr. for Econ. Policy Research, Discussion Paper No. 5326, 2005), available at http://papers.ssm.com/so13/papers.cfm?abstract id=873614. But these entrepreneurs aren't engaging in incentive-draining free riding; rather, they are part of a virtuous circle because they are in tum creating new knowledge spillovers that support still more entrepreneurial activity.

See, e.g., Dietmar Harhoff, R&D Spillovers, Technological Proximity, and Productivity Growth - Evidence from German Panel Data, 52 Schmalenbach Bus. Rev. 238, 258 (2000) ("High-technology firms react more sensitively to spillovers in terms of their R&D spending, and their direct marginal productivity gain from spillovers (in excess to the effect from enhanced R&D spending) is considerably larger than the respective gain for less technology-oriented firms."). Indeed, the positive relationship is so strong that some economists use spillovers as a measure of innovation! See Tobias Schmidt, An Empirical Analysis ofthe Effects ofPatent and Secrecy on Knowledge Spillovers 1 (Ctr. for Eur. Econ. Res., Discussion Paper No. 06-048, 2006), available at ftp://ftp.zew.de/pub/zewdocs/dp/dp06048.pdf. 19

20

One need not rely only on economic theory or empirical studies to explain why a free labor market is a good thing for innovation incentives. History teaches this lesson as well. The computer industry is an obvious example. Both Annalee Saxenian and Ron Gilson have shown that spillovers drove innovation in that industry: Silicon Valley thrived while Boston's Route 128 withered in the 1980s and 1990s in significant part because employees and knowledge moved freely to new companies in Silicon Valley, but not in Boston. See Saxenian, supra, at 161-68; Gilson,

supra, at 577-78. And as Alan Hyde puts it, no shortage of innovation resulted: In California, employees are normally free to change jobs without a lawsuit alleging ... breach of a covenant not to compete. There is no evidence of any social harm from this. In particular, there is no evidence that firms lack incentives to invest in the production of information.

Hyde, supra, at 43. The fact that numerous social science studies have shown that California's free labor movement policy drives technological innovation provides a strong policy reason for the Court to refrain from overturning the legislature's judgment. The presence of even so-called "reasonable" restraints on employee mobility, as exist in Massachusetts and other eastern states, interferes with the free development of vital new industries. Nor does calling those restraints "narrow" solve the problem. States like Montana and Oklahoma, in which the judiciary has rewritten freeemployee-mobility legislation to permit such "narrow" restraints, see Brian M. Malsberger ed., Covenants Not to Compete: A State-by-State Survey (BNA Books 2d ed. 1996), hardly have the sort of vibrant

21

technology economy California should wish to emulate. California should not risk killing the goose that laid the golden egg by undoing the longstanding policy against enforcing employee covenants not to compete. Dated: May 14, 2007 Respectfully submitted, JAMES POOLEY MORRISON & FOERSTER LLP

Ja es ooley Atto s for amici professors of learned treatises

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Appendix A: List of Signatories 20 Professor John R. Allison Spence Centennial Professor Graduate School of Business University of Texas at Austin Professor John R. Barton George E. Osborne Professor Emeritus Stanford Law School Professor Lorelei R. de Larena Florida State University College of Law Professor Rochelle Cooper Dreyfuss Pauline Newman Professor NYU School of Law Professor Sheri J. Engelken Gonzaga University School of Law Professor William T. Gallagher Golden Gate University School of Law Professor Shubha Ghosh SMU Dedman School of Law Professor Ronald J. Gilson Meyers Professor of Law and Business Stanford Law School Professor Eric Goldman Santa Clara University School of Law

Amici are participating in this brief in their personal capacity. Institutions are listed for identification purposes only. 20

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Professor Alan Hyde Visiting Professor, Cornell Law School Sidney Reitman Scholar Rutgers University School of Law Professor Mark A. Lemley William H. Neukom Professor Stanford Law School Professor Lawrence Lessig C. Wendell & Edith M. Carlsmith Professor Stanford Law School Professor Gillian Lester Boalt Hall School of Law University of California at Berkeley Professor David Levine Charlotte School of Law Professor Michael J. Madison University of Pittsburgh School of Law Professor Stephen Melohn Suffolk University Law School Professor Michael A. Mireles University of Denver College of Law Professor Viva R. Moffat University of Denver College of Law Professor Tyler T. Ochoa Santa Clara University School of Law Professor Sean O'Connor Visiting Professor, Boalt Hall School ofLaw, UC Berkeley University of Washington School of Law James Pooley Lecturer in Law, Boalt Hall School of Law University of California at Berkeley Author, Trade Secrets (Law Journal Press)

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Professor Michael Risch West Virginia University College of Law Professor Joshua D. Sarnoff Glushko-Samuelson Intellectual Property Law Clinic Washington College of Law American University Professor Kurt M. Saunders Chair, Department of Business Law California State University - Northridge Dean AnnaLee Saxenian School of Information University of California at Berkeley Professor Jennifer M. Urban Director, Intellectual Property and Technology Clinic University of Southern California School of Law

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WAYNE SCOTT FLICK Latham & Watkins 633 W 5th St #4000 Los Angeles, CA KRISTINE L. WILKES Latham & Watkins 701 B St #2100 San Diego, CA RICHARD A. LOVE Attorney at Law 11601 Wilshire Blvd #2000 Los Angeles, CA MARC JOSEPH POSTER Greines Martin et al LLP 5700 Wilshire Blvd #375 Los Angeles, CA

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LLP Attorneys for Defendant and Respondent ARTHUR ANDERSEN,

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