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Protecting Your Customer List from Former Employees

The Value of a Customer List

Without paying customers, no business can survive. For almost all business owners, the life-blood of their business is their customer or client list. A customer list is really just another way of saying the list of previous, satisfied customers, or “goodwill.” Those previous customers are perhaps the best source of repeat business or new referrals. After all, a list of people who have already purchased a product is substantially more valuable than a list of people who only might be interested in purchasing it.

A customer list also gains value because of the costs incurred to build it. Through the investment of a great deal of time and money in building relationships and providing excellent goods or services, a business owner painstakingly develops a network of people who will hopefully keep money flowing into his or her business.

A Calculated Risk: Allowing Employees to Develop Relationships With Customers

However, as a business grows, the owner must bring in employees to help. Those employees are often exposed to the owner’s customers. By directly servicing those customers themselves on behalf of the business owner, the employee becomes familiar with the customers and builds their own sub-relationship. The customer may begin to think of the employee rather than the company as the go-to person that can satisfy their needs and answer their questions. By allowing this exposure and connection between customer and employee, the business owner takes a calculated risk and knows that some day the employee may leave the company, start their own business, and try to take those customers with them.

Legal Authority for Deeming Customer Lists as Trade Secrets

As many people know, the law of the state of California generally prohibits non-competition clauses in employment contracts. It is generally the policy of the courts to foster competition and a free-market economy. However, there is an exception to this rule in the context of customer lists. In particular, customer lists have been deemed by the courts to be bona fide “trade secrets.” In general, a trade secret is information that a) the business owner derives economic value from because it is not generally known to their competitors, and b) that the business owner uses reasonable efforts to maintain as a secret.

Fortunately, the courts have generally held that an employer’s customer list may be deemed a “trade secret” under California law. Under the Trade Secrets Act, codified atCivil Code §3426, et seq., and prior common law, a customer list may be a trade secret depending upon the nature of the business and characteristics of the customer base. In particular, the more difficult the information is to obtain, and the more time and resources expended by the employer, the more likely a court will find such information to be a trade secret. Morlife v. Perry (1997) 56 Cal.App.4th 1514, 1522. The employer must have spent time and effort identifying customers with particular needs or characteristics.San Jose Const., Inc. v. S.B.C.C. Inc. (2007) 155 Cal.App.4th 1528, 1539. However, if the information is readily-available to the public from business directories and the like, that information is not likely to be deemed a trade secret. Id.

Characteristics that support a claim for trade secret protection include the following:

  1. Products or services that are inherently difficult to sell. See American Credit Indem. Co. v. Sacks (1989) 213 Cal.App.3d 622, 631.
  1. Customer profiles containing specialized information on each customer that was not readily accessible to competitors and that may be decisive in gaining their patronage, such as their buying habits, product preferences, names of decision makers. See Aetna Bldg. Maint. Co. v. West (1952) 39 Cal.2d 198, 205.
  1. Knowledge regarding the special needs or susceptibilities of a customer, as opposed to price, quality, reliable deliver, and efficient service, is more likely to constitute a trade secret. Hollingsworth Solderless Terminal Co. v. Turley (9th Cir. 1980) 622 F.2d 1324, 1333-1334.

In those cases, as well as others, the courts have held that a customer list is a trade secret. In particular, courts have found that a customer list has economic value because its disclosure would allow a competitor to direct its sales efforts to those customers who have already shown a willingness to use a unique type of service or product as opposed to a list of people who only might be interested.

Nor does the fact that the former employee learned the trade secrets through their employment alleviate their obligation not to take advantage of that information after they leave the company. While it is true that the former employee cannot “wipe clean the slate of memory,” providing personal services to a customer whose identity is a trade secret does not render the customer fair game for solicitation. Sacks supra, at 636.

Stated differently,

Trade and business secrets and confidential information are the property of the employer and cannot be used by the employee for his own benefit. A list of subscribers for service, built up by ingenuity, time, labor, and expense of the employer, is a part of the goodwill of his business and in some instances, his entire business. Greenly v. Cooper (1978) 77 Cal.App.3d 382, 392.

In other words, the law recognizes that business owners invest substantial amounts of time and money in developing their customer list, and that those investments must be protected if businesses are to succeed. Customer lists are the intellectual property of the business that creates them, just like a patent, copyright or trademark. Without legal protection, these assets lose their value and businesses will fail.

An Ounce of Prevention

How does one harness this concept and apply it in practice? One way to guard against losing customers to former employees is to have employees sign contracts upon hire, or as a condition of continued employment, wherein they acknowledge that the company’s customer list is a valuable trade secret and that they will refrain from attempting to steal the customer list during their employment or when their employment ends. If the employee violates the agreement, the employer has a cause of action for breach of contract, as well as trade secret misappropriation. Adding clauses to the employment contract that make the breaching employee liable for liquidated damages and/or attorney’s fees can also serve as an added deterrent.

It is important to note that more than just a contract is necessary. The company must continue to treat the customer list as a secret, and limit access to the information contained therein to only a few key, higher-level employees. If the customer list becomes common knowledge around the office or beyond, it loses its trade secret character.

A Pound of Cure

Sometimes the contract and diligent secrecy is not enough and a former employee will decide that it is in their best interest to go ahead and steal the customer list anyway. In those cases, the employer is well within their rights to file a lawsuit against the former employee or the former employee’s new employer, alleging breach of contract, misappropriation of trade secrets, and various other causes of action. Such cases are difficult and cut against the general grain of non-competition. However, if handled properly and seen through to the end, they may be successful.