California Appellate Court Rejects Automatic Attorneys' Fees to an Employee who Successfully Defends Against Lawsuit by Employer

California Labor Code section 2802 generally requires employers to indemnify their employees for losses the employee incurs within the scope of employment. As one common example, section 2802 requires an employer to indemnify an employee for attorneys' fees if the employee is sued by a third party, such as a customer, concerning conduct that falls within the scope of employment. But what about legal fees incurred by an employee in defending against a lawsuit by the employer itself, such as for unfair competition or misappropriation of trade secrets?

Resolving an issue of first impression, in Nicholas Laboratories, LLC v. Chen,1 published on October 12, 2011, a California Court of Appeal held that section 2802 does not require an employer to indemnify an employee for attorneys' fees incurred in defending a lawsuit brought by the employer against the employee, even if the employee prevails. In that case, Nicholas Labs filed an action against its own director of information technology, Christopher Chen, alleging that Chen engaged in a side-business that competed with the company, diverted business opportunities away from Nicholas Labs, stole certain computers and printers, and misused a company credit card, among other things. Nicholas Labs alleged claims against Chen including breach of contract, breach of the implied covenant of good faith and fair dealing, conversion, negligence, money had and received, unjust enrichment, and constructive trust. Chen responded by filing a cross-complaint against Nicholas Labs, seeking indemnification of his attorneys' fees. On the verge of trial, Nicholas Labs agreed to dismiss its claims against Chen provided that Chen's cross-complaint would be submitted to the judge.

Chen alleged that Nicholas Labs was required to pay his attorneys' fees of about $90,000 by virtue of: (1) an indemnification clause in a certain operating agreement; (2) California Corporations Code section 317; and (3) California Labor Code section 2802. Both the trial court and Court of Appeal rejected all three theories.

First, the operating agreement did not apply because Chen did not work for the entity that was a party to the operating agreement—instead, he worked for a related entity, Nicholas Labs, that had no operating agreement with an indemnification clause.

Second, Corporations Code section 317, which requires a corporation to indemnify legal expenses incurred by its agents under some circumstances, did not apply because...