When an employee is sued by his or her employer for alleged wrongdoing related to the job, and the employee wins, does the employer have to pay the employee's attorney fees? In Nicholas Laboratories, LLC v. Chen,¹ published on October 12, 2011, a California Court of Appeal answered “no,” at least not under California Labor Code section 2802.

In that case, Nicholas Labs sued its own director of information technology, Christopher Chen, alleging that he engaged in a side-business that competed with the company, diverted business opportunities away from the company, stole certain computers and printers, and misused a company credit card, among other things.² Chen responded with a cross-complaint against his employer, arguing that the company should have to pay his legal bills if he wins the case. On the verge of trial, Nicholas Labs agreed to dismiss its claims against Chen as long as Chen agreed to let the judge, instead of a jury, decide his cross-complaint for attorneys’ fees.

Chen argued 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 the 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 Nicholas Labs was an LLC, which was not covered under that section of the Corporations Code.

Finally, the court addressed Labor Code section 2802. Section 2802 requires an employer to “indemnify” his or her employee for all necessary expenditures or losses incurred by the employee in direct consequence of the discharge of his or her duties. The question of first impression presented was whether section 2802 requires an employer who unsuccessfully sues its employee to foot the employee’s legal costs? Generally, the court explained, the word “indemnify” implies an employer’s obligation to pay the employee’s defense fees if the employee is sued by a third party for acts taken by the employee in the course of his or her job.

The court found little guidance in prior case law, but the court’s consideration of the “more expansive fabric of the law suggests that any interpretation of section 2802 which would allow the statute to become a unilateral attorney fee statute in litigation between employees and employers would be incompatible with that larger body of law.” For example, the California Uniform Trade Secrets Act only allows a successful party to be awarded attorneys’ fees under limited circumstances, such as where the employer’s suit against the employee for misappropriation of trade secrets was made in “bad faith.” Cal. Civ. Code § 3426.4. Construing Labor Code section 2802 to automatically award attorneys’ fees to an employee who successfully defends any suit by his/her employer would contradict the Trade Secrets Act, as well as other laws pertaining to attorneys’ fees.

In a footnote, the court addressed another significant issue and commented that an employee does not need to win an employment-related lawsuit brought by a third party in order to be entitled to indemnification by the employer for defending against such a lawsuit. As long as the employee was acting within the scope of his or her employment, or in obedience to the employer’s direction, the employer is obligated to pay the employee’s legal fees—even if the employee ends up losing the lawsuit. Likewise, if an employer refuses to pay when it is obligated to do so, the employer will also be forced to pay the legal fees run up by an employee who subsequently is required to sue the employer to obtain the proper reimbursement.

In general, the Nicholas Laboratories decision reinforces the so-called “American Rule” of attorneys’ fees—unless a specific law or contract says otherwise, each side pays their own fees. As a result, Nicholas Laboratories provides some protection for employers who sue their employees in California for wrongful conduct, such as misappropriation of trade secrets or other unfair competition, while still providing protection for employees who are sued by third parties for acts taken in the scope of their employment.

¹ Case No. G044105, Fourth Appellate District, California Court of Appeal.

² The claims alleged in the complaint included 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.

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