Diamonds Are Forever, but Joint Ventures Are Not: Court Finds Claims Preempted by CUTSA in Business Deal Gone Bad

The holiday season is officially upon us: peppermint mochas have popped up on coffee shop menus, carols ring from department store speakers, and you can’t turn on the television without seeing at least three diamond commercials. But it’s not all yuletide and merriment for those in the diamond business. As one diamond importer and wholesaler recently learned, sometimes instead of a gem you get a lump of coal—in this case, from the Northern District of California, which tossed out certain claims against a former business partner on the grounds those claims were preempted by the California Uniform Trade Secrets Act.

The case, Kapu Gems v. Diamond Imports, Inc., began when Kapu Gems (“Kapu”) sued Diamond Imports (“Diamond”) over unpaid invoices and allegedly converted goods, all stemming from a joint venture gone wrong. Diamond then brought a counterclaim against Kapu. According to Diamond, the two companies had agreed to open a San Francisco office of the India-based Kapu, with Diamond handling all sales of diamonds in the United States.  In connection with this joint venture, and in exchange for Kapu’s promise to never contact Diamond’s customers without its knowledge and consent, Diamond shared its confidential customer and price list and introduced Kapu to its customers, including online-fine jewelry retailers Blue Nile, Brilliant Earth, and Ritani. But Diamond claimed it was all a ruse to gain a foothold in the American market; shortly thereafter, Kapu began directly soliciting Diamond’s customers and undercutting its prices, causing Diamond to lose 75% of its United States customers over two years.

Diamond asserted counterclaims for misappropriation of trade secrets, interference with business relationship, and unfair competition. Kapu answered the misappropriation claim, but moved to dismiss the other two on the ground that they were preempted by California’s Uniform Trade Secrets Act (CUTSA).

In a ruling issued November 22, 2016, the district court agreed with Kapu and granted the partial motion to dismiss. The court found that the business-interference claim was based on the same nucleus of facts as the misappropriation claim, bringing it within the scope of CUTSA preemption. Although Diamond alleged that Kapu committed an independently wrongful act by fraudulently inducing the joint venture, the court found that the alleged inducement was “merely the means by which Kapu Gems gained access” to Diamond’s trade secrets, and therefore the interference claim was preempted.  Diamond’s unfair-competition claim suffered the same fate. Diamond alleged that the “unfair business practices” giving rise to its claim were actions taken by Kapu to fraudulently induce entry into the joint venture and obtain Diamond’s confidential information. Thus, because misappropriation of trade secrets was the true “gravamen” of the claim, the court found that it too was preempted.

The court’s ruling goes to show that even if you wrap your non-contractual claims in pretty paper and put a nice bow on top, if they’re just misappropriation claims in disguise, Santa is going to put you on the naughty list.