Google on Friday suffered a setback in its employment dispute with Microsoft over former Microsoft executive Kai-Fu Lee. Federal court judge Ronald Whyte issued a tentative ruling that clears the way for the case to proceed in state court in Washington, where the law favors Microsoft's position.

After Microsoft filed suit in Washington against Google and Lee, Google counter-sued in California, where the non-compete clause Lee signed as a Microsoft employee isn't recognized.

Under Washington state law, Microsoft's case has already proven sufficiently strong to win an injunction that limits the scope of activities Lee can perform for Google. The trial is scheduled for January of next year.

Whyte will likely issue his final ruling in the next few days early next week, and that ruling will likely keep the trial in Washington state, as Microsoft wants.

Last July, Microsoft sued Google and Lee, now working at Google, in a Washington state court to enforce the non-competition clause in Lee's Microsoft employment contract. The company won an injunction in September from a Washington court that limits the scope of activities Lee can pursue on behalf of his new employer.

In testimony filed in Washington state court over the summer, Lee recounted a conversation he had with Microsoft CEO Steve Ballmer after disclosing plans to leave. According to Lee, Ballmer told him, "If you leave, we would have to do something, and when we do something, please don't take it personally. We like you. Your contributions to Microsoft have been immense. It's not you we're after, it's Google."

Google countersued, asking Judge Whyte to invalidate the non-compete clause in Lee's employment contract with Microsoft because California doesn't recognize such agreements. In documents filed prior to today's hearing, Google's attorneys argued, "Microsoft desperately wants to keep this Court from deciding this case under California law. That is because Microsoft knows that the Covenant Not to Compete it is trying to impose on Dr. Lee is invalid and unenforceable under the black-letter law of [California]."

While it looks like Microsoft may get its way, there's still some hope for Google. Prior to finalizing his ruling, Judge Whyte held a hearing Friday morning in U.S. District Court in San Jose. He praised both sides for filing compelling legal briefs. "I think it's a tough case," he said.

Hoping to get the judge to change his tentative ruling, Google attorney Steven Taylor argued that the benefits of letting workers move freely between jobs outweighed the risk they might share proprietary knowledge with new employers. "California's interest in public policy is greater than Microsoft's interest in trade secrets," he said.

The judge posed probing questions to both sides. At one point, Microsoft attorney Michael Bettinger, of the firm Preston Gates Ellis LLP, argued that California's prohibition of non-compete agreements will receive due consideration in a Washington Court. Whyte responded: "[Lee's] injunction basically reads as your non-compete clause, does it not?"

Bettinger responded, "It's not like Dr. Lee is not working for Google. He's working for Google. He's recruiting in China."

Following the hearing, Karl Quackenbush, one of the attorneys representing Microsoft, summed up Microsoft's position: "Our argument is that a deal's a deal."

Neither side would comment on possible settlement talks.

Quackenbush expressed optimism that the final ruling would mirror today's tentative one. "I didn't hear anything today that suggested [Whyte would] change his mind," he said.