Is the non-competition or non-solicitation provision in your California employment agreement legal?

There are three main types of restrictive covenants or non-competition agreements: (1) non-competition agreements between, (2) customer or client non-solicit agreements, and (3) employee non-solicit agreements.

Non-Competition Agreements

Restrictive covenants are governed by California Business and Professions Code §16600, et seq, and non-competes are unenforceable in California.[1]

Prior to 2008, a number of federal court decisions upheld some non-compete agreements under the Narrow Restraint Doctrine, meaning that if the restraint was narrowly tailored, it may be upheld.  In 2008, the California Supreme Court decided in Edwards v. Arthur Andersen LLP[2] that non-competition agreements are unenforceable under California law unless they are explicitly allowed by the exceptions in the Business and Professions Code Sections 16601, 16602 or 16602.5, or where they are restraining the misappropriation of trade secrets.[3]

Consequences for Attempting to Enforce Unlawful Non-Compete

An employer who attempts to include an unenforceable non-compete agreement could theoretically be in violation of California Civil Code 17200 as a form of unfair competition, or Labor Code 432.5 as a criminal violation.[4]

Where a non-compete is in the context of a sale of business, the agreement can restrict the employee from carrying on like business within a specific geographic area in which the business entity was sold or conducted, for as long as business is carried on by the buyer, other members, or anyone who derives title to the goodwill.[5]  The non-compete must be expressly tied to and incorporated into the sale transaction.[6]

Additionally, a subsequent employer can be liable for wrongful termination in violation of public policy if the employer terminates an employee to follow an unlawful non-compete agreement with the employee’s former employer.[7]

Exceptions – Statutory

There are three statutory exceptions to Section 16600’s prohibition: (1) sale of business (§ 16601), (2) dissolution or disassociation of a partnership (§ 16602), and (3) dissolution of a Limited Liability Company (§ 16602.5).

The employer has the burden of proof in showing that an exception applies to the general prohibition against non-competition agreements.[8]

Exceptions – Trade Secrets

Additionally, courts will enforce non-competes to the extent necessary to protect the actual or threatened misappropriation of trade secrets.  Under the version of the Uniform Trade Secret Act (“UTSA”) that has been adopted by California, a trade secret is “Information, including a formula, pattern, compilation, program, device, method, technique, or process, that: (1) Derives independent economic value, actual or potential, from not being generally known to the public or to other persons who can obtain economic value from its disclosure or use; and (2) Is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.”

Customer Non-Solicits

Customer or client non-solicitation agreements are unlawful in California unless the customer list qualifies as a trade secret or the non-solicit is necessary to protect the employer’s trade secrets.[9]

Employee Non-Solicits

Employee non-solicitation agreements prohibit former employees from soliciting employees at their former employer to leave the employer.  The 1985 case Loral Corp. v. Moyes found that employee non-solicitation agreements are valid. [10]  There has been discussion on whether employee non-solicits, which were not discussed in Arthur Andersen, would withstand its scrutiny and be considered “restraints on trade.”[11]  However, federal courts have continued to state that Loral is good law.[12]

Special Rules: Attorney Non-Competes

California Rules of Professional Conduct, Rule 1-500 prohibit a member of the California State bar from entering into an agreement to restrict the practice of law unless the agreement either (1) is part of an employment, shareholders’ or partnership agreement among members and does not survive the termination of employment, shareholder or partnership relationship, (2) requires payments to a member on the member’s retirement from the practice of law, or (3) is authorized by the state’s laws disciplining attorneys for professional misconduct.[13]

Choice of Law and Choice of Forum

There has been a trend of trying to incorporate choice of law and venue clauses designating states that are more favorable to non-compete agreements.  Under the Restatement (Second) of Conflict of Laws, §187, the law of the state chosen by the parties to govern their contract will be applied as long as there is a substantial relationship between the parties and transaction to the state and unless the application of that law would be contrary to a fundamental policy of a state which has a materially greater interest than the chosen state on that issue.

While some courts have accepted the choice of law and forum selection, Delaware likely will not.  In the Delaware Court of Chancery’s 2015 decision Ascension Insurance Holdings, LLC v. Underwood, the court found that a Delaware choice-of-law provision would not control where (1) the law of the “default state” (California) would otherwise apply, (2) enforcing the contract would conflict with a fundamental policy of the default state’s law, and (3) the default state has materially greater interest in whether the contract is enforced.[14]  The court then found that California law applied because the employee was a California resident, the agreement was negotiated in California, the non-compete provision applied primarily to California, and enforcement of the non-compete provision conflicted with California’s fundamental policy prohibiting such agreements under section 16600.[15]

Doctrine of Inevitable Disclosure

The doctrine of inevitable disclosure allows an employer to restrict an employee from competing based on the fact that the employee had access to trade secrets and it is inevitable that he or she will use the confidential information in the new job.  It is unavailable in California because it is a covenant not to compete that restricts employee mobility.[16]

Blue-Penciling

Courts will not modify or blue pencil employment non-compete agreements.[17]  However, courts may blue pencil agreements to allow them to be enforced under one of the statutory exceptions.[18]

[1]Cal. Bus. &’ Prof. Code §§ 16600-16607 (“Except as provided in this chapter, every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.”).  Note that North Dakota and Oklahoma also do not enforce non-competition agreements.

[2] Edwards v. Arthur Andersen LLP, 44 Cal. 4th 937 (2008).

[3] Edwards v. Arthur Andersen LLP, 44 Cal. 4th 937 (2008) (“Section 16600 is unambiguous, and if the Legislature intended the statute to apply only to restraints that were unreasonable or overbroad, it could have included language to that effect.”).

[4] Cal. Lab. Code § 432.5 states “No employer, or agent, manager, superintendent, or officer thereof, shall require any employee or applicant for employment to agree, in writing, to any term or condition which is known by such employer, or agent, manager, superintendent, or officer thereof to be prohibited by law.”

[5] Cal. Bus. &’ Prof. Code § 16601.

[6] Fillpoint, LLC v. Maas, 208 Cal. App. 4th 1170, 1180 (2012).

[7] Silguero v. Creteguard, 187 Cal. App. 4th 60 (2010).

[8] KGB, Inc. v. Giannoulas, 164 Cal.Rptr. 571, 576 (Ct. App. 1980)

[9] Edwards v. Arthur Andersen LLP, 44 Cal. 4th 937 (2008) (finding clause that prevented employee from soliciting the employer’s Los Angeles clients for one year after termination restricted his ability to practice his accounting practice); Thompson v. Impaxx, Inc., 113 Cal. App. 4th 1425, 1429 (2003)(“‘Antisolicitation covenants are void as unlawful business restraints except where their enforcement is necessary to protect trade secrets.'”).

[10] Loral Corp. v. Moyes, 174 Cal. App. 3d 268 (1985)( holding that a contract clause restricting the plaintiff’s former employee from disrupting, damaging, impairing or interfering with the plaintiff by “raiding” its employees did not violate section 16600. The court noted that the clause which prohibited an employee raid did not violate § 16600 because the plaintiff’s current employees were free to apply for positions with the defendant’s new employer so long as they were not recruited by the defendant.).

[11] See, e.g.Fillpoint, LLC v. Maas, 208 Cal. App. 4th 1170 (2012) (noting in dicta that employee non-solicitation covenant at issue “depends entirely on section 16601[(sale of business exception)] for its survival.”

[12] Thomas Weisel Partners LLC v. BNP Paribas, 2010 U.S. Dist. LEXIS 11626 (N.D. Cal. 2010); MSC Software Corporation v. Altair Engineering, 2014 U.S. Dist. Lexis 134165 at *6-8 (E.D. Mich. 2014).

[13] Cal. Rules of Professional Conduct, R. 1-500.

[14] Ascension Insurance Holdings, LLC v. Underwood, 2015 Del. Ch. LEXIS 19, 2015 WL 356002 (Del. Ch. Jan 28, 2015) (unpublished).

[15] Ascension Insurance Holdings, LLC v. Underwood, 2015 Del. Ch. LEXIS 19, 2015 WL 356002 (Del. Ch. Jan 28, 2015) (unpublished).

[16] Schlage Lock Company v. Whyte, 101 Cal. App. 4th 1443 (2002).

[17] Kolani v. Gluska, 64 Cal. App. 4th 402, 408 (1998).

[18] Kolani v. Gluska, 64 Cal. App. 4th 402, 408 (1998)(“Several decisions ‘saved’ covenants not to compete by narrowly construing them, but these covenants were contained in agreements to sell goodwill, where such covenants are permitted under Business and Professions Code section 16601. (General Paint Corp. v. Seymour (1932) 124 Cal. App. 611, 614 . . . John F. Matull &’ Associates, Inc. v. Cloutier (1987) 194 Cal. App. 3d 1049.”).

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