NON-COMPETITION CLAUSES UNDER CALIFORNIA LAW

IVAN HOFFMAN, B.A., J.D.


        California law is very strict in terms of making sure that parties are not restricted in their abilities to compete in the marketplace.  Unlike some other states, California has held provisions in agreements that restrict this competition to be void.  In addition, even where trade secrets are potentially at risk, California has refused to prevent a party from accepting employment with a competitor simply because there is a claim that disclosure of the former employer’s trade secrets is “inevitable.”  There must be actual or threatened disclosure.  Read “Inevitable Disclosure of Trade Secrets.”

        California Business and Professions Code section 16600 provides:

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.
        A recent California Supreme Court decision (Edwards v. Arthur Andersen & Company) has again affirmed this California policy.  This is the Court’s summary of the facts, in part:
In January 1997, Raymond Edwards II (Edwards), a certified public accountant, was hired as a tax manager by the Los Angeles office of the accounting firm Arthur Andersen LLP (Andersen). Andersen's employment offer was made contingent upon Edwards's signing a noncompetition agreement, which prohibited him from working for or soliciting certain Andersen clients for limited periods following his termination. The agreement was required of all managers, and read in relevant part: "If you leave the Firm, for eighteen months after release or resignation, you agree not to perform professional services of the type you provided for any client on which you worked during the eighteen months prior to release or resignation. This does not prohibit you from accepting employment with a client. [¶] For twelve months after you leave the Firm, you agree not to solicit (to perform professional services of the type you provided) any client of the office(s) to which you were assigned during the eighteen months preceding release or resignation. [¶] You agree not to solicit away from the Firm any of its professional personnel for eighteen months after release or resignation." Edwards signed the agreement.
        When Anderson got involved in the Enron scandal, it sold off parts of its practice and Edwards eventually was offered employment by HSBC.  In the Court’s words:
Before hiring any of Andersen's employees, HSBC required them to execute a "Termination of Non-compete Agreement" (TONC) in order to obtain employment with HSBC. Among other things, the TONC required employees to, inter alia, (1) voluntarily resign from Andersen; (2) release Andersen from "any and all" claims, including "claims that in any way arise from or out of, are based upon or relate to Employee's employment by, association with or compensation from" defendant; (3) continue indefinitely to preserve confidential information and trade secrets except as otherwise required by a court or governmental agency; (4) refrain from disparaging Andersen or its related entities or partners; and (5) cooperate with Andersen in connection with any investigation of, or litigation against, Andersen. In exchange, Andersen would agree to accept Edwards's resignation, agree to Edwards's employment by HSBC, and release Edwards from the 1997 noncompetition agreement.

HSBC required that Andersen provide it with a completed TONC signed by every employee on the "Restricted Employees" list before the deal went through. At least one draft of the Restricted Employees list contained Edwards's name. Andersen would not release Edwards, or any other employee, from the noncompetition agreement unless that employee signed the TONC. {Slip Opn. Page 4}

Edwards signed the HSBC offer letter, but he did not sign the TONC. fn. 2 In response, Andersen terminated Edwards's employment and withheld severance benefits. HSBC withdrew its offer of employment to Edwards.

        Edwards brought suit.
Edwards alleged that the Andersen noncompetition agreement violated section 16600, which states "[e]xcept 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." He further alleged that the TONC's release of "any and all" claims violated Labor Code sections 2802 and 2804, which make an employee's right to indemnification from his or her employer nonwaivable.
The Law

        In many states, the law regarding non-compete provisions allows for a balancing of factors.  Such provisions tend to be enforceable if they are “reasonable” in terms of length of time and geographic area of restriction.  The Court reviewed the common law and the statutory law of California before 1872 and concluded, as have other California courts:

Today in California, covenants not to compete are void, subject to several exceptions discussed briefly below.
    The Court stated those exceptions, which did not apply to this case:
The chapter excepts noncompetition agreements in the sale or dissolution of corporations (§ 16601), partnerships (ibid.; § 16602), and limited liability corporations (§ 16602.5).
        The Court went on:
This court has invalidated an otherwise narrowly tailored agreement as an improper restraint under section 16600 because it required a former employee to forfeit his pension rights on commencing work for a competitor. (Muggill v. Reuben H. Donnelley Corp. (1965) 62 Cal.2d 239, 242-243 (Muggill); Chamberlain v. Augustine (1916) 172 Cal. 285, 289 [invalidating contract with partial trade restriction].) In Muggill, the court reviewed an adverse judgment against a company's retired employee whose pension plan rights were terminated after the former employee commenced work for a competitor. (Muggill, at p. 240.) The retired employee had sued the former employer, seeking declaratory relief on the ground that the provision in the pension plan that terminated the retirement payments because the retiree went to work for a competitor was "against public policy and unenforceable." (Ibid.) Muggill held that, with exceptions not applicable here, section 16600 invalidates provisions in employment contracts and retirement pension plans that prohibit "an employee from working for a competitor after completion of his employment or imposing a penalty if he does so [citations] unless they are necessary to protect the employer's trade secrets [citation]." (Muggill, at p. 242.) fn. 4 In sum, following the Legislature, this court generally condemns noncompetition agreements. (See, e.g., Armendariz v. Foundation Health Psychcare Services, Inc. (2000) 24 Cal.4th 83, 123, fn. 12 [such restraints on trade are "illegal"].)

We conclude that Andersen's noncompetition agreement was invalid. As the Court of Appeal observed, "The first challenged clause prohibited Edwards, for an 18-month period, from performing professional services of the type he had provided while at Andersen, for any client on whose account he had worked during 18 months prior to his termination. The second challenged clause prohibited Edwards, for a year after termination, from 'soliciting,' defined by the agreement as providing professional services to any client of Andersen's Los Angeles office." The agreement restricted Edwards from performing work for Andersen's Los Angeles clients and therefore restricted his ability to practice his accounting profession. (See Thompson v. Impaxx, Inc. (2003) 113 Cal.App.4th 1425, 1429 [distinguishing "trade route" and solicitation cases that protect trade secrets or {Slip Opn. Page 11} confidential proprietary information].) The noncompetition agreement that Edwards was required to sign before commencing employment with Andersen was therefore invalid because it restrained his ability to practice his profession. (See Muggill, supra, "62 Cal.2d at pp. 242-243.)

        There was an additional discussion about the waiver and release agreement but for purposes of this article, that issue is not relevant.  However, any employer seeking to get an employee, upon termination, to sign a release should absolutely consult an attorney in California about this proposed document.

Conclusion

        If California law applies to a given transaction, it appears that virtually any form of non-compete provisions (other than those expressly set forth in the statute) are likely to be unenforceable.  And this likely applies as well even when there is the possibility, but not actual disclosure of, trade secrets.

Consult an experienced attorney in California.

Copyright © 2008 Ivan Hoffman.  All Rights Reserved.

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This article is not legal advice and is not intended as legal advice.  This article is intended to provide only general, non-specific legal information.  This article is not intended to cover all the issues related to the topic discussed.  The specific facts that apply to your matter may make the outcome different than would be anticipated by you.  This article is based on United States law.  You should consult with an attorney familiar with the issues and the laws of your country.  This article does not create any attorney client relationship and is not a solicitation.

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