“In many states, employers may restrict former employees’ activity with employee contract provisions called “covenants not to compete” or "noncompetition agreements." California is one of the exceptions. Here, such agreements are generally not enforceable in court.”
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EMPLOYEE AGREEMENTS UPDATE
Common Noncompetition
Agreement Provision
Now Invalid
By Christopher W. Olmsted
When an employee leaves your company, chances are that he or she will go to work for a competitor. It is certainly unsettling to know that someone with inside knowledge of your company has fallen into the hands of a rival. Worse yet, that employee may seek to call on your clients or recruit your key employees.
In many states, employers may restrict former employees’ activity with employee contract provisions called “covenants not to compete” or "noncompetition agreements." California is one of the exceptions. Here, such agreements are generally not enforceable in court.
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."
California law includes five exceptions to this rule—no, make that four exceptions. A recent California Supreme Court case, Edwards v. Arthur Andersen, eliminated one of the exceptions. The five exceptions have been:
The purchaser of a business may restrict a seller from engaging in subsequent competition which would reduce the value of the property right acquired;
Partners may restrict a withdrawing partner from engaging in competition where there is a risk that a partnership's goodwill would be diminished;
Dissolving limited liability companies may restrict a partner from carrying on a similar business within a specified geographic area;
An employer may use a covenant to protect the employer's trade secrets;
A “narrow restraint” that only prohibits an employee from working in a narrow market segment (i.e., a little bit of restraint is ok).
In Edwards v. Arthur Anderson, the California Supreme Court Court eliminated the fifth exception. Mr. Edwards was an accountant for Arthur Anderson. When he was hired, the firm required him to sign a noncompete agreement that prohibited him from working for or soliciting certain Arthur Anderson clients for a 12 to 18 month period following termination.
In 2002, the federal government indicted Arthur Anderson in connection with the Enron debacle. The firm shut down and sold off parts of its practice to a bank. The bank offered to hire Mr. Edwards, but Arthur Anderson refused to release Mr. Edwards from his noncompete agreement.
Edwards filed suit against his employer, claiming that a noncompetition agreement was unenforceable. In opposition, Arthur Anderson pointed to the fifth exception regarding “narrow restraint.” It argued that under the terms of the agreement, Edwards could still work as an accountant, just not with Anderson’s clients.
Although the trial court held that the agreement was enforceable, on appeal a Second District Court panel reversed the decision in 2006, finding the agreement unenforceable. The California Supreme Court upheld the decision in 2008, confirming that the noncompetition agreement was unenforceable.
The court reasoned that the "narrow restraint" exception is contrary to California public policy favoring competition and the ability of citizens to work in their chosen professions. Although prior cases had recognized the narrow restraint exception, the exception was created by federal courts, not California state courts. The court held that the federal courts have misapplied California law, and that therefore those federal precedents are disregarded.
Take Away Tips:
Non-compete agreements are enforceable in California only in limited circumstances.
Any agreements restricting solicitation of business or the right to work for competitors ought to be reviewed and redrafted in light of the Edwards decision.
Trade secret and confidentiality agreements may be used to prevent employees from taking company information to competitors.
Conflict of interest policies may validly prevent employees from competing with the company during the term of employment (but not after termination).
Financial incentives to stay with the company, and financial disincentives for leaving the company (loss of bonuses, tuition reimbursements, etc), are generally valid. Courts have imposed a few restrictions on the disincentives.
Contact Chris Olmsted if you would like assistance updating your employee agreements.
More Legal Update articles.
Download entire September Legal Update in PDF format.
This article is intended as a brief overview of the law and are not intended to substitute as legal advice. Any questions or concerns regarding any statute or case law should be addressed to a licensed attorney. Copyright © 2008 by Barker Olmsted & Barnier, APLC. San Diego, California. All rights reserved.
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