California Non-Competes, Quirky Question # 55

Quirky Question # 55:

We have a highly mobile workforce, and we are concerned about our former employees going to work for a competitor, stealing our customers, and raiding our employees.  We are a technology based company and have developed proprietary information that would give our competitors an edge if our former employees were to use or disclose it to them.  We are based in California and understand that it has a very narrow view of non-competition agreements.  It seems very unfair.  If we put provisions into our contracts to try to stop this from happening, what are the chances that the contract will be enforceable?

[Quirky Question # 55 is another one of our California Questions.  As such, I have requested one of my California colleagues to provide the analysis.  The analysis below was written by Karen Wentzel of our Palo Alto office.  As I’ve described previously, Karen is a Stanford Law School grad, who has been practicing employment law for more than 20 years.  Karen’s biography can be found at www.dorsey.com.  Her email address is:  wentzel.karen@dorsey.com.  If you would like to see other analyses provided by Karen, click on the “View by Topic” box to the left of this posting, and scroll down to “California Questions.”  Click on that category and other California questions will be displayed.

If you have any particularly unusual questions pertaining to California law, you can send them either to Karen or me.]

Karen’s Analysis:

This is a question that attorneys in California are asked all the time, especially from companies with multi-state operations.  And, as is the case in many arenas, California marches to the beat of its own drummer.  The short answer is that non-compete provisions in employment agreements are very rarely enforceable in California.

The California Supreme Court recently affirmed this conclusion and in doing so, underscored California’s strong public policy in favor of open competition and employee mobility.  In a long-awaited ruling, the Court in Edwards v. Arthur Andersen LLP, S147190 (Cal. August 7, 2008) held that California Business & Professions Code 16600 unambiguously prohibits post-employment restrictions unless the agreement falls within statutorily enumerated exceptions, and it is not up to the courts to adopt additional “narrow-restraint” exceptions.

The employment agreement at issue in Edwards included fairly typical non-compete clauses.  The plaintiff,  Raymond Edwards (“Edwards”), worked as an accountant for Arthur Andersen LLP (“Andersen”).  As a condition of his employment, he signed a non-competition agreement which prohibited him from performing certain professional services for his former Andersen clients for 18 months and from soliciting any former clients for 12 months following his termination.  It also prohibited him from soliciting professional personnel for 18 months after his departure.  In the wake of Andersen’s indictment in the Enron scandal, Edwards’ practice group was sold to HSBC USA (“HSBC”).

Before hiring any of Andersen’s employees, HSBC required them to sign a “Termination of Non-Compete Agreement” (“TONC”) pursuant to which the employees would be released from the non-competition agreement with Andersen in exchange for a full release of “any and all claims” against Andersen.  Andersen refused to release any employees from the non-competition agreement unless the employee signed the TONC.  Edwards, worried that he could be sued as part of the Enron debacle, refused to sign the TONC, believing that he could be giving up his right to indemnification by Andersen if he did so.  In response, Andersen terminated Edwards’ employment and withheld severance benefits, and HSBC withdrew its offer of employment.

Edwards sued Andersen for intentional interference with prospective economic advantage, arguing that it was a violation of public policy to require him to sign the TONC to be released from an agreement that was unenforceable under Business and Professions Code 16600.  The trial court, following caselaw from the federal Ninth Circuit in California, decided that the non-competition agreement did not violate Section 16600 because it was narrowly tailored and did not completely deprive Edwards of his right to pursue his profession.

The Court of Appeal and the Supreme Court both disagreed.  Citing the express language of Section 16600, the Supreme Court rejected any “rule of reasonableness” or “narrow-restraint” exception that would uphold a non-competition agreement so long as it did not completely preclude the employee from engaging in a lawful profession, trade or business.  The court concluded, “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.”  The only exceptions are those set forth in the statute itself that allow non-competes in the context of a sale or dissolution of a corporation, partnership, or limited liability corporation where the individual granting the non-compete has an equity interest in the business being sold (e.g., a shareholder or a partner).

In short, the Court’s ruling affirms a strict interpretation of Section 16600.  Any agreements that purport to per se limit an employee’s ability to work for a competitor or solicit former clients or customers will not be enforced in California.

It is important to note, however, that the Court expressly declined to address the so-called “trade secret exception” to Section 16600, which allows an employer to prohibit an employee from using trade secrets to solicit former customers.  California does not follow the “inevitable disclosure” doctrine, which in some states may be relied upon to create a presumption that an employee going to work for a competitor will necessarily use his or her former employer’s trade secrets while working for the competitor.  But, to the extent an agreement prohibits a former employee from using trade secrets to compete unfairly, it will still be enforceable.

What this means is that it is ever-more important for employers to take precautionary steps to ensure that their confidential business information will be protected as trade secrets.  These steps might include identifying information the employer considers trade secret; having a policy that all confidential information is in some way marked “Confidential;”  asking employees (and where appropriate third parties) to sign a Confidentiality and Non-Disclosure Agreement that sets out their duties not to use or disclose proprietary information; and implementing workplace security procedures, including policies and procedure to protect computerized information.

In addition, the Court also declined to specifically decide whether the provision in the agreement prohibiting Edwards from recruiting employees violated Section 16600.  In general, one employee may solicit another to leave current employment to work for a competitor if the solicited employee is not under a contract of employment.  However, knowledge of which employees are the top performers is arguably confidential information.  And, existing caselaw in California has upheld “anti-raiding” clauses so long as they are reasonable in scope and limited to “non-solicitation” of employees, i.e., the provision cannot purport to be a “no-hire” clause.  For the time being, this continues to be the case, but it is not likely to be long before this concept is also tested head-on in the courts in light of the Edwards case.

The bottom line is that California courts will not enforce provisions in agreements that attempt to limit outright an employee’s ability to work for a competitor or go after former customers even if in another state they might be considered reasonable restrictions.  Only if an employee is using trade secrets to compete unfairly will a non-compete provision be upheld.  What becomes even more important, therefore, is that all employers take steps to protect their confidential business information from improper use or disclosure.

Dorsey & Whitney

Dorsey & Whitney

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