After facing the daunting task of litigating the enforceability of a non-competition agreement signed by a business partner and close friend, we wrote an extremely informative letter / article on Non Competition Agreement Laws in Arizona. In order to share our information and research with as many people as possible we have decided to write an article on invalidating non-competition Agreements in California Law. When delivered a letter expressing a former employers attempt to enforce a non-compete agreement or even further being served with a lawsuit for breach of a non-compete agreement do not panic. Understand that the law is always in your favor when it comes to non-compete agreements and that with a simple understanding you can get out of your non-competition agreement. This article specifically pertains to California law which is one of the least flexible states in terms of enforceability of the Covenant Not To Compete.
California Business and Professions Code section 16600 explicitly states: "Except as provided in this chapter, every contract by which anyone is restrained from engaging in lawful profession, trade or business of any kind is to that extent void."
By the explicit language of the California Business and Profession Code, it would seem that all non-competition and covenant not to compete agreements would be void as a matter of law. However chances are if you are reading this blog, you are an employer seeking to have an employee sign an agreement or seeking to enforce an agreement against a former employer. On the other hand, you may be an employee seeking information on how to get out of your non-competition agreement or covenant not to compete. Companies spend nearly billions in California alone to enforce non-compete agreements because despite what the explicit law states, businesses, employers, employees, and entrepeneurs have opposed interests and rights in this area of labor law.
Budding entrepeneurs and employees in California often argue that Business & Professions Code Section 16600 is quite simple and straightforward and explicitly voids in California any contract term that prevents the employee from working for a competitor or him or herself. Specifically, restrictions in any way on the employee's right to work as an entrepeneur or for a competitor are illegal as a matter of law and cannot be enforced.
The explicit language of the California Business & Profession Code Section 16600 would suggest this approach, however the issue becomes unclear if the employee had access to confidential or proprietary information. Section 16600 of the California code does not give a fired or resigning employee an unrestricted right to do whatever he or she wants such as using misappropriated information to compete against the former employer or giving that misappropriated information to your ex-employer so that he / she can benefit from the information.
Employers and companies argue that while California's Business and Profession Code appears extremely restrictive as a "Right to Work" statute, it clearly permits reasonable contracts or agreements to protect an employer's proprietary or confidential information. Examing the law from the surface, this is a true statement of law.
The companies concerns are valid because since the beginning of time, there have been dishonest former employees stealing a company's ideas, techniques, methods and precesses in order to use them to establish their own business. However despite each company's concerns, most companies in all states act dishonestly and employ methods to squash lawful competition by attempting to enforce these agreements.
Typically, a company is often willing to invest huge sums of money for the preliminary battles over a non-compete agreement regardless of the merits of a dispute, because typically, the employee or new start up does not hav ethe means to fully finance a protracted legal battle over the enforceability of a non-compete agreement. However an employee must not fear a potential legal battle, many battles can be averted with a simple letter explaining the sides and terms of the non-compete situation. Additionally, courts are generally quick to toss out frivolous claims and assess penalties against Plaintiff's pursuing frivolous claims.
With that background, let's examine the current case law precedent and its application to facts.
The status of California non-competition law in the labor law sector is constantly changing. Many California courts have interpreted the Business and Professions Code statute to prohibit and thus as a matter of law invalidate non-compete agreements. An employer however will quickly state that there is confidential or proprietary information being used and the courts must evaluate. One of the biggest flaws in Section 16600 is that the Business statute does not provide for the mandatory recovering of attorney's fees and costs expended to fight and protect against a company's illegal use of non-compete agreements. Whereas states like Arizona provide for mandatory attorneys' fees to be paid by the employer.
I. Non Competition Agreements Are Generally Invalid
California Business and Professions Code section 16600 (“Section 16600”) provides that “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 courts typically interpret the statute broadly and refuse to enforce Non Competition Agreements. Except in narrowly drawn, statutorily defined circumstances, discussed below, California courts deem them to violate California’s public policy that promotes freedom of competition and an employee’s right to move between jobs. Consequently, California courts typically invalidate Non Competition Agreements. Hill Medical Corp. v. Wycoff, 86 Cal. App. 4th 895 (2001).
II. Courts Will Not Rewrite Non-Competition Agreements To Make Them Enforceable
Even if an employment agreement contains a clause evidencing the parties’ desire to rewrite a covenant not to compete should it be deemed unenforceable, California law prohibits such revision. A clause that is invalid under Section 16600 is illegal and California courts have deemed the rewriting of illegal covenants unacceptable. Hill Medical Corp. v. Wycoff, 86 Cal. App. 4th 895 (2001); Kolani v. Gluska, 64 Cal. App. 4th 402 (1998).
III. If Enforcement of a Covenant Not To Compete Is Sought in a California Court, California Law Will Be Applied
California courts will apply California law in order to enforce its public policy favoring competition even if a contract designates the law of another state or country as the applicable law. Thus, when a contract designates law other than California law to govern a Non Competition Agreement, a California court will apply California law and render the covenant void unless the agreement falls within an exception or the other state’s interest is more significant than California’s. For example, where an employment agreement designating Maryland law as governing was drafted and entered into by an employer and employee in Maryland, the California court declined to enforce the Non Competition Agreement when the employee left the employer and moved to California to work for a competitor in violation of the agreement. Although Maryland law would have upheld the Non Competition Agreement, the California court ruled that enforcing it would violate California’s public policy of promoting and protecting open competition. The court ruled that enforcing the covenant would more substantially impair California’s interest in enforcing its public policy than Maryland’s interests in upholding the non-compete agreement. As a result, the court applied California law and voided the clause. Application Group, Inc. v. Hunter Group, Inc., 61 Cal. App. 4th 881 (1998). Even though they have refused to enforce Non Competition Agreements governed by the laws of other states, California courts have not gone so far as to enjoin the courts of another state from enforcing Non Competition Agreements. In one case, an employee left his Minnesota employer to work for a California competitor. The employee tried to use California law to prevent the application of a Non Competition Agreement. Rather than waiting to challenge the covenant’s enforcement, the employee sued in a California court to enjoin the Minnesota employer from starting proceedings to enforce the covenant in a Minnesota court. The Supreme Court of California bowed to principles of comity and judicial restraint in not upholding the injunction even though its application would promote California public policy. The court reasoned that it would have been disrespectful to deem the law of California so much more worthy than that of another state and that doing so was an indirect challenge to the dignity and authority of the tribunal of the other state. Advanced Bionics Corp. v. Medtronic, Inc., Cal. 4th 697 (2002).
IV. Employers May Not Force an Employee To Sign a Non Competition Agreement
Generally, California employers may not force their California employees to sign non-compete agreements. Making the signing of an unlawful agreement a condition of employment warrants a claim for wrongful termination. Even asking an employee to sign a Non Competition Agreement or using a signed covenant against an employee or subsequent employer may lead to suits for unfair competition.
V. The Permissible Scope Of The Statutory Exceptions
California’s Business and Professions Code allows a buyer of a company’s goodwill, a partner, or member of a limited liability company to restrict sellers of business interests or departing partners or members from carrying on similar business “within a specified geographic area” in which the business, partnership, or limited liability company has transacted business. Under this rule, California courts have upheld Non Competition Agreements encompassing the entire United States and beyond. So long as a party can show that some business was conducted in those areas, the court may uphold the covenant. Because the exceptions serve to protect goodwill, they cover the area in which goodwill is in need of protection. This has been construed to be the area in which a business’ goodwill has been established, evidenced by where sales, production and phases of the business have been conducted, as well as the area where the business reasonably established its goodwill based on particular business activities being carried on there, such as promotional and marketing activities. Allowing the scope of the covenant to span the breadth of the practice or business comports with the reasonableness requirement of a Non Competition Agreement’s geographic scope. Monogram Indus., Inc. v. Sar Indus., Inc., 64 Cal. App. 3d 692 (1976) (upholding a covenant against a challenge that its geographic scope was overly broad by showing that the company’s goodwill extended or could reasonably be expected to extend to the areas restricted by the agreement); Roberts v. Pfefer, 13 Cal. App. 3d 93 (1970) (allowing a covenant falling within Section 16602 to span beyond the city or town in which the partnership was physically located). Although a Non Competition Agreement must have a limit to its geographic scope, it is not clear whether a Non Competition Agreement must actually designate a specific area of application or whether it is sufficient for the covenant merely to specify that it applies in all areas where a company has transacted business. The statute’s language, January 2004 Enforceability Of Non Competition Agreements In California “specific geographic area,” would appear to require explicitness but courts have not answered this question. Because of the uncertainty in this area, it may be best for someone seeking to enforce a Non Competition Agreement to be specific when designating the geographic scope of the covenant. Fleming v. Ray-Suzuki, Inc., 225 Cal. App. 3d 574 (1990).
Sections 16601, 16602, and 16602.5 specify that Non Competition Agreements can prohibit competition for as long as the buyer of the interest, or anyone gaining title to the interest, other partners, or other members of the limited liability company carry on a like business. Thus, covenants under these sections potentially may last for numerous years. In one case, two brothers engaged in business together agreed that the brother leaving the business would not participate in a competing business in the San Diego area. The final written contract mistakenly omitted the clause. The court found there was sufficient evidence that the covenant was part of the agreement and narrowed the duration so that the brother leaving the business was only prevented from competing with his former business for as long as it carried on a like business in the area. Martinez v. Martinez, 41 Cal. 2d 704 (1953); see also Loral Corp. v. Moyes, 174 Cal. App. 3d 268 (1985) (“We also observe the Legislature has allowed business sellers to promise non-competition to their buyers without time limitation other than for the period ‘so long as the buyer, or any person deriving title to the goodwill or shares from him, carries on a like business therein.’”).
Sections 16601 through 16602.5 provide that covenants may prohibit sellers of business interests, former partners or former members from engaging in any competing business activity in a specified geographic area. Monogram Indus., Inc. v. SAR Indus., Inc., 64 Cal. App. 3d 692 (1976). Thus, although courts may adhere to the concept that a covenant must be reasonable in terms of the activity that it limits, courts have interpreted these sections to reasonably exclude all competing activity from appropriate geographic regions. Isolated instances of competition, however, are not permissibly restricted under the statutory exceptions. The purpose of the exceptions is to allow businesses, partnerships, and limited liability companies to protect themselves from substantial detriment to their competitive position. Because occasional transactions do not typically threaten such an impact, the statute meant to target the solicitation of significant business from the business, partnership, or limited liability company. Swenson v. File, 3 Cal. 3d 389 (1970).
VI. Practical Tips and Suggestions For Creating a Non-Compete Agreement
Despite the difficulty in enforcing covenants not to compete in employment agreements, employers have several methods of protecting their interests. These include the following:
Confidentiality Agreements – Employers should include a confidentiality provision in the employment agreement that defines trade secrets to include, if applicable, customer lists, customer contacts, vendor lists, vendor contacts, pricing lists, product information and testing results, and strategic business and other similar information. Although the employee may take employment with a company competitive with the employer, the employee may not use the protected information against the employer. If practical, the employer should restrict access to trade secrets and maintain a log of all trade secrets provided to the employee.
Covenant Not to Solicit Customers – Employers should include in the employment agreement, or as part of the confidentiality provision, a covenant not to use trade secrets to solicit the employer’s customers. Such covenants are only enforceable when necessary to protect trade secrets and, therefore, should provide that the employee agrees not to use the employer’s trade secrets to solicit the employer’s customers.
Covenant Not to Solicit Employees – Employers should include in the employment agreement a covenant not to solicit the employer’s employees, providing that “during the term of this agreement and for a period of year after leaving the company, the employee will not solicit the company’s employees.”
Non Competition Agreement During Employment – Employers should include in the employment agreement covenants restricting employees from competing during the term of their employment.
Return of Property – Employers should include in the employment agreement a provision requiring employees to return all company property upon leaving the company.
Choice of Law Provision – If the employer desires to include a non-compete agreement in the employment agreement and the company is not exclusively operated in California, or if the employee works and resides in a state other than California, the employer should include in the employment agreement a choice of law provision designating law from a jurisdiction other than California as the controlling law. If suit is brought in another jurisdiction, although not determinative in California, the choice of law provision may control. The employer should be sure, however, that the jurisdiction designated in the employment contract protects trade secrets to the same extent as California.
File First – If an employee is violating a Non Competition Agreement contained in his or her employment agreement or if it appears that the employee may challenge the validity of a non-compete agreement, the employer seeking to enforce a Non Competition Agreement that does not fall within an exception should, if possible, file suit outside of California or, at the very least, in January 2004 Enforceability Of Non Competition Agreements In California federal court. If the employee sues first in California, it is likely that the California court will assume jurisdiction over the employer and invalidate the
Non Competition Agreement—even with a contrary choice of law provision in the employment contract.
California courts consistently disallow covenants restraining employees from competing against their former employers. As discussed, however, there are limited exceptions to this rule. A buyer of a business interest, partners in a partnership and members of a limited liability company may enforce Non Competition Agreements against sellers of business interests, departing partners or departing members, respectively. These exceptions allow covenants to restrain such individuals from competing in the same business within the same geographic area as the buyer, partners or members, as long as the buyer, partners or members continue to operate the same business. Moreover, courts may uphold restrictive covenants to protect trade secrets and prevent unfair competition. Thus, buyers, partners, members, and employers may in certain circumstances utilize covenants to protect their business from the potential competitive harm caused by sellers, departing partners, members or employees. Individuals seeking to protect their businesses with restrictive covenants, however, must take care to properly construct the covenants in order to avoid the numerous pitfalls faced when attempting to overcome California’s general disfavor of such agreements.