California Supreme Court Affirms Ban on Noncompetition and Nonsolicitation Agreements Under California Law

08.13.08

By Jennifer L. Brockett, Stuart W. Miller, John P. LeCrone and Emilio Gonzalez

California’s Supreme Court, in the recent case of Edwards v. Arthur Andersen LLP, has affirmed California’s long-standing ban on noncompete agreements and explicitly extended it to so-called “nonsolicitation” provisions, as well. The Court ruled that noncompetition and nonsolicitation clauses are void in California, unless they fall within a statutory exception, such as agreements involving the sale of a business or shares of stock in a corporation. The Court also found that an employer that requires employees to sign an agreement containing such a clause may commit an unlawful business practice subject to tort damages.

Edwards involved claims by a former accountant at Arthur Andersen LLP who had signed an agreement at the time of hire that provided, “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.” When Andersen collapsed in the wake of the government investigation into the demise of Enron Corporation, Edwards’ unit of Andersen was sold to HSBC and his employment was terminated, after he refused to sign an agreement releasing any claims he had relating to his employment. He was nonetheless bound by the prior nonsolicitation clause.

Edwards filed a complaint against Andersen and others, asserting claims for intentional interference with prospective economic advantage and anti-competitive business practices. He alleged, among other claims, that Andersen’s noncompetition agreement (with its nonsolicitation provisions) violated California Business & Professions Code Section 16600, which provides:

…every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.

It has long been the law in California that Section 16600 “invalidates provisions in employment contracts that prohibit an employee from working for a competitor after completion of his employment or imposing a penalty if he does so.” In addition, Section 16600 has in some cases provided the basis for invalidating nonsolicitation provisions, such as those barring employees from soliciting business from customers with which they had contact during their employment.” Muggill v. Reuben H. Donelley Corp ., 62 Cal. 2d 239, 242 (1965).

Yet, some courts have nevertheless allowed nonsolicitation provisions that only narrowly restrained competition. Relying on these cases, the federal 9th Circuit Court of Appeals—which includes California—had found that narrow restrictions did not violate Section 16600. This—known as the “narrow restraint” doctrine—had led many employers to include limited nonsolicitation or noncompetition clauses in their employment agreements. The Supreme Court inEdwards unequivocally rejected even this narrow form of restraint and reiterated California’s strong public policy favoring open competition and employee mobility. Said the Court:

In the years since its original enactment as Civil Code section 1673, our courts have consistently affirmed that section 16600 evinces a settled legislative policy in favor of open competition and employee mobility. The law protects Californians and ensures that every citizen shall retain the right to pursue any lawful employment and enterprise of their choice. It protects the important legal right of persons to engage in business and occupations of their choosing.

There are, as the Edwards Court recognized, two express statutory exceptions to the restriction on noncompete provisions: Business & Professions Code Section 16601, which applies to the sale of shares of a business when goodwill is being sold, and Section 16602, which applies to the dissolution of partnerships or disassociation of a partner. In either circumstance, nonsolicitation or noncompetition provisions may be upheld.

The Court’s decision in Edwards also does not affect restrictions imposed on employees that are necessary to protect trade secrets. California courts have previously found that nonsolicitation clauses may be upheld where the agreement is necessary to protect trade secrets. Under California’s enactment of the Uniform Trade Secret Act, information may qualify for trade secret protection if the information (a) derives independent economic value from being secret, and (b) is the subject of efforts that are reasonable under the circumstances to maintain its secrecy. The Edwards Court expressly did not address the “trade secrets exception” to Section 16600. Because the trade secret exception is supported by a separate statute—the Uniform Trade Secret Act—agreements that are necessary to protect a trade secret should survive the Edwards decision.

In light of Edwards, employers should have employment counsel review noncompetition and nonsolicitation agreements applicable to California employees, to ensure that any such agreements comply with Edwards. Additionally, in the wake of EdwardsCalifornia employers cannot rely upon nonsolicitation and noncompetition provisions to prevent former employees from engaging in competitive activities, unless such provisions are necessary to protect their confidential, proprietary and trade secret information. As a result, employers should consider evaluating their security protocols to ensure that confidential materials are adequately protected from unauthorized disclosure.

FOOTNOTES

Muggill v. Reuben H. Donelley Corp., 62 Cal. 2d 239, 242 (1965).

Thompson v. Impaxx, Inc., 113 Cal. App. 4th 1425, 1429 (2003).

About Joe Wallin

Joe Wallin focuses on emerging, high growth, and startup companies. Joe frequently represents companies in angel and venture financings, mergers and acquisitions, and other significant business transactions. Joe also represents investors in U.S. businesses, and provides general counsel services for companies from startup to post-public.
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