Definition of No Compete Agreements
Understanding the Legality of Non-Compete Agreements
Typically, an employee and the employer enter into an employment agreement. In addition to general employment agreement provisions, such as salaries, benefits, and work schedules, many employment agreements also contain at least one clause that relates to the protection of proprietary information and company interests. Such provisions might include confidentiality provisions that specifically forbid the employee from sharing confidential and/or proprietary information (whether with clients, friends, family, relatives or other employees of the company), as well as non-competitive provisions that prohibit the employee from working for the competitor or in the same industry for a specific period of time after he/she leaves the employ of the company.
The employer’s rationale for including these provisions in an employment contract is to preserve its investment in the employee and its business. If the employee quits and takes his/her proprietary knowledge to a direct competitor, he/she may gain an unfair competitive edge to the detriment of the employer. Provisions such as those stated above are intended to protect the employer and foster productivity and goodwill.
Generally, a non-competition agreement is drafted to limit employees from working for directly competing companies or in the same industry, thus protecting trade secrets and other intellectual property from being used by competitors to gain advantage over the employer. However , since California is a "right to work state," non-compete agreements are void and unenforceable and operating as a restraint on employment unless it meets the criteria set forth in California Business and Professions Code Section 16600. For example, it would be unlikely that an employee would succeed at enforcing a non-competition agreement that prohibits such activities for a specific duration or in a specific geographic area in California. On the other hand, it is important to note that non-solicitation agreements, which limit employees from soliciting business or clients after termination are generally enforceable considering that they do not limit the right to work of the employee, but instead restrict the manner in which the employee competes for business.
Usually, non-compete clauses are included in employment contracts to protect company interest from being lost to competition. Requiring an employee to sign such a contract is fairly common practice that most employers use when hiring a new employee. Thus, when an employer hires you, you will be asked to sign nondisclosure and non-competition agreements. These restrictions are used in the hope that the employee will not divulge confidential company information to competitors or use the insider knowledge to compete against the company.
Recent California cases have relaxed the standards for evaluating the enforceability of non-disclosure and non-competition agreements.
No Compete Laws in California
California has a long-standing public policy against non-competes. This public policy is codified in the state’s Business and Professions Code ยง 16600. The statute states "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 courts apply this section broadly to make all non-compete agreements unenforceable, unless they fit within a limited series of exceptions.
The courts in California have refused to enforce non-compete contracts where they seek to prevent the former employee from working in any employment or doing business with any competitor by completely locking the former employee out of the "knowledge, skills, and experience acquired during employment." Thus, the same employees that a business trains and hopes to retain, California law may require the business to release to its competitors. Although there are various exceptions, such as where the employer has sold a business or is attempting to protect trade secrets, courts closely scrutinize the circumstances in which an exception would apply. Although some other states allow non-compete covenants provided only that they are "reasonable" in scope and effect, California’s rejection of this standard in favor of a bright-line rule reflects a strong public policy rule against non-compete agreements.
Exceptions to the General Rule
Although California courts have expressed and courts elsewhere have recognized the strong public policy against enforcing non-competition agreements in every circumstance, there are a several exceptions to the rule: Sale of the Business. California Business & Professions Code section 16601 provides as follows: "Except as provided in Sections 16602 and 16602.5, a contract by which anyone is restrained from engaging in a business of any kind is to that extent void, unless the future sale of the goodwill of a business or other subject of property is an element of such contract." Accordingly, if a business owner sells his or her business, and the buyer agrees to pay a premium for the goodwill, the seller may enter into a non-competition agreement with the buyer. However, the scope of any agreement not to compete must be very narrow in order to be enforceable. A non-compete in this context will only be enforceable if: (1) the agreement not to compete is part of the sale of the goodwill, (2) the buyer of the goodwill agrees not to compete with the seller, (3) the restraint on the seller is reasonable (in terms of time and geography), and (4) the goodwill is a material element of the transaction. Stated differently, the sale of goodwill must be an important factor in the value of the business and the sale price of the business must reflect a "reasoned recognition of the value of goodwill." Dissolution of Partnership. Business & Professions Code section 16601 further states that: "One who sells the goodwill of a business may agree with the purchasers not to compete with them in that business provided that the right of the purchaser is appurtenant to the goodwill and that the agreement is not broader in area of extent or longer in time than is reasonably necessary to protect the purchaser in that business." This statute applies to the dissolution of a partnership, however. Hence, if you are dissolving a partnership, you may not compete with your former partner. Tort. In Edmunds v. Edmunds, the Court of Appeal noted that "a restrictive covenant in an employment agreement may be enforced [against the employee] if it is necessary to prevent a former employee from engaging in unlawful competition." This exception applies, for example, when the employee has engaged in fraud, conversion of business assets, breach of fiduciary duty, breach of non-solicitation or non-competition agreement, interference with contractual relations, breach of a confidentiality agreement, breach of a duty of loyalty, or the like. Clearly, because criminal convictions are not usually punishable through a civil proceeding, the criminal actions of an employee cannot form the basis of a non-competition agreement with that employee as that agreement relates to future breaches of law. If, however, an employee has engaged in or has been convicted of a crime that is sufficiently egregious and might reasonably be expected to be repeated in the future, then the employer should seek to enjoin the former employee from engaging in additional misconduct through a judicially issued injunction.
Effects on Employers/Employees
The prohibition against non-compete agreements in California has significant implications for both employers and employees. For employers, the inability to enter into non-compete agreements means they must find alternative avenues to protect their business interests and trade secrets. Employers must craft their employment agreements and personnel policies in a manner that safeguards confidential information, such as by strictly limiting disclosure to third parties and imposing strong consequences for employees who violate confidentiality obligations. Employers can also protect their proprietary information through the use of other employment contracts, such as non-solicitation and non-competition agreements (which restrict employees from soliciting their former employer’s customers or competing against the former employer for a period of time after leaving employment).
From an employee’s perspective , the ban on non-competes allows them to move freely from job to job without worrying about whether they are violating a non-compete agreement, which can benefit both individuals and businesses. Employees have more job flexibility and can seek out better opportunities, while employers have access to a broader pool of talent. However, some employers may still include non-competes in their personnel handbooks or separation agreements, arguing that allowing former employees to compete with them unfairly disadvantages them in the marketplace. As a result, it may become necessary to file lawsuits to have those non-competes found void and unenforceable.
While this scenario presents challenges for employers, there are several strategies they can pursue. They can work with legal counsel to draft strong employment contracts and agreements that include robust trade secrets provisions, confidentiality clauses, and non-solicitation provisions.
New Developments in No Compete Agreements
Within the past few years there have been three significant cases that altered the landscape of California non-compete law. First, in 2014, the California Supreme Court decided to not review the decision by the California Court of Appeal in the case of AMN Healthcare, Inc. v. Aya Healthcare Services. That decision was from November 25, 2013. In essence, the AMN Healthcare decision held that a former employee could be bound by a restrictive covenant prohibiting her from soliciting or hiring her former employing medical facility’s nurses and other workers if the covenant is necessary to protect the goodwill of the employer and is not greater than required for such protection.
Then, in January 2016, the California Court of Appeals decided in the Edwards, et al. v. Arthur Andersen, LLP case that bans all employment agreements from restricting a person from "engag[ing] in any conduct that the statute protects." In so doing, the Court of Appeals held that a covenant not to solicit or interfere with the existing or prospective customers of a preexisting customer made by an employee who was not an owner or seller of a business was unenforceable even though it lasted just six months after termination of his employment and was entered into at the beginning of the employment. Following the appellants’ petition for review, the court of appeal’s decision was certified for publication on May 4, 2016.
In addition, in 2016, the California legislature considered Senate Bill 1241, which would have prohibited employers from requiring a California employee to agree to a provision in an employment contract that would restrict the employee from engaging in activities in California, including pursuing a claim or informally resolving a dispute through alternative dispute resolution, including arbitration, before a claim is filed with the Labor Commissioner or other administrative agency. As written, SB 1241 was intended to apply to any right of an employee to continue an action under the Private Attorneys General Act (PAGA) or any action under FEHA. While the bill was approved by the California Senate Judiciary Committee on May 4, 2016, and unanimously approved by California Senate on May 26, 2016, Senate Bill 1241 stalled in the Assembly and was put on hold when it moved to the Appropriations Committee on August 11, 2016.
Thereafter, on September 26, 2016, the California Governor signed into law AB 1687 (signing the bill without revision), which is similar to Senate Bill 1241 but more broadly prohibits agreements that waive the employees’ right to file a claim or civil action in court. For now, the reach of the new law appears primarily directed at PAGA, FEHA, or any employment-related discrimination claims. The ramifications of the law remain unclear because under the PAGA, individuals may file claims only as representatives of the state and the state must decide if it wants to prosecute the claim in court. If the California Labor and Workforce Development Agency (LWDA) object, the employee is barred from proceeding with the PAGA claim in court. For this reason, even though AB 1687 has been signed, in practice it remains to be seen whether individuals will be able to proceed in court if they are barred from proceeding under PAGA.
Non Compete Agreement Alternatives
Instead of non-compete agreements, California employers can opt for several other legal tools to protect their business interests. These include:
- Non-Disclosure Agreements: A non-disclosure agreement (NDA) protects an employer by prohibiting the employee from disclosing confidential business information to any other party outside of employment. This is acceptable in California. Indeed, California’s statutes recognize a claim for breach of contract when an employee or former employee discloses an employer’s trade secrets. What an employer must show to prevail depends on the circumstances of the disclosure.
- Confidential Information/Proprietary Information Agreement: A trade secret is a form of confidential information that is protectible under the Uniform Trade Secrets Act. This statute provides a civil cause of action to employers who take reasonable steps to protect their trade secrets when "an employee, independent contractor, or another party to a confidential relationship" discloses a trade secret with the intent of causing injury to the owner . To prevail under this statute, the employer must prove that it took reasonable steps to protect the trade secret. Thus, an employer that takes no security measures, such as requiring its employees to sign a nondisclosure agreement (as discussed above), will not be able to avail itself of the protections afforded by the statute.
- Non-Solicitation Agreements. California does not recognize a specific cause of action for the breach of a non-solicitation agreement under any employee/employer relationship other than a partner or other equity interest holder. However, California courts find non-solicitation agreements between employers and employees enforceable where the parties who are the subject of the solicitation are not, and do not have access to, trade secrets.
- No-Poaching Agreements: Employers can solicit job applicants from competitor businesses but cannot agree with other businesses not to solicit each available job applicant to come work for them, except in those limited circumstances discussed here.
Leave a Reply