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California Supreme Court Rejects Employer Effort To Limit Statutory Ban On Noncompetition Agreements

By: Stephen P. Wiman
10/29/08

In a very significant recent employment decision Edwards v. Anderson. the California Supreme Court rejected an employer's effort to limit California's statutory protection of employees from noncompetition agreements. Employers should review their noncompete and trade secret clauses in light of the ruling, in order to reduce substantial litigation exposure.

California has had a strong public policy favoring an employee's right to pursue his or her profession without restriction since 1872. This policy is codified in California Business and Professions Code section 16600, which 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.

On August 7, 2008, the California Supreme Court supported this long-standing public policy by unanimously holding that even "narrow" restrictions on an employee's right to compete freely in his or her profession violate California law.

At issue in the case was a noncompetition agreement Arthur Andersen required its employees to sign as a condition of employment. Looking to federal decisions for support, Arthur Andersen argued that California's Section 16600 should allow an employer to impose narrow restrictions against competition that are reasonable, such as a restriction related to a particular client rather than an entire "profession, trade, or business." Based on this theory, Arthur Andersen's agreement sought to prevent its employee from working for or soliciting Arthur Andersen clients that the employee had worked for while in Arthur Andersen's employ. According to Arthur Andersen, the "narrowness" of the restriction meant that employees quitting the firm would be free to practice their profession, even in competition with Arthur Andersen, so long as they did not work with selected Arthur Andersen clients.

Arthur Andersen's argument was based on a Ninth Circuit decision stating (erroneously it turns out) that California recognized an unwritten exception to its blanket prohibition on noncompetition agreements under Business and Professions Code section 16600. This purported non-statutory "exception" allowed noncompetition provisions that barred an employee from pursuing "only a small or limited part of the business."

In the course of rejecting Arthur Andersen's position and correcting the Ninth Circuit's misinterpretation of California law, the Court clarified that there are no exceptions to section 16600's prohibition against noncompetition agreements except for certain limited statutory exceptions at sections 16601, 16602, and 16602.5 of the Business and Professionals Code largely dealing with the sale of businesses or interests in businesses. In sum, there is no "reasonable restriction" or "narrow restriction" exception to the statute.

How does this decision affect your business?

The immediate impact of this decision is to call into question all contractual noncompetition agreements between employers and employees that are not based on the explicit statutory exceptions for partnerships, corporations, and LLCs. Simply put, if you have such provisions in your employee agreements, they are likely to be void. You may be tempted to view this as a "no harm, no foul" situation based on the assumption that a void noncompetition agreement will simply be severed from the contract. But such an assumption could prove costly. For example, if your employee executed such a noncompetition agreement and then quits to seek new employment, potential employers of your former employee are likely to conduct due diligence with respect to their potential new hire. If such a prospective new employer becomes aware of the noncompetition provision, it may decline to offer employment to your former employee. This could expose you to a claim by your former employee that you, through the noncompete provision, interfered with the former employee's ability to obtain new employment.

Another hazard of leaving an unenforceable noncompetition clause in your employee agreement is that it could trigger liability under an attorney's fees clause, which are common to most noncompetition agreements, should an employee seek to challenge the provision in court. If an employee or former employee brought a declaratory action regarding the enforceability of your noncompetition clause, not only would you most likely lose, but you could have exposure for paying the employee's legal bills as well.

For those employers who primarily use noncompetition agreements to protect trade secrets, we recommend that you review your trade secrets clauses to ensure that they remain focused solely on trade secrets protection and do not bleed into language that may no longer be enforceable after Edwards. Edwards does not affect contractual provisions limiting use of trade secrets which supplement statutory protections. It also does not affect contractual provisions limiting former employees from soliciting your current employees.

Finally, if you are seeking to hire new employees and find that any of your potential hires are subject to a noncompetition agreement, we recommend that you consult legal counsel to determine whether the noncompetition agreement is unenforceable before engaging the prospective hire. This is particularly important if you are seeking to hire a competitor's employee who may be subject to a mixture of enforceable trade secret laws and unenforceable contractual noncompetition provisions.[1]

Steve Wiman is a Partner in Nossaman's Los Angeles office and can be reached at 213.612.7818 or swiman@nossaman.com.



[1] Edwards v. Anderson also addressed a second important issue concerning the validity of employee releases upon termination of employment. The Court held that a provision by which an employee releases "any and all" claims does not encompass nonwaivable statutory protections and is, therefore, not void. This holding in Edwards v. Anderson will be the subject of a separate e-alert.

 

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