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"Competitive Edge"

The Daily Journal
By: Stephen P. Wiman
09/19/07

The California Supreme Court will soon decide an employment case that likely will be one of the most significant decisions in the past 10 years. In Edwards v. Arthur Andersen, S147190, the Supreme Court will be addressing the following issue: Is a noncompetition agreement between an employer and an employee lawful, despite Section 16600 of the Business and Professions Code, if a court determines that the restraint is "narrow" and "reasonable"? Subject to limited exceptions, 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." This case has generated much interest by amici curiae, including a brief filed on behalf of 26 legal and other scholars.

'Edwards' Case

The Arthur Andersen accounting firm hired Edwards, a certified public accountant, as a tax manager. As a condition of employment, Edwards executed a noncompetition agreement that provided in relevant part, "If you leave the Firm, for eighteen months after release or resignation, you agree not to perform professional services of the type you provided for any client on which you worked during the eighteen months prior to release or resignation. This does not prohibit you from accepting employment with a client.

"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.

"You agree not to solicit away from the Firm any of its professional personnel for eighteen months after release or resignation."

Beginning in 2002, Arthur Andersen began selling portions of its practice to competitors. Arthur Andersen sold the practice in which Edwards participated to HSBC's Wealth and Tax Advisory Services. As a condition of the sale, Arthur Andersen required Edwards, among others, to execute a Termination of Non-Compete Agreement. The agreement required that Edwards (1) voluntarily resign from Arthur Andersen, (2) release Arthur Andersen from certain claims, (3) continue indefinitely to preserve confidential information and trade secrets, (4) refrain from disparaging Arthur Andersen and (5) cooperate with Arthur Andersen in connection with any investigation of or litigation against Arthur Andersen. In exchange, Arthur Andersen would agree to, among other things, release Edwards from the noncompetition agreement.

HSBC offered employment to Edwards contingent on Edwards executing the release. Edwards accepted the offer of employment but refused to execute the release. As a result, Arthur Andersen terminated Edwards' employment and withheld certain severance benefits, and HSBC withdrew its offer of employment.

Edwards filed a lawsuit against Arthur Andersen and HSBC challenging the enforceability of the noncompetition agreement and the release. The trial court granted judgment for Arthur Andersen on the enforceability of the noncompetition agreement, concluding that it fell within a "narrow restraint" exception to Section 16600. On appeal, the Court of Appeal, rejecting the so-called "narrow restraint" exception, held that the noncompetition agreement did indeed violate Section 16600: "In sum, we conclude the 'narrow restraint' doctrine is a misapplication of California law. Noncompetition agreements are invalid under section 16600 even if narrowly drawn, unless they fall within the statutory or trade secret exceptions. Thus, the noncompetition agreement at issue here was invalid and violated California's public policy." Edwards v. Arthur Andersen, 142 Cal.App.4th 603 (Cal. App. 2nd Dist. 2006).

Clarifying Competition

Thereafter, the California Supreme Court granted Arthur Andersen's petition for review. Based largely on federal authority, Arthur Andersen argued that Section 16600 of the Business and Professions Code does not prohibit all noncompetition agreements. Under that section, noncompetition agreements that merely impose a "narrow restraint" are permissible. See, for example, Campbell v. Board of Trustees, 817 F.2d 499 (9th Cir. 1987) ("Section 1660 only makes illegal those restraints which preclude one from engaging in a lawful profession, trade, or business"); International Business Machine Corp. v. Bajorek, 191 F.3d 1033 (9th Cir. 1999) (upholding a limited contractual restriction which precluded an employee from working for a competitor in order to retain stock options); Gen Commercial Packaging Inc. v. TPS Package Eng'g Inc., 126 F.3d 1131 (9th Cir. 1997) ("[S]ection 16600 does not impair [the plaintiff's] contract with [the defendant] unless it entirely precludes [the defendant] from pursuing its trade or business.").

In response, Edwards and his supporting amici asserted that controlling California Supreme Court authority rejects the legitimacy of narrow restraints under Section 16600. Chamberlain v. Augustine, 172 Cal. 285 (1916) ("The statute makes no exception in favor of contracts only in partial restraint of trade."); and Morey v. Paladina, 187 Cal. 727 (1922) (same). They pointed out that the 9th Circuit, in Campbell, ignored this authority and based its decision on a misapplication of a California Court of Appeal decision in Boughton v. Socony Mobil Oil Co., 231 Cal.App.2d 188 (1964) (restriction on the use of a parcel of land as a service station did not violate Section 16600).

Amici also urged the Supreme Court to consider that Section 16600 promotes "critical state interests" in fostering a mobile employment market as well as innovation in the marketplace. See for example, Application Group Inc. v. Hunter Group Inc., 61 Cal.App.4th 881 (1998) (Section 16600 promotes an efficient labor market by ensuring that employers "will be able to compete effectively for the most talented, skilled employees in their industries."); see also Gilson, The Legal Infrastructure of High Technology Industrial Districts: Silicon Valley, Route 128, and Covenants Not to Compete, 74 N.Y.U.L.Rev. 575 (1999).

Narrowing Restraint

Should Arthur Andersen prevail, any test of whether a so-called "narrow restraint" is indeed reasonable or acceptably narrow would need to occur case by case. Many employees would not have the financial wherewithal to initiate that test. Thus, more substantial restraints appear likely to go unchallenged, effectively undermining the efficacy of Section 16600. See Kolani v. Glulska, 64 Cal.App.4th 402 (1998) (noting most clauses would go unchallenged). Such restraints are likely to have an in terrorem effect not only on employees but also on prospective employers.

Moreover, a "narrow restraint" test will be difficult to administer judicially with any consistency. In every case, the essential question will be, How narrow is narrow? Is restraining someone in a city, in a county, in a region or in a state sufficiently narrow? What alternative employment must be considered by a court in assessing whether a restraint on a profession, trade or business is more than narrow? How heavy a burden should the restrained employee be forced to bear in order to effect the restraint? If Arthur Andersen wins, employees will be less certain of success in challenging noncompete clauses, likely resulting in fewer challenges and the de facto imposition of onerous noncompete clauses in much greater numbers.

Bright Line

On the other hand, a bright-line test proscribing restraints has the benefit of relative certainty. It is supported by a long line of California authority. Such a test also would promote employee mobility and permit prospective employers to mine the marketplace freely for innovative, ambitious and competent workers. Regardless of outcome, the Supreme Court's decision in Edwards v. Arthur Andersen will have a significant impact on employer/employee relations for California-based employees and for companies located inside and outside of the state.

Stephen P. Wiman is a partner at Nossaman, Guthner, Knox & Elliott in Los Angeles, where his practice focuses on complex litigation.

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