Even limited non-competition covenants are unenforceable in California: The California Supreme Court says no “narrow restraint” exception to California’s prohibition on employee non-competition covenants
October, 2008
Many employers are wary of former employees raiding their workforce and stealing their clients when those employees launch a start-up or join a competitor. Despite California's well-known prohibition on non-competition agreements, except under limited circumstances (under section 16600 of the California Business and Professions Code), employers often wish to use contracts to prohibit their employees from competing directly with them or soliciting business from their customers or clients. These clauses often accompany language prohibiting employees from soliciting former co-workers for employment. Some might have argued that the federal courts have recognized a "narrow restraint" exception to the general prohibition in California, where the noncompete prohibition is limited in time and scope and does not prevent an employee from practicing his trade or profession altogether. But it is now clear that California courts will not recognize this exception.
The California Supreme Court had the latest recent word on this issue, by holding, in Edwards v. Arthur Andersen LLP, 2008 Cal. LEXIS 9618 (Cal. Aug. 7, 2008), that no such exception exists. The contract in question included the following language:
"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. [¶]".
The employee worked for Arthur Andersen, which was selling off the employee's division in the wake of the shut-down of its accounting practices in the US. The employee needed to be released from this language in order to get a contract with a new employer, a division of HSBC USA, Inc., which was acquiring some of Andersen's tax practice, including the employee's group. HSBC required the employee to execute a "termination of noncompete agreement", which would require the employee to resign from Andersen, release Andersen from any and all claims, and continue to preserve confidential information and trade secrets, among other things. In exchange, Andersen would release the employee from the noncompetition agreement. Edwards refused to sign the agreement, Andersen withheld severance benefits, and HSBC withdrew its offer of employment. Edwards then sued for intentional interference with prospective economic advantage, asserting that the noncompetition agreement violated California law and therefore the demand that he sign the agreement with Andersen in order to be released from it (and get his severance compensation) was against public policy.
Andersen fought for the court to recognize a so-called "narrow restraint" judicial exception to 16600, and the trial court agreed that the clause was enforceable. The court of appeal held the clause unenforceable and requiring Edwards to sign the agreement with Andersen to be released from it was wrongful. Andersen argued that, as articulated by the Ninth circuit in an opinion from 1987 (Campbell v. Trustees . . . Stanford), California courts have allowed an exception from 16600 where the former employee "is barred from pursuing only a small or limited part of the [employee's] business, trade or profession." The Supreme Court affirmed that part of the opinion, rejecting the Ninth Circuit reasoning despite court opinions that seemed to accept the Ninth Circuit's theory, and holding the agreement invalid under Section 16600.
It is worth noting that the court found both the non-compete and the non-solicitation of clients provisions unenforceable. Many lawyers and business people insist that there remains an exception to Section 16600 for clauses prohibiting an employee from soliciting former customers and clients. But California courts will find these clauses unenforceable as well, unless they are necessary to protect trade secrets, in essence: the enforceability of these clauses depends on whether trade secrets are involved, which is determined on a case-by-case basis. The Supreme Court in Andersen briefly distinguished cases where anti-solicitation clauses protected trade secrets and apparently did not find Andersen's clause necessary for that purpose.
Businesses need to remember that trade secrets are not usually the same thing as the information defined as "confidential" or "proprietary" information in an employee proprietary information and inventions agreement or confidentiality or nondisclosure agreement. Rather, trade secrets have a much more precise meaning under the Uniform Trade Secrets Act, which is adopted in California's statutes. Customer lists and specific customer information may qualify as trade secret information in California, if the employer took particular care to compile that information, it was not readily ascertainable from publicly available sources, and the employer then took steps to limit dissemination of and control access to the information.
In any situation where the nonsolicitation-of-clients clause is at issue, the party seeking to enforce the clause will have the burden of proving that enforcement is necessary to protect information that does indeed constitute trade secret information. And, also important to note, if an employer cannot justify the necessity of the clause to protect trade secrets, the employer cannot require an employee to sign on to it (and could risk wrongful termination or wrongful "non-hiring" liability as a result).