The enforceability of noncompete agreements in California has always been a question of concern for employers and employees in California.

 

On August 7, 2008, the California Supreme Court ruled on the matter.

 

In the Edwards case, Ray Edwards joined Arthur Andersen as a CPA in 1978.  As part of his employment offer he signed a noncompetition agreement which prohibited him from working for or soliciting certain Arthur Andersen clients for limited periods following his termination.  The agreement read in part:

 

“If you leave the Firm, for 18 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 18 months prior to release or resignation.  This does not prohibit you from accepting employment with a client.  For 12 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 18 months preceding release or resignation.  You agree not to solicit away from the Firm any of its professional personnel for 18 months after release or resignation.”

 

Between 1997 and 2002, Edwards worked for Andersen.  Over this period he was promoted to Senior Manager and on track to become a partner.  Then, in 2002 the United States Government indicted Andersen in connection with the investigation into Enron Corporation and in June 2002, Andersen announced that it would cease its accounting practices in the United States.  In May 2002, Andersen announces that a division of HSBC USA, a New York based banking corporation, would purchase a portion of Andersen’s tax practice, including Edwards’ group.

 

HSBC offered Edwards employment.  However, before hiring any of Andersen’s employees, HSBC required them to execute a “Termination of Noncompete Agreement.”  Among other things that agreement required employees to:

 

In exchange Andersen would agree to accept Edwards resignation, agree to Edwards employment with HSBC, and release Edwards from the 1997 noncompetion agreement.

 

Edwards signed the HSBC offer letter but refused to sign the Termination of Noncompete Agreement.  In response, Andersen terminated Edwards’ employment and withheld severance benefits and HSBC withdrew its offer of employment to Edwards.

 

On April 30, 2003, Edwards filed a complaint against Andersen and HSBC for intentional interference with prospective economic advantage and anticompetitive business practices under the Cartwright Act.  Prior to trial Edwards settled with HSBC.  As part of the lawsuit, Edwards alleged the Andersen Noncompete Agreement violated California Business & 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.”

 

He further alleged that the HSBC Termination of Noncompete Agreement release of “any and all” claims violated California Labor Code Sections 2802 and 2804, which make an employee’s right to indemnification from his or her employer nonwaivable.

 

Edwards refused to sign the Termination of Noncompete Agreement because of this broad waiver in light of the government’s investigation of Andersen and the potential for lawsuits from his old clients.

 

The trial court found in favor of Andersen.  On appeal, the California Appeals Court found the noncompete agreement invalid under Section 16600 and also found the Termination of Noncompete Agreement’s apparent waiver of Edwards’ indemnification rights to be a violation of public policy.

 

The Supreme Court reviewed both issues.

 

Under the common law contractual restraints on the practice of a profession, business or trade, were considered valid, as long as they were reasonably imposed.  However, in 1872, California settled public policy in favor of open competition and rejected this common law “rule of reasonableness” in enacting legislation that would become California Business and Professions Code 16600.  As such, in California, covenants not to compete are void, subject to these few exceptions:

 Andersen argued that its noncompete restraint was limited in scope and time and not a complete restraint on Edwards’ ability to work.  Andersen further argued that the use of the word “restrain” in the Statute means simply to “prohibit” so that only contracts that totally prohibit an employee from engaging in his or her profession, trade or business are illegal.

 

Andersen also pointed to the 9^th Circuit Court’s “Narrow Restraint” Exception, wherein the Federal Court found a noncompete valid “where one is barred from pursuing only a small or limited part of the business, trade or profession.”  Although California is part of the 9^th Circuit, the California Supreme Court held that California State Courts and the California legislature do not follow the “Narrow Restraint” Exception. Rather California looks to Business & Professions Code Section 16600 strict restrictions.  A noncompete in California, even if only a partial restriction on the employee’s ability to work, is invalid.

 

Simply put, an employer in California cannot require an employee to sign a noncompete agreement.  Of course, an employer can still restrict competition by enforcing a “Trade Secrets” agreement.  However, this will require the employer to prove the protected “Trade Secrets” and necessity for the noncompete in protecting those “Trade Secrets.”

 

It is also important to note the California Supreme Court determined that the “waiver of all claims” section of the HSBC Termination of Noncompete Agreement would not serve to waive an employee’s right to indemnification by its employer.  Rather, the Court held that the employee’s right to indemnification under California Labor Code Section 2802 is nonwaivable and outside the scope of a general waiver of claims.  In doing so, the Court did not void the waiver, rather it limited the scope of the waiver to those claims not protected under the California labor code.

 

As a side point, you should review all agreements to ensure they include a severability provision, so that if a provision within an agreement is deemed invalid, it will not serve to invalidate the entire agreement.