By: Richard E Korb[1]
Non-compete clauses are clauses designed to prevent a departing employee from entering the same trade or profession in competition with their former employer. These clauses can usually be found in the employment agreement proposed at the time of hire, or in a severance agreement upon resignation or termination.
This article will explore the enforceability of these clauses in California and the interplay and tension between typical “Non-Compete” clauses and “Trade Secrets” provisions which are often part and parcel of employment restaints on competition.
Example of A Non-Compete Clause:
“During employment with (Company), and for a period of ____ after employment is terminated by the company or me for any reason:
- I will not, in (Geographic Territory) engage in, own, or control any interest in a company substantially similar to (Company), and
- I will not recruit or hire any of the former employees of (Company) or induce said employees to leave to be employed or associated with any company or business with which I am associated with.
-The preceding restrictions are limited to (the type of job or activity that the employee is prevented from engaging in).”
“Most jurisdictions” (states) will enforce such clauses as long as they contain reasonable limits as to the time period in which they are enforceable, the geographical area to which they restrict competition, and so long as they define the type of activity they exclude the former employee from engaging in.
Non-Compete Clauses Are Generally Unenforceable In California: Non-compete clauses are generally unenforceable in California except in a few limited exceptions (discussed below). California’s Business and Professions Code Section 16600 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.”
Exceptions To The Invalidity Of Non-Compete Clauses In California: The few exceptions to the invalidity of non-compete clauses are stated in California’s Business and Profession’s Code §§ 16601-16602.5.
The first exception involves the dissolution of a Partnership or Limited Liability Company (LLC). A non-compete agreement may be enforceable in the event that a partner in a partnership or company departs subject to reasonable limitations, e.g., the restricted competition is confined to a certain geographical area and for a specific duration.
California law also allows agreements whereby the departing partner may compensate the former partner(s) an amount of money in exchange for the right to accept future work without restraint.
The second exception to a non-compete clause’s invalidity is when an owner is selling his or her ownership interest in a company to another. For example, if the owner of 500 shares in company X sells his shares to an owner of company Z, the owner of company Z can require a non-competition agreement with the former owner of company X so that he can restrain him from competing against company Z with all of his insider knowledge about the company.
Again, the agreement must provide reasonable restrictions on the time limits, geographic limits, and activity or job restriction limits. The restrictions should not impose unreasonable restraints or unreasonable hardships on the ex-owner or partner for finding new employment, or else the “non-compete” runs the risk of being rejected by a California court. (Most states will void a non-compete agreement if unreasonable restrictions have been made).
Another key exception that provides an opportunity for non-compete agreement to be upheld in California is when the restraints in the clause relate to protecting the former company’s trade secrets.
Here we face two competing state policies: protecting an employee’s right to openly compete with a former employer without restriction while simultaneously protecting the company’s right to safeguard its trade secrets and prevent a competing company from gaining a competitive advantage by abusing confidential information or using trade secrets obtained from the former company by the departing employee.
Trade secrets can include customer or client lists, marketing strategies, confidential formulas, or other sensitive company information. Trade secrets are defined in California Civil Code §3426.1. In order to be enforceable, they must meet three guidelines:
(1) The company must take reasonable measures to protect the secrecy of its information;
(2) The information is not available to the general public or easily obtainable; and
(3) The non-public information is valuable because it provides the company with an economic advantage.
If the provisions in a non-compete clause are strictly limited to activity that would expose the former business’ trade secrets, and they do not provide any additional unnecessary restraints on trade, usually the restrictions will be upheld as valid.
An example of a non-compete case that successfully argued a trade secrets exception can be found in the Majestic Marketing Inc. vs. Nay (2010). In March of 2004, David Nay signed a contract with Majestic Marketing which included a non-compete clause. In 2007, Nay left Majestic Marketing to start his own company, using a customer list with detailed information concerning each customer he obtained from Majestic Marketing. The detailed customer list had been kept confidential and contained information not known by other competitors in the industry. Majestic Marketing sought an injunction which would prohibit Nay from taking advantage of the information he had.
Both the trial court and the appeals court sided with Majestic Marketing. The appeals court summarized the guidelines for trade secret enforcement in its conclusion: “The more difficult information is to obtain, and the more time and resources expended by an employer to gather it, the more likely a court will find such information a trade secret.” Majestic Marketing’s injunction was granted, as both courts believed that the information Nay was using fulfilled all the requirements of trade secret protection.
In most other instances, non-compete agreements will not be enforceable in the state of California. The case Dowell vs. BioSense Webster Inc. (2009) is an example of how a non-compete case coupled with a trade secret argument can fail. Like the previous case, Mr. Dowell left his employer, BioSense, to move on with his career. When Dowell went to work for St. Jude Medical however, BioSense sent a letter forbidding Dowell from accepting the position for at least 18 months. Thereafter, St. Jude Medical, Dowell’s new employer, sued BioSense for violating California’s Business and Professions Code.
BioSense argued that its non-compete clause in Dowell’s contract was enforceable under the trade secrets exception. The court disagreed, finding BioSense’s definition of trade secrets to be too broad to be enforceable. Unlike Majestic Marketing, which restricted its former employees from using it’s carefully built customer database, BioSense simply prohibited Dowell from engaging in any contact with BioSense’s past or current customers, “even if it is the customer who solicits the former employee.” The court found that the non-compete clause was overbroad and unenforceable against Dowell.
The message from these and other cases is that California courts will look specifically to the facts of each case and apply the law accordingly; one cannot generalize as to the enforceability of non-competes or trade secret restrictions without a careful factual and legal analysis.
Jurisdictional And Choice of Law Issues: In many cases, an employee may work in California, however, the company is headquartered in a state that allows non-compete clauses. Often the company will require the employee to sign an employment agreement which states that the law of the state the company is headquartered in “shall govern” any dispute. This raises the question: if the company is headquartered in a state that recognizes non-compete clauses but the employee lives and works in California—a state that does not recognize such clauses–which state’s law applies?
Generally, California courts will apply California law and invalidate non-compete clauses so long as the employee resides and works in California even if the employee sign an employment agreement giving up their right to have California law apply. Clauses in an employment contract that attempt to assign another state’s law to a California employee are generally held invalid in California. Out of state agreements between an out-of-state employer and a California employee are subject to California law even where the employment contract specifies that some other state’s law shall apply. Why? Simply stated, because California has a strong public policy promoting open and fair competition, California does not want to give employers a loophole to undermine this policy.
Because California policy typically favors employees on the issue of restraining competition, attorneys representing employees will sometimes try to have their case adjudicated in California. To do this, the employee must establish they perform their job in California and/or establish jurisdictional contacts with the state. This is easier said than done. For example, in one case, Microsoft Vice-President Kai-Fu Lee left his job (in Washington) for a new position with Google in California. When Microsoft sued Lee for violating a non-compete agreement, Google attempted to have the case moved from Washington (where Microsoft was headquarter) to California where Google’s principal office was situated. The petition for change of venue failed though, as Lee was expected to work for Google in China, not California. Nevertheless, despite the outcome of this case, the fact remains that California’s public policy favoring open competition is so strong, it continues to be a jurisdiction favored by employees fighting non-compete clauses.
Conclusion: Agreements containing “Non-Compete” clauses are generally unenforceable in California, but each case should be carefully examined by an employer or employee with an attorney before reaching a conclusion. If you have questions or need additional information on non-compete clauses, trade secrets, and their enforceability, please contact business attorney Richard Korb at (510) 524-0903 for a free consultation.
[1] RICHARD E. KORBis a seasoned attorney with 30 years of business, real estate, litigation and transactional experience. Over his legal career, Richard has successfully litigated and resolved over 300 court cases in the fields of contract law, real estate, employment, unfair competition, and general civil law and he has drafted and negotiated over 200 contracts and licenses for large and small companies alike. Richard leverages his experience as a former partner in a 100-person law firm and chief counsel for a public software company to assist individuals and companies, from start-ups to multi-nationals, with a broad spectrum of legal matters. In addition to his legal practice, Richard is a court-approved mediator and serves on the Alternative Dispute Resolution (ADR) panel for both the Alameda and Contra Costs County Superior Courts.
The content in this article is posted is for informational purposes only. It is not intended to serve as legal advice and no attorney-client relationship shall exist by virtue of its dissemination Should you wish legal advice, you may contact Richard for a consultation at 510-524-0903. ©Richard Korb. 2011.
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