Non-Competition Agreements

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Quick Summary

Non-compete agreements are illegal in California. Many companies are unaware of this fact, especially since non-compete agreements are legal in virtually all other states. However, there are two exceptions in California. Non-compete agreements are enforceable for partnerships and when someone is selling their ownership interest in a company. A related topic is the protection of trade secrets. A company can prevent the use of its trade secrets, but it cannot prevent fair competition.

Law Review

Many companies seek to protect their business by requiring that employees sign agreements to not compete with the company should they leave employment. However, unlike in many other states, non-compete employment agreements are illegal in California. Business and Professions Code § 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." Section 16600 invalidates agreements to preclude employment in a certain line of work. The section has also been construed by California courts as invalidating agreements that seek to prevent former employees from accepting work from any of the former employer's clients. (Morris v. Harris (1954) 127 Cal.App.2d 476.) A former employee may also solicit employees from his or her former employer if unlawful means or acts of unfair competition are not used. (Diodes, Inc. v. Franzen (1968) 260 Cal.App.2d 244.)

A company is however, permitted to protect their trade secrets. One type of trade secret is a customer list. Generally speaking, if a company could prevent a former employee from using a customer list or trade secret to prevent unfair competition, the company can enforce an agreement that former employees will not use the confidential information. (Metro Traffic Control, Inc. v. Shadow Traffic Network (1994) 22 Cal.App.4th 853, 861.) For example, an employee could validly be required not to use a confidential list of preferred customers for one year after leaving employment. (Gordon v. Landau (1958) 49 Cal.2d 690.) By comparison, though, even if a former employee cannot solicit his or her former employer's clients, merely informing customers of one's former employer of a change of employment, without more, is not solicitation. Neither is discussing business after being first invited by the former employer's customer. (Hilb, Rogal & Hamilton Ins. Services v. Robb (1995) 33 Cal.App.4th 1812, 1822.)

Business Ownership Exception

Business & Professions Code § 16601 creates an exception permitting lawful non-compete agreements for company owners. A new section 16602.5 also applies to members of limited liability companies. It applies when a shareholder "sells" their stock to another for valuable consideration. (Hilb, Royal & Hamilton Ins. Services v. Robb (1995) 33 Cal.App.4th 1812, 1824-1825.) The typical scenario is when a shareholder sells or disposes of their stock. Assume the owner of ABC company is bought-out by DEF company. DEF can validly protect its investment by requiring the former owner of ABC to sign a reasonable non-compete agreement. A merger is also considered to be a transaction within the exception of section 16601. (Id.) In Hilb, the valid contract provision prohibited competition in several countries for a 3-year period of time.

Partnership Exception

Another exception to section 16600's prohibitions exists for partnerships. (Business & Professions Code § 16602.) However, not every agreement restricting competition between partners is valid. A "rule of reason" applies. (Howard v. Babcock (1993) 6 Cal.4th 409.) For example, a partnership agreement may validly restrict competition by precluding withdrawing partners from practicing in a limited geographic area. (Id.) Unlike business sales and section 16601, there is no requirement pursuant to section 16602 that compensation for goodwill in the partnership be transferred. South Bay Radiology Medical Associates v. Asher (1990) 220 Cal.App.3d1074, 1083.)

Can I be Terminated or Not Hired if I do Not Sign a Non-Compete?

An employee or prospective employee cannot legally be terminated or not hired if they refuse to sign a non-compete agreement. As explained in D'Sa v. Playhut, Inc. (2000) -- Cal.App.4th -- , an employee can sue for wrongful termination if they are fired because they refuse to sign an illegal non-compete agreement. Usually, though, the employee would prefer to be employed rather than be unemployed and embroiled in litigation that could take a long time to resolve. Since non-compete agreements are not valid, one strategy for the employee is to sign the agreement knowing that the paper is worthless and thereby be employed.

What To Do Next

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