One of the toughest tasks facing California businesses is
preventing their employees from leaving the company and going to
work for competitors or starting their own competing businesses.
Many companies require employees to sign employment agreements
which contain post-employment, non-competition clauses. However,
most employers are unaware that such non-competition clauses are
unenforceable in California.
Background
It is considered a fundamental policy of the State of California
that agreements in restraint of competition are to that extent
void. The California Supreme Court, in Edwards v.
Arthur Andersen LLP, 44 Cal.4th 937, unanimously held that
Business & Professions Code Section 16600 invalidated a
provision in Edwards' employment agreement that restricted him
from servicing customers and competing with Arthur Andersen
following the termination of his employment. Notwithstanding
the general premise that non-competition agreements are invalid,
specific Sections of the B&P Code provide certain exceptions to
California's policy against enforcing non-competition covenants
which apply in limited circumstances.
Exceptions to the Rule
One example of such an exception involves a person who sells the
"goodwill of a business" or otherwise disposes of his/her
ownership interest in the business entity. This person may agree
with the buyer to refrain from carrying on a similar business
within a specified geographic area in which the business is
sold. When the goodwill of a business is sold,
non-competition covenants are generally enforceable because it
would be "unfair" for the seller to engage in competition
which diminishes the value of the assets he sold.
Other exceptions concern the dissolution of either a partnership or
limited liability company. Again, in these circumstances, the
person who is leaving the existing entity agrees that he or she
will not carry on a similar business within a specified geographic
area where the existing partnership or limited liability company is
located.
In order to enforce a covenant not to compete entered into when a
shareholder sells his shares in a company there must be a clear
indication that the parties valued or considered
"goodwill" as a component of the sales price. In
contrast, there is no requirement that a withdrawing partner be
compensated for his share of partnership goodwill. The courts
have also held that so long as all partners are subject to the same
limitations, the partners can protect themselves from the risk of
paying a withdrawing partner for goodwill and protect themselves
from the separate risk that the partnership's goodwill will be
diminished by competition from a withdrawing partner by placing the
non-competition covenant in the initial partnership
agreement.
Cherry Picking Venues
Attempts to skirt California's policy against non-competition
covenants by making the contracts in which they are found subject
to the laws of a foreign jurisdiction often fail. California
courts will enforce a contractual choice of law provision if the
chosen state has a substantial relationship to the parties or their
transaction, or if there exists any other reasonable basis for the
parties' choice of law, unless, the chosen state's law is
contrary to the fundamental public policy of
California.
Structuring Non-Compete Agreements
Employers are advised to structure non-competition agreements so
that they are limited to localities where the business is conducted
or is reasonably intended to be conducted, and so that the duration
of the non-compete is limited to the period during which the buyer,
the other partners or the other members, as the case may be, or any
person deriving title to the goodwill, the business, or an
ownership interest in it from the buyer, other partner or member
carries on a like business in the geographic area to which the
restraint applies. Failure to adhere to the locality and
duration restrictions may result in the narrowing or possibly the
invalidity of an otherwise enforceable non-competition
covenant.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.