To protect their business and confidential information, employers often impose restrictions on their employees’ post-employment competitive activities. In the employment context, restraints on competition vary, but generally they fall into three basic categories:
Non-compete covenants;
Customer non-solicitation covenants;
Employee non-solicitation covenants.
1. California’s strong policy in favor of competition
In California, non-compete and non-solicitation covenants are unenforceable. Attempts by employers to restrain an employee’s ability to compete are prohibited and regarded as a violation of the state’s strong public policy in favor of competition.
California public policy is also designed to protect California-based employers, by allowing them to compete for the most talented, skilled employees in their own industries, wherever they may reside.
A. Non-Compete covenants
In California, post-employment non-compete covenants are void by statute. See Cal. Bus. & Prof. Code § 16600. This statutory prohibition applies not only to employment contracts, but also to independent contractor relationships. California courts will not narrowly construe or rewrite (“blue pencil”) unenforceable non-compete covenants to make them enforceable. When a contract is void, it cannot be ratified either by right or conduct.
As an exception to the rule, contractual non-compete covenants are generally enforceable when executed in connection with a bona fide sale of a business, corporate merger, or the dissolution of a partnership. See Cal. Bus. & Prof. Code §16600–16602.5. But even in those cases, the restriction can only run one way – in favor of the buyer, not the seller.
During the term of their relationship, however, employers can prohibit competitive activities of their employees, usually by contract or by virtue of the employee’s separate duty of loyalty.
To protect their business, however, in California employers can demand that their employees sign a confidentiality and non-disclosure agreement, designed to protect the employer’s trade secrets and confidential information both during and after the employment relationship.
B. Customer Non-Solicitation Covenants
In California, customer non-solicitation covenants (considered a form of non-compete covenant) will be enforced only to the extent they are necessary for the protection of trade secrets. Customer lists, for example, may be deemed to be an employer’s trade secret. However, the parties’ designation of certain information as trade secrets in an agreement is not dispositive. A court would still have to make an independent legal determination under the California Uniform Trade Secrets Act as to whether the information qualifies as a legally protected trade secret.
C. Employee Non-Solicitation Covenants
Although the California Supreme Court struck down the enforceability of customer non-solicitation clauses as violating section 16600 of the California Business and Professions Code, the court has not, for the time being, extended its holding to employee non-solicitation provisions, which may be enforceable in certain narrow circumstances. For example, a non-solicitation provision, prohibiting a former employee from disrupting, damaging, or impairing the employer’s business by interfering with or raiding its current employees, has been found enforceable.
Employers may wish to seek legal counsel on how to draft enforceable customer and employee non-solicitation covenants under California law.
2. Other jurisdictions and the “rule of reasonableness”
Other states, such as Texas, Pennsylvania, and Massachusetts, to name a few, enforce non-compete and non-solicitation covenants under a so called “rule of reasonableness”.
In other words, non-compete and non-solicitation covenants may be found enforceable if certain criteria are met, i.e., if such covenants are supported by adequate consideration (initial or continued offer of employment is considered adequate consideration in most jurisdictions), if they are necessary to protect a legitimate business interest (good will, confidential information, and customer lists are considered an employer’s legitimate business interest in most jurisdictions), and if they are reasonable under the circumstances (for example, if they are limited in time, i.e., one to three years, and in space, i.e., if they are limited to specific areas or states within the United States or, if no specific geographic restriction is identified, if they are limited to customers with whom the former employee developed certain contacts and relationships during his or her employment).
3. What are the main risks associated with the breach of non-compete covenants?
In California, former employees may challenge non-compete and non-solicitation covenants since such restraints are generally deem unenforceable. California courts expressly recognize the “preemptive” litigation strategy by former employees and their new employers in bringing claims against former employers for statutory unfair competition and injunctive relief under Cal. Bus. & Prof. Code §17200, or declaratory relief under CCP §1060.
In other states, where non-compete and non-solicitation covenants may be found enforceable if reasonably drafted to protect the employer’s legitimate business interests, the hiring of employees bound by enforceable non-compete covenants with their former employer may represent significant risks.
Depending on the jurisdiction, employers that wish to enforce a valid and enforceable non-compete covenants may sue the former employee under theories of breach of contract and trade secret misappropriation, and the prospective employer under theories of tortious interference with former employee’s contract, tortious interference with former employer’s prospective business relations, trade secret misappropriation, and unfair competition, to name a few.
Depending on the circumstances, available remedies to the former employer may include monetary damages, based on lost-profit damages suffered by the employer in its business or restitution, liquidated damages, if the amount of actual damages sustained by a breach would be impractical or extremely difficult to determine, injunctive relief, if future irreparable harm is threatened or if the former employee has already breached the restrictive covenant, and contractual attorney fees.
Employers may wish to seek legal counsel on how to proceed before hiring employees bound by non-compete or non-solicitation agreements.
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Requests for information or insights on the issue discussed in this article may be addressed to laura.soprana@vallalaw.com. This article is for information purposes only and does not constitute legal advice. The information contained herein may be outdated or incomplete, and shall in no way be taken as an indication of future results. The transmission of this article is not intended to create, nor does its receipt constitute, an attorney-client relationship between preparer and reader. You should not act on the information contained in this article without first seeking the advice of an attorney.