California Supreme Court Says No to Noncompetes. Now What?
(Discussed in KPBS Radio Segment for “These Days” August 26, 2008)
When he joined the Los Angeles office of accounting firm Arthur Andersen in 1997, tax manager Raymond Edwards agreed in writing that if he resigned or was fired from the firm, he would not compete with Arthur Andersen for 18 months and would not, for one year, try to steal any Arthur Andersen client for which he had done work in the previous 18 months. Arthur Andersen, of course, abandoned its U.S. accounting practice in the aftermath of the downfall of its client Enron and a federal indictment of the accounting giant.
When Arthur Andersen refused to release Mr. Edwards from his noncompete when he sought work with another firm that was in the process of purchasing Arthur Andersen’s tax practice, Mr. Edwards sued, claiming among other things that the noncompete agreement was invalid under California law. Arthur Andersen defended its agreement on the basis that California allowed noncompetes, like the one Mr. Edwards had signed, that partially limited the employee’s ability to practice his profession or trade, rather than entirely prohibiting it. On August 7, 2008, in Edwards v. Arthur Andersen LLP (2008) __ Cal.4th __, 81 Cal.Rptr.3d 282, the California Supreme Court unanimously rejected Arthur Andersen’s argument and agreed with Mr. Edwards that noncompete agreements are not enforceable in California even if the agreement is narrowly tailored. Why?
Unlike most states, California has a law dating back almost to its inception as a state that generally makes noncompete agreements unenforceable. Section 16600 of California’s Business and Professions Code says “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 presently sets out the general rule in California—covenants not to compete are void.” (South Bay Radiology Medical Associates v. Asher (1990) 220 Cal.App.3d 1074, 1080.) Other states will enforce such noncompete agreements if they are “reasonable” as to duration and geographic scope. California allows noncompete agreements in only three contexts:
- agreements in the sale and dissolution of corporations;
- partnerships; and
- limited liability corporations.
That’s it. And the California Supreme Court said that 16600 meant what it said about such covenants being unenforceable in employment contracts. “Section 16600 is unambiguous, and if the Legislature intended the statute to apply only to restraints that were unreasonable or overbroad, it could have included language to that effect.” (81 Cal.Rptr.3d at 284.)
The state high court rebuffed Arthur Andersen’s plea that the Court adopt a “narrow-restraint” exception to section 16600’s ban on noncompete agreements articulated in decisions from the United States Court of Appeals for the Ninth Circuit, which decides appeals from California federal trial courts. (See, Campbell v. Trustees of Leland Stanford Jr. Univ. (9th Cir. 1987) 817 F.2d 499; General Commercial Packaging, Inc. v. TPS Package Engineering, Inc. (9th Cir. 1997) 126 F.3d 1131.) “We reject [Arthur] Andersen’s contention that we should adopt a narrow-restraint exception to section 16600 and leave it to the [California] Legislature, if it chooses, either to relax the statutory restrictions or adopt exceptions to the prohibition-against-restraint rule under section 16600.” (18 Cal.Rptr.3d at 292.)
Since the California Supreme Court—not the Ninth Circuit—is the ultimate authority on what California law means, those federal appeals rulings can no longer be used to defend noncompete agreements governed by California law. If an employer cannot prevent an employee from competing against it altogether, does anything in the law block former employees from misusing the most valuable trade secrets of their former employers? As framed, the answer to that question is yes.
In Edwards, the California Supreme Court specifically declined to “address the applicability of the so-called trade secret exception to section 16600, as Edwards d[id] not dispute that portion of his agreement or contend that the provision of the noncompetition agreement prohibiting him from recruiting [Arthur] Andersen’s employees violated section 16600.” (18 Cal.Rptr.3d at 289, note 4.) In invalidating the noncompete agreement of a traffic reporting service that purported to prohibit radio and traffic reporters from offering such services at any competitors in a four-county area for one year after their employment ended, one California Court of Appeal explained that section 16600 “has specifically been held to invalidate employment contracts which prohibit an employee from working for a competitor when the employment has terminated, unless necessary to protect the employer’s trade secrets.” (Metro Traffic Control, Inc. v. Shadow Traffic Network (1994) 22 Cal.App.4th 853, 859, emphasis added, citation omitted.)
That does not mean that noncompete agreements are enforceable if they are justified by a desire to keep former employees from exploiting their former employer’s most valuable secrets in another job. It probably does mean, however, that California’s broad statutory protection for genuine trade secrets can be used to block former employees who seek to compete against their former employers from using such secrets. (See Cal. Civ. Code §3426, et seq. See esp., Civ. Code §3426.1(d), defining the term “trade secret”.) In other words, noncompete agreements are generally unenforceable no matter how narrowly tailored. Agreements by which employees agree not to exploit their employer’s genuine trade secrets after they leave, however, probably remain enforceable, if properly drafted. The law, however, does not treat every piece of information or every relationship in which an employer invests time and money a trade secret so the guidance of counsel is important to avoid overreaching.
In its recent ruling, the California Supreme Court affirmed California’s “settled legislative policy in favor of open competition and employee mobility.” (18 Cal.Rptr.3d at 288, citation omitted.) The California Supreme Court did not rule that the freedom of departing employees to compete carries with it the license to exploit the valuable secrets to which they were exposed during their employment, thus, at least for now, preserving an important balance.
Dan Eaton is a partner at the San Diego law firm of Seltzer Caplan McMahon Vitek, where his practice focuses on defending and advising employers. He is also the on-air legal analyst for the KPBS radio program “These Days.” You may contact Dan at .(JavaScript must be enabled to view this email address) or 619-685-3052. This essay is informational only and does not constitute legal advice.
