August 2008 • Vol. 28 No. 7 | An E-Publication of the Los Angeles County Bar Association

Gimme 5: What Every Lawyer Should Know about Non-Compete Agreements in California

By Holly R. Lake, an associate in Paul, Hastings, Janofsky & Walker LLP’s Los Angeles office, who practices employment law; and Cindy J. Morgan, also an associate in the firm’s Los Angeles office, who also practices employment law. They can be reached at Hollylake@paulhastings.com and Cindymorgan@paulhastings.com, respectively. This article is provided for informational purposes only and does not constitute legal advice.

Non-compete agreements have been the subject of much debate in California where their application is often contested and somewhat limited. The starting place must always be recognition of the general rule: In California, non-compete agreements are presumptively unenforceable except in very limited circumstances. Despite the general unenforceability of non-compete agreements, in very limited circumstances their use can be beneficial to employers. Before attempting to use a non-compete agreement in California, several complex considerations must be fully explored. Here are five important issues for California practitioners to consider when contemplating the use of, drafting, or reviewing agreements containing post-employment restrictions.

1. What is a non-compete agreement? A non-compete agreement (also known as a covenant not to compete) is a contract between an employee and employer that, following the termination of employment, restricts the ability of a former employee from working in a similar profession or trade in competition with the former employer in a specific geographic area for a set period of time. In states that recognize the general enforceability of such agreements, the general policy supporting non-compete agreements is an effort to prevent unfair competition that would occur if the former employee were allowed to compete against the former employer for a specific period of time. The legitimate business interest most often cited is “the legitimate interest an employer has in safeguarding that which has made his business successful and to protect himself against deliberate surreptitious commercial piracy. Thus restrictive covenants will be enforceable to the extent necessary to prevent the disclosure or use of trade secrets or confidential customer information.” Reed, Roberts Assocs., Inc. v. Strauman, 40 N.Y. 2d 303, 308, 353 N.E. 2d 590, 593, 386 N.Y.S. 2d 677, 680 (N.Y. 1976).

2. Issues with non-compete agreements specific to California. In some states, non-compete agreements may be enforced if they are reasonable in time and geographic scope. However, in 1941, California enacted California Business and Professions Code Section 16600, a broadly interpreted provision that prohibits many restraints on trade.  Section 16600 invalidates most non-compete agreements on the theory that an individual cannot be barred from seeking employment in a profession in which he or she has been trained. Nonetheless, notwithstanding Section 16600, California courts have recognized very narrow exceptions to the general prohibition against the enforcement of non-compete agreements.

3. Specific areas where non-competes are permitted by statute. Within the California Business and Professions Code, there are a few limited exceptions to the general rule against the enforcement of non-compete agreements, including: 1) in some circumstances where the buyer of a business wants to prohibit the seller from competing with the newly acquired company; and 2) in the context of the dissolution of a business partnership or the dissociation of a partner from a partnership. 

4. Judicially created exceptions. In addition to the statutory exceptions, California courts have carved out narrow exceptions to the rule against non-compete agreements. First, a non-compete agreement may be upheld if it is necessary to protect an employer’s trade secrets. Employers rarely prevail under this judicially created exception, and any attempt to craft such a non-compete implicates several complex business and legal concerns beyond the scope of this article. Suffice it to say that trying to enforce a non-compete based on the notion that it is necessary to protect a client’s trade secrets involves the complicated substantive area of trade secret law in California, and brings into play sensitive business concerns. Second, the Ninth Circuit created the “narrow restraint” exception to Section 16600; the California Supreme Court granted review of this issue in Edwards v. Arthur Andersen, LLP, Case Number BC 255796, and until that case is decided, California practitioners should be extremely wary of the future vitality of the Ninth Circuit’s “narrow restraint” doctrine.

5. The “inevitable disclosure doctrine.” The inevitable disclosure doctrine is not recognized in California. The Fourth District Court of Appeal expressly rejected the inevitable disclosure doctrine as incompatible with Section 16600, characterizing it as an “after-the-fact covenant not to compete restricting employee mobility.” Whyte v. Schlage Lock Co., 101 Cal. App. 4th 1443 (2002).   




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