Companies Face Consequences for Unenforceable Noncompetition Clauses in California

• Publication year: 2018
• Author: Justene M. Adamec

Companies Face Consequences for Unenforceable Noncompetition Clauses in California

Justene M. Adamec

Justene Adamec has been a partner in Pumilia & Adamec LLP since 1995. Pumilia & Adamec is a Los Angeles law firm, whose clients are mid-size, closely-held companies. With almost 30 years of experience, Justene handles business litigation both in the courts and before arbitration panels. Justene is currently co-chair of the Business Litigation Committee for the California Lawyers Association. She has published several articles on issues that affect businesses.

California has a strong public policy in favor of competition. With very narrow exceptions, any contract provision that restrains competition after an employee leaves the employer is unenforceable.¹ Companies can be held liable in tort for inserting an unenforceable noncompetition clause in an otherwise enforceable agreement. This article summarizes the basic rules on enforceability, discuss the cases that impose liability, and provide guidelines for drafting noncompetition clauses within the exceptions.

Introduction

Although California law prohibits most noncompete clauses, attorneys have tried to draft narrow clauses in order to fall within one of the exceptions. Clients often want to include an unenforceable clause for the chilling effect on competition. The risks of either approach have increased as California courts impose consequences beyond refusal to enforce the clause. The first approach requires a great deal of care, while the second approach is completely prohibited.

In a variety of circumstances, the courts have ruled in favor of plaintiffs who challenge noncompete clauses and seek affirmative relief. In Edwards v Arthur Anderson LLP,² the California Supreme Court ruled that an employer's use of a release of an unenforceable noncompete provision as a bargaining chip with the employee constituted a wrongful act for purposes of the tort of interference with prospective economic advantage.³

Other cases are few, but their effect is pronounced. A company was found liable to a potential employee whose employment was conditioned on accepting a confidentiality agreement with an unenforceable noncompete provision.⁴ Another company was sued when it fired someone based on a former employer's effort to enforce a noncompete clause. The appellate court allowed the case to proceed, finding there were enough facts to support a viable cause of action.⁵ In other cases, facially void noncompete clauses were found to violate Business & Professions Code section 17200, the Unfair Competition Law (UCL).⁶ In 2016, one appellate court turned up the heat. In Robinson v. U-Haul Co. of California,⁷ the appellate court found that U-Haul had violated the UCL by including an unenforceable clause in its contract, even though the contract stated that the clause was "void where prohibited." The court imposed a permanent injunction on U-Haul and also ordered U-Haul to pay over $800,000 in attorneys' fees to Robinson as a private attorney general under California Code of Civil Procedure section 1021.5. The trial court also found U-Haul guilty of malicious prosecution and awarded $195,000 in damages on that claim, which U-Haul did not appeal..

In view of the Robinson v U-Haul holding, counsel should not insert into a contract any provision that might result in a restraint of competition, including a blanket ban on an employee's soliciting or working for clients of the employer. However, clauses to protect trade secrets should still be enforceable, as are clauses prohibiting solicitation of employees of the previous employer. Those clauses should be drafted with care.

Enforceability of Noncompetition Clauses, in a Nutshell

With certain statutory exceptions, Business and Professions Code section 16600 mandates 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."⁸ California courts have recognized that the enactment of section 16600 in 1872 reflected a fundamental public policy of the state.⁹

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Historically, case law has created exceptions for clauses designed to protect trade secrets,¹⁰ requiring those clauses to be narrowly drafted, and clauses requiring non-solicitation of a company's employees, or "anti-raiding clauses."¹¹ Any other restraint on competition is void.

In 2008, the California Supreme Court in Edwards reviewed the state of the law regarding noncompete clauses. Reviewing the case law, including the federal cases that permitted narrow restraints on competition, the California Supreme Court held that any restraint on competition, regardless how narrow, is void. The court found that section 16600 is unambiguous and has no room for a narrow restraint exception.¹²

The California Supreme Court expressly refrained from addressing the question of whether a clause that protects trade secrets would be enforceable.¹³ In The Retirement Group v. Galante,¹⁴ the appellate court held that an injunction to prohibit a former employee from using the employer's customer lists could not be based on an unenforceable noncompetition clause, but could be based in tort,¹⁵ alleging misappropriation of trade secrets under the Uniform Trade Secrets Act (UTSA).¹⁶ Other courts have tentatively disagreed, in view of the facts at hand.¹⁷

Nonsolicitation of Employees Clause

Another exception to the unenforceability of noncompete clauses is a clause barring solicitation of the former employer's employees. In 1985, a California Court of Appeal decided Loral Corp. v. Moyes,¹⁸ upholding a clause in which a departing director agreed that he would not "disrupt, damage, impair or interfere with the business of Conic Corporation, or its TerraCom Division whether by way of interfering with or raiding its employees." The court's reasoning was that the restriction did not prohibit Conic employees from joining the new company, nor did it restrict the new company from hiring Conic employees. The court held that the clause "does not appear to be a significant restraint on [Moyes'] engaging in his profession, trade or business" and "only slightly affects Conic employees."¹⁹

Loral remains good law. The California Supreme Court did not consider the non-solicitation of employees provision in the contract at issue in Edwards.²⁰ After Edwards, no published decision has ruled on the issue. However, given the California Supreme Court's rejection of "narrow restraints," attorneys should use caution in drafting such clauses.

Distinguishing Loral, the court of appeal in VL Systems, Inc. v. Unisen, Inc.²¹ found that a clause that read as follows was really a no-hire clause:

BUYER WILL NOT ATTEMPT TO HIRE SELLER'S PERSONNEL. Any hiring, or offer of employment entitles, but does not require VL Systems, Inc. to immediately cancel the performance period of this agreement. If, during the term of, or within (12) months after the termination of the performance period of this agreement, buyer hires directly, or indirectly contracts with any of seller's personnel for the performance of systems engineering and/or related services hereunder, BUYER AGREES TO PAY

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