Mcle Self-study: to Compete or Not to Compete: That Is the Question
| Publication year | 2023 |
| Author | Wendy Musell |
AUTHOR*
Wendy Musell
An employer's ability to restrict former employees from working for a competitor after leaving employment has again become a hot topic. In California and nationally, this legislative session has seen a number of proposed bills designed to close gaps and loopholes in non-competition laws and to make clear that employees have a right to seek jobs without undue restrictions—including going to work for a competitor.
California law has long precluded non-competition clauses in employment contracts, subject to strict exemptions that limit employees' abilities to work in professions, trades, or businesses. As a general proposition, individuals in California have a right to freely pursue the livelihoods they choose.1
As early as 1872, California passed legislation in favor of open competition, rejecting the "rule of reasonableness" restraining an employee's ability to work in a trade of choice by passing former California Civil Code section 1673. California Business and Professions Code section 16600, passed by the legislature in 1941, repealed that statute and unequivocally prohibited non-competition clauses in California. It states: "Except as provided in this chapter, every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void."
As described more fully below, exemptions to the overall prohibition of non-competition clauses are limited to:
- the sale of the goodwill of a business or ownership interest in or operating assets of a business entity;2
- dissolution or dissociation of a partnership;3 or
- dissolution or sale of a limited liability company.4
The California Supreme Court in Edwards v. Arthur Andersen LLP5 addressed the contours of non-competition clauses under section 16600. It noted that "in the years since its original enactment as Civil Code section 1673, our courts have consistently affirmed that section 16600 evinces a settled legislative policy in favor of open competition and employer mobility."6 The Edwards court rejected the employer's urgings to adopt the federal "narrow-restraint" doctrine that would allow restrictions on employee mobility that were not outright prohibitions, such as time or geographic limitations on the ability to work for a subsequent employer performing similar work.
The Edwards court also determined that the employment contract at issue restraining an employee from working in the same industry for 18 months, as well as a non-solicitation clause in force for a year, was unlawful under California Business and Professions Code section 16600. It ruled that the non-competition agreement the employee was required to sign before commencing employment was therefore invalid, as it unlawfully restrained the employee's ability to practice a profession.
In 2020, the California Court of Appeal in Brown v. TGS Management Co., LLC, addressed the statutory exemptions to the prohibitions for non-competition clauses. The Brown court affirmed that there are three limited exemptions in California in the employment context.
First, one who sells the goodwill of a business, or all ownership interest in a business entity or substantially all of its operating assets and goodwill to a buyer who continues with the existing business may agree to limit the seller's ability to engage in the same type of business within a specified and limited geographic area.
Second, upon dissolution of a partnership or dissociation of a partner, a partner may agree not to engage or create a similar business within a specified geographic area if the business will be carried on by remaining partners or anyone deriving title to the business or its goodwill.
Third, a member of a limited liability company may agree not to carry on a similar business within a specified geographic area, so long as other members or anyone deriving title to the business or its goodwill carries on a like business.7
Two years later, in 2022, the California Court of Appeal in Blue Mountain Enterprises, LLC v. Owen8 considered the applicability of statutory exemptions to California Business and Professions Code section 16600. The court ruled against a former Chief Executive Officer (CEO) who had entered into a contract that was part of a joint venture that involved transfer of the CEO's ownership interests in several businesses as a part of its formation as a limited liability company (LLC). The former CEO, in contravention of the contract between the parties, opened a competing business after selling his ownership interest. He then sent communications to the newly formed LLC's customers that were characterized as denigrating of the LLC. The LLC sued, claiming the former CEO violated the non-solicitation covenant in contracts the parties had entered.
The court of appeal ruled that the settled public policy of California favors open competition in the practice of a profession, trade, or business—and also in employee mobility, citing California Business and Professions Code section 16600. However, the court indicated that the...
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