California Non-competition Law

posted by Neil Klingshirn  |  Jan 2, 2010 4:28 PM [EST]  |  applies to Ohio

At one time California courts enforced contractual restraints on competition as long as they were reasonably imposed. However, in 1872 California adopted a public policy favoring open competition and rejecting the common law “rule of reasonableness," with certain exceptions. These include agreements relating to business sales, withdrawals from partnerships and unfair competition.

California Contracts Restraining a Profession, Trade or Business are Unlawful

California Business and Professional Code section 16600 states that:

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.

Section 16600 evinces a settled legislative policy in favor of open competition and employee mobility. It ensures Californians the right to pursue any lawful employment and enterprise of their choice.  Section 16600 prohibits even a narrow restraint of a profession, trade or business, unless the restraint falls within the trade secrets or statutory exceptions. Edwards v. Arthur Andersen LLP, 44 Cal. 4th 937, 952 (Cal. 2008).

Statutory Exceptions to 16600

California excepts from its prohibition against covenants not to compete agreements made in connection with the:
  • Sale of the goodwill of a business,
  • Sale or disposal of all of an interest in a business,
  • Sale of all or substantially all of the operating assets and the goodwill of a business or the division or a subsidiary of the business and
  • Sale of all of the ownership interest of any subsidiary.
Cal Bus & Prof Code § 16601. In these cases, the seller may agree with the buyer:
  • to refrain from carrying on a similar business
  • within a specified geographic area in which the business had carried on,
  • so long as the buyer or its successor carries on a like business within that area.
Cal Bus & Prof Code § 16601.  Where a physician’s stockholder buy/sell agreement was in fact a sham for an employee covenant not to compete, however, a California court refused to apply the business sale exemption. Bosley Medical Group v. Abramson, 161 Cal. App. 3d 284, 288-290 (Cal. App. 2d Dist. 1984).

Similarly, when a partnership dissolves or a partner leaves the firm, the partners can agree not to carry on a similar business within a specified geographic area in which the partnership transacted its business, so long as any the partnership, a partner or a successor to a partner carries on a like business within that area. California courts have therefore enforced non-competition agreements between lawyers, physicians and accountants who were partners (and not just employees) who withdrew from their firms. Cal Bus & Prof Code § 16602.

These statutory exceptions represent a preservation of the rule of reason for the excepted transactions. Under the rule of reason, the permissible geographic scope may not be broader than that in which the former employer previously engaged and should be reasonable in duration.

Contracts Protecting Trade Secrets

California courts enforce contracts not to disclose trade secrets and not to solicit customers. The so-called “trade secrets” exception to Section 16600 arises from the California common law prohibition against “unfair competition” found in tort law, which is separate from contract law. Unfair competition includes the use of trade secrets, such as confidential customer lists, to solicit clients.  Thus, under the law of unfair competition, California courts will enforce agreements that prohibit the solicitation of former clients and the misuse of trade secret information. Gordon v. Landau, 49 Cal. 2d 690, 694 (Cal. 1958).

Although employees cannot unfairly use trade secrets to solicit clients, California law allows employees to announce their new employment to a list of clients whose identity is a trade secret. American Credit Indemnity Co. v. Sacks, 213 Cal. App. 3d 622, 636 (Cal. App. 2d Dist. 1989). Once employees announce their identity, California’s Trade Secrets Act does not prohibit the client from providing that information to the employees. Hilb v. Robb, 33 Cal. App. 4th 1812, 1822 (Cal. App. 2d Dist. 1995).

Trade Secrets Act

In addition to the trade secrets exception to 16600, California’s trade secrets statute, codified at Civil Code Section 3426-3426.11 protects trade secrets.  Specifically, California’s Trade Secrets Act prohibits the misappropriation of trade secrets, whether an employee has agreed to protect trade secrets or not.  In contrast, the trade secret exception to 16600 is a tort claim that permits a court to enforce an agreement protecting trade secrets and solicitation of former clients.  Such an agreement could impose broader restrictions and allow greater damages than those in the Trade Secrets Act.

Key Cases

  • Edwards v. Arthur Andersen LLP, 44 Cal. 4th 937, 952 (Cal. 2008)(rejecting “narrow restraint” exception to 16600).
  • Gordon v. Landau, 49 Cal. 2d 690, 694 (Cal. 1958)
  • Hollingsworth Solderless Terminal Co. v. Turley, 622 F.2d 1324, 1338 (9th Cir. Cal. 1980)
  • Vacco Industries, Inc. v. Van Den Berg, 5 Cal. App. 4th 34, 47 (Cal. App. 2d Dist. 1992)(5 year non-compete enforced against 3% owner in agreement for the sale of all of his shares).

posted by Neil Klingshirn  |  Jan 2, 2010 4:28 PM [EST]  |  applies to Ohio

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Neil Klingshirn
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