Understanding California's Ban on Non-Compete Agreements

Understanding California's Ban on Non-Compete Agreements
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Although my home state of California, like several other states, will not recognize non-compete agreements, I am always surprised at how many companies still think that forcing employees to sign these them will prevent them from later working for the company’s competitors, or setting up a competing business themselves. California is massive in geographic size and economic impact. The “Golden State” surpassed the country of France last year to become the sixth largest economy in the world.

As a California-based lawyer, I have heard businesses argue that the California laws shouldn’t apply to them because their company is headquartered in a state that recognizes non-compete agreements. California courts have rejected this analysis. Companies have attempted to skirt the ban using “choice of law provisions” stating that the contract is to be interpreted according to a different state’s laws (one that recognizes non-competes). California courts have also rejected these arguments.

I have reviewed agreements that couched the provision in terms of giving up future employment “voluntarily” and “for consideration received.” California courts have still refused to enforce non-compete agreements. Some frustrated companies also adopted “Garden Leave” policies by requiring higher level employees to give extended periods of notice prior to their resignation (typically 90 to 180 days) during which the employee can be asked to stay home and tend to his or her garden (thus the name) while receiving full pay and full benefits. And it turns out that companies also cannot require their employees to provide any specific length of notice, even when they offer to compensate them at 100% of their salary and benefits for the duration of the notice period. California courts have found these mandatory provisions to be an unenforceable restraint, as well (although it appears that companies may be able to offer this to departing employees on a voluntary, opt-in basis – and this requires carefully crafted language from an experienced attorney that understands your business. Even then, there are no guarantees). And courts have applied California non-compete laws to California employment without regard to all of this. In short, both the legislature and the courts are wise to creative tricks, and both have stated, in no uncertain terms, that they will not waver. California will not enforce a non-compete agreement against a former employee.

California has even gone so far as to reject the “inevitable disclosure doctrine.” This means that a non-compete cannot even be enforced to prevent someone from taking a job on grounds that the former employer reasonably believes that the former employee will use prior confidences as a necessary part of performing his or her job. Instead, businesses must simply wait and see if there is a violation, and then prove, that the former employee has actually misappropriated confidential information in his or her new employment.

The foregoing demonstrates that California’s position is crystal clear: except in a few, very limited, circumstances summarized below, a non-compete agreement will not be enforced.

While some may be inclined to chalk this up to yet another anti-business rule from the so-called People’s Republic of California, the reality is that the laws are based in sound policy reasons to keep residents gainfully employed, able to provide for themselves and their families, and off the welfare and social service rolls. Whether you are a business owner or not, it is tough to argue with that logic. Accordingly, any company doing business in California would be wise to spend some time studying the scope – and the exceptions – of California’s laws with respect to non-compete agreements to better understand them.

Unenforceability only applies to limitations on one’s employment after the employment relationship. In California, non-compete agreements that prevent employees from future gainful employment are void, but this ban only applies to non-competes that are or remain effective after the termination of employment. A company may – legally and for very legitimate reasons – prohibit its employees from moonlighting during the term of their employment, particularly when the moonlighting it performed for a competitor. There are a myriad of reasons why companies would demand loyalty of current employees. Thankfully, the California legislature and the courts alike have recognized a business’s need to monopolize a current employee’s commitment to the success of the venture and minimize the risk of corporate espionage. Many companies find that these policies are shared with prospective employees before they begin their term of employment. Most also insert provisions restricting moonlighting in their employee handbooks to serve as a reminder to existing employees.

Exception to the rule: a buyer of a company can prevent a seller from competing with it. The exceptions to California’s general rule are limited, but there are a few, and they are important. The first exception applies to a business owner (sole proprietor) or fractional owner (shareholder) who may sell the “goodwill of a business” or otherwise dispose of his/her ownership interest in the business entity. This is a common sense exception. Where the business and its goodwill have been sold, Courts have held that the buyer’s benefit of the bargain means that the seller can’t then turn around and engage in the kind of competition that would diminish the value of the business and goodwill he just sold, thereby depriving the buyer of the benefit of his or her bargain.

Exception to the rule: business partners and members of a limited liability company can mutually agree that none of them will compete with the business after they leave the business or sell it. For similar reasons to the first exception, courts have held that partners in a business and members of a limited liability company can mutually agree that none of them will engage in competition within a specified geographic area of the existing partnership within some period of time after the dissolution, sale, or other disposition of the partnership business. This exception also applies following the departure of a partner for any reason. The only caveat is that an employer may not grant nominal ownership shares to an employee simply to skirt the non-compete laws. Courts scrutinize agreements to ensure that those entering into these decisions truly are partners and members, and not just employees the business is trying to freeze out of a space, geographic area, or industry.

In closing, case law regarding non-compete agreements is significant, and each set of facts has its own nuances. Businesses operating in the state of California are encouraged to seek counsel from a qualified attorney to discuss how these rules might apply to it, and how a company may best protect its intellectual property, trade secrets, proprietary and confidential information, and processes.

The foregoing is provided for informational purposes only, is not an advertisement, does not constitute legal advice or legal opinion, and does not create an attorney-client relationship. The content may not apply to the specific facts or a particular matter. You should not act or rely on any information contained in this article without first seeking the advice of an attorney licensed to practice in your jurisdiction.

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