PUBLICATIONS

California Supreme Court Reaffirms Ban On Employee Non-Competition Agreements

8/13/2008

In Edwards v. Arthur Andersen LLP, the California Supreme Court clarified that post-employment customer non-solicitation restrictions are invalid – even if those agreements otherwise leave the employee free to compete against the employer. In reaching this conclusion, the court relied on what it described as California's "settled legislative policy in favor of open competition and employee mobility." Although this decision may be viewed unfavorably by employers seeking reasonable limits on post-employment conduct to protect their legitimate business interests, it may provide comfort to employers when hiring current or former employees of competitors, who sometimes use such customer non-solicitation restrictions as a way to deter the hiring.

Edwards, a certified public accountant, was a long-time employee in Arthur Andersen's tax practice group. Upon commencement of employment, Edwards signed, as a condition of his employment, a non-competition agreement that (1) barred him from performing professional services of the type provided for any client for whom he performed work during the 18 months preceding the termination of his employment, and (2) barred him from soliciting any Arthur Andersen client with whom he had worked for a period of 12 months after the end of his employment.

In 2002, as a result of government indictments, Arthur Anderson sold off a portion of its tax practice, including Edwards' group, to HSBC USA, Inc., a banking corporation. HSBC offered Edwards a job on the condition that he sign a "Termination of Non-compete Agreement" (TONC), which required him to release Arthur Andersen from "any all claims," including all claims arising from or related to his employment. In exchange for his signature, Arthur Andersen would agree to accept Edwards' resignation and release him from the non-competition agreement. Edwards refused to sign the TONC, which caused Arthur Andersen to terminate his employment and HSBC to rescind its offer of employment. Edwards sued, claiming that (1) the Andersen agreement was invalid under California Business & Professions Code section 16600, which prohibits restraints of trade; and (2) the TONC's release of "any and all claims" equated to a release of his statutory right to indemnification under the Labor Code in violation of California law.

The California Supreme Court agreed with Edwards as to the first point, holding that the non-competition agreement signed by Edwards at the outset of his employment with Arthur Andersen was an invalid non-competition agreement. The Court ruled that non-competition agreements are valid only in those very few situations set forth in California Business & Professions Code section 16600 et seq., (e.g., sale or dissolution of a corporation, partnership of LLC). In this case, no exception applied, meaning that the non-competition agreement was "invalid because it restrained his ability to practice his profession." The Court also rejected the more lenient "narrow restriction" doctrine adopted by federal courts, which enforced non-competition agreements that restricted employees from only a limited segment of their chosen profession.

The court did not have reason to address the so-called "trade secret" exception to the rule against non-competition agreements. Some lower California courts have recognized this exception in upholding certain post-employment non-competition agreements if necessary to protect the employer's identifiable trade secrets. Employers should carefully consider whether and how to use this exception in connection with any provision that otherwise restrains trade.

The Court disagreed with Edwards' second argument regarding the scope of the release. Under the California Labor Code, an employee is entitled to indemnification for all necessary job-related expenditures, and any contract purporting to void that right is invalid. Edwards argued that the broad release language of the TONC necessarily included a release of his indemnification rights in violation of California law. The Court found otherwise, narrowly interpreting the TONC as not encompassing a waiver of Edward's indemnity claims and, therefore, not invalid. According to the Court, "a contract provision releasing 'any and all' claims does not encompass nonwaivable statutory provisions."

Based on this ruling, employers should review their employment agreements, including any confidentiality or trade secret protection agreements, to ensure that they do not contain invalid restraints of trade, such as customer non-solicitation and/or non-competition provisions. This decision also makes it more important than ever to implement lawful and effective methods to protect trade secrets, such as customer information, including trade secret agreements, policies, training, and security measures. Our employment law attorneys are available to discuss these newest developments and to work with clients to develop effective strategies to protect their information assets, including valuable customer information, and to hire and retain employees in a way that minimizes the risk of litigation with competitors.