Why Most Non-Compete Pacts Are Unenforceable in California

While reasonable non-competition agreements are enforceable in most states, California remains hostile territory for companies wishing to bind their employees to such agreements. This is good news for employees on the move and the companies that wish to hire them. Some 15 months ago, the California Supreme Court nixed most such agreements in a decision involving the now defunct accountancy business of Arthur Andersen. Since that time, California’s appellate courts have shown continued disdain for agreements that seek to impair the right of a California employee to work for a competitor. In the Arthur Andersen case, the California Supreme Court made clear that California law does not permit any agreement that seeks to restrict the right of an employee to go to work for a competitor or solicit a former employer’s customers using information that fails to meet the state’s stringent requirement of being a “trade secret”. . From the employee’s perspective, the court confirmed that agreements which prevent employees from going to work for a competitor or soliciting the former employer’s clients using non-trade secret information violate California law. From the employer’s perspective, the case allows the new employer to ignore any such contractual restrictions that the new employee may have signed and opens the door for the new hire to poach the former employer’s customers. Although the court invalidated agreements which restrict employee movement, it left intact another provision of California law that permits non-compete agreements in certain non-employment settings such as between the buyer and seller of a business, among partners dissolving their partnership or when obtained in connection with the acquisition of a company’s stock. Nor did the Arthur Andersen decision disturb longstanding laws that permit a business owner to protect its valuable trade secrets. Thus, employees who misappropriate the company’s trade secrets when leaving still may be sued for damages and injunctive relief. Suit can also be brought against the employer that hires them in reliance upon bringing the valuable trade secrets to the new business. Some commentators promote the idea of retaining the illegal provisions, hoping that departing employees may adhere to the unenforceable restriction out of ignorance. However, this is a very risky strategy that could embroil the company in needless litigation, as the employer in the most recent case found out the hard way. For example, it is illegal in California for an employer to insist that a job applicant or an employee sign a contract or policy containing an illegal provision. Doing so will set the company up for an expensive wrongful termination case if the employee is fired for refusing to do so or quits in protest. In the latter circumstance, the quitting will likely be deemed an illegal constructive discharge. Also, there is a lot about this area of law in the media. Continuing the illegal practice could undermine employee confidence in management and have an adverse effect on morale. The latest appellate court decision involved Biosense Webster, Inc. In that case, the California Court of Appeal refused to enforce the Biosense Webste rnon-competition and non-solicitation agreements with two California employees. Oddly, the plaintiffs in that case were the new employer St. Jude Medical S.C., Inc. and the two employees who it hired away from Biosense. They sued Biosense to invalidate the offending agreements. Much to the chagrin of Biosense, they won the case, leaving Biosense with nothing but a drawer full of legal bills and an invalid contract it had to then revise for all of its other employees. Here is what happened. Upon starting their employment with Biosense, the two employees in question signed agreements prohibiting them from working for a competitor or using information they learned at Biosense when working for a competitor. The non-solicitation clause in these agreements prohibited the employees from soliciting, selling or rendering “any service,” directly or indirectly, “to any of the accounts, customers or clients” with whom the employees had contact during their last 12 months of employment. The clause remained in effect for 18 months after the employees’ termination of employment. In early-to-mid 2005, two employees left Biosense to take sales positions with St. Jude. St Jude is a direct competitor. Biosense responded with a typical “cease and desist” letter demanding that St. Jude stop its “unlawful raiding” of Biosense employees and informing St. Jude of the non-competition covenants in the agreements signed by the two former Biosense workers. Biosense further indicated that it intended to file a lawsuit if necessary and demanded a response within two weeks. St. Jude and the two employees turned the tables on Biosense by going to court first. They sought a court order invalidating the Biosense agreements. Biosense then filed its own lawsuit against St. Jude and the two former workers for unfair competition, and accused St. Jude of unlawfully “raiding” Biosense employees, by attempting to induce those employees to leave Biosense and use “insider knowledge” to “unfairly recruit” Biosense personnel. The trial court ruled that the non-competition agreements at issue violated California law. Bioseal appealed that ruling, but the Court of Appeal refused to enforce the non-compete agreements. Relying on the Arthur Andersen case, the appellate court ruled that the non-competition agreement was at odds with longstanding California law barring non-compete agreements. The Court also upheld the lower court’s dismissal of Biosense’s cross-complaint for unfair competition since there was no evidence that St. Jude did anything wrong in connection with its hiring of the two former Biosense workers. This latest decision by the Court of Appeal reinforces just how difficult it is for California employers to enforce non-competition and non-solicitation agreements. It is not enough for the agreement to simply define the employer’s trade secrets and confidential information, while broadly prohibiting solicitation of the employer’s customers. The non-solicitation clause must be narrowly drafted so that it only prevents misuse of trade secrets, rather than preventing lawful competition. In light of these rulings, consider one or more of the following steps: • Review existing employment agreements or company policies for any provision that restricts employee movement or their post employment activities. Have them reviewed by labor counsel to be sure the provision is still lawful. Otherwise, you could face suit by a former employee and their new employer when attempting to enforce the agreement. You also set yourself up for an expensive wrongful termination case if a new hire won’t sign the agreement and is fired as a result. , • Take this opportunity to enhance existing policies and agreements designed to protect company trade secrets. If you don’t have one, or you don’t routinely ask employees to sign the one you do have, now is an excellent time to reduce your vulnerability to trade secret theft. • State trade secret laws require more than simply calling something a trade secret in a document. Consult your labor counsel to learn what types of information may qualify as true trade secrets and what steps are essential for insuring that trade secret information will be protected. • Consider adding protections to prevent the solicitation of key personnel. This is still lawful. • Some commentators suggest that you get around the new ruling by putting the non-compete in a retirement plan contract. Since this is an untested theory, review this strategy with legal counsel. Richard S. Rosenberg is a founding partner of Ballard Rosenberg Golper & Savitt LLP, a management side labor law firm in Glendale. Rosenberg was recently selected as one of the 25 best lawyers in the San Fernando Valley. He may be reached at (818) 508-3700 or [email protected].