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Employee non-competes — it’s different in California

July 27, 2011

The third part in my occasional series of how we do things a bit different here in California.

The non-compete, aka covenant not to compete.  A contractual term by which someone, for present purposes a former employee, agrees not to compete against his or her former employer for a period of time, in a particular geographic area, and/or in a particular product or service market.  Many states view them skeptically, but most will enforce them if they are reasonable.

It’s different in California.  We absolutely hate non-competes, and anything that looks, smells, sounds, feels, walks, talks, or acts like one.  And while that’s really all you need to know about non-competes under California law, I’ll fill in below some additional details so you can see just how much we left-coasters loathe these things.

  • We’ve hated ’em for a long time.   Right out of the womb, in fact.  California Business and Professions Code section 16600 was enacted in 1872 (although it was called something else) in the first legal codes we passed as a state.  That section, which embodies California’s policy-based antipathy for non-competes, expressly rejects the concept of non-competes as well as the “rule of reasonableness” that limits (but does not preclude) their enforcement in most other states.  In fact, the California Supreme Court recently slapped the Ninth Circuit — not exactly known as a business-friendly forum — for not being tough enough on non-competes.
  • There are extremely limited exceptions.  The only circumstances under which a California court will enforce a non-compete involve a bona fide sale of a company (including goodwill), a corporate merger, or the sale of a partnership interest.
  • Don’t try to fake one of those, either.  California courts will look hard at the substance of a transaction, and void a non-compete that doesn’t pass the test.  So don’t think about requiring your employees to buy (and then sell upon termination) a small amount of stock.  It’s been tried, and it failed.
  • Former employers can’t take back vested benefits for competing.  California courts have rejected employers’ attempts to claw back vested benefits from competing employees, asserting the same public policy in favor of employee mobility.  So an employee’s earned compensation, bonus, or pension benefits can’t be withheld or forfeited should the employee go to work for a competitor.
  • Don’t even think about “inevitable disclosure.”  ‘Nuff said.
  • Choice of law clauses aren’t much help either.  Some employers insert a provision in their non-competes stating that the parties “agree” to apply some law other than California’s to any dispute.  California courts don’t like these either, especially with a California employer and employee.  Other states’ reactions are mixed, and fact-dependent, but even the states that decline to apply California law have to recognize, and work around, California’s strong public policy interest against non-competes.  Not to mention that such clauses often lead to expensive procedural games when litigation is necessary, with races to the courthouse in competing jurisdictions and duplicative litigation.
  • OK, then, how about a contract not to solicit customers?  Uh, no.  A contract preventing a departing employee from soliciting her former customers is also void under California public policy.
  • Don’t fire employees who won’t sign a non-compete.  Employers who fire California employees (or refuse to hire California applicants) who won’t sign a non-compete can be sued for wrongful termination or unfair hiring practices.
  • Employers can’t even “informally” enforce their competitors’ non-competes.  In an interesting case that demonstrates the depth of California’s hostility to non-competes, the defendant employer learned its new employee had signed a non-compete at her former employer.  The new employer terminated her to avoid being discourteous to a fellow industry member.  Employee sued the new employer — who hadn’t even asked for a non-compete, much less required her to sign one — for wrongful termination.  Guess who won?  (Free blog subscription to the first five correct answers.)
  • C’mon, throw us employers a bone here.  About the only thing an employer can do to limit former employees’ competitive actions is to protect legitimate trade secrets.  Even then, though, you’ll have to prove what you’re trying to protect is a real trade secret, which can be harder than you might think.

So, California employers, think twice, and then think again, and then make darn sure you’ve got a California lawyer on retainer, before you ask your California employees to sign a non-compete.  Out-of-staters, you’d better do the same.  Or else you’ll find you’re helping keep another class of California workers busy — plaintiffs’ attorneys.

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