California - Supreme Court Holds Non-Competition Agreements Unenforceable in California, Rejecting Federal Courts’ “Narrow Restraint” Exception
October 22, 2008
James W. "Jim" Michalski- Los Angeles
In Edwards v. Arthur Andersen LLP, No. S147190, the California Supreme Court confirmed that California law prohibits almost all employee post-employment non-competition agreements. The Court expressly rejected the “narrow restraint” exception to California’s prohibition on non-competition agreements that certain federal courts in California had previously applied. This decision effectively eliminates California employers’ ability to enter into any kind of agreement designed to limit an employee’s post-employment competition, including agreements requiring the employee to forfeit stock options or other benefits if he or she goes to work for a competitor.
Raymond Edwards II worked as an accountant for Arthur Andersen LLP (Andersen) until the firm sold the group in which Edwards worked to HSBC USA (HSBC) shortly after the United States government indicted Andersen. As a condition of employment with Andersen, Edwards had entered into a non-competition agreement prohibiting him from performing professional services “for any client on whose account he had worked during 18 months prior to his termination.” The agreement also prohibited Edwards, for a year after termination, from “soliciting” any client of Andersen’s Los Angeles office.
The Termination of Non-Compete Agreement: A Violation of Public Policy
In July 2002, HSBC offered Edwards employment. But, as a condition of hire, HSBC required Edwards to sign a Termination of Non-Compete Agreement (TONC). One of the key terms of the TONC was a release of “any and all” claims against Andersen. In exchange, Andersen would accept Edwards’ resignation, agree to Edwards’ employment by HSBC and release Edwards from his non-competition agreement. Edwards refused to sign the TONC, causing HSBC to revoke its offer of employment.
Edwards sued Andersen for several claims including intentional interference with prospective economic advantage. He claimed that the non-competition agreement with Andersen was unenforceable and Andersen’s demand that he sign the TONC to be released from that unenforceable agreement violated public policy, thus supporting his intentional interference claim. Edwards also contended that the TONC’s release of “any and all” claims against Andersen violated the California Labor Code, which prohibits waivers of employee indemnity rights.
The trial court ruled against Edwards. Although it recognized that California Business and Professions Code Section 16600 prohibits virtually all post-employment restrictive covenants by employees, it found that Edwards’ non-competition agreement could be enforced under the “narrow restraint” exception created by the California federal courts. This exception allowed for enforcement of a non-competition agreement if it were sufficiently narrow to allow the employee to work in a substantial portion of the market. On appeal, the California Court of Appeal disagreed. It ruled that Section 16600 invalidated the non-competition agreement and that requiring Edwards to sign the TONC in exchange for being released from it was an independent wrongful act supporting Edwards’ intentional interference claim.
Andersen urged the California Supreme Court to adopt the “narrow restraint” exception to Section 16600. In rejecting Andersen’s argument, the California Supreme Court emphasized that Section 16600 prohibits non-competition agreements in almost all instances: “Section 16600 is unambiguous, and if the Legislature intended the statute to apply only to restraints that were unreasonable or overbroad, it could have included language to that effect.” Because it was against public policy to condition employment on execution of an unenforceable non-competition agreement, Edwards could claim intentional interference, the Court ruled.
On the other hand, the Court ruled that the request that Edwards release “any and all” claims against Andersen was not unlawful. Because it must construe ambiguous contract terms in a manner that keeps them lawful, the Court said it would not read the release of “any and all claims” as waiving Edwards’ non-waivable statutory indemnity rights.
Finally, the Court did make clear that its Edwards opinion in no way limited employers’ ability to protect trade secrets, including through contractual agreements prohibiting disclosure of trade secrets.
The primary significance of Edwards is the California Supreme Court’s rejection of the “narrow restraint” exception to Section 16600 previously adopted by the California federal courts. As this exception may no longer be applied, Section 16600 makes all employee non-competition agreements unenforceable unless they satisfy the statutory exceptions concerning the sale or dissolution of a corporation, limited liability corporation or partnership. More specifically, the decision invalidates agreements that call for forfeiture of stock options or other benefits as a penalty for breach of non-competition terms. And, the decision makes clear that California employers that condition employment opportunities on an individual’s execution of an invalid non-competition agreement face liability for wrongful discharge or intentional interference with contract or prospective advantage. California employers should not ask employees to sign non-competition restrictions without legal advice.
For more information, contact:
James W. Michalski
213.896.2585
james.michalski@hklaw.com
toll free: 1.888.688.8500
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