It is no secret that California law strongly disfavors non-compete agreements between employers and employees. However, through careful legal study and competent drafting, a company can still protect itself with different types of agreements to accomplish the same goals. This article will introduce the various ways an employer can still use non-compete type agreements without violating California law.
California law automatically voids all blanket non-compete agreements. See D’Sa v. Playhut, Inc., 85 Cal. App. 4th 927, 933 (2000). Moreover, the inclusion of such non-compete clauses may also open a company to tort suites alleging intentional interference with prospective economic advantage. See Edwards v. Arthur Andersen LLP, 44 Cal.4th 937, 950 (2008). Finally, firing someone if they refuse to sign an unenforceable non-compete agreement opens the employer to tort liability for wrongful termination. See D’Sa at 930. California courts have even extended this wrongful termination liability to employers who fire their newly-hired employees in order to honor another company’s unenforceable non-compete agreement. See Silguero v. Creteguard, Inc., 187 Cal. App. 4th 60, 71 (2010).
Moreover, choice of law or severability provisions alone do not save an employer from the above mentioned tort liability. See D’Sa at 934. Indeed, as long as the employee works mostly in California, California courts will not honor choice of law provisions when dealing with non-compete agreements unenforceable under California law. See, e.g., Frame v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 20 Cal. App. 3d 668, 673 (1971). Furthermore, if a company is based in California, non-compete clauses are also void for any employees it hires outside of California. See Application Group, Inc. v. Hunter Group, Inc., 61 Cal.App.4th 881, 885 (1998). Finally, California courts have gone so far as to refuse to honor the orders of foreign courts if they think those orders purport to enforce a non-compete that is contrary to California law. See Robinson v. Jardine Ins. Brokers Int’l Ltd., 856 F. Supp. 554, 559 (N.D. Cal. 1994) (issuing a preliminary injunction against an English court order that prohibited the plaintiff from doing business with defendant’s clients because the restriction violated California’s non-compete laws).
It is therefore very important for California employers who want to preserve their trade secrets, customers, good will, and employee loyalty to correctly draft their employee agreements in order to both protect themselves to the fullest extent possible and simultaneously avoid going too far. These goals can be achieved by drafting and executing enforceable non-compete clauses within the limited exceptions allowed under California law, employee non-solicitation clauses, confidential information clauses, forum selection clauses, and arbitration clauses.
Enforceable Non-Compete Clauses
Not all non-compete clauses are banned in California. Importantly, California enforces non-compete clauses during the employee’s term of employment, so long as they do not extend after termination. See Fillpoint, LLC v. Maas, 208 Cal.App.4th 1170, 1174 (2012); Edwards at; Cal. Bus. and Prof. Code § 16600. California also enforces post-termination non-compete agreements where the departing employee is also the owner, or partial owner, of the business, and is selling his or her ownership interest as part of the departure. See Fillpoint at 1174; Edwards at 955; Cal. Bus. and Prof. Code § 16601. Importantly, in such a situation, the price paid for the departing owner/employee’s ownership interest must include a premium for “good will” being acquired by the new owner. Id.
California courts have upheld narrowly-drafted non-solicitation clauses – i.e., provisions in an employment agreement prohibiting the employee from “soliciting” the employer’s customers and/or employees after the employee’s departure. See Loral Corp. v. Moyes, 174 Cal.App.3d 268, 280 (App. 6th Dist. 1985). But California courts have made it clear that broad provisions that contain, a customer and employee non-solicitation clause, as well as a post-termination non-compete clause, are invalid. See Fillpoint at 1183.
The enforceability of a non-solicitation clause turns on what the agreement deems “solicitation,” whether the identity of an employer’s customers and/or employees can be considered a “trade secret,” and the extent of the employee’s personal knowledge.
Confidential Information Clauses
California courts have banned all blanket customer non-solicitation clauses. See The Retirement Group v. Galante, 176 Cal.App.4th 1226, 1240 (2009). However, a company can include a “confidential information clause” and an “obligations upon termination of employment clause” to provide the functional equivalent of a customer non-solicitation clause.
First, California law prohibits misappropriation of “trade secrets” – i.e., information that has economic value to the company and kept reasonably secret from the public. See Muggill v. Reuben H. Donnelley Corp., 42 Cal. 2d 239, 242 (1965) (court rules that there is a trade secret exception to the general rule against non-compete clauses); Cal. Civ. Code § 3426.1. California courts do not prohibit agreements in which the employee agrees not to disclose trade secrets. See Loral at 276; See Edwards at 289. Accordingly, California courts have also held that customer information and identity may qualify as trade secrets, and have held that the use or disclosure of a former employer’s customer information to solicit customers for a new employer was a misappropriation of trade secrets. See Morlife, Inc. v. Perry, 56 Cal.App.4th 1514, 1526 (1997).
Again, whether a “confidential information” clause will be upheld if it functionally prohibits a former employee from providing services to the employer’s customers at a new job depends on the facts, and careful drafting.
It is important to note that California courts do not recognize the “inevitable disclosure doctrine,” a theory positing that an employee will inevitably rely on the former employer’s trade secrets in a new job. See Whyte v. Schlage Lock Co., 101 Cal.App.4th 1443, 1447 (2002). This means an employer has to prove the former employee actually misappropriated confidential information in order to prevail when using this method. See Whyte at 1464.
Forum Selection Clauses
A forum selection clause states that any lawsuit regarding the employee agreement must be litigated within a certain state, no matter where the parties file the initial suit. As mentioned above, California will not honor choice of law clauses if the effect leads to enforcing a normally unenforceable non-compete clause. However, California courts have shown a general tendency to honor forum selection clauses even if it means enforcing non-compete agreements that are against California public policy.
California federal courts have a better track record than California state courts enforcing such clauses, but generally the rulings under both jurisdictions have been favorable to forum selection clauses. See generally Hartstein v. Rembrandt IP Solutions, LLC, 2012 U.S. Dist. LEXIS 105984 (N.D. Cal. 2012); Verdugo v. Alliantgroup, L.P., 237 Cal. App. 4th 141 (2015); but see Bullard v. Anaqua, Inc., No. RG14725925 (Cal. Super. April 22, 2015).
The U.S. Supreme Court has ruled that courts must honor forum selection clauses “in all but the most exceptional cases.” See, e.g., Atlantic Marine Constr. Co. v. United States Dist. Ct. for the W. Dist. of Texas. 134 S. Ct. 568, 574 (2013). In California, the courts have interpreted “exceptional cases” to mean situations in which the forum selection clause itself, viewed in isolation, violates California public policy. See, e.g., Am. Online, Inc. v. Super. Ct., 90 Cal. App. 4th 1, 12 (2001). A company can therefore preempt any challenge to the forum selection clause by showing that the employee willingly agreed to the forum selection clause, the company has connections to the forum, and the forum selection clause does not deny anyone their day in court. See Am. Online at 10, 11, and 12 n.5. Finally an employer should not forget to include a choice of law provision, or else the new forum may end up enforcing California law.
The final card an employer has is the arbitration clause. Moreover, agreements which have both an arbitration clause can also include a forum selection clause that specifies the forum that will enforce the arbitral judgment. California courts have ruled that an arbitrator’s decision is final and have refused to hear appeals even when the arbitrator ended up enforcing a non-compete in California. See Jones v. Humanscale Corp., 29 Cal.Rptr.3d 881, 889 (2005).
This means that the arbitrator essentially gets to decide whether the non-compete agreement is enforceable, and California judges will very likely not review their decisions. Therefore, relying on arbitration agreements to enforce non-competes is a high risk, high reward strategy. Although arbitration clauses are not likely to result in the enforcement of a non-compete agreement otherwise void under California law, in a close case, if an arbitrator rules in favor of the employer, that ruling will most likely be upheld by the courts.
This article was written for informational purposes only and not for the purpose of providing legal advice. You should contact an attorney to obtain advice with respect to any particular issue or problem.
Stanley Chen is a law clerk (awaiting bar results) in the civil litigation and transactions departments at Enterprise Counsel Group in Irvine