Employers considering implementing noncompetition and nonsolicitation agreements for their California workforce must understand the differences in these agreements, and California’s public policy against restraints against an employee’s ability to work in their profession or trade. This Friday’s Five covers the top five issues employers must know about noncompetition and nonsolicitation agreements in California.
1. Noncompetition and nonsolicitation agreements cannot violate Business & Professions Code section 16600
In California, noncompetition agreements are governed by Business & Professions Code section 16600, which states: “Except as provided in this chapter, every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.” The statute permits non-competition agreements in the context of sale or dissolution of corporations (§ 16601), partnerships (§ 16602), and limited liability corporations (§ 16602.5). But other than these narrow exceptions connected with the sale or dissolution of a company, California has a strong public policy against non-competition agreements.
Under the common law, as still recognized by many states today, contractual restraints on the practice of a profession, business, or trade, were considered valid, as long as they were reasonably imposed.
2. California Supreme Court ruling in Edwards v. Arthur Andersen regarding non-competition agreements
In 2008, the California Supreme Court ruled on the enforceability of non-competition agreements under California law in Edwards v. Arthur Andersen LLP. Arthur Andersen argued that California courts have held that section 16600 embraced the rule of reasonableness in evaluating competitive restraints.
The Court disagreed with Arthur Andersen and held that the non-competition agreement at issue was invalid under California law because the agreement prohibited the employee from performing professional services for any client he worked with at Arthur Andersen for a 18-month period. It also prohibited the employee from soliciting any client of Arthur Andersen’s Los Angeles office. The Court held that these prohibitions restricted the employee’s ability to practice his accounting profession, and therefore was unenforceable under California law.
3. California Supreme Court refused to recognize the “narrow-restraint” exception in non-competition agreements
Arthur Andersen argued that section 16600 has a “narrow-restraint” exception and that its agreement with Edwards survives under this exception because the restraints against the employee were narrow and reasonable. Arthur Andersen maintained that the federal court in International Business Machines Corp. v. Bajorek (9th Cir. 1999) upheld an agreement mandating that an employee forfeits stock options if employed by a competitor within six months of leaving employment. It also noted that a Ninth Circuit federal court in General Commercial Packaging v. TPS Package (9th Cir. 1997) held that a contractual provision barring one party from courting a specific customer was not an illegal restraint of trade prohibited by section 16600, because it did not “entirely preclude” the party from pursuing its trade or business.
In rejecting Arthur Andersen’s argument, the California Supreme Court refused to recognize the “narrow-restraint” exception for noncompetition agreements in California:
Contrary to Andersen’s belief, however, California courts have not embraced the Ninth Circuit’s narrow-restraint exception. Indeed, no reported California state court decision has endorsed the Ninth Circuit’s reasoning, and we are of the view that California courts “have been clear in their expression that section 16600 represents a strong public policy of the state which should not be diluted by judicial fiat.” [citation] 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. We reject Andersen’s contention that we should adopt a narrow-restraint exception to section 16600 and leave it to the Legislature, if it chooses, either to relax the statutory restrictions or adopt additional exceptions to the prohibition-against-restraint rule under section 16600.
4. Customer nonsolicitation agreements
There are two types of non-solicitation agreements: one that restricts the employee’s ability to solicit customers and another that restricts the employee’s ability to solicit employees (see item #5 below).
Regarding customer non-solicitation agreements, as set forth above, the California Supreme Court in Edwards v. Arthur Andersen ruled that a prohibition on a former employee’s solicitation of clients was an invalid restraint on the employee’s ability to pursue his trade or business. Similarly, in 2009, a California appellate court in Dowell v. Biosense Webster, Inc. held that a broadly worded non-solicitation clause that prohibited an employee for a period of 18 months postemployment from soliciting any business from, selling to, or rendering any service directly or indirectly to any of the accounts, customers or clients with whom they had contact during their last 12 months of employment was void under section 16600. In Dowell, the court rejected the employer’s argument that the agreement was enforceable under the trade secret exception because it found the non-solicitation provision was “not narrowly tailored or carefully limited to the protection of trade secrets, but are so broadly worded as to restrain competition.”
5. Employee nonsolicitation agreements
Employee non-solicitation clauses can also be found to violate section 16600 if drafted too broadly and it in effect becomes an invalid restraint on the employee’s ability to work in their profession or trade. The court in Loral Corp. v. Moyes (1985), ruled that the agreement at issue was more of a “noninterference agreement” between the employer and former employee and upheld the employer’s non-solicitation provision. The ruling upheld an agreement that prevented the former employee from soliciting employees from the employer, and, even though the agreement did not have a time limitation, the court interpreted the agreement to apply a one-year limit.
However, in AMN Healthcare, Inc. v. Aya Healthcare Services, Inc. (2018), a California court of appeal held that employee non-solicitation to be an invalid restrain on trade. The court explained:
Indeed, the broadly worded provision prevents individual defendants, for a period of at least one year after termination of employment with AMN, from either “directly or indirectly” soliciting or recruiting, or causing others to solicit or induce, any employee of AMN. This provision clearly restrained individual defendants from practicing with Aya their chosen profession— recruiting travel nurses on 13-week assignments with AMN.
The ruling in AMN Healthcare arguably overturned decades of decisions, such as Loral, upholding employee non-solicitation agreements. However, some have argued that AMN Healthcare is a unique case with a limited holding – since the issue delt with employees who were professional recruiters, and therefore baring them from recruiting employees would be more impactful on their ability to continue to work in their chosen profession. Nevertheless, AMN Healthcare raises doubt about whether employee non-solicitation provisions can be enforced in California.
California employers are cautioned to carefully review all agreements that restrict former employees’ ability to compete and solicit customers and employees to ensure the restrictions do not violate California’s strong public policy in allowing employees to perform their chosen profession or trade.