California Covenants Not to Compete - Severely Limited Enforceability

Non-competition agreements are tough to enforce in California.

Let’s take a quick look at a major case that deals with non-competition agreements in the employment area.

CPA Ray Edwards (Edwards), a tax manager, was hired by a Los Angeles
accounting firm – Arthur Andersen LLP (Andersen) in 1997. Edwards had
to sign a noncompetition agreement that prohibited him from working for
or seeking Anderson clients for limited periods upon his termination.
The agreement Edwards signed stated: If you leave the Firm, for
eighteen months after release or resignation, you agree not to perform
the professional services you provided clients you worked with during
the eighteen months prior to release or resignation. This does not
prohibit you from accepting employment with a client.
For twelve months after you leave the Firm, you agree not to solicit
any client of the office(s) to which you were assigned during the
eighteen months preceding release or resignation.
Edwards worked for Andersen for six years and was promoted to senior
manager with an eye to becoming a partner. The United States government
indicted Andersen in connection with Enron Corporation.
In May 2002 Andersen internally announced that HSBC USA, Inc. would
purchase a portion of Andersen's tax practice, including Edwards's
group. HSBC offered Edwards a job. Before hiring, all Andersen
employees were required to execute a “Termination of Non-Compete
Agreement” (TONC)
The TONC required employees to (among other things): release Andersen
from "any and all" claims, including "claims that in any way arise from
or out of, are based upon or relate to Employee's employment by,
association with or compensation from" defendant and continue
indefinitely to preserve confidential information and trade secrets
except as otherwise required by a court or governmental agency, etc.
In exchange, Andersen agreed to accept Edwards's resignation, agreed to
Edwards's employment by HSBC, and released Edwards from the 1997
noncompetition agreement.
HSBC demanded Andersen provide a completed TONC signed by every
employee before the deal went through. Andersen would not release
Edwards, or any other employee, from the noncompetition agreement
unless they signed the TONC.
Edwards signed the HSBC offer letter, but he did not sign the TONC.
Andersen terminated Edwards's employment and withheld severance
benefits. HSBC withdrew its job offer. Edwards refused to sign the TONC
because he didn’t want to give up his right to indemnification. He felt
some of Andersen’s clients may sue them and name him as a defendant.
When all was said and done the California Supreme court decided that
Andersen’s noncompetition agreement was invalid because the agreement
restricted Edwards from working for Andersen’s Los Angeles clients
after his separation from Anderson, and therefore restricted his
ability to practice accounting – his profession. This violated express
California law.
Said the court: An employer "cannot lawfully make the signing of an
employment agreement, which contains an unenforceable covenant not to
compete, a condition of continued employment. [A]n employer's
termination of an employee who refuses to sign such an agreement
constitutes a wrongful termination in violation of public policy."
Put another way, the agreement Andersen made Edwards sign in 1997 was
invalid because it didn’t allow him to practice his profession for a
period of time once he left his employment with Andersen. The court
added that under the circumstances of this case, what was illegal was
restraints that precluded one from engaging in a lawful profession,
trade or business. Indeed, California courts are clear in their
expression that section 16600 of the Business & Professional Code
demonstrates a strong public policy of the state which “should not be
diluted by judicial fiat.”

In reference to Edwards not signing the TONC because he didn’t wish
to waive his right to indemnity, the bottom line was that the Labor
Code says that right can’t be waived.

To say that this case was a landmark decision would be a major
understatement, and even today it is still being discussed for the
ramifications it has on non-competition agreements in a whole host of
contexts beyond just employer-employee relationships. The court seemed
to make clear that section 16600 expresses a legislative decision to
invalidate non-competition agreements to be entered into by a seller of
a business so long as its limiting scope is reasonable.

If you find yourself facing a situation where you are required to
sign or want to get someone to sign a non-competition agreement, speak
to a knowledgeable business attorney first before you sign or ask for
anything. The Court in Edwards seemed to suggest that asking for a
non-competition agreement beyond what you are entitled to do may expose
you to liability. So don’t take a chance or you may wind up not being
able to compete after the person from whom you wrongfully extracted
that non-compete gets a big judgment against you. At least that’s what
this lawyer thinks.

Roni Balint writes for the Law Office of Alan M. Insul. The content
contained within this feature is not intended as legal advice and does
not constitute an attorney-client relationship. To learn more, contact Los Angeles business attorney and California corporate lawyer, Alan M. Insul by visiting Insullaw.com.