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.