Background


There are a number of exceptions to B & P §16600 set forth in succeeding statutes. The most important of these validate a non-competition agreement if given in connection with the transfer of a goodwill interest in a business. Even in that situation, however, clients should seek out the advice of competent counsel experienced in mergers and acquisitions transactions, as there are limits and various requirements which must be satisfied.

B & P §16600 has been applied in reported cases to prevent an employer from including a non-competition provision in an employment agreement, which purportedly bound the employee from competing with his or her former employer following termination of employment.[1]

The Edwards Decision

A federal court interpreting state law is supposed to follow the law of that state as articulated by its courts. While many California state court decisions had recited the fact that B & P §16600 evidenced a
strong public policy in favor of free competition[2], several decisions of the federal courts in California had adopted a "narrow restraint" doctrine with respect to contractual provisions which might have a
noncompetitive result[3]. Some practitioners therefore believed that a noncompetition clause might be enforceable in California outside of one of the statutory exceptions if the clause was only such a "narrow restraint" and did not preclude a party from engaging in a field of business entirely.

In 2008, the California Supreme Court issued its long-awaited decision in Edwards v. Arthur Andersen, LLP, 44 Cal. 4th 937 (2008). Edwards considered whether California state courts would adopt this "narrow restraint" exception to B & P §16600—where the noncompetition covenant was narrowly-drawn and did not totally restrict an employee from competing with his former employer, but only restricted the employee from doing business with certain clients or customers.

Edwards arose out of the disintegration of the Arthur Andersen accounting firm. Edwards was a manager for Arthur Andersen, and had signed an agreement which purportedly restricted him from providing
services for eighteen months following his severance from Arthur Anderson to any Arthur Andersen client for whom he had rendered services in the preceding twelve months. Edwards (in an attempt to
sue Arthur Andersen for interference with prospective economic advantage respecting Edwards' prospective employment by the purchaser of Arthur
Andersen's Los Angeles tax practice) alleged that this noncompetition clause was void under California law. Arthur Andersen contended that the clause was enforceable under the federally-created "narrow
restraint" doctrine.

Affirming a decision reached by the California Court of Appeal, the California Supreme Court held that such a clause is not enforceable in California, and rejected the "narrow restraint" doctrine. First,
the Court noted that the process of statutory construction led to this determination. The "plain meaning" of the statute did not support such an exception, and the presence of express exceptions led to the conclusion that additional exceptions were not contemplated by the Legislature.

Second, the Court noted that policy concerns favored a determination that the "narrow restraint" exception not be applied. Allowing the "narrow restraint" exception would allow employers to "push the envelope" of the narrowness requirement, and would place the burden on terminated employees to speculate whether or not particular noncompetition clauses fell within the "narrow restraint" exception. Employees might be likely to assume that such provisions were enforceable, and would be reluctant to commit the resources to challenge noncompetition provisions in court.

Finally, enforcing such "narrow restraint" noncompetition clauses might have a "chilling effect" on the
ability of employees to secure new employment, in view of prospective employers'
reluctance to hire an employees who had signed questionable noncompetition
covenants.

The Edwards Court noted that prior cases had upheld certain contractual provisions which might have a noncompetitive effect where such provisions were designed to protect the trade secrets of the
employer. Since trade secrets were not at issue in the case, the Edwards court left the question of viability of the so-called judicially-created "trade secret exception" for another time.

Therefore, after the Edwards decision, it was common practice among California corporate attorneys to include non-solicitation provisions in employment and similar agreements, although tied to the trade secrets of the employer—that is, that the employee would not use the trade secrets of his or former employer to compete with that employer.

The Galante Decision

In 2009, a California appellate court decided Retirement Group v. Galante, 176 Cal. App. 4th 1226 (2009). Galante addressed the issue which was left open by Edwards—whether a "trade secret exception" to B & P §16600 existed.

Galante was a typical "former employee allegedly steals customers" case. Plaintiff has invested significantly in marketing to identify and attract clients. Defendants had acted as independent contractors to plaintiff, providing investment advice to plaintiff's clients, and subsequently went to work for a competitor and solicited the clients. The plaintiff sued, seeking to enforce non-solicitation agreements signed by the defendants.

Galante held that there is no "trade secret exception" to B & P §16600, and that employees after the termination of their employment cannot be bound by contractual agreements, even those which are designed to protect the trade secrets of the former employer. Rather, the Galante court found that such former employees could only be held liable for tortious trade secret misappropriation under the Uniform Trade Secrets Act.

As a result of Galante, a California employer can no longer assume that any post-termination restriction contained in an employment agreement is enforceable. This would include even a non-solicitation
provision tied to trade secrets.

Instead, a more effective approach for an employer would be to rely on a strong (and written) trade secret protection policy.

Trade Secrets

There are two parts of the definition of what is a "trade secret" under California law. The first is that the information gives the employer a competitive advantage or the opportunity for a competitive
advantage. The second is that the employer undertakes reasonable efforts to maintain the secrecy of the information.[4]

Whether information gives an employer a competitive advantage is of course a factual matter, and some information will not meet this prong of the definition, as the information is too generic. However, even
information that meets the first prong of the definition will not be a trade secret if it does not meet the second prong of the definition—that the employer undertakes reasonable efforts to maintain its secrecy.

There are many reported cases in California which have discussed the issue of whether an employer's customer list is a trade secret. The cases tend to distinguish between customer lists that contain
information developed by the employer over many years through the expenditure of time and other resources (which information is generally not available to the employer's competitors)[5], and customer lists that are generic and generally available to the employer's competitors.[6] Examples of information that might fall into the former protected category are specific customer requirements such as order
history, and pricing information.

Steps that employers take to protect their trade secrets include restricting access to trade secrets internally within a company to those who need to know the information and who have acknowledged receipt of the company's trade secret protection policy; providing password protection to computer files containing trade secrets; marking hard copies of trade secret information as "confidential"; placing restrictions on the ability to photocopy or to download such information; and preventing former employees from having access to such information. But the steps to be taken to protect trade secrets is a factual issue that needs to be analyzed on a case-by-case basis.

A well-drafted trade secret policy should also set forth categories of information which the company reasonably believes qualifies for trade secret protection. Again, this will be highly specific to the
business at issue. Keep in mind, however, that self-serving statements about what is and what is not a trade secret will not be binding on a court, which will make its own determination if there is a dispute which is litigated.

Typical Client Questions and Answers in Response to Current State of California Law

Can't our company just have our employees sign a noncompetition agreement anyway? Maybe our employees won't know the law, and such a covenant might serve an "in terrorem" effect. While it is true that many employees will sign a non-compete without knowledge that it is unenforceable under California law, and might honor the provisions of the same despite its unenforceability, this strategy will not work for two reasons. First, employers who attempt to have employees sign an unenforceable noncompetition provision run the risk that this could create liability on the part of the employer to the employee. For example, there are reported cases which hold that an employee who refuses to sign an unenforceable noncompetition covenant and who is subsequently terminated can sue his employer for tort-based wrongful termination of employment, since California noncompetition law impacts a "fundamental public policy" of the State of California (tort-based wrongful termination permits an employee to seek
punitive damages from the employer).[7] Second, cases now hold that an employer who includes a noncompetition covenant in an employment agreement can be sued by a competitor for an unfair business practice under California Bus. & Prof. Code §17200.[8]

Even though the California Supreme Court declined to follow the "narrow restraint" exception of the federal courts, couldn't my company continue to rely on federal law, and try to enforce such a clause in
federal court? No. Federal courts in California will begin to apply the California principle as set forth in Edwards, rather than the federal "narrow restraint" analysis.

You mention above that noncompetition clauses are valid under the laws of other states. Can't we draft an agreement that contains a noncompetition provision, and provide in that agreement that the "governing law" of the agreement will be another state which permits these type of clauses? Generally parties to a contract are permitted to choose the state law that they want to govern a contract, and such choice will be respected by a court as long as the choice has some reasonable relationship to the matter at issue. However, since as noted above California's non-competition law is a "fundamental public policy", other reported cases have held that at least in connection with matters with a nexus to California, the law of California will override any choice of law other than California of the parties set forth in a
contract.[9]

[1] D'Sa v. Playhut, Inc., 85 Cal. App. 4th 927 (2000).

[2] Ibid.

[3] See, e.g., Campbell v. Board of Trustees of Leland Stanford Junior University, 817 F. 2d 499 (9th Cir. 1987).

[4] Cal. Civil Code §3426.1(d).

[5] Hilb, Rogal and Hamilton Ins. Servs. Of Orange Ctny. v. Robb, 33 Cal App. 4th 1812 (1995).

[6] American Paper & Packaging Prods., Inc. v. Kirgan, 183 Cal. App. 3d 1318 (1986).

[7] D'Sa v. Playhut, Inc., 85 Cal. App. 4th 927 (2000).

[8] Dowell v. Biosense Webster, Inc., 179 Cal. App. 4th 564 (2009).

[9] Application Group, Inc. v. Hunter Group, Inc., 61 Cal App. 4th 881 (1998).