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EMPLOYMENT NOTES

Non-Competition Agreements Under California Law

02.23.2009

 In Edwards v. Arthur Andersen LLP, 44 Cal.4th 937 (2008), the California Supreme Court addressed two important bodies of law surrounding the validity of post-employment restrictions. One area is covenants not to compete and the other is broad employment-related releases in conjunction with non-waivable statutory rights.

 Turning to covenants not to compete, the Court confirmed that non-competition agreements are unenforceable in California. Such agreements that restrict an employee’s ability to pursue similar employment after leaving a job are prohibited, even if narrowly drafted.
 
Unless a non-competition agreement falls within one of the following exceptions, it will be deemed unenforceable in California:
  • Sale of a business, which can legally restrict a seller’s ability to compete with the buyer in the geographic location where
  • the seller previously conducted the business;
     
  • Dissolution of a partnership, which can legally define a specific geographic area within which one of the partners is
  • prohibited from conducting a similar business;
     
  • Trade secrets, which can legally restrict an employee’s ability to use confidential information or company-defined trade
  • secrets; and
     
  • Restrictions relating to limited liability companies.
  •  
    The Court, however, held that the general prohibition against covenants not to compete, which is found in Business and Professions Code §16600, does not allow for an exception for “narrow restraints” on competition, a departure from federal court decisions, and specifically from decisions from the Ninth Circuit Court of Appeals. Thus, narrow restraints on postemployment conduct are not valid under California law. In so holding, the Court observed that by enacting Business and Professions Code §16600, the California Legislature expressly rejected the common law that permitted “reasonable” postemployment restrictions, which are routinely enforced in other states.
     
    The Court then applied Business and Professions Code §16600 and held Edwards’ employment agreement, which prohibited him from performing professional services for other companies that were of the type he provided when he worked at Arthur Andersen, was unlawful and unenforceable because it restricted Edwards’ ability to engage in his profession as a tax manager.
     
    Turning to the general release of all claims that Edwards was asked to execute in exchange for Arthur Andersen agreeing to terminate its non-compete and customer solicitation agreement with Edwards, Edwards was asked to release his statutory indemnification right under Labor Code §2802. Since there were potential criminal and civil proceedings brought against Arthur Andersen, and potentially its employees in the aftermath of Enron, Edwards refused and Arthur Andersen terminated his employment.
     
    The Court held that an employee’s indemnity rights under Labor Code §2802 are unwaivable. The Court analyzed the release language of the questioned agreement and observed that it did not waive indemnity rights under Labor Code §2802. The release language was broad and purported to release “any and all claims”. However, the Court held that such broad language should not be given an interpretation that would render the agreement null and void.
     
    Instead, the Court stated that Edwards and Arthur Andersen were presumed to have known that a waiver of such claims would be prohibited by law. The Court upheld the broad release language, while at the same time holding that such language did not release unwaivable rights under Labor Code §2802.
     
    Recommendations for Employers: The Court’s rejection of the “narrow restraint” doctrine means there is no change in California law. Employers should not follow Ninth Circuit Court of Appeals and federal cases, which established that doctrine, as they are invalid in California. Employers should review all employment agreements, confidentiality agreements, nondisclosure agreements and employment policies to ensure that they do not contain language that could be interpreted as a “narrow restraint” on lawful postemployment competition, which Edwards now held to be invalid.
     
    Employers in California can continue to use broad-based release language in severance agreements without concern that it might be struck down as invalid based on a technical reading of waiving unwaivable rights under Labor Code §2802. Employers should review their release agreements to ensure that they do attempt to release claims that are waivable. Examples of nonwaivable claims include pending workers’ compensation actions, expense reimbursements, and prospective FMLA rights.
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