As with every rule, there is usually an exception. California expressly prohibits non-compete provisions in employment agreements to protect workers from being shut out of their chosen field for a period of time, losing valuable income and risking being obsolete during the specified period. However, a non-compete provision is narrowly permitted where a person owns an interest in the business. Specifically, a non-compete provision may be valid in the following instances:
- When a person sells the goodwill of the business;
- When the owner sells his or her entire interest in the business;
- When the owner sells essentially all of the operating assets along with the goodwill of the business.
For our purposes here, goodwill would be the reputation and name recognition of the business in the mind of consumers. It is important to note that employees who receive stock as part of an equity incentive plan are not considered owners of the company for the purposes of a non-compete provision.
Three Key Considerations for a Non-Compete Provision in California
Even when California law expressly permits a non-compete provision, certain requirements must be observed. Unfortunately, each requirement has room for interpretation based on the facts of the situation.
It is important to ensure there is sufficient consideration—typically a monetary payment—given for the ownership interest, assets or other rights being sold or given up; otherwise, the provision may be void. However, in the employment context, what is considered a sufficient or reasonable consideration will be evaluated on a case by case basis.
What constitutes reasonable duration has also not been established in California. The enforceable time period could be for several years, including up to the lifespan of the business, or as long as someone receives a benefit from the goodwill of the business. Of the three requirements, the duration is the least scrutinized and is generally deemed reasonable as agreed between the parties.
Reasonable Geographic Area
The geographic restriction must be limited to a discrete territory. Such territory may include:
- where the business was sold;
- where the business was transferred;
- where business was transacted; or
- where the business was dissolved.
As with the first requirement, what is deemed a reasonable geographic location is determined on a case by case basis. Here are two examples to illustrate the complexity of the geographic location requirement.
A company sells life insurance and mainly conducts its business in four counties, where it has offices; however, the company covers consumers throughout the state of California. The seller signs a non-compete agreement that identifies the entire state of California in the geographic restriction. The court found the geographic location enforceable.
In contrast, a buyer of a business required the seller to sign a non-compete agreement that prohibited the seller from soliciting any of the buyer’s employees or customers, including employees and customers unrelated to the business. The court found the provision too broad and unenforceable.
Any business entity may take advantage of this narrow exception—whether a partnership, limited liability company or corporation—as regards the sale, transfer or termination of an ownership interest in the business. The key to an enforceable non-compete provision against the person selling the interest will be that the consideration paid is sufficient based on what is being sold, and that both the duration and geographic restrictions are reasonable when measured against the interest being sold and the reach of the business.