Non Compete California: Everything You Need to Know
Non compete California laws are unique, and are structured differently than they are in the rest of the country.12 min read
Non Compete California
Non compete California laws are unique and are structured differently than they are in the rest of the country. The state of California is not only massive in geographic size, but it has a tremendous and undeniable impact on the country's economy and financial strata, and has the sixth largest economy on the planet, surpassing the entire nation of France last year.
Many companies and business owners argue that California's laws shouldn't apply to their businesses or properties because their businesses are headquartered out-of-state, in areas with very different non-compete laws. California courts disagree with this analysis, and for that reason, non-compete laws in the state are quite complex.
Companies have attempted to disavow the ban, using “choice of law” provisions that state the contracts entered upon by the state of California and its business operators should be interpreted in accordance with other state laws, usually a state where a business operating in California has its headquarters, and usually in a state that recognizes non-compete agreements. California, again, disagrees with these analysis, and still refuse to enforce non-compete agreements of any kind, with extremely small and situationally-based circumstances.
Some companies, frustrated with the state's laws, attempt to adopt what are known as “Garden Leave” policies. These policies require high-level employees to give extra extended periods of written or verbal notice prior to their voluntarily resigning or separating from their employment. Instead of the nationally-recognized “two weeks notice” platform, the Garden Leave policies requisite any employees leaving their jobs to attempt to furnish some sort of notice anywhere between 90-180 days prior to their leave. These employees can be told to stay home and “tend to their gardens” while receiving full benefits, and full pay.
In summation, both the state Legislature, and the state courts, have wised up to the many creative tricks, tactics, and underhanded techniques businesses often use to skirt non-compete laws. The courts refuse to waiver and vow to continue to fight the enforcement of any non-compete laws in the state of California.
California's Ban on Non-Compete Agreements
The state will not enforce them against former employees, either. The state has gone so far as to wholly reject the “inevitable disclosure doctrine,” which means that non-compete agreements cannot be enforced, even to prevent someone from taking a position based on the grounds of a former employee's reasonable belief that a former employee will use one or more prior confidences (or trade secrets learned), as a means of securing new employment. In other words, if an employee takes a position with employer A, and learns their secrets that employee can then take a position with employer B, taking with them any knowledge they learned with employer A along the way. This is typical and true of normal skills, but in the realm of intellectual property, it can cause worry for business owners.
Companies have no other recourse than to simply wait patiently for any violations or instances of law breaking to arise. The burden of proof is also on them — they must legally prove that a former employee misused or abused confidential information in any way. If a former employee reveals confidential information to a new employer, the former employer has no means of finding out unless that information surfaces naturally.
This is viewed by many as an “anti-business” issue, particularly by business owners who feel the state of California is not doing enough to protect their rights to keep trade secrets a secret, though the policies are based on sound reasoning. Given the size, and importance of California's economy, their labor laws and workplace policies are arguably very “pro business.”
The state posits that these policies and laws are meant to protect:
- And others in the state of California
The laws help keep people gainfully employed, and the state views non-compete clauses as a potential hamper on workforce productivity. Without such fluid mobility in the workforce in the state of California, there would likely be more individuals on the welfare service rolls, as would there be an increase in people seeking social services from the state.
California is famous for outlawing these non-compete agreements. They're one of the few states who prohibit any unlawful restraint of an individual's profession, business, company, or company property, with limited and circumstantial exceptions.
Knowing how best to navigate the very limited exceptions is not only critical, but of extremely high interest and importance to employers in the state who utilize employee/employer agreements in order to protect their trade secrets, intellectual property, and other business assets.
These non-compete clauses wholly forbid employees who become terminated, or voluntarily resign from an employer, from working for any competitors or starting a business that directly competes with the entity or entities that provided them with trade secrets.
According to some estimates, upward of 20 percent of workers in the United States are bound by a non-compete agreement of some kind. 14 percent of those individuals make $40,000 per year or less.
The Obama administration wanted to ban these agreements entirely and issued a call to action for businesses and individuals to stoke competition and give better rights to employees across the country. The administration hoped this would lead to fast wage growth and economic mobility.
The White House's chief economic advisor at the time said, "If you have less of an ability to threaten to leave one job for a better job then you have less of an ability to earn.” The White House's position reflects laws found in few states, though they are right in line with the courts of California on this issue, for most intents and purposes.
Individual freedoms are important to consider. Finding better, more gainful employment without the need for relocation is crucial to a person's well-being, personal fulfillment, and is in the best interest of the employee, prospective new employers, and the state economy at large. Employees who are out of work need the fastest path towards becoming employed again, which means, in the eyes of the state, striking down any clauses or legislation that could prevent people en masse from rejoining California's workforce.
Switching jobs, furthermore, allows people who are stagnant in their earnings to matriculate into better positions that more accurately reflect their potential value to employers, which, in turn, encourages employees statewide to develop new skills, interests, and careers. This spins the wheel, figuratively speaking, of a robust and diverse state economy one that is now larger than France's.
Unenforceability Only Applies to Limitations on One's Employment
These clauses protect and foster a sort of on-the-job training regimen. The restrictions placed on employee mobility by these clauses may present difficulties for free market advocates.
One crucial element of a flourishing, healthy free market is competition. That's one of the very pillars of our nation's economy. The labor market reflects this, as well. Non-compete clauses restrict competition in many ways. Looking at the issue from another angle, the ability for employers to write private, enforceable contracts, including ones that bind their workers to secrecy, thus protecting the business or company's long-term interests, is rooted in free trade ideology.
Without further study, it's impossible to determine whether or not these non-compete clauses do more harm than good in the context of a free market economy. There is evidence, however, to support the idea that these clauses reduce worker mobility, and force people to remain employed with employers longer than they normally would be.
The workers who become locked-in at one employer earn less than they would in other states or if they were not bound by any non-compete clauses. Evidence also supports the notion that firms and businesses invest more into research and development when their investments are well-protected by non-compete clauses.
This also means that employees and workers who are bound by these clauses also invest less in training, and self-development. This, combined with the behavior of businesses, means that there is a palpable and measurable impact on state economies made by the presence of non-compete clauses.
Restraints on worker mobility, flatly put, reduce a company's investments in human capital. Nobody should be surprised by the fact that non-compete clauses are thought of by some as innovation-killers.
California businesses are tasked with preventing their employees from leaving and working for competitors, or starting businesses that directly compete with the employer. Many businesses, therefore, require their employees to sign employment contracts which contain conditional, post-employment non-compete clauses meant to bind employees to secrecy.
Employers are typically unaware or nonchalant about the fact that such clauses are not enforceable in the state of California. Many consider the state's agreements to restrict any legislation that limits mobility and competition to be a fundamental part of the way the state does business so effectively.
To reiterate, non-compete agreements of any form, with extremely small exception, are illegal, and are not to be tendered under California state law. Employees and independent contractors especially are not bound by the terms of any non-compete clauses they may have signed as a condition of employment.
There are three general types of non-compete clauses. The first is known as a true non-compete, and denotes a situation where employees cannot work anywhere where they would have to, as a necessity of employment at another business, reveal trade secrets of their previous employers. The others are known as non-solicitation of customers restrictions, and a non-solicitation of employees' restriction.
In the state of California, non-compete agreements that seek to prohibit employees from obtaining gainful employment are null and void. However, the ban only applies to non-compete clauses that are effective after termination of employment.
A company can, for perfectly good and legal reasons, prevent employees from freelancing or moonlighting for other business entities during the term of their employment. This is especially true if the moonlighting in question would be performed for a direct competitor of the original, primary employer.
There are a number of valid reasons as to why a company would demand their employees to be loyal, and “team players.” In fact, it's in the best interest of any business to fill their staff with employees and team members who are happy to be a part of that business. California courts agree that a business's attempts to monopolize any employee's commitment to their own venture, particularly where minimizing the risk of corporate espionage is concerned, is vital to their operation.
A lot of businesses find these policies to be readily shareable with prospective employees and applicants prior to making offers of employment. Most companies, in their clauses, insert provisions and restrictions to moonlighting in their employee handbooks. This serves as a reminder to current employees.
Some courts have extended various protections in the state of California meant to help out-of-state employees who intend to become California employees do so. Any employers that use litigation strategically to threaten any noncompete clauses for anticompetitive purposes is breaking state law, and risks exposure to liabilities for operating their businesses outside of the terms of legally binding agreements they have with the state of California. These are unfair business practices in the eyes of California.
There are small exceptions to these rules, however. If someone buys a company, they can prevent the seller, legally, from directly competing with it in the future. In an example, if an individual buys a pizza parlor from another individual, the seller is not allowed, should the buyer choose to pursue these legal restrictions, to turn around and open another pizza parlor that would directly compete with the business he or she just sold.
This is an exception that is rare, but is rooted in common sense and best business practices. California, given its size and importance to the United States economy, strives to implement policies that have a markedly positive impact on the state's financial health.
Edwards vs. Arthur Andersen
To better understand how and when non-compete clauses are enforceable in California, it's important to examine the facts of Edwards v. Arthur Andersen, a seminal court case that took place in 2008. During this case, the California Supreme Court upheld that non-compete agreements are not enforceable in California, and that the policy favoring an employee's ability to move between places of employment was valid.
The public policy related to employee mobility can be found in the California Business and Professions Code in Section 16600. Essentially, this section states that contracts that are meant to prevent someone from finding lawful employment are unenforceable.
In the aforementioned case, the court decided that Section 16600 of the California Business Code expressly forbids the use of non-compete agreements. Note, however, that the court also decided there were certain statutory exceptions to this rule. For example, the court stated that its ruling would not apply to trade secrets.
An important thing to understand is that Section 16600 applies to both independent contractors and traditional employees. Therefore, regardless of the nature of your employment, an employer cannot hold you to a non-compete clause if you work in the State of California.
If you are an employer in California and request that your employees sign a non-compete agreement, you should be aware that the agreement is likely void and will not be upheld. Should you attempt to enforce the agreement, and the case eventually makes its way to a courtroom, your former employee would likely win.
In some cases, the protections described in Section 16600 have extended to employees who do not currently live in California but plan to eventually relocate to the state. This means that if you hire an employee that lives in another state with the goal that they will one day work in California, you cannot require them to sign a non-compete clause.
When an employer tries to enforce a non-compete clause using litigation, they expose themselves to liability, particularly if their only goal in enforcing the clause is preventing competition. In these circumstances, the employee involved in the suit could counter file against their former employer for unfair business practices.
Exceptions to Unenforceability
As with most legal matters, there are some exceptions to the unenforceability of non-compete clauses in California. First and foremost, if you purchase a company, you can prevent the person who sold the company from competing with your business.
This exception applies to both sole owners and fractional owners, which are more commonly known as shareholders, and applies when either the “goodwill of a business” is sold or the person selling the company has disposed their ownership stake.
Preventing the seller of a business from competing with the new owner is what's known as a common-sense exception. Essentially, this exception involves the value of a business. Numerous courts have ruled that a person selling a company cannot decide to compete with their former company, as it harms the buyer by decreasing the business's value as well as its goodwill.
When forming a partnership or a multi-member limited liability company, you can include language in your partnership or operating agreement that states partners or LLC members will not compete with the business if they ever leave.
Courts have consistently ruled that LLC members and business partners may agree not to compete with their former business if they decide to depart the company. This agreement can prevent competition in a geographic area or within a certain period of time. Non-compete clauses agreed to by business partners or LLC members can apply to several issues:
- Departure of a partner or member.
- Dissolution of the business.
- Sale of the business.
The only time that this exception would not apply is if an employer has granted an ownership stake to an employee for the specific purpose of avoiding California's ban on non-compete clauses. To make sure that these exceptions are not used in bad faith, courts closely examine agreements between LLC members and business partners requiring non-competition.
Courts in California have typically considered clauses that restrict solicitation of customers as non-compete agreements, meaning these clauses would not be enforceable. That said, courts at both the state and federal levels have supported the Section 16600 trade secret exception, and have also allowed non-solicitations related to trade secrets to be enforced.
In particular, courts have ruled that employers can prevent former employees from attempting to lure existing customers away from the employer's business to the employee's new business. This rule, however, only applies if the former employee is using trade secrets to attract these customers. Parties in a contract that want to take advantage of these exceptions should be sure that the agreement states that their goal is protecting the goodwill of their business.
A court case called Filipoint, LLC vs. Maas clearly shows that simply signing an employment agreement during the sale of a company does not mean that non-compete clauses are enforceable. In this case, a company employee sold his stock and also approved a stock purchase agreement.
When signing the stock purchase agreement, the employee was also required to provide his signature on a three-year employment agreement that became valid once the stock sale was closed. In the employment agreement, there was also a three-year non-compete clause that applied during the person's employment. Finally, there was another non-compete clause that would apply after termination of the person's employment.
In the case, the court ruled that because both the stock purchase agreement and the employment agreement applied to the same business sale, they must be read together. The court also ruled that the non-compete ban exception did not automatically apply.
Appellate courts in California have ruled that family court judges have the ability to order non-compete agreements when they are needed to appropriately allocate marital property in a divorce. For example, in one case, a judge awarded a business that was owned by a husband and wife to the husband. The judge also ordered that the wife not compete with the business for a period of five years. The reasoning for the non-compete order was that, while the business was being dissolved, the wife attempted to damage the company.
The wife appealed the ruling, and the court upheld the original judge's non-compete order, as it was necessary to maintain the value of the business.
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