March 11, 2014

California Supreme Court Brightens Rule Prohibiting Noncompete Agreements

Edwards v. Arthur Andersen involved an employee, Raymond Edwards (“plaintiff”), of Arthur Andersen (“Andersen”) who attempted to secure employment with competitor HSBC in the midst of the collapse of Andersen in 2002. When Andersen initially hired plaintiff in 1997, plaintiff signed a noncompetition agreement that prohibited him from working for or soliciting certain Andersen clients for limited periods of time following the termination of his employment.

At the time of Andersen’s collapse, HSBC agreed to hire a number of Andersen employees, including plaintiff, provided they sign an agreement that, among other things, released Andersen from “any and all” claims related to his employment. When plaintiff refused to sign the agreement, Andersen terminated him and his employment offer from HSBC was withdrawn.

Plaintiff later filed suit against both Andersen and HSBC. The issues in the suit that were taken up by the California Supreme Court were: “(1) To what extent does Business and Professions Code section 16600 prohibit employee noncompetition agreements; and (2) is a contract provision requiring an employee to release ‘any and all’ claims unlawful because it encompasses nonwaivable statutory protections, such as the employee indemnity protection of Labor Code section 2802?”

With respect to the first issue, the Court held that Andersen’s noncompetition agreement was invalid. The noncompetition agreement at issue prohibited the plaintiff from (1) performing professional services for 18 months following his termination for any client on whose account he had worked during the 18 months prior to his termination, and (2) soliciting any client of Andersen’s Los Angeles office for 12 months following his termination. Section 16600 states, “[e]xcept as provided in this chapter, every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.” Andersen argued that the term “restrained” should be interpreted such that only contracts that completely prohibit an employee from engaging in his or her profession, trade, or business are illegal, while agreements that narrowly constrain competition should not fall within the scope of section 16600.

The Court did not find Andersen’s arguments persuasive. Instead, the Court held that the noncompetition agreement “restrained [plaintiff’s] ability to practice his profession” and was, therefore, invalid. The Court also clarified that the split in interpretation of section 16600 between California state courts and California federal courts which had previously driven employers to seek federal court enforcement of their noncompetition agreements, was due to an erroneous interpretation of section 16600 by a federal court in Campbell v. Trustees of Leland Stanford Jr. University, 817 F.2d 499 (9th Cir. 1987). This clarification will mean that in the future, federal courts should not view noncompetition agreements more favorably than state courts, as they have in the past.

With respect to the second issue, the Court held that “a contract provision releasing ‘any and all’ claims does not encompass nonwaivable statutory protections, such as the employee indemnity protections of Labor Code section 2802[.]” Therefore, such all-encompassing release provisions do not override statutory protections, such as those found in section 2802, but also do not render the entire release null and void as to those other claims that can be waived. In so holding, the Court relied upon the basic tenants of contractual interpretation that call for an interpretation that “makes the contract lawful, valid and capable of being carried into effect.”

The Edwards decision has significant ramifications for California employers:

  • Employers will no longer be able to enforce employee noncompetition agreements, even if the agreement purports to only narrowly restrain competition.
  • Employers who require employees to sign employment agreements that contain noncompetition clauses of any kind should have those agreements revised.
  • Employers should ensure that they refrain from terminating, or refusing to hire, employees who refuse to sign invalid noncompete agreements.
  • Edwards does not limit an employer’s ability to bring suit against a former employee where that former employee is using misappropriated trade secrets to solicit customers. While such solicitation of clients may no longer be considered a breach of a noncompetition agreement, the misappropriation still is an independently wrongful act.
  • Edwards also does not effect the statutory exceptions to noncompetition agreements for the sale of a business, or the dissolution of corporations, partnerships, and limited liability corporations.