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California Supreme Court Invalidates Employee Noncompetition Agreements

August 29th, 2008 Posted in Recent Developments

On August 7, 2008, the California Supreme Court issued its much-anticipated decision in Edwards v. Arthur Andersen LLP (Case No. S147190), on the issue of whether Business and Professions Code section 16600 bars employee noncompetition agreements.

Noncompetition agreements are governed by Business & Professions Code section 16600, which states: “Except 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.” The law, however, allows noncompetition restrictions in the context of sale or dissolution of corporations (§ 16601), partnerships (§ 16602), and limited liability corporations (§ 16602.5). But, under the common law which is accepted by many states today, such non-compete restrictions were valid, if they were reasonably imposed (i.e the Ninth Circuit’s “narrow-restraint exception”). Under the “narrow restraint” exception, a noncompetition agreement would not violate Section 16600 if it involved a limited restriction and left “a substantial portion of the market available to the employee.” 

In this case, the employer Arthur Andersen required its employee Mr. Edwards to sign a noncompetition agreement upon acceptance of employment. The non-compete provision restricted Edwards from soliciting clients or providing accounting/financial services for a period of up to 18 months after termination or resignation. After Mr. Edwards sued, Arthur Anderson asked the Court to adopt the “narrow-restraint” exception, arguing that, under this exception only those restraints that bar one from engaging in a lawful profession, trade or business, and not those restraints that merely impose partial restrictions, are illegal under section 16600.

The Court rejected the “narrow-restraint” doctrine and the noncompetition restriction by asserting:

“The first challenged clause prohibited Edwards, for an 18-month period, from performing professional services of the type he had provided while at Andersen, for any client on whose account he had worked during 18 months prior to his termination. The second challenged clause prohibited Edwards, for a year after termination, from ‘soliciting,’ defined by the agreement as providing professional services to any client of Andersen’s Los Angeles office. The agreement restricted Edwards from performing work for Andersen’s Los Angeles clients and therefore restricted his ability to practice his accounting profession.”

The Court’s decision on this issue strongly reinforces California’s general prohibition on agreements in restraint of trade. But, it does not affect the right of an employer to enforce noncompetition agreements in the context of the sale or dissolution of a business, which is specifically exempt by statute. Likewise, the decision does not affect an employer’s right to use a non-compete provision to protect its trade secrets.  However, I do anticipate the court (or even the Legislature) attempting to close this “loophole” in the future. In the meantime, it is integral for businesses to review and update their employment agreements so that they comply with law.

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