Noncompete Clauses and Noncompetition Agreements in the Employment Setting - Enforceability and Penalties if Illegal
|Prepared By: Melissa C. Marsh, Los Angeles Employment Attorney
Written: March 2009
California employers have for years struggled with California law and how to restrain their current employees from starting a competitive business, or transitioning to a new job with a competitor.
What is a Non-Compete Clause or Non-Competition Agreement?
A non-compete clause or noncompetition agreement is a contract that generally states that an employee, former business partner, or former business owner will not engage in the same type of business as the employer, or former business partner or owner in which the individual had an ownership interest. Despite being very desirable, these agreements are typically illegal and invalid in the state of California unless the non-compete clause is part of the sale or dissolution of a corporation, limited liability company, or partnership (Cal. Bus. & Prof. Code §§ 16601, 16602), or necessary to protect an employer's trade secrets (like certain customer lists).
Why Are Non-Competition Agreements Typically Unenforceable?
In California the courts are loath to enforce a non-competition agreement because pursuant to California Business and Professions Code section 16600, "Except as provided in this chapter, every contract by which anyone is restrained from engaging in lawful profession, trade or business of any kind is to that extent void." Although not all non-competition agreements are void as a matter of law, unless carefully drafted within one of the exceptions provided by Section 16600, a court will invalidate a non-competition agreement. One such exception is the preservation of a company's proprietary information and trade secrets.
When not specifically tailored to the limited protection of a company actual "trade secrets" (which by their nature should not be disclosed to every employee), the California courts have declared them to be prohibited by California's public policy which favors competition in the marketplace, and the right in turn to pursue any lawful employment. Thus, when an employer and employee execute an employment agreement with a non-competition clause, the likelihood is that the courts will find such a clause void and unenforceable.
What Penalties, if any, Does a California Employer Face For Inclusion of a Non-Compete Clause in an Employment Contract?
Despite knowing that non-compete agreements are generally invalid, some unwary employers have continued to include such non-competition clauses in their California employment agreements hoping that they might deter employees from seeking and/or accepting a job with a competitor. However, employers should be aware that including such a provision can be very costly. Pursuant to Labor Code Section 432.5, "[No] employer . . . shall require any employee or applicant . . . to agree, in writing, to any term or condition which is known by such employer . . . to be prohibited by law." Since all individuals are deemed to know the law, saying you were unaware is no defense. But what's the penalty? Well, pursuant to the Labor Code Section 2699(e), a California employer may be fined $100 for each aggrieved employee per pay period for such a violation. While it may not sound so bad, let's do the math. If an employer included a non-competition clause in the employment contracts of 20 employees for a year (paying wages bi-weekly for 26 pay periods) the penalty would be $52,000 (20 employees x 26 pay periods x $100 each).
Worse, California Labor Code §2699(f) permits an aggrieved employee to bring a civil action on behalf of him or herself and all current and former employees against whom the violation(s) were committed. When an employee brings such an action the employee is entitled not only to reasonable attorney's fees and costs, but also 25% of any penalty imposed. Consequently, employees and their attorneys are provided a great incentive to pursue such matters, and to find and prosecute every violation of the Labor Code.
When is a Non-Compete Agreement valid under the law?
As a general rule, a covenant not to compete is unenforceable in California, unless the noncompetition agreement:
- is specifically limited to preventing the release of trade secret information (employee may compete, but may not use company trade secrets such as a customer list);
- is connected with the purchase or sale of a business (with limitations);
- is connected with a shareholder's sale of all, or substantially all, of his or her stock (with limitations); or
- in contained in a partnership agreement that restricts withdrawing partners from competing within a limited geographic area and for a limited time (again with limitations).
Typically, a non-compete agreement is overbroad and in turn unenforceable. Nevertheless, California employers are still demanding their employee's sign a non-compete agreement before they begin working, occasionally at the termination of employment, and sometimes at a job after the employee has been working at for some time. Unfortunately California employers have been slow to wake up and realize the huge penalties they face for asking employees to sign an illegal provision.
Without a Non-Compete clause, How Can an Employer Prevent an Employee From Working For A Competitor?
Although there is no absolute way, a better choice for the employer would be a "code of conduct." While a noncompete agreement is designed to keep a former employee from working with a direct competitor, a code of conduct statement in an employee manual can set forth the company's policies, and specifically a prohibition against soliciting the company's customers and form using any of the Company's trade secrets, or other proprietary information (including customer lists), for a certain period of time after leaving the company.
What if an Employer Threatens to Terminate An Employee Unless She or He Signs a Non-Compete Agreement?
An employer may choose not to hire an employee who refuses to sign an agreement, and may threaten to fire an employee who refuses to sign one midterm. However, if you are employed in the State of California, then you have the right to refuse to sign an invalid non-compete agreement. If an employer threatens to terminate, or does in fact terminate, an employee for not signing an unlawful agreement, then the employee's rights have been violated. In some cases, an attorney can negotiate with the employer, but when that fails the employee may bring a lawsuit.
Employment related agreements (including termination and severance agreements) that contain a noncompete clause, or that restricts an employee’s ability to solicit or accept business, should be reviewed by a California employment law attorney and revised. Employers should also consider reviewing and replacing any agreements previously executed by their employees that contain noncompetition clauses drafted to take advantage of the now invalid "narrow restraint" exception.
Our employment law practice consists of: (1) assisting employees with their wage claims and (2) counseling employers who seek to comply with new state and federal employment laws, providing human resource training, and providing essential contracts and employee policies to prevent employee lawsuits. To schedule a consultation with California employment lawyer, Melissa C. Marsh, Call 818-849-5206 or Send Us An Email.
California employment lawyer, Melissa C. Marsh, is based in Sherman Oaks and West Hollywood, and serves individuals and businesses throughout Los Angeles County, including: West Hollywood, Miracle Mile, Beverly Hills, Century City, Santa Monica, Burbank, North Hollywood, Valley Village, Toluca Lake, Studio City, Sherman Oaks, Van Nuys, Encino, and Woodland Hills.
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