California Affirms Narrow Enforceability of Noncompetition Agreements

The California Supreme Court has affirmed that noncompetition agreements, even if written narrowly enough not to deprive persons of their right to pursue their profession, are invalid under California law unless they fall within one of the few statutory exceptions.  See Edwards v. Arthur Andersen LLP, 189 P.3d 285 (Cal. 2008).

Raymond Edwards II (“Edward”) was a CPA of Arthur Andersen LLP (“Andersen”). When he was hired by Andersen, he signed a noncompetition agreement which prohibited him from working far or soliciting certain Andersen clients for limited periods following his termination. In June 2002, Andersen went out of business and announced that HSBC USA, Inc. (“HSBC”) would acquire a part of Andersen’s business, including Edwards’ section. HSBC offered Edwards employment on condition that he sign a “Termination of Non-compete Agreement” (“TONC”). The TONC required Edwards to, among others, (1) voluntarily resign from Andersen, and (2) release Andersen from “any and all” claims, including claims that in any way arise from or out of, are based upon or relate to Edwards’ employment by, association with or compensation from Andersen. In exchange, Andersen would agree to accept Edwards’s resignation, agree to Edwards’ employment by HSBC, and release Edwards from the noncompetition agreement.

Edwards signed the HSBC offer letter, but refused to sign the TONC because he was afraid that he would lose his right to request Andersen to indemnify his cost that may arise from the government investigation and civil lawsuits against him in connection with Andersen’s involvement in the Enron scandal. Andersen terminated Edwards’ employment and withheld severance benefits. HSBC withdrew its job offer to Edwards.

Edwards sued Andersen and HSBC for intentional interference with prospective economic advantage under the California statute. Edwards alleged that the noncompetition agreement violated California Business and Professions Code § 16600’s prohibition on restraining a lawful profession, trade, or business, and it constitutes one of the elements of the cause of action, i.e., a wrongful and intentional act by the defendant, designed to disrupt the relationship. In addition, Edwards alleged that the TONC was designed to have Edwards waive his indemnity right protected by California Labor Code Section 2804 making all contracts that waive an employee’s right to indemnification invalid, and thus unlawful. The California Court of Appeals agreed with Edwards’ view regarding the both allegations.

The Supreme Court of California agreed with Edwards’ first allegation only. Business and Professions Code § 16600 prohibits noncompetition agreements except for those in the sale or dissolution of corporations, partnerships, and limited liability corporations. The noncompetition agreement in this case did not fall within this exception. Andersen argued that the Ninth Circuit once ruled that another exception is available when a noncompetition agreement is drafted narrowly enough not to deprive the employee’s right to pursue his or her profession, and this case would be covered under this exception. However, the Court held that the Ninth Circuit misunderstood California law and California's strong policy in favor of open competition and employee mobility, and thus did not constitute a precedence. For Edwards’ second allegation, the Court interpreted the TONC narrowly so that it would not violate Section 2804. Under the Court’s interpretation, the waiver required TONC would not encompass Edwards’ right to request indemnity against Andersen, and thus not unlawful.

As a conclusion, the Court held that Andersen’s noncompetition agreement was unlawful and invalid, but the TONC was not unlawful and thus would not support Edwards’ tort claim.

This material will appear in Alan Gutterman’s publication entitled “California Business Transactions” and is presented with permission of Thomson/West.  Copyright 2008 Thomson/West.  For more information or to order call 1-800-762-5272.  Alan Gutterman is the Founder/Principal of Gutterman Law & Business (www.alangutterman.com), which publishes the Emerging Companies Blog and the Business Counselor Blog, and a Partner of The General Counsel LLC (www.thegeneralcounsel.net).

 

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