One of the most common questions we get when assisting with preparing employment and consulting contracts is whether these agreements can include a non-compete provision. Under most circumstances the answer is a “no” in California. General rule in California is non-competes are unenforceable. Of course, there are ways to ensure your business’s proprietary or confidential information is not misappropriate by an employee or consultant both during their relationship with your business and after it ends. In this article, we briefly discuss the general rule against non competes in California, the narrow exceptions, and some of the alternative options to protect against misuse of a business’s proprietary information by its service providers.
Non-Competes, as a general rule, are unenforceable in California
Non-competes in California are governed by Sections 16600 to 16607 of the California Business and Professions Code (the “Code”). Section 16600 explicit voids all contracts (except under the limited exceptions provided under the Code) “by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind”. Under most circumstances, therefore, if your contracts with your employees or independent contractors include non-competes provisions, those will be unenforceable as being void.
Exceptions: Non-competes are only enforceable if they fall within one of these narrow exceptions—
- Sale of goodwill of a business: Under Section 16601 of the Code, a “reasonable” non-compete in connection with (i) the sale of the goodwill of a business, or (ii) the sale by an owner of a business entity (A) of his or her entire ownership interest in the business, or (B) of all or substantially all of the operating assets of a division or a subsidiary of the business entity together with the goodwill of that division or subsidiary, is permitted. To be “reasonable” the applicability of the provision must be limited to refraining the seller from carrying on a similar business within a specified geographic area “in which the business so sold, or that of the business entity, division, or subsidiary has been carried on, so long as the buyer, or any person deriving title to the goodwill or ownership interest from the buyer, carries on a like business therein”. Id. Business entity includes partnerships, LLCs, and corporation; and “ownership interest” means a partnership interest, in the case of a business entity that is a partnership, a membership interest, in the case of a business entity that is a limited liability company, or a stockholder, in the case of a business entity that is a corporation.
- Non-competes from partners of a partnership or from members of LLCs. Besides the above, non-competes are also permissible (i) in case of a partnership, restraining a partner, in connection with the dissolution of the partnership or the dissociation of the partner from the partnership, from carrying on a similar business within a specified geographic area where the partnership business has been transacted, so long as any other member of the partnership, or any person deriving title to the business or its goodwill from any such other member of the partnership, carries on a like business within the specified geographic area; and (ii) in case of a limited liability company, restraining a member, in connection with the dissolution or anticipated dissolution of the LLC or the termination of such member’s interest, from carrying on a similar business within a specified geographic area where the limited liability company business has been transacted, so long as any other member of the LLC, or any person deriving title to the business or its goodwill from any such other member of the LLC, carries on a like business within the specified geographic area.
Except under these narrow circumstances, non-compete agreements are void under all other circumstances in California Hence, if a non-compete provision is included in the employment context, the burden is on the employer to prove the provision falls within one of the above statutory exceptions (see KGB, Inc. v. Giannoulas, 104 Cal. App. 3d 844, 847 (1980)). It is irrelevant that such a provision is otherwise reasonable — unless the provisions fall within one of the exceptions, it will be void as against public policy. Also, employers cannot around this restriction against non-competes by providing for the application of the laws of a different jurisdiction – courts have generally held that Section 16600 represents a fundamental public policy interest that must override any choice of law provision.
Alternatives to Non-Competes: However, a business can protect against the risk of former employees or contractors misappropriating the business’s confidential or proprietary information through confidentiality and non-disclosure agreements. We have discussed the best practices of drafting these agreements in our previous blogpost. Another alternative that businesses often use are non-solicitation agreements that restrain former employees or consultants from soliciting customers or employees of the business. However, in California, customer or employee non-solicitation provisions are strictly scrutinized under Section 16600 and are considered anti-competitive. It remains unsettled whether a carefully worded and vary narrow provision whose purpose is to protect the former employer’s trade secrets will be enforceable. We recommend getting legal advice on the best strategy to ensure protection of your business’s trade secrets against misappropriation by employees or contractors both during and after their relationship with your business has ended.