California Business: Noncompetition Agreement Facts You Should Know

Contracts, Corporations, Protect your business

What California Businesses Should Know About Noncompetition Agreements

California businesses seeking to keep their employees from working for a competitor or starting their own competing business may understandably want to include noncompetition agreements in their employee contracts. However, while noncompetition agreements are enforceable in many states, they are typically void in California.

Subject to a couple narrow exceptions, California law provides that “every contract by which anyone is restrained from engaging in a lawful profession, trade or business of any kind” is void. California courts have rigorously applied this provision in employment cases, especially since California policy favors employees’ interests in their own mobility and prosperity. Thus, even reasonably tailored noncompetition agreements that are limited in duration and geographic scope are unenforceable.

Moreover, employers can incur liability simply by placing invalid noncompetition agreements in their employment contracts. An employer may also be liable if it fires an employee for refusing to sign a non-competition agreement.

Some employers have sought to avoid this prohibition by including forum-selection and choice-of-law clauses in their employment contracts. However, California courts have rejected these efforts. Moreover, as of January 1, 2017, Section 925 of the California Labor Code forbids employers from requiring employees to litigate or arbitrate employment disputes out of California or under the laws of another state. This new law applies to contracts created, modified or extended on or after January 1, 2017, unless the employee was individually represented by a lawyer while the employment contract was negotiated.

Noncompetition agreements are permissible in the following narrow situations.

Sale of a Business

A buyer of a business and its goodwill may enforce a noncompetition agreement prohibiting the seller from carrying on a competing business within the geographic area in which the seller’s business had operated, so long as the buyer or its successors carries on a like business in that area.

A noncompetition agreement may also be enforced when a shareholder sells all of his or her ownership interest in a business entity, provided the agreement lasts only so long as the buyer operates a like business and the agreement is limited to the geographic area in which the business operates. The seller’s ownership interest must be substantial enough that it can be inferred that the parties valued the business’s goodwill as part of the purchase price. Thus, employers may not seek to circumvent the law regarding noncompetition agreements by giving or selling to their employees negligible amounts of stock and then having them sign noncompetition agreements.

Dissolution or Withdrawal from Partnership

Noncompetition agreements are also enforceable upon the dissolution of a partnership or a partner’s withdrawal from the partnership if the agreement is limited to the area in which the partnership’s business has carried on, provided that the partnership continues to operate a like business in that area.

There are, however, other ways a business can protect against damage from current or former employees. For instance, in employment or severance agreements a company can insist on confidentiality covenants that prohibit the employee from using its sensitive and proprietary information. A company can also insist on non-solicitation covenants that prohibit a former employee from seeking to hire current employees of the business. While confidentiality and non-solicitation covenants are subject to certain limitations, they are more broadly enforceable than noncompetition agreements.

If you: