California non-compete and non-solicit agreements: when they matter and when they don’t

You’re a consultant and you sign a non-compete agreement or non-solicit with a company that demands you sign it.  Do they matter?  Do you need to keep track of who you can solicit and who you can’t?  The long answer is:  it depends. 

The short answer is that if you are an employee or contractor (not a partner or owner) and the employer is headquartered in California, then such agreements are unenforceable.

Most non-compete and non-solicit agreements in California are illegal, as against public policy, due to California Business & Professions Code § 16600:

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.

Three situations where such agreements are valid and enforceable:

1. Business Ownership exception: sales of stock, mergers, LLC membership
2. Partnerships
3. Federal Court Boogaloo

Business Ownership Exception

Some of what the California legislature took away from businesses in CA Bus. & Prof. Code § 16600, they gave back in § 16601, 16602, and 16602.5.  Most non-compete and non-solicit agreements coupled with the sale of stock are considered enforceable under § 16601.  Let’s say you are a CEO of a corporation and you own 3% of the company in stock.  As a part of a corporate merger, you sell your stock and sign a non-compete agreement.  The non-compete agreement is valid and enforceable.

The Business Ownership exception also applies to members of an LLC under § 16602.5.  If a member of an LLC signs a non-compete or non-solicit agreement, it is enforceable.

Business owners, I know what you are thinking.  Can’t you just have every employee sign a non-compete agreement, have them buy a small amount of stock, and force the stock’s sale upon leaving the company?  The buy/sell provision will be valid, but you can’t use such measures to circumvent § 16600.  A company tried this technique and lost in Bosley Medical Group v. Abramson (1984) 161 Cal.App.3d 284, where the Bosley court state that a "substantial" sale of all shares must take place, so that it can be said that goodwill of the company is being transferred.  So how much stock must an employee for it to be valid?  No one knows.  However, employers can’t have employees buy a small amount of stock just to validate their non-compete agreements.

Partnerships

A partnership is “two or more persons associated together in a business for profit.”  Also note, no partnership agreement is required in order to be a partner.  So be warned, you may be a partner and not know it.  If you are a partner, non-compete and non-solicit agreements are valid under § 16602.  They are subject to a “rule of reason,” meaning they must be geographically and temporally reasonable.  Generally something like a few years and radius of 40-60 miles are considered reasonable.  Such agreements have been upheld in the context of accountants (Swenson v. File (1970) 3 Cal.3d 389), attorneys (Howard v. Babcock (1993) 6 Cal.4th 409), and physicians (South Bay Radiology Medical Associates v. W.M. Asher, M.D., Inc. (1990) 220 Cal.App.3d 1073, Farthing v. San Mateo Clinic (1956) 143 Cal.App.2d 385).  Consultants beware!   If you sign any consulting agreement make sure that it makes very clear that you are not working “in association,” are not partners, and are not embarking on a joint venture.  Also, contractual denials of partnership formation will be of no avail if all of your conduct indicates otherwise.  Make sure you are consulting and not becoming a partner, or else a non-compete agreement might become valid.

Federal Court Boogaloo

When an employer wants to sue a former employee for violating a non-compete agreement, the employer may try and “remove” the action to Federal Court.  The employer may be able to do so if certain jurisdictional requirements are met, but generally will be able to do so if $75,000+ is at stake and the employer and employee are residents of different states.  (Courts apply many tests when determining where corporations “reside,” but generally look to the corporate headquarters and where they do most of their business.)  The 9^th Circuit (Federal Court) is supposed to respect California law and follow § 16600, but guess what, they don’t like it.  In IBM v. Bajorek (9th Cir. 1998) 191 F.3d 1033, the 9^th Circuit upheld a non-compete agreement in spite of § 16600.

Edwards and Employer Demands

Demand After Employment

Let’s say your employer comes to you and demands you sign a non-compete or non-solicit agreement or they are going to fire you.  You refuse and they fire you.  There may be a valid cause of action for wrongful termination.  In Edwards v. Arthur Andersen LLP (2008) 44 Cal. 4th 937, the court found that an employer cannot lawfully make the signing of an employment agreement, which contains an unenforceable covenant not to compete, a condition of continued employment.

Employment Contingent Upon Agreement

If an employer demands you sign a non-compete or non-solicit agreement in order to get a job, each individual will need to analyze the prospective benefit of employment against the detriment from signing such an agreement (taking its enforceability into account).  However, there is not yet a case on point whether Edwards applies to prospective employment.  An employee would not yet have an action for wrongful termination.  An employer would probably not be intentionally interfering with prospective economic advantage, because usually in such instances a third party is involved.  It is questionable whether or not such an employee would have any claim.  As a result, prospective employees will need to analyze the risk/benefit and enforceability of such agreements before they decide whether to sign them.