"Just Try And Stop Me!" -- The Enforceability of Non-Compete and Non-Solicitation Provisions in Employment Agreements in CaliforniaBy: Joanna R. Mendoza
It is becoming increasingly common in today's business world for a company to have its employees sign agreements that severely restrict or totally prohibit the employee's right to work for a competing company after the employment relationship has been terminated. Almost as equally common is a provision in such an agreement that prohibits the employee from soliciting customers that the employee came in contact with while employed at the company. It is a frequent issue that must be addressed when that employee moves on to a new company in his or her field of expertise. The issue is one that both the new employer as well as the employee must be conscious of, since both parties are likely to be a target if the former employer decides to pursue legal action to attempt to enforce such restrictions.
I. California's Strong Prohibition Against Non-Compete Clauses
California law contains a strong prohibition against non-competition agreements, with limited exceptions. The statute at issue, California Business and Professions Code section 16600, specifically states:
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.
California courts have interpreted the law quite strictly ruling that section 16600 reflects an important state public policy favoring the right of employees to change jobs freely. Courts have held that "the interests of the employee in his own mobility and betterment are deemed paramount to the competitive business interests of the employers, where neither the employee nor his new employer has committed any illegal act accompanying the employment change." Metro Traffic Control, Inc. v. Shadow Traffic Network (1994) 22 Cal.App.4th 853, 860.
Sections 16601 and 16602 permit broad covenants not to compete in two narrow situations: where a person sells the good will of a business, and where a partner agrees not to compete in anticipation of dissolution of a partnership. These two statutory exceptions rarely apply in the standard employment context.
II. Exception for Protection of Employer Trade Secrets
Notwithstanding the general rule and the two limited statutory exceptions, a covenant not to compete will not be viewed as a violation of section 16600 if it is "necessary to protect the employer's trade secrets." Employers have the right to protect proprietary and property rights that are subject to protection under the laws of unfair competition. However, if there are provisions within an agreement designed to provide such protection against trade secret disclosure, the non-compete provision will not be enforced. D'Sa v. Playhut, Inc. 85 Cal.App.4th 927, 935. If the agreement in question addresses the issue of maintaining the confidentiality of trade secrets in a section separate and apart from the non-compete clause, the covenant not to compete will be stricken in its entirety.
Courts generally do not like to re-work contract language to make it enforceable under the law. They are more likely to strike or keep an entire provision rather than edit it to conform to the law. Hence, if the covenant not to compete is combined in a single clause with the employee's duty to maintain the confidentiality of trade secrets, the entire clause will likely be stricken by a court. However, the duty to maintain the confidentiality of trade secrets will nevertheless survive due to California statutory law that imposes such a duty on employees. California Civil Code section 3426.1 et al. (Uniform Trade Secrets Act). However, the matters which the employee is required to keep confidential even after his or her employment are only those things which fall within the statutory definition of a trade secret. That definition is found at Cal. Civil Code section 3426.1(d) and states:
"Trade secret" means information, including a formula, pattern, compilation, program, device, method, technique, or process, that:
Many employment agreements state in a conclusory fashion that the company's trade secrets include, but are not limited to, information as to its customers and vendors, pricing of products, availability of products, sources of product, the identity of contact persons at various suppliers, printed materials, marketing materials, procedures, policies, practices, proprietary information, marketing plans and strategies, and other company business. Nevertheless, despite this pronouncement within the contract terms, the contract itself is not decisive in establishing whether or not something is a trade secret - the contract cannot make a trade secret where none exists under the law. State Farm Mut. Auto. Ins. Co. v. Dempster (1959) 174 Cal.App.2d 418, 426.
There are some items that may be identified by a company as its purported trade secret that could never meet the definition of a "trade secret." For example, pricing of products and availability of products (if pricing and availability are made available to any customer or easily accessible by any third party who requests that information), as well as printed and marketing materials provided to customers are not trade secrets. With regard to suppliers/vendors, if those suppliers and vendors are common and known in the industry (e.g, generally known to the persons who are in the particular business), and if the contact person for each vendor is as easily obtained by calling and asking for the information, this information is not normally deemed a "trade secret." In sum, any information that is either not held in a confidential manner or is easily known or acquired by those who practice in the industry cannot be deemed a trade secret. This is an analysis that the former employee will need to engage in to determine what can and cannot be used by him or her at the new job.
Company policies, procedures, marketing plans and strategies and "proprietary information" would presumably be considered that information which the company makes an effort to keep confidential and is generally not known in the industry. If those presumptions are correct, the information will likely be deemed trade secret and the former employee should not have any discussion with the new employer regarding these items. This does not mean, however, that the employee is precluded from working for the new company. Again, the non-compete provision itself is not enforceable against him or her.
In some states businesses are able to prevent an employee from working for a competitor on the mere assumption that the former employee will "inevitably disclose" the trade secrets they learned of while working for their former employer. This concept of "inevitable disclosure" as a basis for preventing an individual from working with whomever and wherever he or she chooses has been specifically rejected by the California Supreme Court. Its application in California was a subject of much debate for years, but it is now certain that a business cannot enjoin someone from working for a competitor on the mere speculation that trade secrets will be disclosed.
III. Customer Lists and Non-Solicitation Covenant
There are two questions to be addressed with regard to an former employee's specific use of the customer identities and information he or she acquired while working for the previous employer. The first, of course, is whether such information is protected trade secret information and therefore must remain confidential and not used. The second issue is whether the non-solicitation covenant is enforceable against the former employee with regard to the customers and vendors of the former employer.
Whether or not a customer list is a trade secret may be a tricky issue. One must look to the statutory definition and apply it to each specific situation. The court in American Paper and Packaging Products v. Kirgan (1986) 183 Cal.App.3d 1318, held that the customer list and related customer information in that case was not entitled to protection as a trade secret because: (1) the information was known or readily ascertainable to others in the industry; (2) the process of compiling the information was not sophisticated, difficult or time-consuming; and (3) the relevant industry was broadly competitive and customer relationships were usually not exclusive.
Several factors must be considered:
- The nature of the business (highly competitive, with few exclusive relationships?)
- Whether the disputed information is available from public records sources
- Whether the former employee and the customers at issue developed a personal relationship during the former employee's prior employment
- Whether the list included information about customer preferences
- Whether the former employer's customers purchased from multiple suppliers
- Whether the disputed information was compiled through difficult and time consuming processes
While a trade secret claim is strengthened if the customer list contains not only the customers' identity but additional information concerning customers' requirements and preferences, the mere fact that this additional information is part of a customer "list" does not assure its status as a protectable trade secret. The lack of protection may result directly from the willingness of the customer itself to disclose its preferences and specifications to any competitor including a former employee.
It should be noted that, even if customer identities are considered a "trade secret," the former employee's actions are not actionable unless the information is "misused." Such misuse occurs when (1) the customer information falls within the definition of a trade secret and (2) the former employee "solicits" customers from that trade secret list. California courts have distinguished between improper solicitation and simply announcing a job change. The latter conduct is not actionable under California law even if the customer identities are deemed to be trade secrets. So, regardless of the nature of the customer information acquired by the individual while at the prior employer, he or she could nevertheless contact those customers for the sole purpose of announcing the change of employment.
Furthermore, a former employee is not prohibited from discussing business with a party listed on a former employer's customer list when approached by that customer, and the law does not prohibit a former employee from receiving business from his former employer's customers.
Covenants of non-solicitation that require the departing employee to not solicit former co-workers to leave their jobs is generally enforceable if limited in duration (e.g., one or two years). Loral Corp. v. Moyes (1985) 174 Cal.App.3d 268. Provisions which generally require that a departing employee refrain from soliciting customers or business away from the former employer are essentially enforceable only if such customer or vendor information is a trade secret. In other words, the analysis is essentially identical to that found with regard to non-compete clauses - they run afoul of Business and Professions Code section 16600 as an unreasonable restraint on competition. If there exists another provision that provides the necessary protection against misuse of trade secrets, the entirety of the non-solicitation clause should be deemed unenforceable by a court.
Some employment agreements are drafted such that the employer allows the former employee to use its customer and vendor information after a limited time period (e.g., one-year). Under those circumstances it would be a very difficult for the employer to argue that such information is confidential and trade secret. By definition, to be a trade secret, efforts must be continuously made to keep the information confidential. Allowing its use by any former employee after a certain time period argues directly contrary to the fact that it is truly a trade secret.
IV. The Void Provisions May Make the Entire Agreement Void
It is important to determine whether an employment agreement has what is commonly referred to as a "severability clause." A severability clause essentially states that if any provision of an agreement is rendered void or illegal, the remainder of the agreement shall remain in full force and effect. This clause is often necessary since the courts in general hesitate to re-write contracts in any manner, and will often throw out the entire contract if portions of it are found void or unenforceable. An exception exists if the parties have acknowledged their intent to allow the remainder of the agreement to remain in force with the severability clause.
If the employer fails to include a severability clause in a contract that contains unenforceable provisions, there is a likelihood that the entire contract would be deemed void if the company were ever to attempt to enforce the agreement. Nevertheless, since there remains a statutory obligation on the part of the former employee not to disclose or misuse that information which falls within the definition of a "trade secret," that duty would continue even if the employment agreement were to be voided in its entirety.
While Non-Compete and Non-Solicitation clauses are generally void under California law, the issue of protecting a company's trade secrets is one that needs serious consideration when an employee changes employment and goes to work for a competitor. Only the former employee will be able to determine what must be kept to him or her self and what can be shared with others. As an employer who is losing an employee to a competitor, it is often worthwhile to specifically advise that individual what the company deems to legitimately be trade secrets that are not to be shared with anyone. This makes it easier for everyone involved to be certain that trade secrets are not shared with a competitor. As the hiring employer, it is worthwhile to enter into an agreement whereby the employee agrees not to use or disclose to the new company any trade secret information acquired by him or her from any former employer. This will help to avoid or reduce potential liability (it should eliminate any claims of intentionally trying to use a competitor's trade secret information, if there is any such information), as well as remind the employee of his responsibility not to use any information that is truly trade secret information of the former employer.