Decided a few weeks ago, Edwards v. Arthur Anderson (Cal. August 2008) clarifies California state courts’ position on nonsolicitation of customers provisions contained in an employment agreement. For years, California restrictive covenant practitioners looked to California federal law in an attempt to breathe life into nonsolicit of customers provisions. Post-Edwards, attorneys drafting restrictive covenants for their California clients ought to carefully consider removing these provisions from any future employment agreements.
Facts:
Arthur Anderson employed Edwards in its LA office as a tax manager. When Anderson hired Edwards, it required him to sign an agreement that prohibited him, for an 18-month period post employment, from “performing professional services of the type he provided while at Anderson, for any client on whose account he worked during 18 months prior to his termination.” He also was prohibited, for a 12-month period post employment, from soliciting professional services to any client of Anderson's LA office.
After the Enron scandal, Anderson sold its domestic accounting practice to, among others, HSBC. To work for HSBC, Edwards had to release Anderson from all claims it had against Anderson and, in return, Anderson agreed to release Edwards from his nonsolicitation requirements. Concerned that, by releasing Anderson, Anderson would not indemnify him from any action brought by a client against Anderson, Edwards refused to sign the release, and HSBC refused to hire him. Edwards then challenged the nonsolicit provision.
California has a statute that renders “covenants not to compete” void, subject to several exceptions. Bus & Prof. Code sec. 16600. Section 16600 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.”
Anderson reviewed the landscape of case law interpreting section 16600 to argue that the court should interpret the term “restrain” under section 16600 to mean simply to “prohibit,” so that only contracts that totally prohibit an employee from engaging in his or her profession, trade or business are illegal. It would then follow, argued Anderson, that a mere limitation on an employee’s ability to practice his or her vocation would be permissible under section 16600, as long as it was reasonably based.
More specifically, Anderson relied on a series of cases from the Ninth Circuit that created a narrow restraint exception to Section 16600 in federal court. For example, in General Commercial Packaging v. TPS Package, 126 F.3d 1131 (9th Cir. 1997), the Court held that a nonsolicit of customers provision barring one party from courting a specific named customer was not an illegal restraint of trade prohibited by section 16600, because it did not “entirely preclude” the party from pursuing its trade or business. Id. at 1133.
The California Supreme Court shunned the federal decision “exception,” stating that “no reported California state court decision” had endorsed the Ninth Circuit reasoning. It held that section 16600 is “unambiguous” and if the California legislature intended the statute to apply only to restraints that were unreasonable or overbroad, it could have included language to that effect. Because it did not, the California Supreme Court held that the nonsolicit was void.
Bottom line:
While some commentators have stated that the Edwards decision did not surprise them, it now makes clear – at least as to any nonsolicit of customers provision addressed in a California state court – that a nonsolicit of customers of any form between an employer and an employee in California is void. Given case law in California that suggests that even requiring an employee to sign an agreement with a void restrictive covenant provision may create a claim for unfair competition, it would be wise for California employers to remove any nonsolicit of customers or noncompete provisions from their employment agreements.
If you have any questions regarding this decision or other issues related to covenants not to compete or nonsolicitation agreements, please contact the author of this newsletter, Jeff Mokotoff, jmokotoff@fordharrison.com, 404-888-3804, or the Ford & Harrison attorney with whom you usually work.