The Second District Court of Appeal in Los Angeles issued a significant opinion last week, finding that non-compete agreements in California employment contracts are impermissible. In Edwards v. Arthur Andersen LLP, the Second District explicitly rejected decades of prior decisions – many of them in federal courts – which had found such agreements to be permissible if they were narrowly crafted so that an employee who left a company still could work in his or her profession. The Court of Appeal’s decision makes clear that such agreements are generally invalid and employees cannot be compelled to sign them as a condition of employment. Edwards v. Arthur Andersen LLP, No. B178246 (Cal.App. 2 Dist./Div. 3) (8/30/06).
The case was brought by Raymond Edwards II, who was hired by Arthur Andersen (“Andersen”) in 1997. At the time of his hire, Edwards was required to sign a non-compete agreement, which prohibited him from working for, or soliciting business from, certain Andersen clients in the event of his termination. When Andersen went out of business following the 2002 Enron accounting scandal, its tax practice was sold to HSBC, which hired various Andersen personnel, including Edwards. As a condition of Edwards’ employment with HSBC, however, Andersen required that he sign a “Termination of Non-Compete Agreement,” which released him from his 1997 non-compete agreement in exchange for a variety of promises that were highly favorable to Andersen. When Edwards refused, his offer from HSBC was withdrawn, and Edwards sued Andersen under a variety of legal theories, including intentional interference with prospective economic advantage and violation of the Cartwright Act. The trial court sustained Andersen’s demurrer to the Cartwright Act claim and dismissed Edwards’ intentional interference claim. In its ruling, the trial court found that both the 1997 non-compete agreement and the 2002 “Termination of Non-Compete Agreement” were valid.
The Court of Appeal disagreed, finding that non-compete agreements between an employer and employee are, under most circumstances, invalid in California. In so holding, the three-judge panel stated that such agreements violate California’s public policy in favor of protecting employee mobility. Specifically, the Court held that “Section 16600 prohibits noncompetition agreements between employers and employees even where the restriction is narrowly drawn and leaves a substantial portion of the market available for the employee.” The Court went on to state that “noncompetition agreements burden a terminated employee with the task of guessing, at his or her peril, whether a court might find particular restrictions sufficiently narrow or overly broad.”
The Court of Appeal’s ruling clarifies a long-standing split of authority regarding whether such agreements are lawful. In light of this decision – which allows non-compete agreements only to protect trade secrets – employers should be more cautious than ever when drafting employment contracts.