In VL Systems, Inc. v. Unisen, Inc., a California Court of Appeal recently held that a broad "no-hire" provision in a consulting contract was unenforceable as an impermissible restraint on trade. "No-hire" clauses are common in the consulting industry (and other similar industries such as the temporary services industry) in which the consulting companies provide specialized labor to their clients. The reason for the "no-hire" provisions is that the consulting companies fear that the clients will hire their employees directly as employees and thereby eliminate the need for the consulting company.
VL Systems, a computer consulting company, had entered into a short term consulting contract with Star Trac. VL Systems included a provision that restricted Star Trac from hiring away VL Systems’ consultants. The "no-hire" provision required Star Trac to pay liquidated damages to VL Systems if it hired any VL Systems’ employee within one year of the consulting contract. The "no-hire" provision was extremely broad and applied to all VL Systems’ employees regardless of whether they worked on the Star Trac contract or even if they worked at VL Systems at the time of the Star Trac contract.
After the completion of the Star Trac contract, VL Systems hired a new consultant (David Rohnow). As he was hired after the Star Trac contracted ended, Mr. Rohnow never worked with Star Trac, nor had any contact with Star Trac as an employee at VL Systems. After only two months at VL Systems, Mr. Rohnow began looking for a new job. Coincidently, at the same time Star Trac posted an internet job listing for a director of information technology. Mr. Rohnow responded to Star Trac’s job posting and was hired. Star Trac did not actively seek out Mr. Rohnow. After Mr. Rohnow was hired, VL Systems sent Star Trac an invoice for $60,000, representing liquidated damages for Star Trac hiring one of VL Systems’ employees. Star Trac refused to pay and VL Systems sued.
The Court found that the "no-hire" clause was unenforceable because it impermissibly restrained Mr. Rohnow’s ability to seek employment. The Court rejected VL Systems’ argument that the "no hire" clause did not prevent Mr. Rohnow from seeking employment with Star Trac, it merely required Star Trac to pay liquidated damages. The Court took the practical view that companies would be unwilling to hire Mr. Rohnow if they had to pay liquidated damages to VL Systems in addition to his salary. Consequently, the "no-hire" clause restricted his ability to seek employment.
The Court found the wide breadth of the VL Systems’ "no hire" clause untenable and distinguished prior California cases which upheld more narrow "no-hire" clauses. The Court implicitly suggested that more narrow "no hire" clauses, ones applicable only to employees that worked on the contract or that only restricted the contracting party from actively soliciting employees, might be enforceable.
Companies in the consulting, temporary services, or other industries that wish to utilize "no-hire" clauses should consider VL Systems when drafting "no hire" provisions in the future. Companies should consult their labor counsel to determine if their existing contracts are enforceable.