I recently posted a discussion about employee noncompete covenants based on a friend’s experience in negotiating with a current employer, and I thought it would be helpful to generalize the discussion, and then drill down to the implications for California based employers and employees. 

As a general point, noncompetition agreements (noncompete agreements, or covenants not to compete) may or may not be enforceable depending upon the state law which applies.  From there, the specific facts and circumstances of a particular agreement are important.

As a general rule (and by statute), noncompetition agreements in California are void as a restraint of trade, except those agreements that fit within stated exceptions.  It is a fair operating assumption that, at least in California, a noncompete covenant within an employment agreement is generally unenforceable.  For the more legally inclined, there is a decent discussion of relevant law at http://www.andersenalumni.net/%5CCalifornia%20Non-Compete%20Agreements.pdf.

Of course, there are exceptions listed in the California statute, and they allow noncompete agreements when a business or an interest in a business is sold. The philosophy behind allowing noncompete or noncompetition agreements in the sale of a business is that the buyer of the goodwill of an ongoing business is entitled to restrain the seller of the business from continuing to compete with the buyer. If the seller was allowed to continue to operate, or start a new business in the same line of work, the seller could utilize the goodwill he or she purported to sell.

Noncompete agreements under California law must be limited to preventing the business seller (or selling shareholder or partner) from engaging in a business similar to the business sold in specified locations in which the business was carried on prior to the transfer.  These are generally enforceable for so long as the business continues to be carried on in that area by the buyer or a successor to the buyer.

I recommend that purchasers of a business obtain the seller’s covenant not to compete in every purchase of a business or purchase of an interest in a business. Such a provision is clearly enforceable under California law and it can be very valuable to the buyer of a business. Even if the buyer does not expect the seller to compete, it is wise to include such a provision to preclude the seller from engaging in activities which may be harmful to the business.

From a buyer’s perspective, you cannot anticipate the specific circumstances which may arise or actions which may be taken by another party, and the broad protection offered by a noncompete agreement can be unexpectedly beneficial.

Conversely, if you are the seller of a business, the noncompete agreement should be avoided. If the noncompete agreement is demanded as part of the purchase, attempt to limit the covenant to a defined territory and type of business. You will want to be free to engage in other business activities without objections from the buyer of your business, and the narrower the noncompete covenant, the better.

Focusing in specifically on California employment law, California law does not allow noncompete agreements with employees, other than with employee-owners of a business in the context of a sale of a business as discussed above. In fact, the attempt to restrict a former employee from competing with a business may subject the business to liability for restraint of trade.

Generally, California companies attempting to prevent ex-employees from competing must seek to do so through means other than the use of a noncompete agreement. One popular way of doing so involves protecting trade secrets or other proprietary information such as customer lists, customer information, marketing methods, and production methods through the use of a proprietary information protection agreement (a nondisclosure agreement or confidential disclosure agreement).  Through such an agreement,  an employer can have employees (as well as any other individuals or firms with access to proprietary information) agree that certain information is proprietary to the employer, that they will not disclose it or use it, and that they will protect it from improper disclosure or use.  You can see partial views of large numbers of Noncompete Agreements here.  Using the advanced search functionality at www.realdealdocs.com, you can drill down into specific noncompete agreements by state or other relevant search criteria.

Although an agreement is not legally necessary in order to have a trade secret under California law, the best way to show that certain information was identified as a trade secret and protected from disclosure is by having a nondisclosure agreement signed by all those who have access to the information.

As an aside, it should be noted that for information to be treated as a trade secret, it must be kept secret in order to be entitled to protection, so steps to identify and protect such information must be taken prior to disclosure.

Business owners should appreciate the benefits of a noncompete agreement when buying a business or an interest in a business, and of a nondisclosure agreement to protect the proprietary information of the business.  Careful steps must be taken to preserve these protections in the context of an employment or consulting relationship.