No business wants their former employees to take their talent, the talent of their co-workers and the company’s trade secrets to a competitor. To prevent this, businesses have required employees to sign confidential information, non-competition and non-solicitation agreements. Questions often arise regarding the enforceability of such agreements because, while the law attempts to protect the confidential business information of employers, it also places a higher value on protecting the rights of individual employees to pursue gainful employment. California’s Business and Professions Code Section 16600 confirms the preeminence of the protection of the individual’s employment rights in stating, “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.”
In California, agreements requiring a former employee not to compete against their former employer are clearly void except as specified by statute. However, what is less clear is the enforceability of agreements restricting former employees from soliciting their former co-workers, and restricting their use of their former employer’s confidential and trade secret information. We review case law in the following to provide a guide of the extent to which such agreements have been successfully utilized by companies.
Covenants not to Work for a Competitor
Covenants not to Solicit a Former Employers’ Clients
Covenants not to Perform Work for a Former Employers’ Clients
In the case of Edwards v. Arthur Andersen LLP, Edwards signed an employment agreement that included a clause limiting Edwards’ ability to perform certain types of work, should he accept a position of employment with one of his former employers’ clients. The agreement further prohibited him for a period of time from soliciting clients from his former employer, and also from soliciting any of his former employer’s personnel. The California Supreme Court held that Andersen’s noncompetition agreement was invalid because the agreement restricted Edwards from performing work for Arthur Andersen’s Los Angeles clients and, therefore, restricted his ability to practice his accounting profession.
Enforceable Agreements Protect True Trade Secrets
For an employer to stand a chance of enforcing the terms of a non-competition agreement, the employer must establish that the former employee’s actions while employed by their competitor threatens to expose truly confidential trade secret information, such that the former employer could be damaged and is entitled to protection. Employer information is only entitled to protection if it is a true trade secret.
In the case of The Retirement Group v. Galante, TRG alleged that Advisers had misappropriated confidential information (i.e., trade secrets) contained on TRG’s secure database that Advisers might use to solicit TRG’s customers. TRG obtained, among other things, two preliminary injunctions against Advisers. The first injunction was upheld, and precluded Advisers from using in any manner TRG information found solely and exclusively on TRG databases. However, similar information found on servers, databases and other resources owned and operated by other entities or businesses was excluded from the injunction. The second injunction prevented Advisers from directly or indirectly soliciting any current TRG customers to transfer any securities account or relationship from TRG to Advisers or any broker-dealer or registered investment advisor other than TRG. The court concluded that second injunction was invalid since it could “only operate to preclude the precise type of competition Edwards declares is otherwise permissible.”
Dowell v. Biosense Webster, Inc. is a case which provides some additional insight into the court’s measure of what constitutes a true trade secret. Biosense hired Dowell and Chapman who each signed non-compete clauses that prevented them, for a period of 18 months post-employment with Biosense, from rendering services, directly or indirectly, to any competitor in which the services they may provide could enhance the use or marketability of a conflicting product by application of confidential information to which the employee had access during employment. They were also prevented, for a period of 18 months post-employment, from soliciting any business from, selling to, or rendering any service directly or indirectly to any of the accounts, customers or clients with whom they had contact during their last 12 months of employment.
Biosense contended that the clauses were valid because they were tailored to protect trade secrets or confidential information and, as such, satisfied the trade secret exception to Section 16600. The non-competes defined “Confidential information” as information disclosed to or known by the employee, including such information as the number or location of sales representatives, the names of customers, customer preferences, needs, requirements, purchasing histories or other customer-specific information. The court concluded it would be nearly impossible for employees like Dowell and Chapman, who worked directly with customers, not to have possession of such information and invalidated them.
Enforceability of Non-Solicitation Agreements is Less Clear
There are several examples of how the courts are split on the enforceability of Agreements that prohibit solicitation of other employees. In Metro Traffic Control v. Shadow Traffic Network, Metro is a traffic reporting business that signed a one-year contract with a radio station. The contract included an acknowledgment by the radio station that Metro’s employees agreed in writing to treat all traffic gathering and reporting procedures as confidential trade secrets of Metro and to not compete with Metro in the traffic reporting business during their employment and for one year following their termination. After the contract expired, the radio station gave the work to Shadow, which extended offers of employment to employees of Metro. Metro sued Shadow for inducing its employees to breach their contracts. The court did not enforce the agreement, finding that a group of trained and talented at-will employees did not constitute Metro’s trade secrets, the talent belonged to the employee to market however the employee pleased.
The case of ReadyLink Healthcare v. Cotton yielded a different result. The employer, a staffing provider for healthcare facilities, the court affirmed a preliminary injunction to prevent the employee from soliciting the employer’s employees and customers issued against its former employee, a recruiter. The appellate court affirmed because there was evidence that there existed a threat that the former employee would use misappropriated trade secret information to solicit the employer’s employees and customers.
In yet another instance, the case of VL Systems, Inc. v. Unisen, Inc., included a contract between the parties providing that the client would not hire any employee of the consulting firm for 12 months after the contract’s termination, subject to a liquidated damages provision. Within that period, the client hired an employee of the consulting firm who had not performed any work for the client and who had not been employed by the consulting firm at the time the client’s contract was performed. The court held that the no-hire provision was unenforceable as a matter of law. Although the contract was an agreement between employers, rather than a covenant not to compete, the court concluded that enforcing the clause would unfairly limit the mobility of the employee.
Crafting an enforceable employment agreement that will survive a challenge if/when employment terminates can help employers survive in highly competitive business sectors. So if you are an employer entering into, or pursuing enforcement of, a non-competition or non-solicitation agreement, keep in mind the following:
1. An employer cannot prohibit an employee from working for a competitor after termination. An agreement that attempts to do so is unenforceable.
2. A clause prohibiting a former employee from using trade secret information to identify existing customers, facilitate the solicitation of such customers, or otherwise unfairly compete with the former employer may be enforceable. However, where the practical effect is to prevent the employee from working in his or her field, it is unenforceable. The question becomes whether the purportedly “confidential information” is really confidential. If it is not, this clause will be ineffective.
3. The question of whether a clause prohibiting the solicitation of other employees is enforceable remains open. If actual trade secrets are used to solicit the employees, it is likely that such a clause will be enforceable.
If you have any questions or are involved in a dispute regarding non-competition or non-solicitation agreements, please call Lori Lutzker in the firm’s Business Litigation Group or Valerie Menager in the Employment Practices Group.