Many of our clients have inquired in recent years whether non-competition agreements are actually legally binding. The answer to this question does vary from state to state. However, there is some commonality among many state statutes.
The recent case of Kolani v. Gluska, 64 Cal.App.4th 402, 75 Cal.Rptr.2d 257 (1998) underscores the importance of paying attention to the validity of a particular non-competition agreement. In this case, a covenant not to compete contained in an employment contract was construed as an outright prohibition on competition, and hence was held to be void and unenforceable. The contract at issue included a "savings clause", which expressly authorized a court to revise the non-compete covenant if it was deemed to be "unfair" or "commercially unreasonable."
But the court refused to rewrite the illegal broad covenant into a narrower contractual constraint on the departing employee to prohibit him from using confidential information taken from the former employer. Such a prohibition on the misappropriation of confidential customer lists and trade secrets would have been legal. However, the court declined to undermine the important public policy of promoting competition, noting that employers would have no disincentive to use the broad, illegal clauses if they were permitted to retreat to a narrow, lawful construction in the event that an employee was tenacious enough to resort to litigation.
Basically, public policy in America favors open, unfettered competition. In keeping with promoting the basic freedom to pursue one's livelihood and to facilitate free competition, contractual arrangements which prohibit former employees or independent contractors from competing against their former employers often violate these fundamental public policies.
Most states, including California, permit non-competition agreements to be enforceable in certain situations, such as:
- Upon the sale by a shareholder of the goodwill of a business;
- Upon the sale by a shareholder of all of his or her shares in a corporation; or
- Upon the sale by a corporation of substantially all of its operating assets together with the goodwill of the entity.
The relevant California statutes also provide for the enforceability of a non-competition agreement upon the dissolution of a limited liability company, or the sale by a member of all his or her interests in a limited liability company. Similarly, the validity of a non-competition agreement will be recognized upon the dissolution of a partnership or the sale by a partner of all his or her interests in the partnership. In these circumstances, California statutes provide that the seller may agree with the buyer to refrain from carrying on a similar business within a specified area or time period.
Thus, even when permitted, a non-competition agreement will be enforced only within certain parameters. For example, the acceptable duration of a non-competition agreement will usually be limited to no more than several years. Also, case law construing the applicable statutes typically limits the territory for which a non-competition agreement may be enforced, so that such territory is geographically reasonable under the circumstances.
Generally, the courts are more liberal in enforcing a non-solicitation covenant than they are in enforcing a non-competition covenant. The difference is that a non-solicitation covenant basically precludes a former employee from soliciting the previous employer's other employees or customers; whereas a non-competition covenant would restrain an individual from engaging in a lawful profession, trade or business. Being aware of these basic limits will increase your chances of understanding and negotiating an enforceable non-competition agreement. Please contact our offices if you desire further consultation regarding the enforceability of a non-competition agreement to which you may be subject, or in drafting an enforceable non-competition agreement for your existing or prospective employees.