What Will Not Work to Protect Trade Secrets or Enforce Non-Competes in California

California’s Business and Professions Code (“B&P”) Section 16600 invalidates contractual restraints on a person’s ability to engage in a profession, trade, or business. This statute, which has been interpreted expansively, expresses a strong California public policy and contains only the three limited exceptions set forth in the third article of this Take 5.

Employers have tried to utilize various contractual provisions and constructs to circumvent this policy without success. Out-of-state employers routinely include choice of-law provisions in employment contracts to specify that these agreements should be interpreted under the laws of a state that is generally more amenable to restrictive covenants. Even though choice-of-forum provisions that have a reasonable relationship to one or more of the parties to the contract are presumed enforceable in California, that presumption does not apply when the choice-of-law provision is used to circumvent the public policy against non-competes.

Employers have had better luck in the past with choice-of-forum provisions, and federal courts in California have enforced those provisions in some instances. When the choice-of-forum provision is enforced, it can make it difficult on an employee who may have to defend a non-compete lawsuit in another jurisdiction, where those courts may be less inclined to apply California law to the dispute. This “loophole” was substantially closed on January 1, 2017, with new legislation that prohibits employers from requiring, as a condition of employment, that employees who primarily reside and work in California agree to litigate claims outside of California that arise in California or otherwise deprive the employee of the substantive protections of California law.

While an employee may nevertheless sign such agreements, they are voidable at the employee’s option unless he or she was individually represented by counsel to negotiate the venue or choice-of-law provisions. The law applies to litigation and arbitration, and to any contract entered into, modified, or extended on or after January 1, 2017. With respect to agreements after such date, employers will be unable to rely on choice-of-law provisions unless the employee is represented by counsel.

In addition, “narrow restraints” in contracts will not be enforced. In 2008, the California Supreme Court rejected the narrow restraint exception and held that a covenant not to solicit customers was unenforceable. A covenant that prohibits hiring employees or penalizes an employee for competing will likewise not be enforced. As discussed in the third article of this Take 5, it is unclear whether contractual provisions prohibiting solicitation or other conduct by a former employee will be enforced. The creation of sham agreements that require an employee to purchase stock or other bogus constructs that attempt to come within the scope of one of the exceptions to B&P Section 16600 by suggesting that there has been a “sale of a business” will not be enforced. California courts will examine the realities of the agreement to determine if the agreement complies with the statute’s intent.

Employers should think twice before including the unenforceable provisions in employment contracts merely for their deterrent effect. Such a practice is risky. If an employer terminates an employee who refuses to sign an agreement that contains an unenforceable non-compete provision, such action would constitute a wrongful termination in violation of public policy and would entitle the employee to recover tort damages, including punitive damages, as well as economic damages. We are not aware of any case that expressly holds that the refusal to hire an employee who refuses to sign an agreement that contains an unlawful non-compete as a condition of employment would likewise constitute tortious conduct under California law, yet strong arguments can be made that it would. Moreover, a clause that is void under Section 16600 may also violate the provisions of the California Unfair Practices Act, which could subject an employer to liability for committing an unfair business practice.  Given the strong protections against non-competes in California, it is too risky to require employees to sign employment agreements that contain these provisions. All employment agreements entered into with employees who live or work in California should be carefully reviewed to ensure compliance.