Non-Compete Agreements: Are They Enforceable?

Non-Competition Agreements in the Wake of Edwards v. Arthur Anderson

In Edwards v. Arthur Anderson LLP (2008) 44 Cal. 4th 937, the California Supreme Court addressed the scope of the statutory ban on non-competition agreements embodied in California Business and Professions Code Section 16600, which provides:

“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.”

The Supreme Court gave the statute a strict constriction and ruled that, given the strong and settled legislative policy in favor of open competition and employee mobility, non-competition agreements are invalid under Section 16600 unless expressly permitted by statute.

Given the prevalence of non-competition and non-solicitation agreements in the insurance industry, the issues raised in Edwards are obviously of great concern to insurance agencies and their employees. While the impact of Edwards is substantive, there are important areas in which non-competition and non-solicitation agreements are still permissible.

In Edwards, the plaintiff worked as a tax manager for Arthur Anderson LLP in its Los Angeles office. As a condition of employment, he was required to sign a non-competition agreement. The agreement prohibited him from performing services for 18 months following termination of his employment for any Anderson client for whom he had performed work during the previous 18 months, and from providing services to any clients in the Los Angeles office for 12 months following termination.

Prior to the enactment of Section 16600 in 1872, California courts recognized the validity of agreements restricting an employee from competing with his or her former employer, so long as the restriction was reasonable. Bosley Medical Group v. Abramson (1984) 161 Cal. App. 3d 284, 288; Wright v. Ryder (1868) 36 Cal. 342, 357. However, Section 16600 and its predecessor changed that rule.

The Business and Professions Code specifically excepts non-competition agreements in the sale or dissolution of corporations, partnerships and limited corporations (Business and Professions Code Section 16601, 16602 and 16602.5). Thus, the purchaser of an insurance agency is permitted to require a non-competition agreement as a purchase condition. However, under Edwards, an insurance agency or brokerage firm cannot (subject to an implied trade secret exception discussed below) require an employee to sign a non-solicitation agreement as a condition of employment.

The crux of the issue in Edwards is the meaning to be given the term “restrain” as used in Section 16600. Anderson argued that the term “restrain” should be interpreted as simply meaning to “prohibit” so that only contracts that totally bar an employee from competing are illegal, but that a reasonably based limitation would be permissible.

The Supreme Court rejected Anderson’s argument, and stated that if the Legislature intended the statute to apply only to restraints that were unreasonable or overbroad, it could have included language to that effect.

Thus, following Edwards, broad-based non-competition agreements are generally unenforceable in California, except in connection with the sale of the assets of a business. Left unresolved, however, is the validity of non-compete and non-solicitation agreements that prohibit a former employee from using “trade secrets” to compete with his or her former employer. The Supreme Court in Edwards specifically declined to address the applicability of what it described as the “so-called trade secret exception to Section 16600.” However, it is noteworthy that in Edwards, the Supreme Court cited, with approval, Thompson v. Impaxx, Inc. (2003) 113 Cal. App. 4d 1425, 1429, a case that held that non-solicitation agreements designed to protect an employer’s trade secrets or confidential proprietary information are not prohibited under Section 16600. Moreover, on Sept. 9, 2008, in Asset Marketing Systems, Inc. v. Gagnon (9th Cir. 2008) WL 413 8181, the Ninth Circuit interpreted Edwards as not applying such agreements.

Given the long-established policy of California courts to provide protection for trade secrets, it is likely that such non-solicitation agreements will be remain enforceable. Even in the absence of a contractual restriction, the law of unfair competition generally prohibits a former employee from disclosing or misusing an employer’s trade secrets and confidential information. Loral Court v. Moyes (1985) 175 Cal. App. 3d 268, 275.

Customer lists (such as the identity of insureds serviced by a brokerage firm) and related information may under certain circumstances be protected trade secrets. The law in the field developed in the so-called “route” cases, which involved employees who operated routes of customers whom they supplied with laundry and linen service, ice, bread, milk and similar products. The names and addresses of the customers on the routes enabled one employee to take the place of another, either temporarily or permanently, without interruption of the service, and the friendly business relationship with the customers made for a continuation of the patronage along the route. Courts early held that those considerations, which gave the employers an advantage over competitors, constituted business secrets that were entitled to protection. King v. Pacific Vitamin Corp. (1967) 256 Cal. App. 2d 841.

An important consideration is whether the information is readily accessible to a reasonably diligent competitor. Some courts have held that the identity of customers is not a trade secret if it is common knowledge in the trade. See, e.g., Mathews Pain Co. v. Seaside Paint and Lacquer Co. (1957) 148 Cal. App. 2d (168). However, that is not always the case. In Hollingsworth Soldersless Terminal Co. v. Turley, 622 F. 2nd 1324 (9th Cir. 1980), the Ninth Circuit, applying California law, recognized that a list of the people who have already purchased the product is substantially more valuable than a list of people who might only have a potential interest in purchasing. (Id.) However, trade secret protection will generally be afforded where a business, through some effort, acquires knowledge of a customer’s special needs or susceptibilities. Continental Car-Na-Var Corp. (1944) 24 Cal. 2d 104.

For example, an insurance agent may acquire special understanding and knowledge of the peculiar insurance needs of an insured, risks and hazardous that may be unique to an insured’s account, and the nature of insurance products and coverages purchased in the past. In American Credit Indemnity Co. v. Sacks (1989) 213 Cal. App. 3d 622, American Credit Indemnity marketed credit insurance. However, only 6.5 percent of the businesses that could use the product actually did so. The court noted that there was no way a competitor could distinguish those who did purchase, from the 93.5 percent that did not. Because knowledge of the customer list would allow a competitor to direct sales to the elite 6.5 percent, the customer list was held to have economic value and a trade secret.

While non-solicitation agreements designed to protect trade secrets might remain enforceable, an employee, nonetheless, has the right to announce his or her new job position, and to receive business from the former employer’s customers in a manner that does not involve solicitation. Merely informing the former employer’s customers of a change of employment without more is not solicitation. Hilb, Rogal & Hamilton Insurance Services v. Robb (1995) 43 Cal. App. 4d 1812; Aetna Building Maintenance Co. v. West (1952) 39 Cal. App. 2d 198.

Topics California