California Court of Appeals rejects exception to ban on noncompetes

By Stacey Mark
September 1, 2006

On August 30, 2006, the California Court of Appeals ruled in Edwards v. Arthur Anderson LLP, 2006 WL 2498013, that there is no “narrow restraint exception” to California’s Business and Professions Code section 16600, which prohibits most noncompetition agreements. The court left intact the statutory and “trade secret” exceptions to section 16600.

The case was brought by Raymond Edwards, an employee in Arthur Anderson’s (AA’s) Los Angeles office. When he was hired in 1997, Edwards signed a noncompete that precluded him from soliciting or working for certain AA clients for 18 months following the termination of his employment. AA sold the tax practice for which Edwards worked to HSBC, which extended offers of employment to AA’s Los Angeles office personnel. However, as a condition of employment with HSBC, AA allegedly required its managers to sign a Termination of Non-Compete Agreement (TONC) that contained a broad release of claims against AA. When Edwards refused to sign the TONC, HSBC withdrew its offer and AA withheld severance benefits. Edwards sued AA for intentional interference with a prospective economic advantage, among other things.

Until now, two Ninth Circuit opinions, General Commercial Packaging v. TPS Package Engineering, Inc., 126 F3d 1131 (9th Cir 1997) and International Business Machines v. Bajorek, 191 F3d 1033 (1999), allowed narrow exceptions to California’s ban on noncompetition agreements under section 16600. In TPS, the Ninth Circuit upheld a contract prohibiting TPS from directly soliciting work from General Commercial Packaging’s (GCP’s) major client, for whom TPS worked indirectly through a contract with GCP. In Bajorek, the Ninth Circuit upheld a stock option agreement that required the employee to repay gains from and payments made on the exercise of his stock options if he worked for a competitor within six months of exercising the options. Reiterating California’s broad prohibition under section 16600, the court rejected these exceptions:

We believe the Ninth Circuit’s “narrow restraint” gloss on section 16600 is a misapplication of California law when applied to an employee’s noncompetition agreement. In our view, section 16600 prohibits noncompetition agreements between employers and employees even when the restriction is narrowly drawn and leaves a substantial portion of the market available for the employee.

The court also held that AA’s insistence on a broad release as a condition of employment with HSBC violated public policy because it purported to waive Edward’s statutory right to indemnity under Labor Code Sections 2802 and 2804. Section 2802 requires employers to indemnify employees for liability arising from employees’ acts within the course and scope of their employment and section 2804 renders void any purported waiver of rights under section 2802. By conditioning employment on signing the release, the court found that AA committed a wrongful act in violation of public policy, further supporting Edwards’ interference claim.

It remains to be seen whether other California courts of appeal adopt the holding in Edwards. In the meantime, employers may want to re-evaluate any agreements they have with California employees that impose any kind of post-termination restrictions on competition.

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