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California Supreme Court Expands Rights of Departing Employees to Solicit Former Employers’ Customers

In Edwards v Arthur Andersen, LLP, (August 7, 2008), Case No. S147190, the California Supreme Court adopted an expansive interpretation of Business & Professions Code § 16600 ("§ 16600") and its prohibition against non-competition agreements. The Court held that § 16600 prohibits employee non-competition agreements unless the agreement falls within a statutory exception. The Court specifically rejected the "narrow restraint" exception adopted by the Ninth Circuit Court of Appeals.

Under the Andersen decision, an employer will likely only be able to restrain a former employee from soliciting its customers under two circumstances: (1) if the employee is using trade secrets or other protectable confidential information to solicit customers, or; (2) if the solicitation restraint arises as the result of the sale or dissolution of a corporation, partnership or Limited Liability Company. If these exceptions do not apply, a covenant prohibiting the post-employment solicitation of customers will be unenforceable and a public policy violation. As such, if an employer refuses to hire or terminates an employee because the employee refuses to sign the non-competition agreement, the employee will likely have a claim for wrongful termination in violation of public policy which could ultimately subject the employer to tort damages.

Case Overview

The plaintiff, Raymond Edwards, II ("Edwards") is a Certified Public Accountant and was an employee of the Los Angeles office of Arthur Andersen, LLP ("Andersen"). In order to become employed with Andersen, Edwards signed a non-competition agreement in 1997 which read in relevant part:

If you leave the Firm, for 18 months after release or resignation, you agree not to perform professional services of the type you provided for any client on which you worked during the 18 months prior to release or resignation. This does not prohibit you from accepting employment with a client.

For 12 months after you leave the Firm, you agree not to solicit (to perform professional services of the type you provided) any client of the office(s) to which you were assigned during the 18 months preceding release or resignation.

You agree not to solicit away from the Firm any of its professional personnel for 18 months after release or resignation.

In March 2002, the United States indicted Andersen in connection with its investigation into Enron Corporation, and in June 2002, Andersen announced that it would cease its accounting practices in the United States. Andersen began selling off its practice groups and in May 2002, announced that HSBC USA, Inc. ("HSBC") would purchase a portion of its tax practice, which included Edwards' group.

In purchasing Edwards' practice group, HSBC extended employment offers to Edwards and other Andersen professionals. However, before hiring them, HSBC required each to execute a "Termination of Non-Compete Agreement" ("TONC"). Edwards signed the HSBC offer letter, but did not sign the TONC. In response, Andersen terminated Edwards' employment and HSBC withdrew its offer of employment to Edwards.

The issues on appeal related only to Edwards' claims against Andersen. Edwards alleged, in part, that the Andersen non-competition agreement was illegal under § 16600 and that requiring him to sign the TONC as consideration to be released from the non-competition agreement was an independently wrongful act that interfered with his prospective economic advantage with HSBC.

The Court's Decision

The Court addressed only the portions of the agreement limiting Edwards' ability to service or solicit Andersen clients. Edwards did not challenge the provision limiting his ability to solicit Andersen employees, and the Court did not address the issue. The Court also did not address the applicability of the trade secret exception to § 16600.

The Business & Professions Code § 16600 states:

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 Chapter excepts non-competition agreements in the sale or dissolution of corporations, partnerships, and limited liability corporations.

Andersen argued the term "restrain" under § 16600 should be interpreted to mean "prohibit," so that only contracts that totally prohibit an employee from engaging in his or her trade, business or profession are illegal. Andersen relied on a series of decisions from the Ninth Circuit Court of Appeals to support this argument—the so-called "narrow restraint exception."

The Court found that § 16600 was unambiguous and that if the Legislature intended the statute to apply only to restraints that were unreasonable or overbroad, it would have included language to that effect. The Court rejected Andersen's contention that it should adopt the "narrow restraint exception" and found that the Andersen non-competition provisions were invalid. Since the Ninth Circuit must follow the decisions of the California Supreme Court on issues of California law, in light of the Andersen decision, no court in California should now apply the narrow restraint exception.

What This Means To Employers

Employers need to review their existing agreements with California employees to determine whether those agreements violate California law. If the agreements contain provisions that prohibit an employee from post-employment solicitation of the employer's customers, or contain other post-employment restrictions on competition, the provision may be unenforceable and a violation of public policy. Covenants that violate public policy can subject an employer to substantial risk if the employer refuses to hire an employee or terminates an employee because the employee will not sign an agreement that incorporates the offending covenant. If that occurs, the employee will have a claim for wrongful discharge in violation of public policy and can recover, in part, tort damages. Confidentiality and non-solicitation agreements should, therefore, be carefully drafted to insure they do not run afoul of § 16600.

This decision does not limit an employer's right to protect its trade secrets. If an employee uses trade secret information to engage in post-employment solicitation, an employer can obtain injunctive and monetary relief under, in part, the Uniform Trade Secrets Act.

The enforceability of a provision prohibiting solicitation of employees was not challenged by Edwards and, therefore, was not addressed by the Court. Under current law, a covenant prohibiting solicitation of employees is lawful and should be included in employment and confidentiality agreements. However, based on the broad language contained in the Andersen decision, we anticipate the enforceability of non-solicitation of employee covenants will also be challenged.

For more information about this Client Alert, please contact:

James A. Goodman
Los Angeles
[email protected]