New Liability for Non-Compete Agreements
Posted by Jeremy Naftel
Question: Are there any risks to having an employee sign a covenant not to compete, as long as it is narrowly written?
Answer: Yes. Covenants not to compete are attractive to an employer because they limit an employee's potential to compete with his or her employer after termination of his or her employment. However, California Courts have ruled that such covenants are not enforceable except under limited circumstances surrounding the sale of a business or where necessary to protect trade secrets.
In addition, the most common exception, known as the “narrow restraint” exception, permits non-compete agreements if the covenant is narrowly crafted so that an employee who leaves a company still can work in his or her profession. However, on August 30, 2006, the narrow restraint exception was explicitly rejected by the California Court of Appeal. (See Raymond Edwards II v. Arthur Andersen.) The Court of Appeal’s decision makes clear that non-compete agreements between an employer and employee are invalid in California even if narrowly drawn, unless they fall within the statutory or trade secret exceptions. The Court stated that such agreements violate California’s public policy in favor of protecting employee mobility. Public policy ensures that every citizen retains the right to pursue any lawful employment and enterprise of his or her choice. The Court specifically held that covenants not to compete are prohibited between employers and employees even where the restriction is narrowly drawn and leaves a substantial portion of the market available for the employee.
Importantly, prior cases have held that requiring execution of a non-competition agreement violates public policy and constitutes an independent wrongful act. An employer’s termination of an employee who refuses to sign an agreement that includes an invalid covenant not to compete constitutes a wrongful termination in violation of public policy. Now, with the elimination of the narrow restraint exception, many employers will find that agreements they have used for years have become invalid. Further those newly invalid agreements may actually result in liability for the employer.
Because requiring an employee to execute an invalid non-competition clause as a condition of an employee’s hire is an independent wrongful act, an employer must be cautious of requiring employees to sign such covenants. For example, requiring a prospective employee to sign an illegal agreement as a condition of employment will satisfy a necessary element of a tort cause of action for intentional interference with prospective economic advantage.
Accordingly, employers should review any agreements they use that contain covenants not to compete to ascertain whether they fall within one of the exceptions before requiring an employee to sign such a contract. Reviewing the employment agreements before requiring execution of an illegal contract may save the time and money involved in defending a lawsuit.