In Enforcing Non-Compete Agreements Against California Employees — Part I, I discussed how a Massachusetts company might be able to enforce a non-compete against a California employee by including a Massachusetts choice of law provision in an employment agreement. In this post, I will discuss three scenarios under which an employer may be able to obtain an actual (or the functional equivalent) of a non-compete with respect to California residents/employees even if California law applies.
1. Enforcing a Non-Compete Against the Seller of Goodwill or Equity
Section 16601 of the California Business and Professional Code states:
Any person who sells the goodwill of a business, or any owner of a business entity selling or otherwise disposing of all of his or her ownership interest in the business entity, or any owner of a business entity that sells (a) all or substantially all of its operating assets together with the goodwill of the business entity, (b) all or substantially all of the operating assets of a division or a subsidiary of the business entity together with the goodwill of that division or subsidiary, or (c) all of the ownership interest of any subsidiary, may agree with the buyer to refrain from carrying on a similar business within a specified geographic area in which the business so sold, or that of the business entity, division, or subsidiary has been carried on, so long as the buyer, or any person deriving title to the goodwill or ownership interest from the buyer, carries on a like business therein.
Plainly, in light of this provision, a purchaser of the goodwill of, or equity in, a California business should not think that she necessarily has to risk being in competition with the seller. A traditional non-compete might be both negotiable and enforceable in such circumstances. Having said that, however, it is important to keep in mind that this exception to the general prohibition against the enforceability of non-competes only applies to the actual seller; it does not apply to any other employee of the business at issue.
2. Using Post-Employment Forfeiture of Compensation to Obtain a Non-Compete
An option that may be effective in some situations is to have an employment agreement that calls for the employee to forfeit a benefit if she were to compete against the company post-employment. While one of the most common ways to structure such an arrangement is through an employment agreement that calls for an employee to forfeit her right to unvested stock options if she competes with the company post-employment, giving up equity (or potential equity) is not the only type of “forfeiture-for-competition” agreement that will be enforceable. A February, 2012 blog post by Irving M. Geslewitz provides other examples and has a nice discussion of how to structure such agreements.
3. Enforcing a Non-Compete Where Trade Secrets are at Issue
While not technically an exception to California’s bar on non-competes, the Court of Appeals of California has made it clear that an employer can prevent a former employee from competing – even absent an agreement – if that competition hinges on the use of the former employer’s confidential information or trade secrets. In The Retirement Group v. Galante the Court held that “a former employee may be barred from soliciting existing customers to redirect their business away from the former employer and to the employee’s new business if the employee is utilizing trade secret information to solicit those customers.” Thus, while there surely is a high threshold to prove that information is legally confidential or a true trade secret, protecting such information by obtaining a de facto non-compete is viable.
In sum, even if California law applies there still may be ways that in-house counsel can protect their businesses from the competition of former employees.