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Understanding Confidentiality, Nonsolicitation and Noncompete Agreements and Clauses

Prepared By: Melissa C. Marsh, Los Angeles Employment Attorney
Written: December 2008

Business owners are typically concerned about protecting their brand, name, territory, affiliations, employees, customer lists, technology, amongst a host of other items that may give them a competitive advantage in their industry. To protect these valuable items, companies often require their employees to sign a written employment agreement, or severance agreement, that includes: a confidentiality clause, non-solicitation clause, and in some cases a non-compete clause. As with all contracts and agreements, before they are signed it is important for both the employer and the employee to clearly understand what is being presented, and whether it's enforceable.

Pursuant to California Business and Professions Code 16600, et. seq., except in limited circumstances, "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 effect of this law is to limit the enforceability of confidentiality, non-solicitation, and non-compete clauses in employment contracts and severance agreements.

No matter how slight the impact on competition, such clauses (non-disclosure, non-solicitation, and non-competition) are vulnerable to challenge and must be carefully drafted to withstand judicial scrutiny. Caution must be observed because If an employee is requested to sign an unlawful non-solicitation or non-compete clause, the employee may have grounds to sue the employer for wrongful termination, unfair restraint of trade, amongst a host of other claims.

What is a Non-Compete Clause or Non-Competition Agreement?

A non-compete clause or noncompetition agreement is a contract that generally states that an employee, former business partner, or former business owner will not engage in the same type of business as the employer, or former business partner or owner in which the individual had an ownership interest. Despite being very desirable, these agreements are typically illegal and invalid in the state of California unless the non-compete clause is part of the sale or dissolution of a corporation, limited liability company, or partnership (Cal. Bus. & Prof. Code 16601, 16602), or necessary to protect an employer's trade secrets (like certain customer lists). See, Edwards v. Arthur Andersen, LLP, 44 Cal.4th 937 (2008).

In Edwards v. Arthur Andersen, LLP, 44 Cal.4th 937 (2008), Edwards worked as a CPA in the Los Angeles office of Arthur Andersen, LLP. Andersen required Edwards to sign a non-competition agreement which for a period of 18 months after leaving the firm prohibited Edwards from: (1) performing accounting services; (2) soliciting clients from the Los Angeles office; and (3) soliciting any professional personnel from Arthur Andersen. In a unanimous decision, the California Supreme Court held that the non-competition and non-solicitation clauses were illegal, and in turn void and unenforceable as an unnecessary restraint on trade.

Why Non-Competition Agreements Are Typically Unenforceable?

In California the courts are loath to enforce a non-competition agreement because pursuant to California Business and Professions Code section 16600, "Except as provided in this chapter, every contract by which anyone is restrained from engaging in lawful profession, trade or business of any kind is to that extent void."

Does this now mean that all non-competition clauses in the employee context are illegal? Yes, except in the limited circumstance where absolutely essential to protect a company's trade secret. One common misconception, however, is that a "trade secret" is any confidential or proprietary information held by the employer. This is simply false. Pursuant to California Civil Code 3426.1 et. seq., for something to be considered a protectable trade secret, the business must show: (1) the company takes reasonable measures to protect the secrecy of its information; (2) the information is not available to the general public; and (3) the non-public information is valuable because it provides the company with an economic advantage. When such is the case, the courts will be more apt to afford trade secret protection to certain data such as customer lists, business plans, and bid specifications. For example, a customer list that is NOT readily available to competitors through general sources (e.g., the Internet) and is provided only to employees on a need-to-know basis subject to a signed confidentiality agreement that specifically states the customer list is confidential proprietary information has been found to be a protectable trade secret by the California courts. However, if the customer list was generated from an internet search, or is unprotected and readily assessable by the company's employees, arguably it is NOT a trade secret since: (1) no protective measures were in place to protect the information and (2) anyone can perform a similar internet search to generate a similar list.

In sum, covenants not to compete in California are generally unenforceable due to Business & Professions Code 16600. Any clause in an employment agreement, or severance agreement, that restricts post-employment activities should either be removed, or specifically tailored to only providing protection for a company's trade secrets.

What is a Non-Solicitation clause?

There are two types of non-solicitation clauses: customer non-solicitation clauses and employee non-solicitation clause. A non-solicitation clause typically prohibits the party to be bound from directly or indirectly asking company employees (or customers in some cases) to leave the company and join the departing employee in his new business. Many employers mistakenly believe that non-solicitation clauses fall outside the scope of California Business and Professions Code 16600. As with non-competition clauses, California courts are loath to enforce non-solicitation clauses that pertain to customers, and reluctant to enforce non-solicitation clauses that pertain the company's then existing employees, unless necessary to protect an employer's trade secrets.

In Thompson v. Impaxx, Inc., 113 Cal. App. 4th 1425 (2003), a California Court of Appeal addressed the enforceability of a customer non-solicitation clause in the context of a wrongful termination case. In Thompson, the plaintiff (Thompson) sued his former employer for wrongful termination after being terminated for refusing to sign an employment agreement that contained the following customer non-solicitation clause which he believed violated California Business and Professions Code 16600:

"For a period of one (1) year following the termination of employment, I will not (1) call on, solicit, or take away any of Pac-West Label's customers or potential customers with whom I have had any dealings as a result of my employment by Pac-West Label."

The California Court of Appeal held that Impaxx's customer non-solicitation clause was enforceable only if it was necessary to protect the company's legitimate trade secrets. As the Thompson case illustrates, even narrowly drafted customer non-solicitation clauses are unenforceable unless restricted to protecting the employer's legitimate trade secrets, as defined in the Uniform Trade Secrets Act (Civil Code sections 3426.1-11).

See Morlife, Inc. v. Perry, 56 Cal.App.4th 1514, 1526 (1997), in which a former employee's use or disclosure of confidential customer information to solicit new accounts on behalf of a new employer was found to constitute the misappropriation of a trade secret. Typically a claim for misappropriation must be brought against the former employee. Consequently a well drafted confidentiality and non-disclosure agreement will better serve the employer over a customer non-solicitation clause which may be subject to challenge.

Unlike customer non-solicitation clauses which are typically unenforceable, employee non-solicitation clauses that prohibit a former employee from "raiding" or directly soliciting the employer's existing employees for a limited period of time are generally enforceable and do not violate Business and Professions Code 16600. However, inclusion of such a clause in an employment agreement may be of limited value because such a clause cannot prohibit the non-departing employees from contacting the former employee, or seeking employment with the former employee.

What is a confidentiality provision?

A confidentiality clause (typically contained in a non-disclosure agreement or NDA) is typically used to protect trade secrets and other proprietary information, such as research and development; designs, ideas, techniques, methods, and processes; customer lists, and other non-public information. A confidentiality clause generally requires the party to be bound to treat certain information (as specifically set forth in the agreement) as confidential, and when properly drafted prohibits the party to be bound from using or disclosing the information to third parties.

California's courts generally will enforce a confidentiality agreement that prohibits the use or disclosure of confidential information such as customer lists so long as the Court can find that the information is a protectable trade secret. To prove a customer list is a protectable trade secret the employer must prove: (1) the information is not well-known, and cannot be easily acquired in the trade or industry (e.g., was not simply downloaded off the internet or purchased from some other vendor); (2) the fact that the information is not generally known, or easily available, gives the business a competitive edge; and (3) the business goes to great lengths to maintain the secrecy of the information (password protected, maintained in a locked file cabinet, and only presented to employees on a need-to-know basis and then only if the employee has signed a well drafted clearly written confidentiality agreement that specifically states that the company considers its customer lists to be confidential proprietary information.

If a former employee later violates, or threatens to violate, the confidentiality agreement the employer can bring suit for violation of the agreement as well as for unfair competition.

Before you sign.

Employers Beware. Many employment contracts and severance agreements, especially those downloaded from the internet or picked up off the shelf at an office supply store, include at least one of the three restrictive clauses outlined above. Don't just use such an agreement, unless you plan to spend some serious money defending a lawsuit for wrongful termination or unfair interference with business.

Employees should also exercise caution. Employees shouldn't blindly sign an employment agreement, thinking ah those clauses are not enforceable, or that they have no other option. Instead, the employee would be wise to contact an attorney to review his or her options. The laws can and do change, vary from state to state, and the employee shouldn't jeopardize his or her future.

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Our employment law practice consists of: (1) assisting employees with their contracts and wage claims and (2) counseling employers who seek to comply with new state and federal employment laws, providing human resource training, and providing essential contracts and employee policies to prevent employee lawsuits. To schedule a consultation call 818-849-5206 or Send Us An Email.

California Business and Employment attorney, Melissa C. Marsh, is based in Sherman Oaks and West Hollywood, and serves individuals and small and mid-sized businesses throughout Los Angeles County, including: West Hollywood, Miracle Mile, Beverly Hills, Century City, Santa Monica, Burbank, North Hollywood, Valley Village, Toluca Lake, Studio City, Sherman Oaks, Van Nuys, Encino, and Woodland Hills.

© 2008 Melissa C. Marsh. All Rights Reserved.

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Located in Los Angeles, California, the Law Office of Melissa C. Marsh handles business law and corporation law matters as a lawyer for clients throughout Los Angeles including Burbank, Sherman Oaks, Studio City, Valley Village, North Hollywood, Woodland Hills, Hollywood, West LA as well as Riverside County, San Fernando, Ventura County, and Santa Clarita. Attorney Melissa C. Marsh has considerable experience handling business matters both nationally and internationally. We routinely assist our clients with incorporation, forming a California corporation, forming a California llc, partnership, annual minutes, shareholder meetings, director meetings, getting a taxpayer ID number (EIN), buying a business, selling a business, commercial lease review, employee disputes, independent contractors, construction, and personal matters such as preparing a will, living trust, power of attorney, health care directive, and more.