12 August 2008

California Weakens Non-Competition Clauses

If you work in a field that values relationships or specialized skills, a critical question when you leave your job is whether you can take your clients with you to a new job.

The mad dash to divy up clients and employees in the absence of a non-competition clause was exemplified in the movie Jerry McGuire (1996) featuring Tom Cruise (in the title role) as a sports agent, who comes out of one of those mad dashes, after being fired for his "fewer clients, less money" idea, with just one client (played by Cuba Gooding, Jr.) and a secretary (Renee Zellweger).

In California, the Jerry McGuire scenario is now clearly the law, regardless of what an employment agreement says. According to the ContractsProf Blog, "California Supreme Court has ruled that virtually all non-competition agreements are invalid in that state." Basically, non-competition agreements are permitted in California only in connection with business ownership transactions.

The California court also defined what counts as a prohibited non-competition agreement broadly to include, for example, prohibitions on solicitation of clients of the ex-employer introduced to the employee at the former employer.

California law has never greatly favored the clauses. Indeed, some economists cite weak non-competition clauses as an important driver of economic growth in California relative to states like Massachusetts, where they are enforced more strictly.

Less obviously, this ruling may have considerable impact in Colorado, because many multi-state companies that employ people in Colorado often enter into contracts incorporating California law into their employment contracts.

Also, in employment agreements without a choice of law clause, Colorado employees in non-competition agreement disputes with their former employers may try to beat California based former employers to the court house by filing declaratory judgment actions in California courts, before employers can file in Colorado. California courts are likely to apply favorable California law even to disputes with out of state employees. Colorado courts, in contrast, are likely to apply Colorado law which disfavors non-competition agreements, more than in a typical state, but permits them in more circumstances than California law does.

Colorado generally bans non-competition agreements (indeed insisting that an employee enter into an invalid non-competition clause is a criminal offense in Colorado), but has several more exceptions to the rule than California, and has historically been understood to take a narrower view of what counts as a non-competition agreement than California. For example, Colorado law expressly validates non-competition agreements narrowly tailored to protect trade secrets. This is important because trade secrets are frequently defined to include information about clients the employee worked with at a former employer. So, non-solicitation clauses are easier to validate in Colorado than in California.

The Recorder at Law.com, however, suggests that the distinction may be not as great as it seems.

The decision, several attorneys said, could place new emphasis on California's Uniform Trade Secrets Act, a statute that gives employers the right to protect certain company information, including, in some narrow circumstances, client lists. The Supreme Court, in a footnote in Thursday's ruling, declined to address a trade-secret exception to §16600.

"What this decision does not do is eliminate the possibility of former employers saying to employees, 'You cannot solicit our customers because our customers are trade secrets,'" [Jennifer] Redmond [a partner with Sheppard, Mullin, Richter & Hampton, who was not involved in the case,] said.

The would include the most important exception under Colorado law to the ban on non-competition agreements to California law as well.

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