What Is California’s Ban on Non-Compete Covenants?
California’s ban on non-compete covenants is one of the most strict in the United States. The law declares such contracts void unless they fall under very limited exceptions. Unlike states that permit “reasonable” non-compete agreements that are limited in scope and duration, California starts with a presumption of unenforceability.
Employers who attempt to enforce non-compete agreements in California not only risk having the agreement struck down but could also face legal repercussions, including penalties and being liable for the employee’s attorney fees.
Therefore, many employers with California-based employees often choose not to include non-compete clauses in their employment contracts. If they do, the clauses are often crafted with great care to align with the narrow exceptions allowed under California law.
What Are Some of the Exceptions to California’s Ban?
While non-compete covenants are generally unenforceable in California, there are a few limited exceptions:
Sale of Business Exception to California’s Non-Compete Ban
The “Sale of Business” exception is a significant carve-out from California’s generally strict stance against non-compete agreements. When an owner sells the entire business or a substantial portion of its assets or shares, the law permits a non-compete covenant to be part of the sale contract. The rationale is to protect the buyer’s investment by preventing the seller from immediately entering the same market and leveraging former business relationships to compete directly.
The geographical and temporal scope of such non-compete agreements still needs to be reasonable and, ideally, precisely defined to avoid any future legal challenges. Generally, the court will consider whether the scope and duration of the non-compete clause are proportionate to the value and nature of the business sold.
Dissolution of a Partnership Exception
Another exception to the general rule against non-compete covenants in California occurs during the dissolution of a partnership. The law permits the existing partners to agree not to engage in a competing business within a specified geographical area where the partnership operated. This allows the remaining partners to continue the business without facing immediate competition from former partners who are familiar with the business operations, clientele, and trade secrets.
However, any agreement under this exception should be carefully drafted to ensure it doesn’t overreach in terms of scope and duration, as excessive restrictions could still be found unenforceable.
Termination of LLC Membership Exception
The rules governing the termination of Limited Liability Company (LLC) memberships mirror those for dissolving partnerships to a large extent. When a member exits an LLC, the law allows for agreements that limit that member from engaging in a similar business within a defined geographical area where the LLC operated.
This allows the LLC to protect its business interests and continue operations without the fear of direct competition from former members. However, such agreements must be tailored to be as narrow as possible in scope and duration to ensure enforceability.
Trade Secrets Exception
While not a direct exception to the unenforceability of non-compete covenants, California law does provide protection for trade secrets. Employers are allowed to enforce confidentiality and non-disclosure agreements aimed at protecting legitimate business interests like trade secrets, proprietary information, and customer relationships.
Even though an employer cannot prevent an employee from working for a competitor generally, they can take legal steps to prevent the employee from using or disclosing trade secrets to the advantage of a new employer. In practice, this can act as a form of restricted competition, as employees found to be in violation could face legal consequences. These include, but are not limited to injunctions, monetary damages, and even criminal penalties under the California Uniform Trade Secrets Act.
Wrongful Termination
One important factor that could further complicate the enforceability of non-compete and non-disclosure agreements is wrongful termination. In California, employment is generally “at-will,” meaning either the employer or the employee can terminate the employment relationship at any time, for any reason or no reason, as long as the reason is not illegal.
However, if an employee is terminated for reasons that violate California employment laws or public policy—such as discrimination, retaliation, or harassment—the termination could be considered wrongful. In cases of wrongful termination, the enforceability of a non-compete or non-disclosure agreement could be called into question.
An employee who is wrongfully terminated may have grounds to argue that the employer should not be allowed to enforce the non-compete or NDA, given that the termination itself was unlawful. This adds another layer of complexity to the already intricate landscape of employment contracts in California. If you have questions about wrongful termination or any of the exceptions mentioned above, a local California attorney can help you.
How Are Non-Disclosure Agreements Different?
Non-disclosure agreements and non-compete covenants are often used in the same employment context. However, they serve distinct purposes and are subject to different rules, especially in California. At the heart of the difference is what each type of agreement aims to restrict or protect.
Non-disclosure agreements focus on protecting sensitive company information. This information could range from client lists and business strategies to proprietary technology and product development roadmaps. NDAs are typically drafted to specify what constitutes confidential information, what the employee’s obligations are concerning that information, and what consequences might arise from unauthorized disclosure.
The key is that an NDA restricts the sharing of information, not the future employment of the individual. Essentially, it says, “You can go work wherever you want, but no matter where you go, you can’t talk about what you learned here.”
Contrast this with non-compete covenants, which aim to restrict an individual’s employment opportunities after they leave a company, often by barring them from working for competitors or in the same industry for a set period. As discussed earlier, these are generally unenforceable in California due to state laws promoting free labor markets and business competition.
One of the reasons NDAs are generally enforceable in California is that they are seen as a more reasonable and targeted means to protect a company’s specific interests without overly restricting an individual’s employment opportunities.
The state recognizes the importance of businesses being able to protect their confidential information, trade secrets, and intellectual property. NDAs allow companies to do this without crossing the line into dictating where an individual can work post-employment, thus striking a balance between individual freedoms and business protections.
However, the enforceability of an NDA also depends on its reasonableness. It must be limited in scope (i.e., it can’t designate all information the employee ever encounters as “confidential”), and it generally must have some sort of time limit. However, what’s considered “reasonable” can vary depending on the industry and the specific kinds of information being protected.
For example, an NDA that attempts to restrict an employee from ever sharing that the company uses commonly known software systems like Microsoft Office would likely not hold up in court. Conversely, an NDA that restricts sharing proprietary code or secret recipes for a reasonable time after employment ends is far more likely to be enforced.
Also worth mentioning is that while an NDA can restrict what you say, it generally can’t restrict what you know. This is the concept of “inevitable disclosure,” where a court might prevent someone from taking a new job because it’s assumed they will inevitably disclose what they know. California courts have generally rejected this theory when not tied to the misuse of explicit trade secrets.
What Is the Most Recent Law Governing Non-Compete Agreements?
The Final Rule, also called the Non-Compete Clause Rule, is a new law that will govern non-compete agreements that will take effect at the end of 2024. In April of 2024, the Federal Trade Commission (FTC) voted to enact a new law that bans most non-compete agreements.
This rule will go into effect 120 days following its publication in the Federal Register. This is estimated to be around August of 2024. At this time, every type of employer will have to comply with this new law.
Because of this, all employers should consult with their legal counsel as soon as they can to prepare for these upcoming changes to ensure they comply with the law when it takes effect.
Only one exception was carved out in this rule. This is for agreements that were made with senior executives.
This exception was included in the rule because these types of agreements, when made with higher level employees, are more likely to have been negotiated. However, if a worker was not a senior level employee at the time they signed their agreement, it will not be enforceable once this new law takes effect.
All employers will be required to give their workers notice that the non-compete agreements they signed will no longer be enforceable. This means that employers may have to revise or completely rewrite the employment agreements that they are currently using.
How Does this Affect State Laws?
The new Final Rule law will preempt any state laws that conflict with it. However, as California already prohibits non-compete clauses in most situations, the law will likely not be greatly affected.
What if the Final Rule Is Challenged in Court?
This new law will likely be interpreted by a court or challenged in court in the future. As noted above, since California already prohibits most non-compete agreements as a matter of public policy, it may not have a great effect on employers in the state.
It is important to be aware that the Final Rule has a severability clause, which means that if any part of the law is invalidated or unenforceable, the remainder of the law will still apply. It is also possible that the law will be struck down in its entirety at some point in the future.
Employers in California should still consult with their lawyers to make sure the new law will not affect their business practices as they currently stand. They should request their lawyers to keep them updated on any changes and ensure they are in continuous compliance with the law as it changes.
Do I Still Need to Know about the Previous Non-Compete Agreement Laws?
Yes, it is important to know about previous California non-compete agreement laws, the Final Rule, and how they will interact. As previously noted, as California already bans these types of agreements, they will not likely see many changes, even as the Final Rule itself is interpreted or changed.
Employers should still be concerned about these issues and how the new law may affect their businesses practices. If needed, an employer’s lawyer can help them draft and edit current and future employment agreements to ensure they are in compliance with the current laws.
How Can a Lawyer Help with a Covenant Not to Compete Issue?
There are many complexities and nuances surrounding covenants not to compete in California. Because of this, consulting with a local California attorney experienced in employment and contract law is highly advisable.
You may be an employer seeking to protect your business interests or an employee concerned about a restrictive covenant in your employment contract. If this is the case, an attorney can provide tailored advice and strategies for your specific situation. They can help review, negotiate, or even litigate contracts to ensure that your rights and interests are protected.
Find a qualified California contract lawyer through LegalMatch to assist you in resolving your concerns effectively and efficiently.
