If you are attempting to grow your team by recruiting a new employee, particularly a high-level executive, you may be wondering if a non-compete agreement is necessary, or worth considering. Generally, non-compete agreements are used to expressly prohibit an employee from working with a direct competitor during, or immediately after, their employment with your company. These types of agreements can be beneficial if you are in an extremely competitive sector and have concerns about an employee being “poached” by a competitor.
Non-Compete Agreements in California
In California, non-compete agreements are generally unenforceable and deemed to be in violation of public policy, with very specific exceptions as they relate to a sale of a business. As a result, a non-compete agreement will typically only be upheld in limited, specific circumstances. According to the California Business and Professions Code Section 16600, any contract by which an employee is restrained from “engaging in a lawful profession, trade, or business of any kind is to that extent void.” California courts strictly apply Section 16600 and use this statutory provision to nullify employment agreements that would have prevented an employee from joining a competitor after the completion of their employment. That said, in limited circumstances, Section 16601 permits purchasers of a business to protect themselves through a covenant not to compete. As originally enacted, Section 16601 and its predecessor statue only applied to the sale of a business. Subsequently, however, the California legislature recognized that customers or clients might also develop personal relationships with shareholders running a business in the form of a corporation. Section 16601 present reads in pertinent part: “Any person who sells the goodwill of a business, or any shareholder of a corporation selling or otherwise disposing all of his shares in said corporation … may agree with the buyer to refrain from carrying on a similar business within a specified county or counties, city or cities, or a part thereof, in which the business so sold, or that of said corporation, … has been carried on, so long as the buyer, or any person deriving title to the goodwill or shares from him, carries on a like business therein.” Based on the revised statute, California courts have provided companies with the ability to structure their business in a way that could potentially allow for an enforceable non-compete provision. This would entail that the company grant the employee equity ownership in the business, which may be bought back from the employee upon termination at a value that represents the fair market value (including goodwill) of the equity being repurchased. Employers need to make sure that their structure complies with current California case law; otherwise, they may face other repercussions as set forth below.
Potential Exposure to Wrongful Termination Claim
In addition to the strict application of Section 16600, California courts have shown a propensity to not only negate the non-compete agreement but punish the employer by holding them liable for wrongful termination. This usually occurs when an employer terminates or otherwise discharges an employee who was unwilling to sign an employment agreement that contained an unenforceable non-compete clause.
How to Properly Draft a Non-Compete Agreement
When drafting a non-compete agreement, you should keep in mind where the employment will be taking place to ensure you know what types of non-compete provisions are allowed in specific jurisdictions. For example, as previously mentioned, California Business and Professions Code Section 16601 allows an agreement containing a stipulation where an individual will be prohibited from engaging in a similar business that is located within the same geographic area that their prior business is and the owner of the business is selling their ownership interest. In addition, while courts have enforced a non-compete agreement that applied to a three (3%) percent stockholder of company – rejecting the argument that the employee was not a substantial shareholder to allow for enforcement for Section 16601 –they have assigned more importance that the purchase price for the stock being repurchased reflect fair market value and include payment for goodwill.
Duty of Loyalty
California also allows a non-compete clause and other similar restrictions to be enforced during a specific term of employment. This means that, while someone is employed, they owe the employer a common law duty of loyalty.
The common law duty of loyalty to an employer can be set forth in more detail with the employment contract. The employment contract can include terms that can prohibit an employee from doing certain things while they are still employed by the employer such as competing with the employer or using the employer’s trade secrets.
Have Questions or Concerns? Speak to an Experienced Business Lawyer in Los Angeles Today
To learn more about whether it makes sense to include a non-compete clause in an employment agreement, take action by contacting the highly reputable and experienced business attorney in Los Angeles who understands the nuances of California law. Hakim Law Group represents a wide range of entrepreneurs, operating companies, venture capital firms, and financiers in numerous sectors of the economy. We possess the experience, knowledge and professionalism to produce more efficient, responsive and effective results for our clients. To schedule a consultation or for further information please contact HLG at (310) 993-2203 or visit www.HakimLawGroup.com to learn more.