A covenant not to compete is a clause that is sometimes included in an employment contract between an employer and employee. A covenant not to compete says that for a specified period of time following the employee’s separation from the company, they may not work with a rival company or start a business similar to that of the employer.
Covenants not to compete in employment contracts (also commonly referred to as “non-compete clauses” or “non-compete agreements”) allow employers to keep valuable information secret. They also prevent former employees from profiting off of information they learned while working for the employer. It is also not uncommon for companies to require people who are not actually employees, but may hear or see confidential information (such as consultants or independent contractors) to sign a non-compete agreement, as well.
Some common things that non-compete clauses are written to accomplish include:
- Forbidding former employees from sharing information about upcoming products, clientele information, manufacturing processes, trade secrets, and marketing or business plans
- Prohibiting a former employee from exploiting client information or client relationships formed while working for the company
- Making the employee agree that upon leaving the company, they will not form a business that would be in competition with the company.
- They will not recruit other employees of the company to leave with them and form a business that would be in competition with the company
For example, a car salesman might be required to enter into a non-compete agreement stating that if/when they leave the dealership where they are employed, they will not take their client list with them and attempt to retain all the same clients while working for a different dealership, thus taking business away from the dealership they previously worked for.
An employee of a restaurant or food manufacturer may also be asked to sign a non-compete agreement so that they cannot take information about the restaurant or manufacturer’s special recipes or practices along with them when they leave the restaurant.
Non-compete agreements are fairly common in the United States. Nationwide, about 20% of employees are bound by a non-compete agreement. The agreements are not limited to just high-paying jobs, either. About 14% of Americans bound by a non-compete agreement make under $40,000 per year.
What is California’s Ban on Non-Compete Covenants?
Non-compete covenants are enforceable in most states, so long as the covenant is not overly broad or restrictive on the employee. Usually this means that the covenant must be limited in the activity it prohibits, in what locations, and for what length of time.
In order to be valid, the covenant can only cover activity to the extent that it protects an important business interest of the employer. The location must be limited to areas in which the employer operates, and the time period has to be limited, usually to no more than 2 years.
In California, however, covenants not to compete are almost always not enforceable. California state law says that a covenant that restrains someone from engaging in a lawful profession, trade, or business is void. The idea behind the law is that every person should be allowed to retain the right to pursue any lawful employment of their choice.
That doesn’t guarantee that an employer will not still attempt to present an employee with a non-compete agreement or that the employee will not be told that they are required to sign one as a condition to their employment. A California employee who is fired for refusing to sign a non-compete agreement has a viable case for wrongful termination.
A non-compete agreement that is the subject of a California lawsuit may be deemed valid if it was entered into in a different state. For example, a non-compete agreement between a California-based employer and an employee based in a different state could be scrutinized under California law or under the law of the other state depending on the circumstances and wording of the agreement.
Should an employee sign a non-compete agreement in California and then violate it, the California courts will almost surely dismiss a legal claim filed against the employee. In such an event, the employee is entitled to receive repayment for the legal fees they incurred in protecting themself from the lawsuit.
What are Some of the Exceptions to California’s Ban?
While most non-compete agreements are not enforceable in California, there are a few exceptions.
- A non-compete agreement is allowable if the buyer of an existing business wishes to restrict the seller of the business from competing with the company buying the business. Even in this situation, the covenant must be narrowly tailored.
- A covenant not to compete will also be considered valid if it only protects a proprietary or property right of the employer.
- A covenant not to compete will be deemed valid if it only restricts the employee’s opportunity to compete while they remain employed with the employer requiring the covenant, but imposes no restrictions on the employee once they separate from the employment.
- Business partners and members of a limited liability company can mutually agree that they will not compete with the business if they leave.
California employers could previously attempt to have non-compete agreements enforced based on their reasonable belief that a former employee will use the employer’s confidential information at their new job. This was considered “the inevitable disclosure doctrine”.
However, California courts recently began ruling that a former employer cannot use that belief as a reason to enforce a non-compete agreement. The courts said that an employer can only file such a claim if the employee actually does disclose confidential information.
How Are Non-disclosure Agreements Different?
An employer in California is not left with no way to protect themselves from former employees hindering their business interests. An employer can still use a non-disclosure agreement (NDA) to protect themselves. A non-disclosure agreement will prevent employees from disclosing confidential business information.
Unlike a non-compete agreement in California, a NDA does not prevent employees from working for competitors but merely protects the previous employer’s business or trade secrets.
Nondisclosure agreements may be the most effective protection available to a California employer. If the NDA is written well, it can provide many of the same benefits that a covenant not to compete is intended to provide.
Nondisclosure agreements are the most likely to be upheld by a California court attempting to determine whether the restrictions placed on a departing employee are reasonable and not in violation of state law. The main reason an employer would want a covenant not to compete is often to make sure that an employee who leaves the employer to join a competitor is not able to give their new employer secret information that would give them a competitive advantage. A nondisclosure agreement can protect the company against that risk without infringing upon the employee’s future employment prospects.
How Can a Lawyer Help with a Covenant Not to Compete Issue?
The laws surrounding a non-compete agreement, especially those in California, can be very complicated and difficult to understand. As with any legal matter, an attorney will help you to understand the law as it applies to your case and will ensure that all of your rights are protected.
If you have any questions or concerns about a non-compete agreement, please speak to a qualified California contract lawyer.