Although California law prohibits absolute restrictions on post-employment competitive activities, it is less clear about which, if any, less restrictive constraints are permissible. This Commentary explores the options available to California employers in restricting an employee's post-employment activities in California.

California Business And Professions Code Section 16600 Prohibits Restraints On Trade, Unless Necessary To Protect Trade Secrets

It is well established that non-compete agreements are generally unenforceable in California. Business & Professions Code Section 16600 ("Section 16600") provides that " . . . every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void." Indeed, in Walia v. Aetna, a Superior Court in San Francisco recently ruled that terminating an employee for refusing to sign a non-compete agreement constitutes a violation of California's public policy. (See Morrison & Foerster's February 2000 Employment Law Commentary, "Walia v. Aetna: Discharge for Refusing to Sign Non-Compete Agreement Violates Public Policy.")

However, a judicially recognized exception to this broad prohibition lies in an employer's right to protect its trade secrets. See, e.g., Metro Traffic Control, Inc. v. Shadow Traffic Network, 22 Cal. App. 4th 853, 859 (1994). Courts have enforced covenants not to compete to the extent that enforcement was necessary to protect a company's trade secrets. Muggill v. Reuben H. Donnelley Corp., 62 Cal. 2d 239, 242 (1965).

One common misconception among many employers is that a trade secret includes all the information encompassed within the definition of proprietary and confidential information as those terms are broadly defined in standard non-disclosure agreements. On the contrary, by statute, a trade secret is more narrowly defined. A trade secret must "derive independent economic value, actual or potential, from not being generally known to the public or to other persons who can obtain economic value from its disclosure or use" and be "the subject of efforts that are reasonable under the circumstances to maintain its secrecy." California Civil Code § 3426.1(d). For example, customer lists that contain information not readily available to competitors through general sources have been found to be trade secrets by California courts. See MAI Syst. Corp. v. Peak Computer Inc., 991 F.2d 511, 521 (1993); Morlife, Inc. v. Perry, 56 Cal. App. 4th 1514 (1997); American Paper & Packaging Prods., Inc. v. Kirgan, 183 Cal. App. 3d 1318, 1325 (1986). Conversely, employees' talents, qualities, and characteristics are not considered trade secrets. Metro Traffic Control, Inc. v. Shadow Traffic Network, 22 Cal. App. 4th 853, 861-62 (1994).

Even if the information is clearly a trade secret, proving that a former employee has disclosed trade secrets to a new employer can be difficult. Accordingly, some federal courts outside the Ninth Circuit have adopted a theory commonly referred to as the "inevitable disclosure doctrine." Under this doctrine, the former employer need not show that trade secret information has actually been disclosed, but rather, that the new position would necessarily require the former employee to rely on trade secret information. In those jurisdictions in which the doctrine has been adopted, employers have successfully relied on the doctrine to prevent a former employee from working for a direct competitor.

The applicability of the inevitable disclosure doctrine in California remains in doubt. Last year, a California Court of Appeals expressly adopted the inevitable disclosure doctrine in Electro Optical Industries, Inc. v. White, 76 Cal. App. 4th 653, 660 (1999), without considering whether the doctrine violated Section 16600. However, the Electro Optical decision was unanimously depublished by the California Supreme Court in April of this year, and a recent federal district court opinion has held that the inevitable disclosure doctrine is not the law in California or the Ninth Circuit. See Danjaq LLC v. Sony Corp., 50 U.S.P.Q.2d (BNA) 1638, 1640 n.1 (C.D. Cal. 1999).

Is A Limited Restriction On Competition Permitted In California?

Some older California cases and recent federal court decisions have enforced restrictive covenants "where one is barred from pursuing only a small or limited part of a business, trade or profession." Boughton v. Sacony Mobil Oil Co., 231 Cal. App. 2d 188, 192 (1964); King v. Gerold, 109 Cal. App. 2d 316 (1952); see also General Commercial Packaging, Inc. v. TPS Package Eng'g, Inc., 114 F. 3d 888 (9th Cir. 1997). The Ninth Circuit recently applied the "small or limited part" exception to a non-compete clause in a stock option agreement. Bajorek v. IBM, 191 F. 3d 1033 (9th Cir. 1999). (See also Morrison & Foerster's October 1999 Employment Law Commentary, "Can California Employers Include Non-Competition Clauses in Their Stock Option Agreements?")

The employee-plaintiff in Bajorek was subject to a non-competition agreement used nationwide by his former employer, IBM, in its stock option agreements. The clause specifically prohibited him from working for a competitor for the six months following the exercise of his options. The plaintiff eventually left IBM and exercised his stock options, worth approximately one million dollars, but then went to work for a competitor. Pursuant to the non-compete clause, IBM rescinded the options and demanded repayment of the profits.

After reviewing the court's earlier decisions under Section 16600, the Ninth Circuit found that the non-compete clause was valid and enforceable because it only restrained individuals from engaging in a "small or limited part" of the trade or profession. Specifically, the plaintiff was only prohibited from working for one competitor and only for six months, which was a "small or limited part" of his profession.

It is not clear whether the holding in Bajorek will be followed by California state courts, however. Application of the "small or limited part" exception by California courts has been limited to commercial contracts. No California court has applied the "small or limited part" exception to restrictive covenants entered into between an employer and its employees. On the contrary, California courts have broadly applied California's prohibition against non-competition agreements in the employment setting. Indeed, the California Superior Court's decision in Walia v. Aetna illustrates California courts' continued aversion to non-compete agreements between employers and employees.

Agreements Prohibiting "Raiding" Of Employees Are Enforceable

In Loral Corp. v. Moyes, 174 Cal. App. 3d 268 (1985), the California Court of Appeals upheld an agreement that restrained former employees from disrupting, damaging, impairing, or interfering with the former employer's business by "raiding" its employees, presumably referring to solicitation of a large number of employees. In upholding the anti-raiding clause, the court reasoned that Section 16600 invalidates an agreement penalizing a former employee for obtaining employment with a competitor. However, according to the court, Section 16600 does not affect an agreement limiting how the former employee can compete. Such clauses do not restrain trade because the former employee is not restricted in finding employment and current employees may seek employment with the former employee's new employer. In the words of the court, "[e]quity will not enjoin a former employee from receiving and considering applications from employees of his former employer, even though the circumstances be such that he should be enjoined from soliciting their applications."

Still unresolved by Loral is whether the case stands for the general proposition that agreements prohibiting the solicitation of employees in California are valid or whether it is simply another "raiding" case. On the one hand, Loral dealt with a prohibition against interfering with a company's business by raiding employees. On the other hand, the reasoning of the Loral court did not limit itself only to raiding cases. Instead, it broadly rejected the argument that an agreement prohibiting solicitation of employees is unenforceable under Section 16600. See also, in re Ingle, 1997 U.S. App. LEXIS 423 (1997). (In an unpublished opinion, the Ninth Circuit found that two competing companies could agree not to solicit each other's employees without violating Section 16600.)

However, at least one court has questioned Loral's holding in this regard. In Liberty Mutual Insurance Company v. Gallagher & Company, No. C94-3384 MHP, 1994 U.S. Dist. LEXIS 18412 (N.D. Cal. Dec. 19, 1994), the federal district court analyzed California law and concluded that Section 16600 prohibits enforcement of all restrictive covenants, including non-solicitation clauses. The court found that the only exception to that broad prohibition is when the challenged activity constitutes unfair competition, such as the unauthorized use of trade secrets or confidential information. According to the court in Liberty Mutual, the holding in Loral is against the weight of authority in California.

Agreements Not To Solicit Customers Are Enforceable To The Extent Needed To Protect Trade Secrets

Where the identities of customers are trade secrets, the courts have consistently upheld covenants prohibiting the solicitation of customers. In one of the few relatively recent California cases to discuss the issue, the California Court of Appeals held that "[a]ntisolicitation covenants are void as unlawful business restraints except where their enforcement is necessary to protect trade secrets." Moss, Adams & Co. v. Shilling, 179 Cal. App. 3d 124, 130 (1986).

In Moss, Adams, two employees of an accounting firm formed their own competing firm. Before leaving, however, they removed a rolodex from the office to obtain addresses of clients with whom they had worked and had personal contact. They then sent announcements of their new firm to those clients of their former employer. The former employer sued for, among other claims, misappropriation of trade secrets, breach of contract, and unfair competition. Notably, the two former employees had signed employment agreements stating that the names and addresses of the employer's clients were trade secrets and could not be used to solicit those clients during employment or within one year thereafter.

Although the court found that the announcement did not amount to a solicitation, it considered whether the former employees unlawfully used trade secret information (e.g., the information contained in the rolodex) to announce their change of employment. Because the employees knew the names of the clients through personal contact and their addresses were easily obtainable through normal resources, the court held that such information was not a trade secret. The court then concluded, without analysis, that because there was no use of trade secrets, the non-solicitation clause was not enforceable under Business and Professions Code Section 16600.

The extent to which agreements restricting solicitation of customers are enforceable remains unsettled. To date, no California court has discussed provisions prohibiting non-solicitation of customers in depth. Additionally, at least one California case has stated that an agreement restricting an employee's ability to solicit the former employer's customers is valid and enforceable under Section 16600, regardless of whether the customer information constitutes a trade secret. Golden State Linen Serv., Inc. v. Vidalin, 69 Cal. App. 3d 1, 9 (1977).

Drafting Post-Employment Restrictions

Entering into restrictive covenants with employees raises a host of legal questions that are not readily answered by existing case law. Many employers nonetheless find such agreements useful for protecting company assets and discouraging unfair competition by disgruntled former employees. However, entering into unenforceable agreements is of little benefit to California employers. Thus, employers should keep the following points in mind when drafting restrictive covenants.

1. Covenant Not To Compete. A covenant not to compete in California is unenforceable under Business & Professions Code Section 16600. Any clause in an employment agreement restricting post-employment activities should be narrowly tailored to protecting trade secrets. An aggressive option would be to require an employee not to compete for a reasonable period of time following termination of employment unless the employee can prove that such competition would not involve use or disclosure of trade secrets. An employer should be aware, however, that such a clause has yet to be tested in California, and a California court may well find that it constitutes a restraint on trade in violation of Section 16600.
2. Non-Solicitation of Employees. Given the broad reasoning in the Loral opinion, there is a strong argument that clauses restricting solicitation of employees - not just "raiding" of employees - are enforceable and do not run afoul of Section 16600. However, inclusion of such a clause in an employment agreement may be of limited value to an employer. As stated in the Loral decision, a clause prohibiting the solicitation of employees does not restrain current employees from contacting, seeking employment with, or being employed by the former employee's new employer.
3. Non-Solicitation of Customers. A clause prohibiting solicitation of customers when the identities of customers are trade secrets is generally enforceable under Section 16600. Whether a customer list constitutes a trade secret depends entirely on the facts of the particular company and its market. Although a clause restricting solicitation of customers may arguably be imposed on former employees even when a trade secret is not involved, at best, California case law is mixed on this point.

This area of the law is very unsettled, and it is unclear how far California courts will allow employers to go in restricting post-employment activities. While there is nothing wrong with an aggressive posture in these cases, employers should make sure that the information they are trying to protect is worth protecting. If it is, a court is more likely to find a particular clause enforceable.