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Are Non-Compete Clauses Valid in California

July 20, 2021

Although the quick and easy answer to this question is No under California Business and Professions Code § 16600, there are some grey areas and caveats. While an employer cannot lawfully prevent a former employee from competing in California, the employer can prevent a former employee from soliciting or influencing other employees to leave and join a competitor for a reasonable period of time. An employer can also prohibit a former employee from using or disclosing any of its trade secrets. If an employer’s customer list is legitimately a trade secret, a high burden to meet, then the employer may lawfully prohibit former employees from soliciting those trade secret clients.

There is also an exception to the rule against non-competes for employees who own shares of the company and sell all those shares when they are terminated. Cal Bus. & Prof. Code § 16601. The exception was designed to protect a company’s goodwill in the event of a sale of the company. The acquiring company may legitimately require the owners who are selling their company to not start a competing business right after the sale, thereby hurting the value of the company they just sold. However, the selling of all a terminated employee’s stock will not necessarily validate the non-compete if the stock is a small amount and does not represent goodwill of the company. In Hill Medical Corp. v. Wycoff (2001) 86 Cal. App. 4th 895, 907, 103 Cal. Rptr. 2d 779, 788, the departing employee was required to sell back his shares, which amounted to only 7% of the corporation.  “The transfer did not involve a substantial interest such that it could be said that the transfer of goodwill was considered.”  When a company requires employees to purchase, or gives them, a small amount of stock, and then requires it to be sold back to the company or other shareholders upon termination in order to validate a non-competition clause, the courts will look through the sham arrangement. See Bosley Medical Group v. Abramson (1984) 161 Cal. App. 3d 284, 292, 207 Cal. Rptr. 477, 482 (“We are satisfied that under any interpretation of section 16601, other than the literal interpretation proposed by plaintiffs, the stock purchase agreement involved in this case is a sham created to avoid the prohibitions of section 16600.”) 

Companies cannot evade California’s law prohibiting non-competes by specifying in a contract that the law of another state applies. If the employee is working in California, then California’s statutory rule against non-competes will apply regardless of any choice of law provision in the contract. This is important, as the laws of many other states are more favorable towards non-compete clauses.

Finally, in California it is illegal for an employer to “require any employee or applicant for employment to agree, in writing, to any term or condition which is known by such employer . . . to be prohibited by law.” Cal. Labor Code § 432.5. Thus, employers are statutorily prohibited from requiring employees to sign non-competes that they know are invalid under California law. Unfortunately, many employers still try to get around this important California protection.

If your employer is requiring you to sign a non-compete, or if you have questions about a non-compete agreement that you signed, call Geniene Stillwell for a consultation.