By Mahdi M. Ibrahim, Senior Associate of Shustak Reynolds & Partners, P.C. posted on Tuesday, March 14, 2023.

Mahdi M. Ibrahim

Senior Associate

Location: San Diego, California
Phone: (619) 696-9500 (Ext. 127)
Direct: (619) 546-5567
Email: [email protected]

Many employees have faced this situation. You have accepted a new position with a new employer. On your first day, you are handed a stack of forms and documents and asked to review and sign them. It is your first day at the new job and your head is swimming.

Aside from tax withholdings, health insurance, and myriad other new employee selections and forms, you most likely are asked to review and sign an Employment Agreement. You are not a lawyer and don’t want to start off on the wrong foot in your new job. You sign the agreements given to you. But if the Employment Agreement contains a non-solicitation and/or non-compete provision, what do you do? Call a lawyer and schedule a meeting the first day of the new job or just sign what you are handed? And if you do sign a non-compete, non-solicitation agreement, will you be bound by what you signed if and when your new employment ends? What are you signing that you may be “stuck with?”

An Employment Agreement is a contractual understanding between the employer and employee that typically controls the parties’ rights and obligations during the employment relationship. Often, however, Employment Agreements also seek to control the employees’ behavior even after the termination of the employment relationship. The typical ways Employers routinely attempt to control former employee behavior through contract are: (1) non-solicitation clauses; and (2) non-compete clauses. 

A non-solicitation clause is a provision in the agreement, whereby, for a time, the employee agrees not to use the company’s clients, customers, and contact lists upon leaving the company, and agrees not to solicit business from, service, or contact the former employer’s current customers or employees.

A non-compete clause, on the other hand, prohibits a departing employee from “competing” with the former employer by entering a similar profession or trade in competition against the employer, usually for a set time and/or in a certain geographical area.

Although many states still enforce reasonable non-solicitation and non-compete clauses, California courts are unlikely to enforce either of these types of agreements. California has a strong, longstanding, and well-settled public policy favoring open competition and worker mobility. In fact, it is the law in California that, with very narrow, and limited statutory exceptions, “every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.”[1] A broad proscription making California one of the few states that imposes a rebuttable presumption that any anti-competitive contract is void.

As the California Supreme Court stated in the seminal case, Edwards v. Arthur Andersen LLP (2008) 44 Cal.4th 937:

Under the common law, as is still true in many states today, contractual restraints on the practice of a profession, business, or trade, were considered valid, as long as they were reasonably imposed. [Citation omitted]. This was true even in California. (Wright v. Ryder (1868) 36 Cal. 342, 357 [relaxing original common law rule that all restraints on trade were invalid in recognition of increasing population and competition in trade].) However, in 1872 California settled public policy in favor of open competition, and rejected the common law “rule of reasonableness,” when the Legislature enacted the Civil Code…. Today in California, covenants not to compete are void….”

Id. at 945.

Moreover, “California courts ‘have consistently affirmed that section 16600 evinces a settled legislative policy in favor of open competition and employee mobility.’ . . . . Section 16600 expresses California’s strong public policy of protecting the right of its citizens to pursue any lawful employment and enterprise of their choice.” Id. at 946. Under Section 16600, contracts, of whatever form, that seek to prevent an employee from competing against his former employer are simply illegal and void. Kolani v. Gluska (1998)64 Cal. App. 4th 402, 407. The agreement does not need to outright prohibit competitive employment to be invalid under section 16600, it only needs to restrain it[link] . Edwards, 44 Cal.4th at 946.

Section 16600 applies equally to independent contractors and employees. The California Supreme Court recently clarified “section 16600 applies to business contracts,” and is not limited to employment contracts. Ixchel Pharma, LLC v. Biogen, Inc. (2020) 9 Cal. 5th 1130, 1149–50.

There are only three, very limited exceptions for a Court to hold a non-compete clause valid in California: (1) sale of goodwill or interest in a business;[2] (2) dissolution of a partnership;[3] or (3) dissolution or sale of a limited liability company.[4]

California courts have interpreted the non-compete exceptions, in particular the term “sale of the business,” very narrowly and in favor of open competition. “[I]n order to uphold a covenant not to compete pursuant to section 16601, the contract for sale of the corporate shares may not circumvent California’s deeply rooted public policy favoring open competition. The transaction must clearly establish that it falls within this limited exception.” Hill Med. Corp. v. Wycoff (2001) 86 Cal.App.4th 895, 903. “[T]he Legislature, in amending section 16601, intended to permit non-competition agreements only in situations in which the transfer of ‘all’ of the owner’s shares involves a substantial interest in the corporation so that the owner, in transferring ‘all’ of his shares, can be said to transfer the goodwill of the corporation.” Bosley Med. Group v. Abramson (1984) 161 Cal.App.3d 284, 290.

California’s courts have been on the forefront of a trend towards finding restrictive covenants in Employment Agreements void. Following this trend, on January 5, 2023, the Federal Trade Commission (“FTC”) proposed a federal rule that would prohibit employers from imposing non-compete clauses on workers.[5] The FTC proposal has been over a year in the making as the White House shared it would direct the FTC to propose such a rule back in July 2021[link]. Whether the rule will pass and in what form is yet to be seen.

Nevertheless, many employers still choose to include such clauses in their Employment Agreements hoping to deter competition from employees who do not understand their rights. As stated by the Court in Robinson v. U-Haul Co. of California (2016) 4 Cal.App.5th 304, “Why would you possibly put something in a contract where the law says it’s void? You do that so you can cause somebody to think that that clause is, in fact, valid when it isn’t.” Id. at 312. And many national employers routinely ask California based employees to sign their “national,” “standard” employment agreements even though these non-solicitation, non-competition provisions violate California law and are unenforceable.

Our firm regularly advises employees and employers on non-solicitation and non-compete clauses, including during broker and advisor transitions. If you have a situation you’d like to discuss, feel free to contact us for a confidential initial consultation. We can help you take necessary steps to protect yourself and your livelihood.

Shustak Reynolds & Partners, P.C. focuses its practice on securities and financial services law and complex business disputes.
We represent many investment advisers, IARs, broker-dealers, registered representatives, and businesses.
We can be reached in the firm’s San Diego office at (619) 696-9500.

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