The California Supreme Court rejects non-competition agreements and clarifies requirements for broad release/waiver agreements

By Jeffrey M. Tanenbaum and Matthew J. Frankel

The California Supreme Court has now clarified state law governing non-competition and release/waiver agreements between employers and employees. In Edwards v. Arthur Andersen LLP, Case No. S147190 (Aug. 7, 2008), the Court held that Business & Professions Code § 16600 prohibits virtually all contractual provisions that purport to limit a former employee’s ability to compete with a former employer. In so doing, the Court wholly rejected the so-called “rule of reasonableness”—previously intermittently applied by California’s federal courts and the majority rule across the country—which allowed for the enforcement of contractual provisions that reasonably restrict, but do not prohibit outright, competition by a former employee.

The Court also held that employers drafting broad release and waiver agreements with departing employees need not include express exceptions for non-waivable statutory provisions. The Court’s ruling made clear that agreements waiving or releasing “any and all” claims will not be deemed invalid for failure to specifically except employees’ non-waivable statutory rights, and that an employer’s attempt to enforce such a provision, without more, does not constitute wrongful conduct.

Non-competition agreements

In his suit, Edwards challenged Andersen’s attempt to contractually prohibit him from performing services for or soliciting Andersen’s clients following his departure. The Supreme Court (quoting the Court of Appeals) noted that “[t]he first challenged clause prohibited Edwards, for an 18-month period, from performing professional services of the type he had provided while at Andersen, for any client on whose account he had worked during 18 months prior to his termination. The second challenged clause prohibited Edwards, for a year after termination, from ‘soliciting,’ defined by the agreement as providing professional services to any client of Andersen’s Los Angeles office.” The Court held that the agreement was “invalid because it restrained his ability to practice his profession.”

The Court’s ruling upheld California’s long-standing legislative policy rejecting restrictions on competition by former employees. Outside of enumerated exceptions in the context of dissolution of businesses (see Business & Professions Code §§ 16601, 16602, and 16602.5), California employers cannot restrict their employees from competing with them post-employment. In fact, other courts have held that even attempting to do so may be a violation of California’s unfair competition laws, potentially subjecting wayward employers to liability and injunctive relief. See Application Group, Inc. v. Hunter Group, Inc., 61 Cal. App. 4th 881, 906-08 (Cal. Ct. App. 1998).

With the Supreme Court removing any doubt about the scope of California’s wide-ranging prohibition on non-competition agreements, employers should be especially wary of including such provisions in their California employment agreements. Employers can still require employees to sign agreements that protect the employer’s trade secrets and other confidential or propriety information. However, those provisions must not extend to preventing the employee from competing with the employer—by, for example, working for a competitor or soliciting the employer’s clients—once the employment comes to an end. Employers who transgress the bright line drawn by the California Supreme Court in Edwards may well find themselves defending lawsuits filed by aggrieved current and former employees. Conversely, when hiring new employees in California, pre-existing non-competition clauses should prove far less troublesome to resolve.

Release/waiver agreements

Edwards also challenged as invalid a broad waiver/release provision that released “any and all” claims that Edwards might have had against his employer. He argued that the provision’s failure to specifically exclude claims based on Labor Code § 2802—which provides a right of action for employees to seek indemnity from employers for acts taken within the scope of employment—was unlawful, and that Andersen’s attempt to enforce the provision was an independently wrongful act sufficient to support a tortious interference claim.

The Court rejected Edwards’ contention, relying primarily on the maxim of construction that a contract should be interpreted in such a way “as will make it effective rather than void.” Noting that the agreement did not mention Section 2802 or indemnity one way or the other, the Court rejected Edwards’ suggestion that the phrase “except as otherwise prohibited by law” should have followed the words “any and all,” thus expressly excepting Edwards’ Section 2802 and other non-waivable statutory rights. Such a requirement, the Court noted, would require “voiding all existing releases which include the language ‘any and all,’” an inappropriate result. In sum, the Court held that “a contract provision releasing ‘any and all’ claims…does not encompass non-waivable statutory protections, such as the employee indemnity protection of section Labor Code 2802.”

The holding in Edwards makes it clear that employers need not create express carve-outs for non-waivable statutory rights when using broad waiver/release language in severance and other termination-related agreements. Of course, numerous federal and state laws do require mandatory language with respect to a host of other issues, and employers are well-advised to run all waiver and release language by employment counsel. Employers can rest easier, however, knowing that a failure to include express exceptions for non-waivable statutory rights will not invalidate an otherwise sound waiver/release agreement. The flip side, of course, is that even the broadest permissible release and waiver provision will not prevent an employee from bringing suit to enforce his or her non-waivable statutory rights, including claims for indemnity based on Section 2802.