Employee mobility can be a thorny issue for companies of all sizes and employees of all pay grades. In California, this issue is especially challenging given the state’s strong policy against non-compete agreements. Simply put, compared to some other states, there is little a California employer can do to prevent an employee from leaving for another company, even if that company is a direct competitor. Section 16600 of California’s Business and Professions Code states 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.” The California Supreme Court, in its 2008 decision in Edwards v. Arthur Andersen, made clear that the statute prohibits a range of restrictive post-employment agreements, not just traditional non-compete agreements, which prohibit ex-employees from competing with their former employer for a limited period of time and in a limited geographic area. So where does that leave California employers?
Types of agreements that are unenforceable in California:
- Traditional non-compete agreements prohibit ex-employees from competing with their former employer for a limited period of time and in a limited geographic area.
- Customer non-solicitation agreements prohibit ex-employees from soliciting business from the employer’s customers,
- Forfeiture agreements that penalize competition require ex-employees to forfeit benefits or pay money if they compete with their former employer.
In Muggill v. Reuben H. Donnelley Corporation, the Supreme Court of California invalidated a contractual provision that required an ex-employee to forfeit his retirement pension upon accepting employment with a competitor. The court found that the employee had earned the retirement pension as a result of his past work for his former employer, and requiring its forfeiture represented a significant restraint on his ability to find work elsewhere.
Types of agreements that are likely unenforceable in California:
- Co-worker non-solicitation agreements prohibit ex-employees from soliciting former co-workers to join their new company.
The court in Edwards did not address the enforceability of co-worker non-solicitation agreements, but had such an agreement been at issue it is likely the court would have struck it down. In California, any agreements that might impact a former employee’s ability to do his job effectively will be interpreted in the employee’s favor. If an employee is asked to recruit talent but is barred by a non-solicitation agreement from pursuing all recruitment avenues, including the talent at his former company, the agreement would be unenforceable.
Types of agreements that may be enforceable in California:
- Forfeiture agreements that incentivize continued employment require ex-employees to forfeit deferred compensation such as unvested stock options.
In Muggill v. Reuben H. Donnelley Corporation, the California Supreme Court invalidated a contractual provision that punished an employee who starting working for a competitor, by taking away his previously accrued benefits. There is an important distinction between forfeiture agreements that penalize employee departure and forfeiture agreements that incentive an employee to remain with the company. Generally, forfeiture provisions that involve benefits the employee has already earned, such as regular wages, commissions, ordinary bonuses, and retirement contributions, are not enforceable.
By contrast, employee agreements that merely require forfeiture of prospective benefits are likely enforceable. In 2009, the Supreme Court evaluated such an agreement in Schachter v. City Group Incorporated. In that case the plaintiff voluntarily agreed to an incentive plan with his employer, City Group, in which he exchanged 5% of his regular compensation for the chance to purchase shares of company stock at a 25% discount. The stock, however, did not fully vest until two-years after the agreement, and if the employee took another job of was fired for cause within a two-year vesting period, the stock would be forfeited. The employee left the company voluntarily within the two-year vesting period and subsequently argued that City Group owed him cash for the amount of his annual compensation he had exchanged for the discounted stock. The court held that the discounted stock was offered as an incentive rather than as compensation for past services, and the employee had no rights to the forfeited compensation because he had voluntarily put the compensation at risk by exchanging it for the unvested stock.
- Garden leave clauses require departing employees to remain with the company for a period of time during which the employee receives normal compensation but does no meaningful work; by retaining the employee in this symbolic capacity the employee is unable to work for a competitor.
Increasingly employers in the United States are utilizing garden leave clauses as a means of preventing former employees from competing. The enforceability of garden leave clauses in California is an open question, and will be explored more fully in a later post.
Using employment contracts too restrict competition by former employee remains a perilous proposition in California. Employers are better off using a multi-pronged strategy that promotes retention, but also puts the company in the optimal position to mitigate potential risks caused by employee departure. Such a strategy will be the topic of future posts.
Sources:
Bay Tech Law 