San Diego Business Lawyer Blog

In California, post employment non-competition clauses are generally unenforceable. The prohibition of such clauses stems from the state's strong public policy favoring freedom of employment and competition, and there can be little doubt that savvy California businesses are aware of this. Yet businesses in San Diego and throughout the state routinely include non-competition clauses in their employment contracts, especially those with upper management. Businesses likely feel justified in including non-compete language because they know it is legal in nearly every other state in the country. In addition, many businesses have legitimate concerns regarding the protection of trade secrets. Companies invest in the creation of customer lists, customer loyalty, and in methods and procedures for maintaining and building a customer base, and they want to protect their investment.

Most employees don't intend to steal their former employer's secrets. They are simply interested in taking advantage of employment opportunities. The problem arises because of the difficulties in distinguishing between a former employee's inappropriate use of trade secrets and that same employee's utilization of personal skill and experience for the new employer. Competitors often solicit business from the same customer pool and use similar mechanisms to seek out and maintain a customer base. Who can say for certain that the former employee isn't soliciting clients consistent with the new employer's standard operating procedures? Whatever the case, California has chosen to err on the side of competition.

Employers, on the other hand, have chosen to err on the side of inclusion. Despite their illegality, businesses still include non-compete clauses in their employment contracts. Most prospective employees are unaware of California's employment laws and are unlikely to consult an attorney, and employers know that in most cases their employees will honor non-compete agreements upon the termination of their employment.  Moreover, employers merge non-compete language with trade secret language. If a former employee chooses to go to work for a competitor, employers will look past the non-compete language and allege theft of trade secrets. California courts have long recognized a "trade secrets" exception to the prohibition on non-compete clauses. By alleging theft of trade secrets, employers reduce the risk of having the case dismissed early for failure to state a cause of action, and increase the pressure on the former employee now faced with prolonged and costly litigation. Sometimes, the new employer will absorb the cost, but not often.

There is anecdotal evidence that California's competitive friendly approach has been successful. Some argue that the success of Silicon Valley compared to other technology corridors is in large part due to California's competitive environment. Whatever position one takes, recent developments make it clear that California businesses should exercise caution when including non-compete language in their employment contracts. California Labor Code § 432.5 makes it a misdemeanor to include illegal terms in an employment contract, and Labor Code § 2699 provides for a private right of action for any alleged violation of California's Labor Code and provides for a penalty for each violation of up to $200 per employee per pay period. With 25% of the penalty going to the prevailing plaintiff, employees concerned about non-compete clauses have an additional incentive to bring such actions. Moreover, a recent case casts doubt on the continuing validity of the trade secret exception. In Dowell v. Biosense Webster, Inc., the appellate court found a non-compete clause unenforceable and questioned, but did not rule on, the "continued viability of the common law trade secret exception to covenants not to compete."

Considering these developments, employers and their business attorneys should at the very least take care to ensure that non-compete language is narrowly tailored to address the protection of trade secrets. Including broader non-compete language risks liability under California law.

On December 22, 2008, the California Supreme Court ruled in Patel V. Liebermensch that the parties had entered into an enforceable option contract for the sale of real property despite the absence of terms specifying the time and manner of payment. The controversial decision was widely reported by the media and in attorney blogs and the moral of the story appeared to be that parties could forego the inclusion of contract terms setting forth the time and manner of payment (at least for the purchase of real property in California). Although the decision is important, businesses entering into contracts should not be lulled into thinking exclusion of such terms is acceptable simply because their exclusion does not render a California contract unenforceable. Time and manner of payment is an important detail in any contractual relationship, and prudent business owners do not enter into contracts (for the sale of real property or otherwise) without knowing when and how they will be compensated.

The purpose of entering into a contract is set forth clearly and concisely the material terms agreed to by the parties and to affect a means of enforcing those terms should there be a dispute. A good attorney or other negotiator will ensure that all material terms are agreed to and that important factors such as the time and manner of payment are included in the contract regardless of any law or court decision that may appear to minimize their importance. Having a clear understanding of the contractual relationship is the best way to minimize potential misunderstandings and avoid future disputes. Whether a court will ultimately enforce the contract has little benefit to parties embroiled in a battle over when and how each side is to be compensated. The object of a good contract is to avoid these kinds of disputes in the first place. Such disputes are costly to businesses even with the long term prospect of prevailing in court. A business' goodwill, reputation and bottom line all may suffer by the dispute's mere existence. Too often, businesses and their lawyers lose sight of these practical aspects.

Of course, the Patel decision will impact the enforceability of many existing California contracts, particularly those executed by unsophisticated parties without the benefit of a contract attorney. In fact, the contract at issue in Patel was a short contract in the form of a proposal sent by fax. The point of this article is that while Patel may be the law of the land for California, San Diego businesses shouldn't rely on it and similar decisions in place of common sense and sound contractual negotiation.