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California Supreme Court Voids Non-Compete Clause and Waiver of Indemnity Rights

August 11, 2008

An employer’s nightmare is the productive employee who leaves the company and begins competing against it.  Given this reality, what is an employer to do?  In many cases, the answer is:  write an employment contract that prohibits such conduct.  It is not at all uncommon to have a “non-compete” clause in an employment agreement.  The clause usually prohibits an employee from competing against the company while employed, and also from doing so for a period of time after leaving the company.

In California, these clauses usually are void as a matter of law.  Section 16600 of the California Business & Professions Code protects a person’s right to earn a living by flatly declaring:  “Except as provided in this chapter, 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 key exceptions are situations involving the sale or dissolution of a corporation, partnership or limited liability company (see §§16601, 16602, 16602.5).

In short, unless a non-compete clause is bargained for in connection with the sale of a business, competition against a former employer cannot be prohibited by contract in California.  This principle was affirmed by the California Supreme Court on August 7, 2008 when it issued the decision in Edwards v. Arthur Anderson LLP, 2008 WL 3083156. 

The case involved an accountant, Raymond Edwards II, who was hired by Arthur Anderson in 1997 as a tax manager in the firm’s Los Angeles office.  In order to accept the job, Edwards was required to sign an employment agreement that contained a non-compete clause. The clause stated:  “If you leave the Firm, for eighteen months after release or resignation, you agree not to perform professional services of the type you provided for any client on which you worked during the eighteen months prior to release or resignation.  This does not prohibit you from accepting employment with a client. [¶] For twelve months after you leave the Firm, you agree not to solicit (to perform professional services of the type you provided) any client of the office(s) to which you were assigned during the eighteen months preceding release or resignation. [¶] You agree not to solicit away from the Firm any of its professional personnel for eighteen months after release or resignation.”   Edwards signed the agreement and went to work for Arthur Anderson.

Five years later, after the Enron scandal broke and Arthur Anderson had been indicted, the firm announced it would cease doing business in the United States.  Arthur Anderson then began selling off its assets and the division in which Edwards worked was sold to HSBC USA, a New York based banking operation.  HSBC offered Edward employment, but required him to sign a “Termination of Non Compete Agreement.”  The agreement contained several elements, including a provision that Edwards would voluntarily resign from Arthur Anderson; would cooperate with the firm in connection with investigations; and would release Arthur Anderson from “any and all” claims, including “claims that in any way arise from or out of, are based upon or relate to [Edwards’s] employment by, association with or compensation from” Arthur Anderson.

Edwards balked at signing the termination agreement because he was worried about the waiver of rights, and specifically about waiving his right to be indemnified by the Firm in the event he became a defendant in the massive Enron-related litigation.

For its part, Arthur Anderson said it would not release Edward from the non-compete clause unless he signed the termination agreement.  Edwards stood firm.  Given his concern about indemnity and the impact the waiver might have, he refused to sign the termination agreement.  Arthur Anderson fired him and HSBC withdrew its offer of employment.

In 2003, Edwards sued Arthur Anderson (and others, including HSBC), contending the non-compete clause and the waiver clause were invalid.  He asserted that the non-compete clause violated Business and Professions Code Section 16600, and that the waiver of all claims violated California Labor Code Sections 2802 and 2804, which provide that employees have a non-waivable right to be indemnified by their employer  with respect to claims against them that arise out of the course and scope of employment.

The California Supreme Court not only held the non-complete clause void under Section 16600, but also specifically rejected a line of cases that indicated there was an exception to the statute for clauses that were narrowly tailored and “reasonable.”  In short, said the Court, any non-compete clause is void unless it falls within one of the specific statutory exceptions.

The Court also ruled that an employer may not insist upon an employee’s waiver of indemnity rights.  The clause in question was allowed to stand, however, as it did not specifically purport to waive these rights.  A waiver of “any and all rights,” such as that insisted upon by Arthur Anderson, may dispose of many rights, but in California it does not -- and cannot -- waive an employee’s indemnity rights.

There is one important limitation on the Supreme Court’s ruling.  In a footnote, the Court observed that “We do not here address the applicability of the so-called trade secret exception to section 16600 as Edwards does not dispute that portion of his agreement or contend that the provision of the non-compete agreement prohibiting him from recruiting Andersen's employees violated section 16600.”  The trade secret exception permits agreements under which an employee agrees not to use the employer’s trade secrets after termination of the employment relationship.

Employment contracts are important documents and they must be drafted carefully, especially in the area of non-compete clauses and waivers of important rights.  If you would like further input on this topic, or any of your labor and employment law questions, feel free to contact any of our offices.