Noncompetition Agreements: When are they enforceable?

Noncompetition Agreements
When are they enforceable?
by Mary Hanson

Noncompetition agreements (noncompete agreements, or covenants not to compete) may or may not be enforceable depending upon the state law which applies and the facts and circumstances of the agreement.

In California, by statute, noncompetition agreements are void as a restraint of trade, except those agreements that fit within stated exceptions.

The exceptions listed in the California statute allow noncompete agreements when a business or an interest in a business is sold. The philosophy behind allowing noncompete agreements in these circumstances is that the buyer of the goodwill of an ongoing business is entitled to restrain the seller of the business from continuing to compete. If the seller could continue in the same business, he or she could utilize the goodwill he or she purported to sell.

Noncompete agreements allowed by the exceptions under the California law must be limited to preventing the business seller, or selling shareholder or partner from engaging in a business similar to the business sold in specified counties or cities in which the business was carried on prior to the transfer for so long as the business continues to be carried on in that area by the buyer or a successor to the buyer.

I recommend that buyer’s obtain the seller’s covenant not to compete in every purchase of a business or purchase of an interest in a business. Such a provision is clearly enforceable under California law and it can be very valuable to the buyer of a business. Even if the buyer does not expect the seller to compete, it is wise to include such a provision to preclude the seller from engaging in activities which may be harmful to the business.

In my experience, you cannot anticipate the specific circumstances which may arise or actions which may be taken by another party, and the broad protection offered by a noncompete agreement can be unexpectedly beneficial.

Of course, if you are the seller of a business, the noncompete agreement should be avoided. If the noncompete agreement is demanded as part of the purchase, attempt to limit the covenant to a defined territory and type of business. You will want to be free to engage in other business activities without objections from the buyer of your business.

Restrictions on Employees

California law does not allow noncompete agreements with employees, other than employee-owners of a business. In fact, the attempt to restrict a former employee from competing with a business may subject the business to liability for restraint of trade.

California employers wishing to prevent former employees from competing must seek to do so through means other than the use of a noncompete. If trade secrets or proprietary information are involved, steps taken by the employer to protect trade secrets or proprietary information may assist the employer in restraining former employees from competing with the business. Since customer lists, customer information, marketing methods, and production methods can be trade secrets or proprietary information, protection of this information can be effective in restricting competition.

Through the use of a proprietary information protection agreement (a nondisclosure agreement or confidential disclosure agreement) an employer can have employees (as well as any other individuals or firms with access to proprietary information) agree that certain information is proprietary to the employer, that they will not disclose it or use it, and that they will protect it from improper disclosure or use.

Although an agreement is not legally necessary in order to have a trade secret under California law, the best way to show that certain information was identified as a trade secret and protected from disclosure is by having a nondisclosure agreement signed by all those who have access to the information.

Since information must be kept secret in order to be entitled to protection as a trade secret, steps to identify and protect such information must be taken prior to disclosure.

Business owners should appreciate the benefits of a noncompete agreement when buying a business or an interest in a business, and of a nondisclosure agreement to protect the proprietary information of the business.

Mary Hanson, MBA, Attorney at Law (310) 543-1355 Torrance (Los Angeles County), California USA