Court Expresses Skepticism Over Use of Non-Compete Clauses to Protect Trade Secrets

The fact pattern is all too familiar. In a technical industry, an employee signs a “non-compete” clause and then changes employers and begins to compete against his or her old firm. Litigation ensues and one of the claims is that the employee agreed not to compete with “trade secrets” learned during employment with the first company. The former employer sues the employee and the new employer and asks for an injunction to prevent the employee from working for the new company and/or from using trade secrets in his new job.

In recent years, California courts have ruled that “non compete” clauses are illegal because the legislature has expressed a clear statutory policy in favor of employee mobility. The courts routinely cite section 16600 of the California Business & Professions Code, which clearly states that any contract that restrains an individual from engaging in a lawful profession is void. There are only three exceptions, each set forth in a separate statute: (1) when someone sells good will of a business and agrees as part of the deal not to compete for a set period of time (section 16601); (2) upon dissolution of a partnership (section 16602); and (3) upon dissolution of a limited liability company (section 16602.5).

The key case on this issue is Edwards v. Arthur Andersen, 44 Cal.4th 937 (2008). In that case, the California Supreme Court ruled that non compete clauses are void unless they fall within one of the statutory exceptions. But the court also said in a footnote that it was not ruling on the question of whether there was a “judge made” common law exception for agreements designed to protect trade secrets.

The question of a non-compete clause designed to protect trade secrets was left for a later case.

In Dowell v. Biosense Webster, Inc., an intermediate California Court of Appeal tackled the trade secret issue and noted that “[a]lthough we doubt the continued viability of the common law trade secret exception to covenant not to compete, we need not resolve the issue here.” The court took this route because the agreement in question was not narrowly drawn as required, nor was it carefully limited to trade secrets. In fact, the agreement was so broad that it restricted completion in violation of the statute. For that reason, the trial judge was correct in ruling that the agreement was void in its entirety.

For your convenience, a full copy of the court's ruling is attached.

In the wake of the Edwards and Dowell decisions, it appears that a covenant not to compete will not be enforced except on the clear statutory grounds outlined above (sale of goodwill; partnership dissolution; limited liability company dissolution).

Our firm regularly counsels companies, including start ups, on these and related issues.