California Business and Professions Code Section 16600 provides that subject to certain limited exceptions "every contract by which anyone is restrained from engaging in a lawful profession, trade or business of any kind is to that extent void." Thus, the general rule is that a non-compete agreement is void as a matter of law and California courts will not enforce it. The reason is a public policy against contracts preventing people from earning a living.

A non-compete agreement IS enforceable under certain, limited conditions

In determining whether an exception to non-compete agreements being void the California courts apply a balancing test with the courts being willing to uphold reasonable limited restrictions.

Exceptions

California law provides for certain limited exceptions to the rule that non-compete agreements are void. California Business and Professions Code Section 16601 provides that a person who sells substantially all of his/her interest in a company or all the assets thereof may have a valid non-compete agreement that will be enforced by California courts. The statute does not permit a non-compete agreement where the shareholder sells less than substantially all of his shares. Thus, where an employee signs an agreement not to compete against his/her employer after the employment has ceased, there is no sale of his/her ownership interest in the company and a non-compete agreement will not be enforceable.

Limited scope in order for the non-compete agreement to be valid.

Despite the fact that Business and Professions Code Section 16601 permits non-compete agreements, there are still other requirements in order for such a non-compete agreement to be valid. In order to be valid, the non-compete agreement must, in addition to being part of a sale of substantially all of the person's interest in the company, be limited in terms of both time and geography.

Time Limitation

Since there is a general policy against preventing a person from earning a living, the Courts are reluctant to uphold these agreements in general. Where a non-compete agreement fits within the exception of the sale of substantially all of a person's interest in the company, there still must be a limitation on the length of time that the non-compete agreement is valid. If the non-compete agreement provides that the seller will not compete with the purchaser for 50 years it is almost certain that California courts will void such an agreement as being too great a limitation on the seller's ability to earn a living.

California courts generally permit non-compete agreements for only relatively short-term duration, usually not to exceed two to three years. A non-compete agreement with a two to three year limitation on competition is likely to be enforceable. Any longer period of time and the courts will look with a skeptical eye towards enforcement. Here too, however, there may be circumstances that justify a longer term. Consultation with an attorney in this area is essential to drafting an enforceable non-compete agreement.

Geographical limitation

The limitation on competition must also be restricted by geographical area. Whether a geographical limitation is reasonable will depend upon the particular facts involved. There are some basic guidelines to determining whether a non-compete agreement will be enforceable. However, an attorney should be contacted to review and properly research your particular case.

Let's look at an example: If I sell an Italian Restaurant in Moorpark and sign an agreement not to compete with the Restaurant, the non-compete agreement must have a reasonable limitation in the geographic area in which I am agreeing not to compete.

In other words, if the agreement provides that I cannot set up an Italian restaurant in Ventura County, California courts are likely to enforce this non-compete agreement since it has a reasonable geographic limitation on competition. If, on the other hand, the agreement provides that I cannot compete against my Moorpark restaurant anywhere in the United States, the courts are unlikely enforce such a non-compete agreement as being overbroad and an unreasonable restraint on trade.

However, if I sold a chain of Italian restaurants that operated throughout most of the major cities in the United States, it is much more likely that the courts would uphold such a non-compete agreement. The idea being that a person that purchases a business will only do so if the person that they are buying from cannot open up a new competing business across the street.

The Internet and the New Economy

The rise of popularity of the Internet and b2b (business-to-business) commerce has contributed to a worldwide economy. Businesses now sell products and services exclusively over the Internet. Thus, when a person sells their business the question of geographical limitations on non-compete agreements is a more open question.

The courts can now enforce non-compete agreements on a much larger geographical basis since sales and income can be generated over the Internet worldwide. Thus, non-compete agreements relating to Internet commerce and large geographical areas are increasingly likely to be enforced by the courts.

Non-compete agreements while employed are valid

It is important to note that while only post-employment non-compete agreements are void, non-compete agreements during employment are quite enforceable. This is true for several reasons. Business and Professions Code 16600 applies only to post-employment non-compete agreements.

Additionally, every employee owes to his/her employer a duty of loyalty. If an employee goes into competition with the employer while continuing to be employed by that employer is likely to be in violation of his/her duty of loyalty. Further, if the employee is using any information obtain from his employer for the employer's competitor, both the employee AND the competitor may have liability for unfair competition/unfair trade practices.

There are too many legal pitfalls for the unwary. Therefore, it is vitally important that a business consult with an attorney when hiring and when purchasing or selling a business.

PRESENTED BY:
J. Caleb Donner and Lori Donner are attorneys and partners in the law firm DONNER & DONNER, a full-service law firm practicing throughout Central and Southern California. They can be reached at (805) 494-6557 or e-mailed at donner@lawyer.com for legal questions. See their web site: www.donnerlaw.com for more legal information and articles.