In a long-awaited decision, the California Supreme Court has confirmed that restrictive agreements that limit an employee's ability to engage in a lawful profession are unenforceable in California unless given in connection with a sale or dissolution of a corporation, a partnership or a limited liability corporation. In Edwards v. Arthur Andersen LLP, Cal. No. S147190 (August 7, 2008), the court held that the provisions of a restrictive agreement given in connection with employment are unenforceable and expressly rejected the "narrow restraint" doctrine that has been recognized by the Ninth Circuit, the federal court jurisdiction that includes the state of California.

Raymond Edwards was hired as a tax manager for Arthur Andersen LLP ("Andersen"). As a condition of hire, he was required to sign a noncompetition agreement, agreeing that for a period of time after separation from Andersen, he would not provide the same type of professional services to clients that he had provided while employed by Andersen and would not solicit such clients to offer such services. The agreement did not prohibit Edwards from accepting employment with a client, so long as he did not provide the same services to the client as a direct employee that he had previously provided while affiliated with Andersen. The agreement also did not prohibit Edwards from working in his trade for non-clients, although he was prohibited from soliciting any former clients of the Andersen office in which he had worked for one year after leaving Andersen.

Five years later, the Andersen firm was indicted in connection with the federal investigation into Enron Corporation, and very soon thereafter announced that it would no longer perform accounting services. Andersen sold its practice groups to various other companies, and the division that had employed Edwards was sold to HSBC.

HSBC offered employment to Edwards, provided that he, among other conditions, voluntarily resigned from Andersen and released it from "any and all claims," including all claims arising from his employment. In exchange, Andersen would accept Edwards' resignation, release him from his noncompetition agreement and permit his employment by HSBC. Edwards refused to sign the release and, as a result, was not employed by HSBC. Edwards sued Andersen, HSBC and HSBC's subsidiary under a variety of legal theories. He settled with HSBC and its subsidiary, and the case proceeded against Andersen.

At the core of Edwards' case against Andersen was whether the noncompetition agreement was enforceable. California Business and Professions Code section 16600 states: "Except as provided in this chapter, every contract by which any one is restrained from engaging in a lawful profession, trade or business of any kind is to that extent void." The exceptions in the chapter are those noted above.

Andersen argued that the word "restrained" meant wholly prevented or precluded. It argued that because Edwards was not entirely prevented from performing his trade, but was prevented only from performing it on behalf of certain former clients for a limited period of time and from soliciting clients, he was not "restrained" from practicing his trade as a tax manager. The Supreme Court noted, however, that all of the cases cited by Andersen were cases that did involve the statutory exceptions. The court rejected Andersen's argument, finding any limitation on an employee's ability to practice his or her vocation, unless given in connection with one of the exceptions, would be void. Thus, the court held the provisions that restricted Edwards from performing his trade for a specified universe of clients, and from soliciting them to work with him after his departure from Andersen, were impermissible "restraints." The court specifically rejected the Ninth Circuit's ruling upholding the enforceability of noncompetition agreements when they minimally restrained the employee from performing his business, trade or profession. The court concluded: "Noncompetition agreements are invalid under section 16600 even if narrowly drawn, unless they fall within the applicable statutory exceptions. . . ."

A second issue in the case was whether a contract requiring Edwards to release "any and all claims" against Andersen was unlawful and void. Edwards noted that Labor Code section 2802 requires an employer to indemnify its employee for all that the employee necessarily loses or expends in direct consequence of discharging his or her duties, or in his or her obedience to the directions of the employer, even if such directions are unlawful, unless the employee believed the directions to be unlawful. The right to statutory indemnity under section 2802 was important, given the fact that the Andersen firm had been indicted and individual indictments of employees could follow. Labor Code section 2804 voids any agreement to waive the protections of section 2802. Edwards argued that the general release of "any and all" claims against Andersen included a waiver of his statutory indemnity rights and, as such, would be an unlawful agreement.

The Supreme Court rejected Edwards' argument on this issue, finding nonwaivable statutory rights are not encompassed within the scope of a general release of "any and all claims" and the presentation to Edwards of the general release agreement was not an unlawful act.

What This Means for Employers

There is no longer any doubt that noncompetition agreements are unenforceable in California unless given under one of the statutory exceptions. Even agreements that purport only to limit the employees' working for clients or customers, or from soliciting such clients or customers, will be found unenforceable. Employers who require employees to sign such agreements do so at their peril - they may be found to have engaged in unlawful acts and unfair competitive business practices by requiring their employees to execute unenforceable agreements.

Of course, employers have a legitimate need to prevent former employees from unfairly competing against them. This may be accomplished through the use of carefully-crafted trade secret and proprietary information agreements, and careful programs aimed at establishing the confidential nature of the company's trade secrets. A common mistake on the part of many companies is the failure to properly define trade secrets or to take precautions to protect such information as proprietary and confidential.

Employers should conduct reasonable due diligence in hiring employees and should determine whether any of those employees have executed noncompetition agreements in other states where such restrictions are enforceable. Though the agreements will not be enforced in California (even where the parties agree that the contact will be governed by the law of another state that enforces these restrictions), the employer who unknowingly hires employees who are bound by a former employer's noncompetition agreement may suddenly find itself entrenched in litigation with the former employer. Employers should know before hiring whether an employee comes with this potential "baggage," and should have a plan to address the possibility that a former employer will seek to enforce the noncompete, usually by suing the worker and the new employer in another state.

Finally, employers whose departing employees sign general releases can expect that properly drafted releases will be enforceable (provided that they are supported by adequate consideration). Such releases will not abrogate nonwaivable statutory rights, and will not be rendered invalid by broad language stating that "any and all" claims are released.

The ruling in the Edwards case is far reaching. Employers should not rely upon old forms of offer letters or other documents containing post-employment restrictions, but should have them reviewed and possibly revised in light of the new ruling.