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NONCOMPETITION AGREEMENTS
WHEN ARE THEY REALLY ENFORCEABLE
California Civil Code Section 16600 provides that contracts prohibiting competition are “void.” Section 16601, however, makes an exception to this rule. Noncompete agreements are enforceable if they apply to the sale of a business including the sale of goodwill. Based on Section 16601, owners selling their businesses are generally obligated to comply with reasonable post-closing noncompetition provisions.
Employees on the other hand are generally not required to comply with noncompetition provisions in California. Even if the employee is the Chief Executive Officer, controls the clients and otherwise is the key to running the business, it is highly unlikely that any restrictions would prevent that employee from competing. Other restrictions such as prohibitions against soliciting or hiring the company’s employees or soliciting customers may be used. These alternative restrictions are generally void unless required to protect trade secrets of the company (such as detailed customer lists). These alternative restrictions are usually agreed to after the initial date of employment (such as when the company is being sold). The absence of any additional consideration at the time the noncompete agreement is entered into further invalidates what are, most likely, already unenforceable contract provisions. Giving an employee a very small interest in the company that is later sold is a common strategy. This tact will not work unless the ownership is more than nominal (both in terms of “percentage ownership” and actual “value”). Note, to add further insult to injury, if these types of non-enforceable provisions are included with other enforceable noncompete provisions in an agreement, the court may void the entire agreement.
Noncompetition laws vary by state. Some states do allow employers (or buyers) to prevent employees from competing for reasonable periods of time in a reasonable geographic area. Determining governing law is an important part in determining the enforceability of non-compete agreements.
For additional information regarding this subject matter please contact the M&A Law Firm, Roger L. Neu, JD, CPA, Principal, at (949) 863-1700.
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