Non-Compete Agreements in San Diego: When are They Valid?

In general, under California law, a current employer cannot restrict an employee from leaving and taking another job, even with a competitor. In many states, employers are allowed use so-called “Restrictive Covenants” or a “Non-Compete Agreements” to prevent an employee from working for a competitor, but not in California. However, there are a few exceptions, which we will discuss here in this article. Importantly, restrictive covenants are allowable with partnerships and with limited liability companies. The ability to use restrictive covenants might be a valid reason to choose those corporate forms over the alternatives. A trusted and experienced corporate lawyer can help.

San Diego Corporate Law: California Legal Principles

Restrictive covenants are generally prohibited by California statute. See Cal. Bus. & Prof. Code, § 16600 which states in pertinent part:

“Except as provided in this chapter, every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.”

Section 16600 has been interpreted broadly by California courts. For example, section 16600 has been the basis for California courts rejecting the “inevitable disclosure doctrine” with respect to trade secrets. See Whyte v. Schlage Lock Co., 125 Cal.Rptr.2d 277 (2002). In that and subsequent cases, the inevitable disclosure doctrine has been rejected as incompatible with the strong public policy in favor of employee mobility.

San Diego Corporate Law: Allowable Restrictive Covenants

However, as noted, there are some exceptions that are created by the Business and Professions Code. Essentially, if a person is selling his or her business or leaving a partnership or an LLC, then a restrictive covenant may be entered into, and California courts will enforce it. Likewise, if a partner is leaving his or her partnership or a member of an LLC leaves her or her LLC, then a restrictive covenant is permissible.

Section 16601 covers the sale of a business and business goodwill. In summary, a restrictive covenant is allowable when:

• Any person sells the goodwill of a business
• An owner of a business entity selling or otherwise disposing of all of his or her ownership interest in the business entity
• Any owner of a business entity that sells all or substantially all of the operating assets of a division or a subsidiary of the business entity together with the goodwill of that division or subsidiary
• Any owner sells all of the ownership interest of any subsidiary

Section 16602 covers partnerships. Basically, if the partner is dissociated from the partnership or the partnership dissolves, then the partner may be validly restrained by a restrictive covenant. Section 16602.5 covers limited liability companies. That section states:

“Any member may, upon or in anticipation of a dissolution of, or the termination of his or her interest in, a limited liability company … may agree that he or she or it will not carry on a similar business within a specified geographic area where the limited liability company business has been transacted, so long as any other member of the limited liability company, or any person deriving title to the business or its goodwill from any such other member of the limited liability company, carries on a like business therein.”

As noted above, because a member of an LLC may be validly held to a restrictive covenant, an LLC might be preferable over another corporate form.

San Diego Corporate Law: The Three Extra Conditions

Aside from the specific circumstances described above — for example, the sale of a business — there are three additional conditions necessary for a restrictive covenant to be valid:

• The covenant can only restrain the person from “carrying on a similar business”
• The covenant must specify a geographic area which can be no larger than the geographic area where the pre-existing business or partnership or LLC has been operating
• The covenant is only valid if the pre-existing business or partnership or LLC is going to continue to carry on a “like business”

Note that there may also be a “reasonable duration” or “not-excessive duration” requirement, although such has not been explicitly established by California courts. See Loral Corp. v. Moyes, 174 Cal. App. 3d 268 (Cal. App. 6th Dist. 1985).

Contact San Diego Corporate Law

For further information, please contact Michael Leonard, Esq. of San Diego Corporate Law. Mr. Leonard has the experience to help draft and implement non-compete agreements that will be valid and enforceable. Mr. Leonard has been named a “Rising Star” three years running by SuperLawyers.com and “Best of the Bar” by the San Diego Business Journal. Contact Mr. Leonard via email or by calling (858) 483-9200.

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