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Caution Regarding “No-Hire” Provisions

Posted in Trade Secrets

By James Kachmar

Businesses, especially consultants, frequently include a no-hire provision in connection with service or consulting agreements. These provisions are usually intended to prevent the client from soliciting or hiring away the consulting company’s employees. No-hire provisions have two primary goals:  First, to protect the employees of one business from being recruited away by the companies they provided services to. The second goal is to help retain customers, i.e., if the client business is able to recruit a consulting business’s employees, there would be no further need for the consulting company’s services.

 On June 25, 2007, the Court of Appeals for the Fourth Appellate District struck down a “no- hire” provision in VL Systems, Inc. v. Unisen, Inc. (Case No. G037334). Though the VL Systems Court emphasized that there were limitations on the extent of its holding, companies that rely on “no-hire” provisions, and the attorneys who advise them, should take heed of some of the concerns raised by the VL Systems Court.

In 2004, VLS entered into an agreement with Star Trac (a Unisen dba) to provide computer consulting services with regarding a new computer server. The contract was not large and estimated only 16 hours of work by VLS’ consultants. The contract, however, included a 12-month no-hire provision which stated: “BUYER WILL NOT ATTEMPT TO HIRE SELLER’S PERSONNEL.  Any hiring or offer of employment entitles but does not require VL Systems, Inc. to immediately cancel the performance period of this agreement.” The “no-hire” provision also contained a liquidated damages clause.

VLS confirmed that the purpose of the no-hire provision was “to deter the hiring of consultants by its customers, to protect both VLS’s investment in its consultants and to protect its customer base.” After the signing of the contract, the project was completed and Star Trac paid for the work. 

After the contract was completed, VLS hired a senior engineer. Two months later, Star Trac’s IT manager advised that he intended to leave the company but would stay long enough to recruit his replacement. The following month Star Trac posted a want ad for a Director of Information Technology. The senior engineer, who had been hired by VLS only months earlier, applied for the position and was hired in September 2004.

At the time Star Trac hired the Senior Engineer, it recalled the no-hire provision in its contract with VLS but decided that it was not relevant since the Senior Engineer did not work at VLS until after the completion of its contract with Star Trac. Shortly after the hiring of the Senior Engineer, VLS sent an invoice to Star Trac for $60,000 pursuant to the liquidated damages clause in the no-hire provision. Star Trac declined to pay the invoice and VLS filed suit in February 2005 alleging claims for breach of contract, breach of the implied covenant of good faith and fair dealing and declaratory relief. A bench trial was held a year later and the court found in favor of VLS and enforced the no-hire provision. Star Trac appealed the court’s ruling and the appellate court considered whether the no-hire provision was enforceable under California law.

         

The Court began by examining the no-hire provision in connection with Business and Professions Code section 16600 which provides: “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.” The court recognized that “California courts have consistently declared this provision an expression of public policy to ensure that every citizen shall retain the right to pursue any lawful employment and enterprise of their choice.” The court further recognized that employers generally can solicit and recruit away another company’s employees “so long as the inducement to leave is not accompanied by unlawful action.” In the VLS case, it was clear that Star Trac had not done anything that was unlawful or tortious in hiring the senior engineer. Rather, the only allegation was that Star Trac violated the no-hire provision in the consulting contract.

Thus, the court realized that the crux of the case turned on the question of “whether two parties can agree on a no-hire provision as a matter of contract.” The court recognized that parties’ freedom to enter into contracts was an important principle but that such freedom must give way where it “may seriously impact the rights of a broad range of third parties.” Specifically, the court found that the no-hire provision affected a broad range of people ,including those persons who may have been employed by VLS at one point but had not performed any services under the Star Trac contract or, as in the case of the Senior Engineer, were not even employed at the time the contract was being performed.

Because the VLS court could not find any prior case directly on point, it looked more generally to policies that have been established by the courts in striking down contractual provisions that restrict employment opportunities. In doing so, the court recognized that:  “If the interests of the employee trumped the interests of the employers as a matter of public policy, then it logically follows that a broad-ranging contractual provision such as the one at issue here cannot stand.” 

The court further recognized that courts have upheld limited restrictions on employment in only a few instances. For instance, in Loral Corp. v. Moyes (1985) 174 Cal.App.3d 268, the court allowed an action to proceed against the defendant former employee for allegedly inducing other employees to go work for his new employer. The Loral court recognized that “reasonably limited restrictions which tend more to promote than restrain trade and business do not violate” California law. The Loral court ultimately held that the provision at issue there was more like a non-solicitation/non-disclosure agreement than an invalid agreement not to complete. The VLS court distinguished the Loral decision by finding that there, the defendant had actively solicited the plaintiff’s employees where as in the present case, Star Trac did not solicit the senior engineer’s application for employment. Rather, he applied independently of any action by VLS or Star Trac.

The VLS court also distinguished an Illinois case, H & M Comm. Driver Leasing v. Fox Valley Cont. (Ill. 2004) 805 N.E. 2nd 1177, which addressed a no-hire clause that was expressly limited to employees who had provided services to the client company. The VLS court found that the scope of that clause was “far less broad and impacted a substantially smaller number of employees.”

VLS argued that Star Trac had a positive prior experience with its employees and that equated with a “free look” of the senior engineer’s abilities prior to his hiring. The court rejected this argument as being overbroad and illogical. It found that if Star Trac knew of the senior engineer’s prior employment with VLS, it would have known that it was only for a short time and that there was nothing in the record demonstrating that it was a causal factor in Star Trac’s decision to hire him. The court also found that enforcing the $60,000 liquidation clause in the no-hire provision would have significantly influenced Star Trac’s decision to hire him and thus, “upholding such a contractual provision would unfairly narrow the mobility of an employee who had never worked for Star Trac as a VLS employee and had independently sought out Star Trac’s job opportunity.” The court found that enforcing the no-hire provision would be no different than enforcing other improper covenants not to compete and would unfairly limit the job mobility of the senior engineer. 

Nevertheless, the VLS court did leave the door open as to whether a more narrowly drawn no-hire provision would have been enforceable. It is likely the VLS court would have upheld the provision had it been limited to only those VLS employees who performed services for Star Trac pursuant to the consulting agreement. Businesses that wish to protect their employees would be well advised to re-visit any no-hire provisions in their contracts to ensure that they are narrowly drawn to avoid having them invalidated by a California court.


James Kachmar is a Senior Associate in Weintraub Genshlea Chediak Tobin & Tobin’s litigation section. He represents corporate and individual clients in both state and federal courts and various business litigation matters, including trade secret misappropriation, unfair business competition, stockholder disputes, and intellectual property disputes. For additional articles on intellectual property issues, please visit Weintraub’s law blog at www.theiplawblog.com