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Edwards v. Arthur Andersen LLP The Death of Non-Competition Agreements?

Posted in Trade Secrets

By James Kachmar

Last summer, I wrote about the appellate court’s decision in VL Systems, Inc. v. Unison, Inc. in which the Court struck down a “no hire” provision contained in a consulting agreement as violating section 16600 of California’s Business and Professions Code. Section 16600 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.” This summer, the California Supreme Court in Edwards v. Arthur Andersen used the same reasoning to strike down a “non-competition” provision in an employment agreement.

Raymond Edwards was hired by Arthur Andersen as a tax manager in January 1997. His employment by Andersen was made contingent upon his signing a non-competition agreement which prohibited him from working for or soliciting certain clients for a limited period of time following the termination of his employment. The agreement also prohibited Edwards from soliciting Andersen’s employees who he worked with for an 18 month period following the termination of his employment.

During the next five years, Edwards worked for Andersen and moved into the firm’s private client services group where he serviced the accounts for large income/net worth individuals and entities. However, the U.S. government indicted Andersen in connection with the collapse of Enron in March 2002. Andersen announced in June 2002 that it would cease its accounting practices in the United States. Andersen then sold a portion of its tax practice, including Edwards’ Group, to HSBC. Before hiring of any of Andersen’s employees, HSBC required them to execute a “Termination of Non-Compete Agreement” (“TONC”) in order to gain employment with HSBC. The TONC contained a release of any claims that the employee may have against Andersen and was required to be signed by every employee before the deal with HSBC/Andersen went through. Edwards signed his HSBC employment offer letter but declined to sign the TONC. As a result, Andersen terminated Edwards’ employment and HSBC withdrew its employment offer.

In April 2003, Edwards sued Andersen and others for intentional interference with prospective economic advantage and anti-competitive business practices under the Cartwright Act. After Edwards settled with all parties except Andersen, the Court dismissed all but one of the claims against Andersen and later entered judgment in Andersen’s favor on the remaining intentional interference claim. The trial court found that the non-competition agreement did not violate section 16600 because it was narrowly tailored and did not deprive Edwards of his right to pursue his profession. [Note: This article will not address the other issue in the Edwards v. Andersen case; whether the provision in the TONC that required Edwards to waive his right to indemnification from Andersen was also invalid.] 

 

To prevail on his intentional interference claim, Edwards had to prove: (1) an economic relationship between himself and a third party with the probability of future economic benefit to him; (2) Andersen’s knowledge of the relationship; (3) an intentional act by Andersen designed to disrupt the relationship; (4) actual disruption of the relationship; and (5) economic harm to Edwards proximately caused by Andersen’s wrongful act. Edwards also had to prove that Andersen’s interference was wrongful independent of its interfering character. At issue before the California Supreme Court was the third element of Edwards’ intentional interference claim: whether the non-competition agreement was illegal under section 16600.

 

The California Supreme Court began by examining the history of section 16600. The Court noted that under common law, as is still true in many states today, “contractual restraints on the practice of a profession, business or trade were considered valid as long as they were reasonably imposed.” This was the law in California until 1872 when the California Legislature enacted the Civil Code. Today, such covenants not to compete are void under California law subject to several exceptions such as: (1) the sale or dissolution of a corporation (§16601); (2) partnerships (§16602); and (3) limited liability corporations (§16602.5). The California Supreme Court recognized that with its enactment, section 16600 “evinces a settled legislative policy in favor of open competition and employee mobility.” In addition, the Court noted “the law protects Californians and ensures `that every citizen shall retain the right to pursue any lawful employment and enterprise of their choice.’” 

 

Andersen argued that the Court should interpret the term “restrain” in section 16600 to mean “prohibit” so that only a contract that completely prevented an employee from engaging in his or her profession would be illegal. Essentially, Andersen claimed that California law permitted non-competition agreements provided they were “narrowly tailored.”

 

Edwards argued that the cases relied upon by Andersen in support of its “narrowly tailored” position were simply cases that relied upon the statutory exceptions to section 16600 cited above. In rejecting Andersen’s arguments, the California Supreme Court held that because the provisions of the non-competition agreement prevented Edwards from providing accounting services to any Andersen client for a year after termination, “the agreement restricted Edwards from performing work for Andersen’s Los Angeles clients and therefore restricted his ability to practice his accounting profession.” The California Supreme Court concluded that “[t]he non-competition agreement that Edwards was required to sign before commencing employment with Andersen was therefore invalid because it restrained his ability to practice his profession.

 

The California Supreme Court noted that Andersen’s argument for a “narrowly tailored” exception to section 16600 was based in part by confusion that had arisen over the Ninth Circuit’s application of section 16600. The California Supreme Court noted, however, that “no reported California state court decision [had] endorsed the Ninth Circuit’s [narrow restraint] reasoning and we are of the view that California courts `have been clear in their expression that section 16600 represents a strong public policy of the state which should not be diluted by judicial fiat’.” The California Supreme Court concluded that section 16600 was “unambiguous” and that it was up to the California Legislature to rewrite it if it intended its provisions to only apply to those non-competition restraints that were “unreasonable or overbroad.” Thus, the California Supreme Court concluded that: “Non-competition agreements are invalid under section 16600 in California even if narrowly drawn unless they fall within the applicable statutory exception of sections 16601, 16602 or 16602.5.” 

 

The California Supreme Court’s ruling in the Edwards case will have significant impact on California’s employers. Many employers utilize such agreements to protect their customer base from competitors, who may hire away the employer’s employees to take advantage of their relationships with customers. The Court’s decision in Edwards will deprive employers of this protection unless the California Legislature accepts the Supreme Court’s invitation to amend section 16600.