Non-Disclosure & Non-Competition Issues
The Basic Approach in California.
With some exceptions involving sales of businesses and the like,
California law prohibits non-competition provisions. On the other hand,
California law protects trade secrets and the vast majority of
In California (and this is NOT true in many other states),
non-competition provisions are void except for very limited situations.
Business & Professions Code
Section16600: "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."
While it has been argued that Section
16600 applies only in the employer-employee relationship, that
interpretation is not supported by the language of the statute and it
has been rejected by the courts. In other words, Section 16600 protects
independent contractors as well.
Non-competition provisions are allowed with the following types
of owners in the following situations:
Proprietors. Any person who sells the goodwill
of a business.
Any shareholder of a corporation selling or otherwise disposing
of all his shares in
said corporation, or any shareholder of a corporation which sells (a)
all or substantially all of its operating
assets together with the goodwill of the corporation, (b) all or
substantially all of the operating assets of a division or a subsidiary
of the corporation together with the goodwill of such division or
subsidiary, or (c) all of the shares of any subsidiary.
A partner upon or in
anticipation of (a) a dissolution of the partnership, (b)
dissociation of the partner from the partnership, or (c) a sale or other
disposition of the partner's interest in a partnership.
Liability Company Members. Any member, upon or
in anticipation of a dissolution of a limited liability company
or a sale of his or her or its interest in a limited liability company.
All of these exceptions require that a
geographic area be established by naming "a specified county or
counties, city or cities."
Ownership: The courts have held that giving token amounts of
stock etc. to employees will not allow these exceptions to apply.
Law: California will uphold the prohibition even if another
state’s law is designated as governing the agreement IF the chosen
state has no substantial relationship to the parties or the transaction.
The Courts have held that the prohibition applies to a California
employer hiring out-of-state employees.
When hiring out-of-state employees in
particular, it is important to find out whether the employee signed a
non-competition provision and what its terms are; otherwise you may find
yourself defending against a lawsuit in another state.
Option Plans: A Court has held that an employee stock-option plan
did not violate Section 16600 even though it included a provision that
the employee would return any profits from the stock options if he
worked for a competitor within six months after he exercised his
Restrictions: One case has held that a provision barring one
party from courting a specifically named customer, as opposed to a
significant part of the industry, does not violate Section 16600.
Obviously, there can be disputes over what constitutes a significant
part of an industry.
Though this is a federal case, there is
older California case law stating that a partial restraint on
competition is allowed
"where one is barred from pursuing only a small or limited part of the
business, trade or profession." (Boughton v. Socony Mobil Oil Co.
(1964) 231 Cal.App.2d 188, 192.)
Caution: adding a "savings" clause
that states the restriction, if found invalid, is to be narrowed rather
than removed, will be ignored IF the restriction is blatant.
In fact, a blatantly invalid
non-compete clause may well void the entire agreement. As a result, if
you are going to use a non-compete provision, place it in an entirely
separate agreement so that confidentiality and ownership provisions are
not at risk.
Employees to Sign Invalid Provisions. A California case found the
employer liable for terminating an employee who refused to either sign a
non-competition agreement (preventing the employee from working in the health-care
field in the same state for six months after termination) or
accept work in a different part of the company. The Court held that the
employer’s action violated public policy and upheld a $1.2 million
judgment against the employer.
Still, this was an obvious violation. If
the agreement had been restricted to one or two key clients, it might
On the other hand, since California does
not give the same sort of rights to prospective employees as it does to
existing employees, make sure each prospective employee signs a
confidentiality agreement as a condition of getting the job.
in Customer Agreements. Courts have already held that an employer
cannot evade the non-competition restrictions by putting clauses in its
contracts with its clients that prohibit the clients from hiring the
employer’s former employees.
Clauses that state that the client will
not solicit the employer’s employees while they are working for the
employer are valid though.
Also, an employer may be able to place a
provision in its agreements with its clients stating that the work that
the employer performs for the client is a trade secret and, although the
client can use it, it will not divulge the trade secrets to any of
employer’s former employees or consultants. Since the former employee
or consultant would not be able to continue the same work, this makes
him/her much less attractive to the client.
Trade Secrets and Non-Disclosure
Non-disclosure agreements (also known as confidentiality agreements or
NDA’s) protect trade secrets.
secret" means information, including a formula, pattern,
compilation, program, device, method, technique, or process, that:
Derives independent economic value,
actual or potential, from not being generally known to the public or to
other persons who can obtain economic value from its disclosure or use;
Is the subject of efforts that are
reasonable under the circumstances to maintain its secrecy. (Civil Code
§3426.1(d), part of California’s version of the Uniform Trade Secrets
Agreement. The Uniform Trade Secrets Act ("UTSA") protects a
trade secret even if there is no written agreement if, among things, the
information was acquired under circumstances giving rise to a duty to
maintain its secrecy or limit its use. Employees, officers and directors
owe duties of confidentiality to their company, but a written agreement
provides more secure–and often broader–protection.
Disclosure. On the other hand, California has rejected the
"inevitable disclosure" doctrine, which allows an injunction if it
is "inevitable" that the employee will have to use the former
employer’s trade secrets in order to do the new job.
Efforts. To show reasonable efforts to maintain secrecy, have
signed non-disclosure agreements with the employees and
principals of your company as well as with independent contractors and
other businesses where appropriate.
Definition. Be certain that your definition
of what constitutes confidential material is specific enough to
identify the confidential information without disclosing it. Vague or
overly broad definitions of what constitutes proprietary material may
nullify non-disclosure agreements.
Employees with prior experience who are
coming on board may require exceptions for knowledge they already have.
You cannot make something a trade secret by contract. If your
definitions are too broad, you risk invalidating the protection. For
this reason, make sure that you include the usual exceptions:
information in the public domain, information the employee acquired
before taking the job, information obtained legitimately from a third
party under no obligation of confidentiality.
Have your confidentiality agreements with employees signed at the time
when they first start work, and
give existing employees additional consideration such as small
amounts of stock or money–or a bottle of wine (but be sure to document
it!)--as consideration for signing the agreement. If existing employees
are not given additional compensation to sign, the agreement may well
not be enforceable.
When hiring a new employee, be sure to
ask if he/she has signed any non-disclosure agreements with former
employers–and make a record of the response.
Memory. It is misappropriation to use trade secret information
from memory; no taking of paper or electronic information is required.
Lists and Preferences. Confidentiality agreements can protect customer
preferences and sometimes customer lists. If the former
employee develops a customer list from other legitimate sources, though,
it is not a violation, even though there is a great deal of overlap
between the lists.
Although one case has questioned the distinction, in general California
courts have held that contract provisions may validly prohibit former
employees from soliciting
(raising the issue of doing business with) the former employer’s
customers–but not prohibit announcements.
In other words, the former employee is entitled to send an announcement
(including to some of the employer’s customers) stating that the
former employee is with another business and giving contact information,
even if trade-secret information is involved.
Ideally, have outsiders sign a non-disclosure
agreement (or letter agreement with a place for them to sign and
accept) BEFORE giving them confidential information. However, many large
companies will refuse to do this.
If you can’t get a signed
non-disclosure agreement, second best is sending a letter
PRIOR to disclosing the confidential information stating that you
will be providing confidential information and expect the other side to
keep it confidential.
Even a post-meeting
letter–confirming that you disclosed confidential information
and expect the recipient to keep it confidential–is better than
In all of these cases, be sure to describe
the confidential material sufficiently to identify it.
Other Allowed Provisions.
It is permissible to state in an employment agreement that the employee
Divert the employer’s customers
during the period of employment.
Organize a competing business during
the period of employment.
Solicit the company’s employees to
work elsewhere–whether during
or after the period of employment.
Inventions. If you are in California, your agreements with
employees regarding inventions must comply with California Labor
Code Section 2870. This means that inventions developed entirely on an employee’s
own time without using the company’s equipment, supplies, facilities,
or trade secret information must NOT be assigned to your company
unless they relate to your
business. Making invention-assignment clauses too broad will
nullify the agreement. On the other hand, failure to use an
invention-assignment agreement with employees may mean an employee owns
Contractors. If you do not have a written agreement with an
independent contractor, the work developed will be owned by that
contractor–and you will have only a non-exclusive license to use it.
In addition, you need to make sure that your "work for hire"
agreements with independent contractors (such as programmers and Web
designers) also include an assignment
of ownership rights in the resulting product to your company. "Work
for hire" clauses alone may not be sufficient.
Utility patents cover inventions that are
novel and non-obvious, among other things.
Novelty deals with timing.
With potentially patentable ideas, be sure to contact an attorney early
enough so that a patent application can be filed within one
year of the earlier of a) the publication of the invention in any
patent or printed publication anywhere in the world by anyone and b)
anyone placing the invention in public use or on sale. Otherwise patent
rights are lost.
"Non-obvious" means not obvious at
the time the invention was made to a person having ordinary skill in the