The Death of the Non-Solicitation Clause

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Since the California Supreme Court decision in Edwards v. Arthur Andersen, LLP, non-solicitation clauses have been held to be generally unenforceable.  There were two exceptions to this general rule.  Today, there may be none.

Solicitation Clauses are Generally Unenforceable

In Edwards v. Arthur Andersen, LLP, the employee, Edwards, signed a non-solicitation agreement.  When Edwards began soliciting past clients, Andersen sued.  At issue was the general enforceability of non-soliciation clauses.

The Edwards court said Business & Professions Code section 16600 “protects ‘the important legal right of persons to engage in businesses and occupations of their choosing’” (Edwards (2008), 44 Cal.4th at p. 946 quoting Morlife, Inc. v. Perry (1997) 56 Cal.App.4th 1514, 1520), and under section 16600’s plain meaning “an employer cannot by contract restrain a former employee from engaging in his or her profession, trade, or business unless the agreement falls within one of the exceptions” to section 16600. (Edwards, at p. 946.)  The Edwards court rejected Andersen’s argument that the term “restrain” under section 16600 should result in non-competition clauses being unenforceable while lesser restrictive non-solicitation and other like provisions should be permitted.

In a case that I worked on, The Retirement Group v. Galante, the trial court issued a preliminary injunction enjoining the defendants from soliciting past clients, which was appealed.  The appellate court reviewed the Edwards decision and its predecessors and came to the following, very interesting, conclusion:

We distill from the foregoing cases that section 16600 bars a court from specifically enforcing (by way of injunctive relief) a contractual clause purporting to ban a former employee from soliciting former customers to transfer their business away from the former employer to the employee’s new business, but a court may enjoin tortious conduct (as violative of either the Uniform Trade Secrets Act and/or the Unfair Competition Law) by banning the former employee from using trade secret information to identify existing customers, to facilitate the solicitation of such customers, or to otherwise unfairly compete with the former employer.

Retirement Group v. Galante (2009) 176 Cal.App.4th 1226, 1238 [98 Cal.Rptr.3d 585, 593].

It may help the lay reader to know, in the world of litigation, there are two kinds of claims: contract claims and everything else, known as tort claims.  The above passage is saying that the courts will not enforce contractual provisions that run up against Business and Professions Code Section 16600.

Possible Exceptions to the Ban on Non-Solicitation Clauses

We know that non-solicitation clauses are generally not enforceable to restrain competition.  So, the question is: When is a non-solicitation provision in a contract enforceable, if ever?

#1: Clauses Limited to Protecting Trade Secrets

Although Edwards reaffirmed the broad California rule that invalidates noncompetition agreements falling outside of statutorily-prescribed exceptions, Edwards expressly stated it was not “address[ing] the applicability of the so-called trade secret exception to section 16600[.]” (Edwards, supra, 44 Cal.4th at p. 946, fn. 4, 81 Cal.Rptr.3d 282, 189 P.3d 285.)

In so doing, the Edwards Court acknowledged the existence of an exception, i.e., for a contractual provision that prohibits the use of company trade secrets in soliciting customers, but did not give the exception a lot of attention or weight.  Indeed, the Supreme Court’s use of the phrase “the so-called trade secret exception” suggests the Supreme Court is less than certain such an exception actually exists, and lower court decisions have inadvertently resolved the question in favor of the general ban.

In a case called Dowell v. Biosense Webster, Inc., the Court of Appeal had this to say:

Biosense contends that the clauses are valid because they were tailored to protect trade secrets or confidential information, and as such satisfy the socalled trade secret exception, citing cases such as Thompson v. Impaxx, Inc. (2003) 113 Cal.App.4th 1425, 1429–1430, 7 Cal.Rptr.3d 427; Whyte v. Schlage Lock Co. (2002) 101 Cal.App.4th 1443, 1462, 125 Cal.Rptr.2d 277; Metro Traffic, supra, 22 Cal.App.4th at p. 860, 27 Cal.Rptr.2d 573; and American Paper & Packaging Products, Inc. v. Kirgan (1986) 183 Cal.App.3d 1318, 1322, 228 Cal.Rptr. 713. Plaintiffs counter that in light of our Supreme Court’s recent decision of Edwards, supra, 44 Cal.4th 937, 81 Cal.Rptr.3d 282, 189 P.3d 285, a common law trade secret exception no longer exists.
The Court in Edwards concluded that section 16600 “prohibits employee noncompetition agreements unless the agreement falls within a statutory exception.” (Edwards, supra, 44 Cal.4th at p. 942, 81 Cal.Rptr.3d 282, 189 P.3d 285.) In rejecting the Ninth Circuit’s “narrow-restraint” exception to section 16600 (Edwards, supra, at pp. 948–950, 81 Cal.Rptr.3d 282, 189 P.3d 285), the Court stated: “Section 16600 is unambiguous, and if the Legislature intended the statute to apply to restraints that were unreasonable or overbroad, it could have included language to that effect. We … leave it to the Legislature, if it chooses, either to relax the statutory restrictions or adopt additional exceptions to the prohibition-against-restraint rule under section 16600” (id. at p. 950, 81 Cal.Rptr.3d 282, 189 P.3d 285). The Court went on to state: “Noncompetition agreements are invalid under section 16600 in California even if narrowly drawn, unless they fall within the applicable statutory exceptions of section 16601, 16602, or 16602.5.” (Id. at p. 955, 81 Cal.Rptr.3d 282, 189 P.3d 285.) Biosense notes that the Edwards Court relied on its prior decision in Muggill v. Reuben H. Donnelley Corp. (1965) 62 Cal.2d 239, 242, 42 Cal.Rptr. 107, 398 P.2d 147 (Muggill ), which held that section 16600 invalidates provisions in employment contracts that “prohibit[ ] an employee from working for a competitor after completion of his employment … unless they are necessary to protect the employer’s trade secrets.” In a footnote, the Edwards Court stated: “We do not here address the applicability of the socalled trade secret exception to section 16600, as Edwards does not dispute that portion of his agreement or contend that the provision of the noncompetition agreement prohibiting him from recruiting Andersen’s employees violated section 16600.” (Edwards, supra, at p. 946, fn. 4, 81 Cal.Rptr.3d 282, 189 P.3d 285.) Given this language, Biosense argues that the trade secret exception is still “alive and well.”
Plaintiffs argue that the trade secret exception rests on shaky ground in the first place. They point out that many of the cases recognizing a trade secret exception cite to Muggill and that the language in Muggill regarding a trade secret was dicta, as no trade secrets were at issue in that case. Plaintiffs also point out that Muggill, in turn, relied on Gordon v. Landau (1958) 49 Cal.2d 690, 321 P.2d 456, a “trade route” case in which the employee was a door-to-door salesman, whose employment agreement prevented him from divulging the names of his prior customers or soliciting their business for one year following termination of employment. TheGordon court concluded that the agreement was valid under section 16600 because it did not restrain the employee from engaging in his profession. (Gordon v. Landau, supra, at p. 694, 321 P.2d 456.) Plaintiffs suggest that the trade secret exception should be limited to “the narrow and antiquated circumstances of door-to-door trade routes” where it is proven that the identity of the customers is a trade secret. Biosense counters that the exception has not been so limited, noting, for example, that the exception was at issue inMetro Traffic, supra, 22 Cal.App.4th 853, 27 Cal.Rptr.2d 573, a case having to do with the news radio business and not trade routes.
At oral argument, plaintiffs’ counsel discussed the recent case of The Retirement Group v. Galante (2009) 176 Cal.App.4th 1226, 98 Cal.Rptr.3d 585 (Galante ), the first published California case to discuss Edwards reference to the trade secret exception in footnote four.3 The Galante court stated that “Edwards did not approve the enforcement of noncompetition clauses whenever the employer showed the employee had access to information purporting to be trade secrets. Instead, Edwards merely stated it was not required to ‘address the applicability of the socalled trade secret exception to section 16600’ (Edwards, supra, 44 Cal.4th at p. 946, fn. 4, 81 Cal.Rptr.3d 282, 189 P.3d 285) because it was not germane to the claims raised by the employee.” (Galante, supra, at p. 1239, 98 Cal.Rptr.3d 585.) In reconciling the “tension” between section 16600 and trade secrets, the Galante court stated: “We distill from the foregoing cases that section 16600 bars a court from specifically enforcing (by way of injunctive relief) a contractual clause purporting to ban a former employee from soliciting former customers to transfer their business away from the former employer to the employee’s new business, but a court may enjoin tortious conduct (as violative of either the Uniform Trade Secrets Act (Civ.Code, § 3426 et seq.) and/or the unfair competition law) by banning the former employee from using trade secret information to identify existing customers, to facilitate the solicitation of such customers, or to otherwise unfairly compete with the former employer. Viewed in this light, therefore, the conduct is enjoinable not because it falls within a judicially created ‘exception’ to section 16600’s ban on contractual nonsolicitation clauses, but is instead enjoinable because it is wrongful independent of any contractual undertaking.” (Galante, supra, at pp. 1233, 1238, 98 Cal.Rptr.3d 585.)

Although we doubt the continued viability of the common law trade secret exception to covenants not to compete, we need not resolve the issue here.  Even assuming the exception exists, we agree with the trial court that it has no application here. This is so because the noncompete and nonsolicitation clauses in the agreements are not narrowly tailored or carefully limited to the protection of trade secrets, but are so broadly worded as to restrain competition. (See Kolani v. Gluska, supra, 64 Cal.App.4th at p. 407, 75 Cal.Rptr.2d 257 [finding as a matter of law on demurrer that a noncompete clause was void because it was not “narrowly tailored” but “an outright prohibition on competition”].)

Dowell v. Biosense Webster, Inc. (2009) 179 Cal.App.4th 564, 575-77 [102 Cal.Rptr.3d 1, 9-11].

Though the Dowell Court claimed to not decide whether the exception exists, in a way, it actually did.  The effect of this ruling is to say any contractual provision that is not strictly limited to the use of trade secrets, but rather, is more broad, will run afoul of Business & Professions Code Section 16600.  The court leaves open the possibility that a clause limited to banning the use of trade secrets is enforceable.

But no one would ever need to enforce a contractual provision that prohibits the use of trade secrets because such a provision is already enjoinable under the California Unifrom Trade Secrets Act (“UTSA”).

In sum, so much for the “so-called” trade secret exception.

#2: Enforcement to Prevent “Unfair Competition”

The Unfair Competition Law (“UCL”) can be found at Business & Professions Code Section 17200.  It generally prohibits any “unlawful” or “unfair” acts or practices and permits the courts to enjoin such conduct in the name of healthy market competition.The UCL was widely used by plaintiffs lawyers since it originally permitted what are called, “private attorney general” actions, which are basically class actions without the strict requirements needed for an actual class-action.  In 2004, California voters passed Proposition 64, which eliminated this right.  The UCL is now generally just used for its injunction power and to get restitution in applicable cases.

Under UCL case law, an “unlawful” act or practice is a practice that violates some other law or regulation.  An “unfair” practice is one that is misleading or deceptive.  It is a much squishier concept.

The question we should concern ourselves with is: Can an employer ban solicitation not tied to the use of trade secrets under the UCL?

In Morlife, Inc. v. Perry (1997) 56 Cal.App.4th 1514, 1519., the Court of Appeal stated: “While it has been legally recognized that a former employee may use general knowledge, skill, and experience acquired in his or her former employment in competition with a former employer, the former employee may not use confidential information or trade secrets in doing so.” (Ibid.)  This suggests that there was a difference between “confidential information” on the one hand and trade secrets on the other. In a 2005 case called Readylink, the court first analyzed whether the customer list at issue was a trade secret and concluded that it was.  Readylink quoted another case, Courtesy Temporary Services Inc., in its analysis:

In Courtesy, the plaintiff, a temporary employment agency, provided various companies with temporary workers. The defendants, former employees of the agency, admitted scheming to form a competitive business and compiled a list of the agency’s major customers while employed by the agency. The agency sued the defendants for unfair trade practices and injunctive relief for setting up a competing agency. The trial court issued a preliminary injunction enjoining the former employees from soliciting the agency’s customers and temporary labor force. The trial court also found, however, that the agency’s customer list and related information was unprotected work product, and thus denied an injunction enjoining use and disclosure of the information.

The Courtesy court reversed the trial court ruling denying the injunction, concluding the customer list was a protectable trade secret under the UTSA and unfair competition statutes. In reaching this conclusion, the Courtesy court noted that the UTSA and case law “establish that a customer list procured by substantial time, effort, and expense is a protectable trade secret.” (Courtesy Temporary Service, Inc. v. Camacho, supra, 222 Cal.App.3d at p. 1287, 272 Cal.Rptr. 352.) Such a list is a protectable trade secret even if the list contains information available to the public or competitors: “[E]ven if the customers’ names could be found in telephone or trade directories, such public sources ‘ “would not disclose the persons who ultimately made up the list of plaintiff’s customers.” ’ [Citation.] It is the list of persons who actually purchase Courtesy’s services that constitute confidential information.” (Courtesy, supra, at p. 1288, 272 Cal.Rptr. 352.)

The Courtesy court thus concluded that “Here, the evidence established that Courtesy’s customer list and related information was the product of a substantial amount of time, expense and effort on the part of Courtesy. Moreover, the nature and character of the subject customer information, i.e., billing rates, key contacts, specialized requirements and markup rates, is sophisticated information and irrefutably of commercial value and not readily ascertainable to other competitors. Thus, Courtesy’s customer list and related proprietary information satisfy the first prong of the definition of ‘trade secret’ under section 3426.1.” (Courtesy Temporary Service, Inc. v. Camacho, supra, 222 Cal.App.3d at p. 1288, 272 Cal.Rptr. 352.)

Likewise, here, some of the enjoined information might have been available to the public and/or to ReadyLink’s competitors but there is substantial evidence establishing that ReadyLink’s lists of hospitals and nurses, as well as other proprietary and confidential information listed in the preliminary injunction, were procured by substantial time, effort, and expense.

Considering the admitted misappropriation of sophisticated, detailed customer information and active solicitation by Cotton in the instant case, the trial court’s granting ReadyLink injunctive relief was not an abuse of discretion. (Courtesy Temporary Service, Inc. v. Camacho, supra, 222 Cal.App.3d at pp. 1290–1291, 272 Cal.Rptr. 352.) In Courtesy, the court also found that the trial court should have granted a preliminary injunction under the unfair competition provisions, Business and Professions Code section 17200, et seq. (Courtesy, supra, at p. 1291, 272 Cal.Rptr. 352.) The court concluded that, “even if Courtesy’s customer list would not qualify as a ‘trade secret’ under section 3426.1 [of the UTSA], the unfair and deceptive practices of employees in stealing Courtesy’s customers should have been enjoined under Business and Professions Code section 17200 et seq.” (Ibid.)

ReadyLink Healthcare v. Cotton (2005) 126 Cal.App.4th 1006, 1019-20 [24 Cal.Rptr.3d 720, 729-30].

It is the next part of the Readylink decision that is of interest here because it goes on to suggest the use is also enjoinable under the UCL separate and apart from the trade secrets act:

In discussing unfair competition, the court in Courtesy explained that a former employee has the right to compete with his former employer, even for the business of those who had formerly been the customers of his former employer, provided such competition is fairly and legally conducted and so long as it does not constitute unfair competition: “[A] former employee’s use of confidential information obtained from his former employer to compete with him and to solicit the business of his former employer’s customers, is regarded as unfair competition. [Citation.]” (Courtesy Temporary Service, Inc. v. Camacho, supra, 222 Cal.App.3d at p. 1292, 272 Cal.Rptr. 352.)

In the instant case, there is ample evidence supporting the trial court’s finding that Cotton misappropriated trade secret information and committed acts of unfair competition such that it is reasonably likely ReadyLink will prevail on its misappropriation claims and that denying a preliminary injunction will likely cause irreparable harm to ReadyLink.

ReadyLink Healthcare v. Cotton (2005) 126 Cal.App.4th 1006, 1020-21 [24 Cal.Rptr.3d 720, 730].

Edwards was published in 2008, and after that came The Retirement Group v. Galante passage, which states:

We distill from the foregoing cases that section 16600 bars a court from specifically enforcing (by way of injunctive relief) a contractual clause purporting to ban a former employee from soliciting former customers to transfer their business away from the former employer to the employee’s new business, but a court may enjoin tortious conduct (as violative of either the Uniform Trade Secrets Act and/or the Unfair Competition Law) by banning the former employee from using trade secret information to identify existing customers, to facilitate the solicitation of such customers, or to otherwise unfairly compete with the former employer.

Retirement Group v. Galante (2009) 176 Cal.App.4th 1226, 1238 [98 Cal.Rptr.3d 585, 593].
The idea here, which might excite employers, is that there is “confidential information” that is not a trade secret that may be protected under the UCL.

The problem is that all of these cases were basically decided employing trade secret principles.  There is no case supporting a ban on solicitation under the UCL that would not otherwise qualify under the trade secret law.  There is also, if not another way of saying the same thing, no guidance on what information might be considered “confidential” that would not quality as a trade secret, i.e., is valuable because it is secret.  Still, if you are an employer drafting a complaint against employees who have departed and are soliciting your customers

Conclusion

At the end of the day, we can say with confidence that contractual provisions prohibiting solicitation of customers are dead and gone.  They are unenforceable, period.  As far as prohibiting solicitation under something other than the Uniform Trade Secrets Act, employers have some hope of preventing “unfair” competition under the Unfair Competition Law, and will want to pursue that when discussing their case with an attorney.  But, their optimism should be mitigated.  The Edwards decision, re-enforcing an a California employee’s right to compete but for cases in which trade secrets are at issue, will likely result in any use of information that does not qualify as a trade secret as fair game.