California employers that do not enter into invalid noncompetition agreements can nonetheless be liable for ratifying or enforcing them, so holds the California Court of Appeals in a recent decision. Rosemary Silguero v. Creteguard, Inc. et al. (Cal. Ct. App., 2nd Dist. July 30, 2010).
Floor Seal Technology, Inc. (“FST”) gave its employee, Rosemary Silguero, a choice: either sign FST’s confidentiality agreement containing a noncompetition provision that prohibited Ms. Silguero “from all sales activities for 18 months following either departure or termination” or be terminated. Although Ms. Silguero signed the agreement, FST terminated her employment a month later. Shortly after, Ms. Silguero started working at Creteguard, Inc., a company in the same industry as FST. After learning that Creteguard had hired Ms. Silguero, FST contacted Creteguard seeking Creteguard’s “cooperation and participation . . . in enforcing the confidentiality agreement, including those provisions prohibiting Ms. Silguero from “all sales activities for 18 months following Silguero’s . . . termination from FST.” Although Creteguard expressed its belief to Ms. Silguero that the noncompetition agreement was not enforceable in California, it nonetheless reached an “understanding” with FST that it would honor FST’s noncompetition agreement and terminate Ms. Silguero’s employment.
Ms. Silguero filed a Tameny claim against Creteguard alleging that she was wrongfully terminated in violation of public policy. In Tameny v. Atlantic Richfield Co. (1981) 27 Cal.3d 167, the California Supreme Court declared that employers may not terminate an at-will employee for a reason that is contrary to public policy. Here, Ms. Silguero alleged that she was terminated in violation of the public policy set forth in California Business and Professions Code Section 16600 (“Section 16600”) which provides that “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 lower court sustained Creteguard’s demurrer without leave to amend and dismissed the case based on Creteguard’s argument that FST — not Creteguard — violated Section 16600, and further, that no public policy prohibits “a subsequent employer from honoring a putatively valid noncompete/confidentiality agreement entered into by an employee and a former employer.”
Ms. Silguero appealed, and the Court of Appeals reversed in her favor, holding that she stated a viable Tameny claim for violation of public policy based on Section 16600 and case law interpreting that section. See, e.g., Edwards v. Arthur Andersen LLP (2008) 44 Cal.4th 937, 946 (rejecting the Ninth Circuit’s “narrow restraint” exception to Section 16600 and holding that even narrowly tailored covenants not to compete which allow an employee to work in a substantial portion of the market violate Section 16600) and D’Sa v. Playhut, Inc. (2000) 85 Cal.App.4th 927, 932 (holding that termination of employee for his failure to sign noncompetition agreement constituted wrongful termination in violation of public policy of Section 16600).
Creteguard argued that it could not be held liable under Section 16600 because it did not require Ms. Silguero to enter into the noncompetition agreement; rather, FST did. According to Creteguard, “[n]owhere in Section 16600 or subsequent sections is a legislative intent to impose third party liability evident” or “to make third parties the arbiters of the viability of non-compete agreements.” The court, relying on VL Systems, Inc. v. Unisen, Inc. (2007) 152 Cal.App.4th 708, rejected Creteguard’s argument, holding that similar issues have been adjudicated under Section 16600 in connection with “no hire” agreements.
In Unisen, VL Systems, Inc. (“VLS”) and its customer, Star Trac, entered into a consulting contract in which employees of VLS would provide services to Star Trac. As part of the deal, Star Trac agreed that it would not hire VLS’s employees for 12 months after the termination of the contract and if it did, Star Trac would pay VLS 60 percent of the employee’s annual compensation. After posting a job listing, Star Trac hired a former VLS employee who had never worked under the Star Trac contract as a VLS employee, and was not employed by VLS during the course of the Star Trac contract. Pursuant to the consulting contract’s “no hire” provision, VLS sent Star Trac an invoice but Star Trac refused to pay. VLS sued Star Trac to enforce the no hire agreement. The court in Unisen held that upholding the no hire provision would seriously impact the rights of third parties, including by unfairly narrowing the mobility of an employee who had never worked for Star Trac as a VLS employee. The Unisen court held that broad no hire provisions present the same problems as noncompetition agreements. The court held that the broad no hire provision was not necessary to protect VLS’ interests and was outweighed by the policy favoring freedom of mobility of employees.
Applying this reasoning, the Court of Appeals in Creteguard likened the “understanding” between Creteguard and FST that Creteguard would honor FST’s noncompetition agreement to the unenforceable no hire agreement between VLS and Star Trac. “Such ‘understanding’ between Creteguard and FST would be void and unenforceable under Section 16600 because it ‘unfairly limit[s] the mobility of an employee’ and because FST ‘should not be allowed to accomplish by indirection that which it cannot accomplish directly.’”
Significance for Employers
Employers who hire employees with noncompetition agreements should be cautious. The California judiciary has once again affirmed that the interest of employees in their own mobility and betterment is paramount to the competitive business interests of employers. While Creteguard makes clear that employers cannot terminate employees who entered into unenforceable noncompetition agreements with their former employer, the decision creates more questions than it answers. Creteguard does not address whether it is permissible for an employer to consider a prospective employee’s arguably unenforceable noncompetition agreement in making its hiring decision. Creteguard also does not offer hiring employers guidance if the employer is not certain whether or not an employee’s or applicant’s restrictive covenants are enforceable. Until California courts clarify the extent of Creteguard, California employers should proceed with caution, and not make any hiring or firing decisions based on an employee’s arguably unenforceable noncompetition agreement with a previous employer.
For more information on this alert or any other labor and employment issues, please contact any of the lawyers listed below:
John Adkins, firstname.lastname@example.org, 617.951.8551
Jenny Cooper, email@example.com, 617.951.8473
Louis Rodriques, Co-chair, Labor and Employment Group, firstname.lastname@example.org, 617.951.8340
This article was originally published by Bingham McCutchen LLP.