The California Supreme Court's Edwards

Noncompetition Agreements, Indemnity Rights and Broad Releases: The California Supreme Court’s Edwards v. Arthur Andersen Medley Jonathan Werner, Esq. and Cynthia Fair Moir, Esq. On August 7, 2008, the California Supreme Court delivered its much‐anticipated opinion in the Edwards v. Arthur Andersen case and, as expected, it is a significant decision. In addition to definitively rejecting the “narrow restraint” doctrine that had been developed over a series of federal court decisions as an exception to California Business & Professions Code § 16600’s strong prohibition against noncompetition agreements, the justices also weighed in on the validity of broad release agreements waiving “any and all claims” that an employee might have against his employer, concluding that such broad releases are enforceable, and that they do not encompass the unwaivable statutory indemnity obligation an employer owes its employees under California Labor Code § 2802. Background Raymond Edwards II was employed by the now‐defunct Arthur Andersen LLP in its Los Angeles tax group from January 1997 to April 2002. As a condition of employment, Arthur Andersen required Edwards to sign a noncompetition agreement prohibiting him from working for or soliciting Arthur Andersen clients or employees for 18 months after his termination. In 2004, Arthur Andersen sold its practice to various entities, including HSBC. In connection with the sale, HSBC offered employment to certain Arthur Andersen employees (including Edwards), conditioned upon their executing a Termination of Non‐Compete Agreement (“TONC”). The TONC purported to release the employees from the terms of Arthur Andersen’s non‐competition agreement, but also required employees to release Arthur Andersen from “any and all claims” related to their employment with Arthur Andersen. When Edwards refused to sign the TONC, he was terminated from Arthur Andersen, and HSBC withdrew its offer of employment. California law severely limits an employer’s ability to prohibit former employees from competing against the employer. This limitation is codified in California Business & Professions Code § 16600. Section 16600 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 statute provides very narrow exceptions to section 16600, and only permits noncompetition agreements that are entered into in connection with the sale of a business or dissolution of a partnership or limited liability company. In addition to these stated exceptions, California courts have held that an employer has a protectable interest in its trade secrets, and may prohibit an employee from using those trade secrets to compete against the employer. Other than these limited exceptions, California courts have routinely invalidated agreements containing limitations as to time and geographical scope that would otherwise be acceptable in most other states. The California courts’ strict application of section 16600’s prohibition can be contrasted with the looser application of the statute by the Ninth Circuit Court of Appeals. The Ninth Circuit has construed section 16600 to permit employers to restrict employees’ post‐termination activity as long as the restrictions imposed only constituted a “narrow restraint” on the employee. It is the Ninth Circuit’s application of this “narrow restraint” doctrine that gave rise to the dispute in Edwards. No More “Narrow Restraint” The California Supreme Court soundly dispatched the “narrow restraint” doctrine espoused by the Ninth Circuit as a misapplication of California law. Noting that Business Professions Code § 16600 “unambiguously” rejects even partial restraints on an individual’s right to practice his profession, the Court held that the noncompetition agreement Edwards signed as an Arthur Andersen employee was invalid because it precluded him from soliciting Arthur Andersen clients regardless of whether he was using trade secrets to do so, which unduly limited Edwards in pursuing his chosen profession. The Court noted that “California courts have not embraced the Ninth Circuit’s narrow restraint exception. Indeed no California state court decision has endorsed the Ninth Circuit’s reasoning, and we are of the view that section 16600 represents a strong public policy of the state which should not be diluted by judicial fiat.” An Employee’s Statutory Indemnity Rights are Unwaivable On a separate issue, the Court held that the broad release language contained in the TONC proffered to Edwards was lawful, and that such broad releases, which are routinely used by employers, should not be read to include a release of an employee’s statutory indemnity rights under Labor Code § 2802. In its ruling, the Court overturned the Court of Appeal’s holding to the contrary, noting that the indemnity contained in Labor Code § 2802 was made expressly unwaivable by operation of Labor Code § 2804. The Court’s decision, while unhelpful to employers to the extent that it forecloses the use of the “narrow restraint” doctrine to protect their valuable business interests, is useful to the extent that it offers clarity by resolving the longstanding split between California courts and the Ninth Circuit regarding section 16600. Moreover, the Court’s upholding of the broad release language contained in the agreement Arthur Andersen proffered to Edwards should provide some reassurance to California employers that the broad releases routinely used by employers to resolve potential claims with employees will be honored by the courts. In view of Edwards, employers would be well‐advised to conduct a thorough audit of all current employment agreements, employee handbooks and other written policies to ensure that these documents do not contain any language (a) that would constitute a “narrow restraint” on an employee’s right to compete, or (b) that would purport to contain a release of an employee’s indemnity rights under Labor Code § 2802. Jonathan Werner is an Associate in the Firm’s Labor & Employment Practice Group. He can be reached at (213) 891‐
5203 or [email protected] Cynthia Fair is an Associate in the Firm’s Labor & Employment Practice Group. She can be reached at (415) 227‐3507 or [email protected]