What You Don't Know Can Hurt You

If you thought you were safe from the craziness of California employment law just because you don’t have any employees there — think again.

Welcome to the second edition of this column. For those of you who missed the introduction in the July 2003 issue, this column is dedicated to keeping my fellow in-house counsel out of trouble — caused by either relying on a seemingly reasonable assumption that turns out to be wrong, or by being blindsided by a risk you never saw coming.

The topic discussed here provides an example of a risk that I venture most of us would never anticipate.

Jeff Brody, an employment law partner at Jackson Lewis LLP, assisted me in preparing this article. Jeff specializes in advising employers on day-to-day workplace issues, such as family and medical leave laws, wage and hour laws, employee discipline and discharge and non-competition agreements.

Ugly Scenario

Here is a very ugly scenario we would ask that you consider.

Your company is headquartered in Connecticut, and you hire a new executive vice president of sales to head up your sales team. The new sales chief was already residing in Connecticut and will work out of your Connecticut headquarters. He will manage your national sales team and meet with clients by traveling from Connecticut as necessary.

You have him sign your standard non-compete agreement, which has a choice of law provision calling for Connecticut law to apply.

By the way, you drafted the form non-compete agreement as one of your first tasks as in-house counsel for the company and the form had been blessed by your local (and very expensive) outside counsel.

After working for you just long enough to learn every dirty little secret of your company, the sales chief takes a job as head of sales for your largest competitor, a California company. The former employee, however, does not relocate to California, but instead continues to reside in Connecticut.

As soon as your CEO finds out, she comes screaming into your office demanding the former employee’s head on a stick. You send a nasty notice letter to the former employee and new employer and get a response you didn’t expect. — a letter from the California company’s counsel pointing you to the California statute prohibiting non-competes and informing you that any effort to enforce it might subject you to damages under the California unfair business practices act.

After you do a little research and find out California counsel might be right, you sit down and try to figure out how you are going to tell the CEO that you might not be able to enforce the company’s non-compete agreement.

Specifics Of California Law

Section 16600 of the California Business and Professions Code renders non-competition agreements unenforceable in California, stating 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.” (There are some very limited exceptions to this general rule under California law, but they are outside the scope of this column.)

Adding insult to injury, a violation of Section 16600 may also be a violation of California’s unfair business practices act. More specifically, Section 17200 of the California Business and Professions Code prohibits unfair competition, defined as “any unlawful, unfair or fraudulent business act or practice and unfair, deceptive, untrue or misleading advertising.”

A Case In Point

Just in case you thought my horror story above was interesting but could never happen in real life, read on.

In Application Group, Inc. v. Hunter Group, Inc (61 Cal. App. 4th 881 (1998)), the defendant, Hunter Group, Inc., hired a specialist in computerized human resources management systems to work out of its Baltimore office.

Hunter had the employee sign a non-competition agreement prohibiting the employee from working for a Hunter competitor for one year after terminating her employment. The agreement also contained a Maryland choice of law provision.

After the employee had worked for Hunter for approximately 16 months, the plaintiff, Application Group (AGI), a direct competitor of Hunter, recruited and hired away the employee. The employee did not relocate to California, but instead worked for AGI from her residence in Maryland.

AGI and the employee filed suit in California seeking a declaratory judgment that the restrictive covenant contained in the employment agreement was unenforceable.

The trial court entered a judgment declaring the restrictive covenant unenforceable, and Hunter appealed.

The specific issue before the appellate court was whether California or Maryland law should apply. Hunter argued that Maryland law should control because that is where the noncompetition agreement was signed, and that is where the former employee resided during and even after her employment ended.

AGI and the employee argued California law should control to protect a California employer.

The appeals court held that California’s interest in protecting its policy against non-competition agreements outweighed the interest in Maryland in upholding them.

Just to show they weren’t fooling around, the court upheld the trial court’s decision that the non-competition agreement also violated California’s unfair business practices act, thus exposing Hunter to a potential claim for attorney’s fees.

What Are You Supposed To Do?

It depends. (This is just such a clichéd lawyer’s response that I couldn’t resist).

In this case, however, it really does depend. If you are fortunate enough to be in the position of trying to avoid the problem before it happens, you have some ability to draft yourself some protection.

Even in California, employers can protect trade secrets and confidential information through a properly drafted agreement. California will also enforce a narrowly tailored non-solicitation agreement that prohibits an employee from soliciting the customers he solicited on behalf of his former employer, provided that the non-solicitation agreement is designed to protect confidential information and/or trade secrets. (Careful drafting can also assist employers with enforcing post-employment restrictive covenants in other states that, like California, will enforce such agreements only in very limited circumstances, such as Texas, Oklahoma, Georgia, Colorado and Illinois.)

Another novel approach is to consider using an ERISA severance plan with a non-compete as a condition of the plan. Such a plan is arguably governed by ERISA and preempts any conflicting state laws.

Before you get too excited about this option, the end result would likely be a return of the severance payment rather than an enforceable non-compete.

If, however, a former employee takes that job with your California competitor, and you don’t have any fancy drafting in place already, your only hope is the proverbial race to the courthouse. Get to court in your state, before the new employer and former employee get to a court in California, and try to move your case as quickly along to judgment as you can.

Here’s why.

Late last year, the California Supreme Court had a case with a story strikingly similar to Application Group, but that came to the court under different procedural circumstances.

In Advanced Bionics Corp. v. Medtronic, Inc. (59 P.3d 231 (Cal. 2002)), a Minnesota court entered a temporary restraining order preventing an employee and his new California employer from violating the non-competition agreement the employee entered into with his former Minnesota employer.

While the Minnesota case was pending, a California court entered a temporary restraining order prohibiting the former employer in Minnesota from taking any further action in the pending Minnesota case.

Let me repeat that, just to make sure get the full flavor of the mischief the California court was up to.

It issued a TRO against the former employer prohibiting it from taking any further action in the Minnesota case that predated the California action.

Surprisingly, the California Supreme Court held that the trial court went too far in enjoining the proceeding of another state court and overturned the lower court’s ruling. Just in case, however, you were beginning to relax, thinking that the world was once again right, the California court made clear that the Minnesota court did not divest the California court of jurisdiction and that the employee and his new employer remained free to continue litigating the California action until the former employer can demonstrate that it received a binding judgment.

In other words, gentlemen and ladies, start your engines.

Conclusion

Okay, now what do we do with our newfound knowledge on the enforceability (or lack thereof) of non-competition agreements when California finds a way to get involved?

At the very least, you probably mention the risk to the senior folks involved in the hiring and firing process for your company before there is a problem. If you don’t already require non-solicitation agreements, consider making it a requirement of the employee’s next stock option or restricted stock grant or (God willing, as my mother would say) pay raise.

Finally, you need to be prepared to move quickly if you hear that a former employee has taken a job with a California employer. (One of your HR department’s standard exit interview questions should be have you taken a job somewhere else.) This means having a relationship with qualified local employment counsel, ideally one that is already familiar with your employment agreements and business.

I hope that you found this article helpful. Of course, it’s not intended to be legal advice and you should seek outside counsel if faced with a similar issue

If you have any questions, comments or suggestions on this column or suggestions for future topics, please contact me at [email protected].

Gabriel Miller is general counsel and secretary for Captivate Network, the national news and entertainment network. Captivate reaches over 1.4 million affluent consumers and business professionals every work day via ‘TV’ screens in elevators of premier office towers across North America. Captivate is headquartered in Massachusetts and has offices throughout North America.

Jeffrey S. Brody is a litigation partner at Jackson Lewis LLP in the firm’s Boston office. Jackson Lewis is a national law firm, with 20 offices, exclusively representing management in the field of workplace law and related litigation.