Are noncompetition clauses legal in California?
Is it legal for an employer to make a new employee sign an employment agreement reciting that if the new employee leaves the company he/she may not compete in business? Spoiler alert: no.
Is it legal in a business sale transaction for the seller to restrict the buyer from competing in business or soliciting existing customers of the business after the close of the sale? Spoiler alert: read on.
Business Sale: Soliciting Customers Prohibited
The facts in our case today Blue Mountain Enterprises v. Owen are more complicated than we need but suffice it to say that Blue Mountain Air, a leader in the heating, ventilation and air conditioning market in Northern California, was sold. The company was principally owned by Gregory Owen. In the sale documents Owen contracted to manage Blue Mountain and agreed that for three years after the sale he would not “solicit for himself or any entity the business of a customer of any of the Blue Mountain Entities.” Of course, the purpose of the nonsolicitation clause was to protect the goodwill of the seller. Blue Mountain’s customers included in DR Horton, KB Homes, Lennar Corporation, Pulte Homes, Shea Homes, and Toll Brothers. Indeed, Blue Mountain was a substantial company in Northern California.
For reasons not disclosed in the court opinion, Owen was terminated for “cause.” He formed a new (competing) company Silvermark.
Owen and Silvermark wasted no time sending a general announcement to businesses and specific individuals who were customers of Blue Mountain informing them that he had started Silvermark. So far, so good. The (solicitation) letter went on to announce that Silvermark had “more resources and a much stronger team” and named two former Blue Mountain employees who had joined Silvermark.
Blue Mountain sued Owen for improperly soliciting its former customers for business.
Noncompetition Clauses are Generally Void
In California, contracts that prevent a person from engaging in a trade or business are generally void under California Business and Professions Code section 16600. Open competition and mobility are encouraged.
Thus, an employee can’t contract away his/her right to continue to work for another company in the same type of business upon his/her termination of employment.
However, like all laws there are exceptions. Section 16601 recites: “Any person who sells the goodwill of a business…may agree to refrain from carrying on a similar business within a specified geographic area…so long as the buyer…carries on a like business therein.” One of the goals of section 16601 is to protect the buyer’s interest in preserving the goodwill of the acquired business.
Owen argued that his emails to Blue Mountain’s former customers was not a “solicitation” but a general announcement of his new (competing) company.
The First Appellate District Court of Appeal noted that Owen’s emails were not sent to the general public which would arguably be an announcement of his new business, but were sent directly to Blue Mountain’s customers and their key ownership employees.
The court wrote that “merely informing customers of one’s former employer of a change of employment, without more, is not solicitation.” Actively encouraging Blue Mountain customers to leave Blue Mountain and do business with Silvermark is entirely different.
Having a lawyer involved in a business sale is wise. Besides sale terms and tax ramifications involved in a business sale, directly soliciting customers of your old business after signing a nonsolicitation clause is an obvious no-no.
Ruling in favor of Blue Mountain.
Jim Porter is an attorney with Porter Simon licensed in California, with offices in Truckee and Tahoe City, California, and Reno, Nevada. These are Jim’s personal opinions. Jim’s practice areas include: real estate, development, construction, business, HOA’s, contracts, personal injury, accidents, mediation and other transactional matters. He may be reached at firstname.lastname@example.org or http://www.portersimon.com.
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