Generally speaking, non-compete provisions are invalid in California, though they are valid in many other states. California is a labor-friendly state and does not want employers to be able to restrict former employees’ ability to earn a living. So in most cases, non-compete clauses are invalid and unenforceable in California. There are three exceptions, however, which mostly deal with selling or dissolving a company or partnership.
• The three exceptions are:
o Selling the goodwill of a business or otherwise disposing of all of one’s ownership in a business entity.
o The dissolution of a partnership.
o The dissolution of an LLC.
The first exception permits the enforcement of a non-compete provision against any seller or owner of a business entity. This means that any foundation document for a business entity, such as a shareholder agreement or operating agreement (for a corporation or LLC, respectively), can restrict its owners from competing against the company, whether in an ownership, employment or other capacity, if they are to withdraw from or sell their interest in the business entity. This exception also allows a buyer to require that a seller who is selling all of its interest in a business to agree to a non-compete restriction.
The second and third exceptions, applicable only to the dissolution of a partnership or LLC, allow the same restriction to apply even if the business is not being continued. Oftentimes, owners of a company decide to simply dissolve a company when a key participant leaves, rather than try to continue to operate it as is. One or more of the owners may, however, have intentions of starting or working for a similar or competitive business to the dissolving business soon after the dissolution takes place, rather than simply continuing to operate the existing business. To prevent an owner from starting the same type of business right after the dissolution, the other owners may require that all or certain owners cannot start or work for a business that would have been competitive with the dissolving business by adding a non-compete provision to the business dissolution or settlement agreement.
It is important to remember that all non-competes must be limited in time and geography, e.g. up to two years after the sale or withdrawal within a 25-mile radius of the business’ headquarters. Moreover, there are other valuable provisions that can be used effectively to either circumvent the general prohibitions against non-compete provisions or to supplement the valid use of non-compete provisions, such as non-solicitation, confidentiality, proprietary materials and trade secret clauses.
The takeaway here is that non-competes are rarely valid in California, but don’t miss the opportunity to use them in the cases when they are enforceable, in the sale or dissolution of a business, or to use similar provisions that are valid in much broader circumstances.