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Enforceability of Covenants
Not To Compete in California
By Dan Woods and Tim Rusche
White & Case, Los Angeles

Introduction
Many employers consider covenants not to compete in
employment agreements essential to protecting their
companies, their confidential information, and their top
employees from former employees whose departures
raise the threat of unfair competition.
It is important for employers relying on such clauses
in employment agreements to realize that California
courts disfavor covenants that restrain competition
and generally refuse to enforce them. This is true
even if the employer is located outside of California
but employs California residents. To be enforceable
in California, a covenant not to compete must fall
within an exception to the blanket rule of unenforceability without overstepping that exceptions
narrow bounds.
This article addresses the California law rendering
covenants not to compete unenforceable, when
covenants not to compete can be valid in California,
the difference between Californias and the Ninth
Circuits treatment of such covenants, and some
practical suggestions employers may use to protect
their businesses.

I. Covenants Not To Compete Are

Generally Invalid
California Business and Professions Code section
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. California courts

typically interpret the statute broadly and refuse to
enforce covenants not to compete. Except in
narrowly drawn, statutorily defined circumstances,
discussed below, California courts deem them to
violate Californias public policy that promotes
freedom of competition and an employees right to
move between jobs. Consequently, California courts
typically invalidate covenants not to compete. Hill
Medical Corp. v. Wycoff, 86 Cal. App. 4th 895 (2001).

II. Courts Will Not Rewrite Non-Competition

Agreements To Make Them Enforceable
Even if an employment agreement contains a clause
evidencing the parties desire to rewrite a covenant
not to compete should it be deemed unenforceable,
California law prohibits such revision. A clause that
is invalid under Section 16600 is illegal and
California courts have deemed the rewriting of
illegal covenants unacceptable. Hill Medical Corp. v.
Wycoff, 86 Cal. App. 4th 895 (2001); Kolani v. Gluska,
64 Cal. App. 4th 402 (1998).
For example, in one case, a California employer
attempted to incorporate a clause into a covenant
not to compete that granted the court permission to
rewrite the covenant if the court found it to be
unreasonable. The court invalidated and refused to
rewrite the covenant. The court reasoned that
permitting employers to include broadly written
non-compete clauses in employment agreements
and allowing them to rewrite the clauses if

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challenged would violate Section 16600. The court

foresaw employees feeling obligated to honor the
broad clauses without seeking the advice of counsel.
To prevent this practice, the court refused to permit
the revision of illegal covenants not to compete.
Kolani, 64 Cal. App. at 407.
Although California courts will not rewrite noncompetition agreements to make them legal, they
have narrowly construed such clauses in order to
keep them within permissible bounds of the
exceptions that permit restrictive covenants. Loral
Corp. v. Moyes, 174 Cal. App. 3d 268 (1985); General
Paint Corp. v. Seymour, 124 Cal. App. 611 (1932).

III. If Enforcement of a Covenant Not To

Compete Is Sought in a California Court,
California Law Will Be Applied
California courts will apply California law in order to
enforce its public policy favoring competition even if
a contract designates the law of another state or
country as the applicable law. Thus, when a contract
designates law other than California law to govern a
covenant not to compete, a California court will apply
California law and render the covenant void unless
the agreement falls within an exception or the other
states interest is more significant than Californias.
For example, where an employment agreement
designating Maryland law as governing was drafted
and entered into by an employer and employee in
Maryland, the California court declined to enforce
the covenant not to compete when the employee
left the employer and moved to California to work
for a competitor in violation of the agreement.
Although Maryland law would have upheld the
covenant not to compete, the California court ruled
that enforcing it would violate Californias public
policy of promoting and protecting open
competition. The court ruled that enforcing the
covenant would more substantially impair
Californias interest in enforcing its public policy
than Marylands interests in upholding the
covenant. As a result, the court applied California
law and voided the clause. Application Group, Inc.
v. Hunter Group, Inc., 61 Cal. App. 4th 881 (1998).

Even though they have refused to enforce

covenants not to compete governed by the laws of
other states, California courts have not gone so far
as to enjoin the courts of another state from
enforcing covenants not to compete. In one case, an
employee left his Minnesota employer to work for a
California competitor. The employee tried to use
California law to prevent the application of a
covenant not to compete. Rather than waiting to
challenge the covenants enforcement, the
employee sued in a California court to enjoin the
Minnesota employer from starting proceedings to
enforce the covenant in a Minnesota court. The
Supreme Court of California bowed to principles of
comity and judicial restraint in not upholding the
injunction even though its application would
promote California public policy. The court
reasoned that it would have been disrespectful to
deem the law of California so much more worthy
than that of another state and that doing so was an
indirect challenge to the dignity and authority of the
tribunal of the other state. Advanced Bionics Corp.
v. Medtronic, Inc., Cal. 4th 697 (2002).

IV. Employers May Not Force an Employee

To Sign a Covenant Not To Compete
Generally, California employers may not force
their California employees to sign non-compete
agreements. Making the signing of an unlawful
agreement a condition of employment warrants
a claim for wrongful termination. Even asking an
employee to sign a covenant not to compete or
using a signed covenant against an employee or
subsequent employer may lead to suits for
unfair competition.
For example, an employee sued his employer for
wrongful termination alleging that his employer
violated public policy when it fired him for refusing
to sign a confidentiality agreement that contained a
non-compete clause. The court ruled that an
employer could not lawfully make the signing of an
employment agreement containing an unenforceable covenant not to compete a condition of
continued employment. It made this finding even
though the agreement not to compete also

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contained a choice of law provision specifying the

law of a state that enforces such covenants and a
severability provision enabling the court to void the
problematic clause. The court held that an
employers termination of an employee who refuses
to sign an agreement that is contrary to California
law and policy constitutes a wrongful termination.
DSa v. Playhut, Inc., 85 Cal. App. 4th 927 (2000);
Kolani v. Gluska, 64 Cal. App. 4th 402 (1998).
Because covenants not to compete between an
employer and employee are invalid, the inclusion
of such a covenant subjects the employer to claims
of unfair competition under California Business
and Professions Code section 17200 (Section
17200). Section 17200 deems any unlawful
practice by a business to be unfair competition.
Because Section 17200 covers an employers
business practices concerning its employees, this
section subjects employers to suits for unfair
competition should they include an unlawful
covenant not to compete in their employment
agreement. Application Group, Inc. v. Hunter
Group, Inc., 61 Cal. App. 4th 881 (1998). Remedies
for unfair competition under Section 17200 include
restitution or an injunction preventing the
covenants enforcement. Cortez v. Purolator Air
Filtration Products Co., 23 Cal. 4th 163 (2000).

V. Covenants Not To Compete Arising From

the Sale of a Business May Be Valid
California Business and Professions Code section
16601 (Section 16601) permits an exception to the
blanket non-enforcement of covenants not to
compete. It provides that any person who sells the
goodwill of a business, any owner of a business
selling or otherwise disposing of all of his or her
ownership interest in that business, or any owner of
a business that sells, together with the goodwill of
the business, all or substantially all of its operating
assets, all or substantially all of the operating assets
of a division, or all of the ownership interest in a
subsidiary, may agree with the buyer to refrain from
carrying on a similar business within a specified
geographic area in which the business has been
carried on, so long as the buyer, or any person

deriving title to the goodwill or ownership interest

from the buyer, carries on a like business in that
area. In short, this exception permits a buyer of a
business interest to enforce a covenant not to
compete against the seller.
Included within this exception are merger
arrangements in which an employee sells his
business interest in a company by exchanging his
shares in that company for shares of the newly
merged company. For example, an insurance
company sought a preliminary injunction against its
former employee to enforce a covenant not to
compete entered into in conjunction with a merger.
The court held that, although the covenant arose in
a merger rather than an outright sale, the
transaction was included within Section 16601s
ambit. The employees exchange of his shares in the
pre-merger company for stock in the new company
served as consideration for the non-compete
agreement and did not prevent the transaction from
being a sale under Section 16601. Thus, the covenant
not to compete accompanying the merger was
enforceable. Hilb, Rogal and Hamilton Ins. Servs.,
Inc. v. Robb, 33 Cal. App. 4th 1812 (1995).
Courts have rejected a literal interpretation of
Section 16601 that would make all sales of assets
sufficient to bind sellers to covenants not to
compete. Instead, courts have interpreted Section
16601 to require the sale of a business entitys
goodwill along with its assets. The court may find
the existence of goodwill in a transaction through
the examination of all aspects of the transaction,
particularly the purchase or repurchase price of
stock, the structure and context of the transaction,
and the relative substantiality of the sellers portion
of the business. Hill Medical Corp. v. Wycoff, 86 Cal.
App. 4th 895 (2001); Bosley Medical Group v.
Abramson, 161 Cal. App. 3d 284 (1984). In a sale of
shares, fair market value can indicate that goodwill
was part of the transaction because one can infer
that that price incorporates the value of goodwill.
Hill Medical Corp., 86 Cal. App. 4th at 904.
In one case, after a doctor who sat on a medical
corporations board of directors resigned and

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sold back his stock in that corporation for its book

value, the corporation sought to enforce a
covenant not to compete entered into upon the
share sale. Because the book value was below
the market value of the shares, the court
determined that the sale did not include goodwill.
Accordingly, the resigning doctor was not bound
by the covenant not to compete. Id. at 906-907.
Sometimes, the specifics of the transaction indicate
a sham by which a party is trying to circumvent
California law to restrain an individuals ability to
engage in business rather than to protect a
legitimate interest in the value of a purchase. In such
a case, the covenant will not be enforceable
regardless of its literal alignment with Section
16601s exception. Bosley Medical Group, 161 Cal.
App. 3d at 291-92 (reasoning that a doctor who was
forced to buy shares and who was not provided any
real benefit from the stock, could not be bound by a
covenant not to compete accompanying a sale of
those shares far below market price).
The particular shareholders interest itself also
cannot be a sham for a sale to fall within Section
16601s exception. This, however, does not mean
that a shareholder needs an extraordinary or
majority interest. This issue was addressed when a
purchasing company entered into an agreement
with a selling company and several of its key
employees agreed not to compete with the
purchasing company upon leaving the company.
The court determined that the operations manager,
also a corporate officer, of the selling company who
owned 3% of the outstanding shares held a
sufficient interest in the selling company to render a
covenant prohibiting him from competing
enforceable. Although the employee argued that his
3% interest in the company and the fact that he
received less than $500,000 of the $23 million
purchase price made his interest too slight to
enforce the covenant, the court found that because
he was a substantial shareholder, owning the ninth
largest share, and because he was a principal officer
in the company, the purchaser had a legitimate
interest in restraining the officers competition
following the companys sale. Vacco Indus. Inc., v.
Van Den Berg, 5 Cal. App. 4th at 48-49.

Finally, the validity of a covenant not to compete

associated with the sale of an interest in a
company does not depend on the covenants
location in a particular type of agreement. For
example, one court upheld a covenant not to
compete, even though the covenant was
contained in an employment agreement as
opposed to the merger agreement. The court
ruled that the validity of the covenant did not
depend on its location, since Section 16601 does
not explicitly prescribe a mandatory form for a
covenant not to compete. The court reasoned
that courts should look to the purpose of the
statute over a covenants form in determining
whether to enforce covenants not to compete.
Hilb, Rogal, 33 Cal. App. 4th at 1825-26; Vacco
Indus., 5 Cal. App. 4th at 49.

VI. Covenants Not To Compete Arising

In Conjunction With The Dissolution
Of Or Dissociation From A Partnership
May Be Enforceable
Another exception to Californias policy disfavoring
covenants not to compete is found in the context of
the dissolution of a partnership or a partners
dissociation from a partnership. California Business
and Professions Code section 16602 (Section
16602) reads: Any partner may, upon or in
anticipation of a dissolution of the partnership or
dissociation of a partner from a partnership, agree
that he or she will not carry on a similar business
within a specified geographic area where the
partnership business has been transacted, so long
as any other member of the partnership, carries on
a like business therein. This exception applies to all
partnerships, including those of physicians,
accountants, and attorneys. Howard v. Babcock, 6
Cal. 4th 409 (1993) (applying the exception to a
partnership of attorneys); Swenson v. File, 3 Cal. 3d
389 (1970) (accountants); South Bay Radiology
Medical Assocs. v. Asher, 220 Cal. App. 3d 1074
(1990) (physicians); Haight, Brown & Bonesteel v.
Superior Court, 234 Cal. App. 3d 963 (1990)
(attorneys).

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Unlike the sale of a business exception, the

partnership exception does not rely on the departing
partner being compensated for goodwill. When a
physicians disability rendered him unable to
continue practicing in his area of medicine, the
partnership agreement deemed him a dissolving
partner, restrained him from competing with his
former partners, and did not compensate him for
goodwill. The court upheld the covenant not to
compete, ruling that the partnership was free to
agree to a covenant not to compete that did not pay
a withdrawing partner any amount for goodwill.
South Bay Radiology, 220 Cal. App. 3d at 1084.
California law has not only permitted the restraint of
competition by departing partners, but it has
permitted departing partners to enter into agreements to pay the partnership for the money it is
expected he or she will take away from the
partnership through competition. This allows a
departing partner to accept or solicit work without
restraint while protecting the interests of the
partnership by replacing the income and capital that
will likely be taken by the withdrawing partner.
Haight, Brown, 234 Cal. App. 3d at 969; Farthing v.
San Mateo Clinic, 143 Cal. App. 2d 385 (1956).

VII. Covenants Not To Compete Arising in

Conjunction with the Sale of a Limited
Liability Company May Be Enforceable
Californias Business and Professions Code allows
for another exception to the non-enforceability of
covenants not to compete in section 16602.5
(Section 16602.5). It sets out that [a]ny member
may, upon or in anticipation of a dissolution of a
limited liability company, agree that he or she or it
will not carry on a similar business within a specified
geographic area where the limited liability company
business has been transacted, so long as any other
member of the limited liability company, or any
person deriving title to the business or its goodwill
from any such other member of the limited liability
company, carries on a like business therein.
Although there is no case law on this particular
exception, it shares much of the same language as
Section 16602, implying that Section 16602.5 will
be treated in the same manner as Section 16602.

VIII. The Permissible Scope Of The

Statutory Exceptions

A. Territory
Californias Business and Professions Code allows a
buyer of a companys goodwill, a partner, or member
of a limited liability company to restrict sellers of
business interests or departing partners or members
from carrying on similar business within a specified
geographic area in which the business, partnership,
or limited liability company has transacted business.
Under this rule, California courts have upheld
covenants not to compete encompassing the entire
United States and beyond. So long as a party can
show that some business was conducted in those
areas, the court may uphold the covenant.
Because the exceptions serve to protect goodwill,
they cover the area in which goodwill is in need of
protection. This has been construed to be the area in
which a business goodwill has been established,
evidenced by where sales, production and phases of
the business have been conducted, as well as the
area where the business reasonably established its
goodwill based on particular business activities
being carried on there, such as promotional and
marketing activities. Allowing the scope of the
covenant to span the breadth of the practice or
business comports with the reasonableness requirement of a covenant not to competes geographic
scope. Monogram Indus., Inc. v. Sar Indus., Inc., 64
Cal. App. 3d 692 (1976) (upholding a covenant
against a challenge that its geographic scope was
overly broad by showing that the companys
goodwill extended or could reasonably be expected
to extend to the areas restricted by the agreement);
Roberts v. Pfefer, 13 Cal. App. 3d 93 (1970) (allowing
a covenant falling within Section 16602 to span
beyond the city or town in which the partnership
was physically located).
Although a covenant not to compete must have a
limit to its geographic scope, it is not clear
whether a covenant not to compete must actually
designate a specific area of application or whether
it is sufficient for the covenant merely to specify
that it applies in all areas where a company has
transacted business. The statutes language,

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specific geographic area, would appear to

require explicitness but courts have not answered
this question. Because of the uncertainty in this
area, it may be best for someone seeking to
enforce a covenant not to compete to be specific
when designating the geographic scope of the
covenant. Fleming v. Ray-Suzuki, Inc., 225 Cal.
App. 3d 574 (1990).

B. Time
Sections 16601, 16602, and 16602.5 specify that
covenants not to compete can prohibit competition
for as long as the buyer of the interest, or anyone
gaining title to the interest, other partners, or other
members of the limited liability company carry on a
like business. Thus, covenants under these sections
potentially may last for numerous years.
In one case, two brothers engaged in business
together agreed that the brother leaving the
business would not participate in a competing
business in the San Diego area. The final written
contract mistakenly omitted the clause. The court
found there was sufficient evidence that the
covenant was part of the agreement and narrowed
the duration so that the brother leaving the business
was only prevented from competing with his former
business for as long as it carried on a like business
in the area. Martinez v. Martinez, 41 Cal. 2d 704
(1953); see also Loral Corp. v. Moyes, 174 Cal. App.
3d 268 (1985) (We also observe the Legislature has
allowed business sellers to promise noncompetition to their buyers without time limitation
other than for the period so long as the buyer, or
any person deriving title to the goodwill or shares
from him, carries on a like business therein.).

C. Activity
Sections 16601 through 16602.5 provide that
covenants may prohibit sellers of business
interests, former partners or former members
from engaging in any competing business activity
in a specified geographic area. Monogram Indus.,
Inc. v. SAR Indus., Inc., 64 Cal. App. 3d 692 (1976).
Thus, although courts may adhere to the concept

that a covenant must be reasonable in terms of the

activity that it limits, courts have interpreted these
sections to reasonably exclude all competing activity from appropriate geographic regions.
Isolated instances of competition, however, are not
permissibly restricted under the statutory
exceptions. The purpose of the exceptions is to
allow businesses, partnerships, and limited liability
companies to protect themselves from substantial
detriment to their competitive position. Because
occasional transactions do not typically threaten
such an impact, the statute meant to target the
solicitation of significant business from the
business, partnership, or limited liability company.
Swenson v. File, 3 Cal. 3d 389 (1970).

IX. Californias Treatment of Covenants

Not To Compete Differs from that of
Federal Courts in California
California state courts uniformly invalidate
covenants not to compete when an employee is
restrained from pursuing an entire business, trade,
or profession. Unlike California state courts,
however, when the covenant restricts only a small or
limited part of the employees business, California
federal courts may uphold these covenants. In one
case, the plaintiff challenged a covenant not to
compete, claiming that it did not fall within a
statutory exception. While the federal court agreed
that California law prohibits covenants that restrict
trade unless specifically authorized by statute, it
read the statute narrowly and held that only
covenants not to compete that entirely restrain an
employee from pursuing his trade, profession, or
business are void under Section 16600. Campbell v.
Board of Trustees, 817 F.2d 499 (9th Cir. 1987).
Subsequent federal courts in California have applied
Campbell to uphold covenants not to compete. In
one case, a court enforced a covenant not to
compete against a crating company because it only
limited former employees ability to work in a
narrow segment of the packing and shipping
market. Likewise, in a later case, the court upheld a
six-month covenant attached to an employees sale

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of his stock options. The court reasoned that the

limited scope of the restriction made the covenant
enforceable. The court recognized the inconsistency
with California state court rulings but stated that the
federal courts had to defer to their own precedent.
IBM v. Bajorek, 191 F.3d 1033 (9th Cir. 1999); General
Commercial Packaging, Inc. v. TPS Package Engg,
Inc., 126 F.3d 1131 (9th Cir. 1997).
Comparing these federal decisions to California
state court decisions shows a difference in the
treatment of covenants not to compete. California
courts do not follow these federal decisions and the
federal courts continue to uphold narrowly drawn
covenants. None of the courts have shown a
willingness to modify their treatment of these
covenants, providing an incentive for employers
attempting to enforce a covenant not to compete to
file in federal court.

X. Practical Tips and Suggestions

Despite the difficulty in enforcing covenants not to
compete in employment agreements, employers
have several methods of protecting their interests.
These include the following:
Confidentiality Agreements Employers

should include a confidentiality provision in the

employment agreement that defines trade
secrets to include, if applicable, customer lists,
customer contacts, vendor lists, vendor contacts,
pricing lists, product information and testing
results, and strategic business and other similar
information. Although the employee may take
employment with a company competitive with
the employer, the employee may not use the
protected information against the employer. If
practical, the employer should restrict access to
trade secrets and maintain a log of all trade
secrets provided to the employee.
Covenant Not to Solicit Customers

Employers should include in the employment

agreement, or as part of the confidentiality
provision, a covenant not to use trade secrets to
solicit the employers customers. Such covenants

are only enforceable when necessary to protect

trade secrets and, therefore, should provide that
the employee agrees not to use the employers
trade secrets to solicit the employers customers.
Covenant Not to Solicit Employees

Employers should include in the employment

agreement a covenant not to solicit the
employers employees, providing that during
the term of this agreement and for a period of [1]
year after leaving the company, the employee
will not solicit the companys employees.
Covenant

Not to Compete During

Employment Employers should include in the
employment agreement covenants restricting
employees from competing during the term of
their employment.

Return of Property Employers should

include in the employment agreement a

provision requiring employees to return all
company property upon leaving the company.
Choice of Law Provision If the employer

desires to include a non-compete agreement in

the employment agreement and the company
is not exclusively operated in California, or if
the employee works and resides in a state
other than California, the employer should
include in the employment agreement a choice
of law provision designating law from a
jurisdiction other than California as the
controlling law. If suit is brought in another
jurisdiction, although not determinative in
California, the choice of law provision may
control. The employer should be sure,
however, that the jurisdiction designated in the
employment contract protects trade secrets to
the same extent as California.
File First If an employee is violating a

covenant not to compete contained in his or her

employment agreement or if it appears that the
employee may challenge the validity of a noncompete agreement, the employer seeking to
enforce a covenant not to compete that does not
fall within an exception should, if possible, file
suit outside of California or, at the very least, in

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federal court. If the employee sues first in

California, it is likely that the California court will
assume jurisdiction over the employer and
invalidate the covenant not to competeeven
with a contrary choice of law provision in the
employment contract.

Conclusion
California courts consistently disallow covenants
restraining employees from competing against
their former employers. As discussed, however,
there are limited exceptions to this rule. A buyer
of a business interest, partners in a partnership
and members of a limited liability company may
enforce covenants not to compete against sellers
of business interests, departing partners or
departing
members,
respectively. These
exceptions allow covenants to restrain such
individuals from competing in the same business

within the same geographic area as the buyer,

partners or members, as long as the buyer,
partners or members continue to operate the
same business. Moreover, courts may uphold
restrictive covenants to protect trade secrets and
prevent unfair competition. Thus, buyers,
partners, members, and employers may in certain
circumstances utilize covenants to protect their
business from the potential competitive harm
caused by sellers, departing partners, members
or employees. Individuals seeking to protect their
businesses with restrictive covenants, however,
must take care to properly construct the
covenants in order to avoid the numerous pitfalls
faced when attempting to overcome Californias
general disfavor of such agreements.

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