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Covenants Not to Compete: Five “Exceptions” That Do Not Swallow the Rule

Posted in Covenants Not to Compete in California

Everybody who cares probably knows that, in California, covenants not to compete (agreements that restrain an individual from pursuing a lawful trade of profession) are generally unenforceable.  There are only five “exceptions” to this rule.  I put “exceptions” in quotes because two of them really aren’t exceptions at all. They are independent legal doctrines that run parallel to and (sometimes) trump California’s rule against covenants not to compete. The rules prohibiting these covenants are codified at section 16600 of California’s Business and Professions Code.

The statutory exceptions to that rule are found in the next three sections of the code and allow restrictions when: 1) the goodwill (or the entirety of someone’s interest) in a business is sold; 2) a partner leaves a partnership; or 3) a member leaves a Limited Liability Company.  The two other “exceptions” are restrictions on competition that arise from a legitimate effort to protect bona fide trade secrets and when, on rare occasions (due to the terms of a contract and the interaction of state and federal law), California must enforce an injunction against competition obtained in another jurisdiction.

These five paths to an enforceable covenant not to compete are each worth a long chapter in a fat book.  They are all the subject of substantial case law and legal commentary.  In many cases, the outer limits of these exceptions have not been fully defined.   When obtaining an enforceable covenant not to compete is important, these “exceptions” should be carefully considered.

At the outset of a business transaction, or when an enterprise is formed, there is a lot that knowledgeable actors can do to make a business fit within the sometimes murky limits of these exceptions.  While California law is filled with examples of judicial hostility to sham business arrangements designed to evade section 16600, California courts will and do enforce covenants that meet the requirements of a recognized exception.

To be sure, restraining employees against future competition in California isn’t easy.   But it is not impossible.