Covenants not to compete still unenforceable in California

One of the most frequent questions I get asked comes from clients who want to start a business but are fearful of provoking a lawsuit from their employers to enforce covenants not to compete.  California Business & Professions Code, section 16600 states:

Except as provided in this chapter, every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.

Despite this clear expression of policy by our legislature, employers still routinely use these illegal clauses in employment agreements.  In most cases, the straightforward rule of Section 16600 applies.  There are some instances, involving business owners selling their businesses or employees unlawfully using trade secrets, which can complicate the analysis.  However, California courts and private arbitrators are routinely setting aside these illegal agreements to restrain competition.  In July 2013, Hon. Burton S. Katz (Ret) issued a final, binding arbitration award in a lawsuit between Tri-City Healthcare District (“Tri-City”) and Pediatrix Medical Group of California (“Pediatrix.”) Tri-City and Pediatrix participated in arbitration before the American Arbitration Association to resolve a dispute over Tri-City’s May 2011 decision to replace Pediatrix with Dr. Hamid Movahhedian as head of Tri-City’s Neonatal Intensive Care Unit (“NICU”). Pediatrix sought to enforce an illegal “no hire” provision contained in its contract with Tri-City that purported to prevent Tri-City from hiring the best and most qualified physician, Dr. Movahhedian, to run the NICU. Pediatrix also sought over $2 million in damages against Tri-City for allegedly inducing Dr. Movahhedian to violate an illegal covenant not to compete contained in its employment agreement with Dr. Movahhedian.

California law has long condemned the use of and has consistently refused to enforce “no hire” provisions and “covenants not to compete.” Ruling that these clauses are in fact illegal in California, Judge Katz noted:

This is not a case of who … is at fault; rather it is a case about the freedom in making decisions to renew or not renew an existing contract and to hire another provider. This is a free society and the law has little patience with either restrictive covenants that purport to limit this freedom of choice or penalties imposed because such free choices are exercised.

Tri-City sought and received a judicial determination that the “no hire” provision in its contract with Pediatrix was illegal. Judge Katz also ruled that Tri-City is not liable to Pediatrix for inducing Dr. Movahhedian to breach the illegal covenant not to compete in Dr. Movahhedian’s employment agreement and hence denied Pediatrix’s request for two million dollars in alleged lost profits that Pediatrix claimed it would have earned over a four year period. Following ten days of testimony, Judge Katz did award Pediatrix $3,800 in damages against Tri-city because Tri-City did not allow Pediatrix to complete the final 18 days of its contract in May 2011.

Tri-City was represented by Jeffrey Lewis and Hanni Pichel of BROEDLOW LEWIS LLP. Pediatrix was represented by Matt Oster of McDermott Will & Emery. Dr. Movahhedian was represented by William W. Whelan of SOLOMON WARD SEIDENWURM & SMITH, LLP

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