California Non-Solicit & Non-Compete Multi State Startup Problems?
Restrictive Covenants In California — Multiple laws and parties
We share with you an interesting fact pattern we recently dealt with in connection to non-competes and non-solicits in California startups.
Fact Pattern
Mr. X, a former employee of Startup A, is now a new employee of Startup B, both in the same line of business. Startup A is based in Pennsylvania while Startup B and Mr. X are based in California. In 2019, Mr. X signed a standard employment agreement with Startup A with Delaware as the governing law. The employment agreement contained a non-solicit and non-compete agreement valid for term of employment and 12 months after which restricts Mr. X from:
- Engaging in any manner in any business that provides similar services with Startup A in the geographical area Mr. X worked in during employment
- Soliciting or aiding another in soliciting an employee or client of the Startup A.
Both Startup A and Startup B are in the business of recruiting talent for companies. Startup A works with contractors from India (“Foreign Contractors”) and Mr. X would like to solicit some of these contractors for Startup B.
Applicable Law
Cal. Lab. Code § 925(a) provides that an employee may not require an employee who primarily resides and works in California, as a condition of employment, to agree to a provision that would do either of the following: (1) [r]equire the employee to adjudicate outside of California a claim arising in California; (2) [d]eprive the employee of the substantive protection of California law with respect to a controversy arising in California.
It is well established that California has a strong public policy against the enforcement of restrictive covenants, such as non-compete and non-solicit covenants, against employees. This is so even when the employer invokes Delaware law as the governing law in restrictive covenant agreements with their employees. Based on this, the Delaware courts usual choose to invalidate the Delaware choice-of-law provisions and apply California law to void the restrictive covenants — i.e., except where an exception applies. In the case of Ascension Insurance Holdings, LLC v. Underwood, the Delaware Court of Chancery found a covenant not to compete to be void and unenforceable under California law (despite the the agreement containing Delaware forum-selection and choice-of-law provisions) because of the well-established principle that (i) California public policy disallows contractual agreements not to compete, and (ii) because California law would have applied in the absence of the Delaware choice-of-law provision.
Non-compete.
Cal. Bus. & Prof. Code § 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. Although there are exceptions to this — e.g., where the employee was advised by counsel the non-compete is a condition to a sale of business owned by the employees or as a result of a dissociation from, or dissolution of, a partnership, none of these exceptions are applicable here. As such, the non-compete restrictive covenant will not be applicable to Mr. X and Mr. X can start work with Startup B after termination of service with Startup A.
Non-solicitation.
First, the non-solicit provision in the agreement provides that A shall not solicit or aid another in soliciting Startup A’s employees, i.e., employees only, and does not mention contractors. Depending on the context, there are many definitions of who an employee is. In most cases, an employment relationship exists (i) if employer has right to control the work process, as determined by evaluating the totality of the circumstances and specific factors; or (ii) where an individual is economically dependent on a business for continued employment; or (iii) by looking at (i) and (ii). However, while it’s not clear what the services the Foreign Contractors provide, based on the nature of the business, i.e., recruitment of talent for corporate entities, the Foreign Contractors are likely not employees of Startup A. Therefore, the non-solicit clause does not apply in this instance.
However, assuming that the Foreign Contractors may be considered employees of the Company, the non-solicit clause in the agreement with Startup A would still be considered void since Mr. X’s employment with Startup A is governed by California law. In the case of AMN HealthCare Inc. v. Aya Healthcare Services Inc., the California Court of Appeal held that the provision of Cal. Bus. & Prof. Code § 16600 is an absolute bar on contractual restrictions. i.e., any restrictions that restrained a person from engaging in a lawful profession, trade, or business of any kind is to that extent void. If part of Mr. X’s duties as an employee in Startup B is recruiting candidates, the non-solicit clause is a form of restriction on his profession and for that reason, would be considered void. Therefore, the non-solicit clause in the agreement with Startup B would not be considered sufficient to prevent Mr. X from soliciting the Foreign Contractors.
Trade Secrets.
Please note however that it may be argued that because Startup A functions as a recruitment agency, the names, identities, addresses, and contact details of its candidates (including the Foreign Contractors) are trade secrets and by reaching out to Startup A’s Foreign Contractors, Mr. X has disclosed Startup A’s trade secrets and should not be protected by Cal. Bus. & Prof. Code § 16600.
For this to succeed, Startup A would have to show that solicitation is wrongful independent of any contractual undertaking, i.e., the action would not be under a “breach of contract claim” but that the solicitation is wrong under another theory of law. For instance, if Startup A can prove that (i) it is an employment agency; and (ii) the details of the Foreign Contractor is part of its customer list — i.e., it is part of its trade secrets, Mr. X can be sued by StartupA for misappropriation of trade secrets. To scale this hurdle, Mr. X would have to be able to prove that Mr. X had access to or obtained such names and contact details independent of his employment with Startup A; that the Foreign Contractors work with many different recruitment firms in order to increase the likelihood that they will be placed in assignments which fit their needs; or that the details of the Foreign Contractors were available elsewhere independent of Foreign Contractors knowledge.
Conclusion.
Although under California law the non-solicit clause in the employment agreement would not be sufficient to prevent Mr. X from soliciting the Foreign Contractors for Startup B, there is a possibility that the details of the Foreign Contractors may be considered trade secrets and by reaching out to the Foreign Contractors for Company, Mr. X may be liable for misappropriation of trade secrets.
The above is based on the Fact Pattern and the Foreign Contractors may have restrictive covenants in their own respective agreements which may restrict them from engaging with Startup B. Additionally, other issues may exist that could affect the facts that are the subject of this analysis.
