The Future of Loral and Employee Non-Solicit Provisions By Rick - - PDF document

The Future of Loral and Employee Non-Solicit Provisions

By Rick Bergstrom & Mhairi Whitton

Introduction Recent high-profile cases involving challenges to anti- solicitation agreements between companies under antitrust laws have caused California employers to question the continued enforceability of employee non-solicitation provisions typically included in proprietary/confidential information agreements. The answer (at least for now) is - it depends.1 Non-Competes and Employee Non-Solicitation Provisions California’s general disdain for non-compete agree- ments is well publicized. Its broad public policy prohibiting non-compete agreements is codified in California Business & Professions Code section

• 16600. In general, this section provides that agreements

that prohibit a former employee from ‘‘competing’’ with his or her former employer, whether in the context of joining a competitor company or founding a competing entity, are unenforceable in California except in limited circumstances defined by the statute.2 Further, in 2008 the California Supreme Court determined that provisions preventing former employees from competing with their former employers by soliciting their customers (absent use of trade secrets) are likewise void based on Section 16600.3 The law regarding agreements prohibiting an employee from soliciting employees from former employers, however, is far less clear at this point. Employee non-solicitation agreements can be split into two general categories: (a) no-hire provisions in which an employee (or another company) agrees that he or she will not hire other company employees; and (b) non-solicitation provisions in which the employee (or another company) agrees that he or she will not solicit other company employees. There is a dearth

• f authority in California regarding both forms of

non-solicitation agreements, with three main cases providing the touchstones for determining a provision’s enforceability. For more than two decades, Webb v. West Side District Hospital4 and Loral Corporation v. Moyes5 were the seminal California cases concerning the enforceability

• f non-solicitation provisions.6 Webb upheld the en-

forcement of a no-hire provision, and Loral held that a non-solicitation agreement was valid. For more than 20 years, these two cases were the defining cases regarding non-solicitation agreements, until the 2007 decision by the California Court of Appeal in VL Systems, Inc. v. Unisen, Inc.,7 which held a no-hire provision to be an unenforceable restraint on trade. VL Systems, however, did not eviscerate the holdings in either Webb or Loral, but rather reaffirmed the ex- tent to which the breadth of the provision – and the facts unique to each case – will come to bear on its enforceability. Webb and Loral: Two Decisions, Two Decades In 1983, the court of appeal in Webb upheld a no-hire agreement that was relatively narrowly tailored. West Side District Hospital had entered into an agreement with Dr. Harry Webb, whereby Webb would provide West Side with physicians to staff the hospital’s emer- gency room in exchange for payment by West Side. The agreement contained a provision whereby West Side agreed that it would not hire (direct or indirectly) any physician who had, through Webb, previously worked for the hospital. If West Side breached this provision, it would be required to pay Webb the sum of $30,000 per physician hired. After termination of the parties’ agreement, West Side, through a different contracting company, hired four physicians who had previously performed work at the hospital through Webb’s service.

1

The question of whether non-solicitation agreements comply with anti-trust laws is outside the scope of this article.

2

• CAL. BUS. & PROF. CODE § 16601.

3

Edwards v. Arthur Andersen LLP, 44 Cal. 4th 937, 942 (2008).

4

144 Cal. App. 3d 946 (1983), disapproved on other grounds in Moncharsh v. Heily & Blase, 3 Cal. 4th 1 (1992).

5

174 Cal. App. 3d 268 (1985).

6

The 2006 decision in Strategix, Ltd. v. Infocrossing West, Inc., 142 Cal. App. 4th 1068 (2006), addressed non- solicitation provisions, but only in the context of the sale of a business.

7

152 Cal. App. 4th 708 (2007).

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In arbitration, West Side argued that the no-hire provision rendered the contract void as an unenforceable restraint

• n trade. The arbitrator disagreed and found for Webb – a

ruling which was confirmed by the superior court. On appeal, the court addressed a two-pronged restraint on trade argument: that the provision unreasonably re- strained the hospital from hiring whom they chose, and also restrained the physicians from plying their trade as they wished. The court of appeal ultimately held that the $30,000 fee that would have to be paid by the hospital to Webb per physician hired were reasonable and did not illegally restrain trade. Indeed, as the court noted, the fee was similar to the rate the hospital would have had to pay to an employment agency to recruit a

• physician. In addition, the appellate court held that the

no-hire provision did not constitute an unreasonable restraint on the physicians, as they could still work at the hospital, provided the hospital paid the ‘‘reason- able’’ fee.8 Two years later, in Loral the court of appeal upheld a different type of restrictive covenant: an agreement to refrain from actively soliciting employees. Robert Moyes was an executive with, and member of, the Board of Directors of Loral Corporation when he resigned his employment and signed a termination

• agreement. Pursuant to the agreement, Moyes agreed

to preserve the confidentiality of Loral’s trade secrets and confidential information, and to not ‘‘now or in the future disrupt, damage, impair or interfere with the business’’ of his prior employer.9 Almost im- mediately upon securing new employment, Moyes allegedly breached the agreement by offering em- ployment to a number of Loral employees. Moyes’s poaching of Loral’s employees caused the company to spend over $400,000 recruiting replacement employees. The trial court granted nonsuit to Moyes, agreeing with his contention that the agreement was void under Business and Professions Code section 16600 as an unlawful restraint in trade. The appellate court had a different take, holding that the restriction on soliciting employees did ‘‘not appear to be any more of a significant restraint . . . than a restraint on solicitation of customers or on disclosure

• f confidential information.’’10 The court noted that

unlike a no-hire provision, the non-solicitation agree- ment ‘‘only slightly affects’’ Loral employees, because they were not prevented from seeking employment by contacting Moyes – they were only affected inso- much as Moyes could not contact them.11 In holding the non-solicitation provision enforceable, the court

• f appeal found that the provision ‘‘has no overall

negative impact on trade or business’’ and was therefore ‘‘not void on its face’’ under Section 16600.12 VL Systems: Distinguishing Webb and Loral In the 22 years between Loral and VL Systems, Cali- fornia courts did not specifically address no-hire or non-solicitation provisions, but continued to disfavor restraints on employee mobility. More particularly, court decisions trended towards supporting restrictive covenants only to the degree ‘‘necessary to protect the [prior] employer’s trade secrets.’’13 For instance, in determining that customer non-solicitation agreements are enforceable only to the extent necessary to protect an employer’s legitimate trade secrets, the California Court of Appeal reiterated the importance of having a basis for the restrictive covenant separate and apart from restraining trade for business purposes.14 In the VL Systems case, VL Systems entered into a consulting contract with Star Trac Strength for the provi- sion of a relatively small amount of consulting services (approximately 16 hours of work). The contract between the two businesses included a provision that barred Star Trac, for a period of 12 months after the consulting agreement ended, from hiring any employee of VL Systems (regardless of whether Star Trac had interacted with that employee during Star Trac’s work for VL Systems). In the event Star Trac breached this provision, the contract provided for liquidated damages in the amount of 60 percent of the annual compensation paid to the hired individual. Months later and after Star Trac’s work with VL Systems had ended, VL Systems hired an engineer named David Rohnow. After only two months on the job, Rohnow informed VL Systems that he was resigning, but would stay on to train his

• replacement. After he had already given notice to VL

Systems, Rohnow responded to an advertisement placed by Star Trac and was eventually hired. The trial court found for VL Systems and ordered Star Trac to pay the liquidated damages.

8

Webb, 144 Cal. App. 3d at 954-55.

9

Loral, 174 Cal. App. 3d at 274.

10

174 Cal. App. 3d at 279.

11

174 Cal. App. 3d at 279.

12

174 Cal. App. 3d at 280.

13

Metro Traffic Control, Inc. v. Shadow Traffic Network, 22 Cal. App. 4th 853, 859 (1994).

14

Thompson v. Impaxx, Inc., 113 Cal. App. 4th 1425 (2003).

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In its 2007 decision, the court of appeal weighed the ‘‘important principle’’ of freedom of contract against the ‘‘serious[] impact [to] a broad range of third parties’’ that could result from the enforcement of no- hire provisions.15 Finding that the holding in Webb was not controlling ‘‘in light of its very different facts.’’16 The appellate court noted that the scope of the no-hire provision at issue in Webb was limited to physicians who had actually worked for the hospital, while the provision in VL Systems’ contract had no such limitation as it applied equally to employees with whom Star Trac had worked and those with whom they had had no contact whatsoever. Similarly, the court distinguished the Loral decision by pointing to the different impact on employees. In Loral, the issue was the direct solicitation of employees – not the hiring

• f employees who had sought out the new employment
• independently. The contract in VL Systems, however,

barred the hiring of employees – even when (as in the case at issue) the employee was not solicited and never even performed any work for Star Trac under its contract with VL Systems. In finding the no-hire provi- sion unenforceable, the court of appeal noted that it was not taking a position on ‘‘whether a more narrowly drawn and limited no-hire provision would be per- missible under California law.’’17 The Continuing Application of Arthur Anderson Neither Webb, Loral, nor VL Systems resulted in review by the California Supreme Court, leaving open the possibility that the State’s highest court may one day either affirm the current law regarding employee non- solicitation agreements or change the law entirely. The supreme court most recently addressed issues concerning provisions that restrain trade in the employment context in Edwards v. Arthur Anderson, LLP.18 There, the court found that a customer non-solicitation was an unlawful non-compete and violated Section 16600. It is difficult to predict, however, how the court would view an em- ployee non-solicitation provision, and the outcome may depend in large part on the language of the provision at issue and the facts of the case. What Now? The Current State of Employee Non-Solicitation Agreements By carefully noting that it could distinguish both Webb and Loral, the court of appeal in VL Systems evaded making a definitive statement about the en- forceability of no-hire and non-solicitation provisions. It did, however, give a roadmap for crafting a provision that is likely to hold up under judicial scrutiny. Provisions that outright bar the hiring of employees are likely to be found unenforceable in many circum- stances and should generally be avoided. Where such provisions are used, they should be narrowly tailored, apply only to employees with whom the restrained individual works or becomes aware of during their employment, and/or make any hiring contingent on the payment of fixed sum liquidated damages. Separately, non-solicitation agreements between em- ployer and employee, like the one at issue in Loral, are likely permissible with the caveat that they should be limited in term and scope. The term of such provi- sions is typically limited to one or two years, and large employers should consider limiting the scope to em- ployees that the individual worked with and/or be- came aware of during the individual’s employment. Rick Bergstrom is a partner in the San Diego office of Jones Day, where his practice focuses on representing corporate clients in complex litigation in federal and state courts. He has significant experience defending companies in wage and hour class actions, litigating trade secret and employee mobility issues, whistle- blower claims, public access/disability claims, and advising companies regarding Affordable Care Act employment issues. Mhairi Whitton is an associate in Jones Day’s San Diego office, where her practice focuses on employment

• litigation. She has significant experience defending

corporate clients in state and federal court in single plaintiff, multi-plaintiff, and class actions up to and through trial.

15

VL Systems, 152 Cal. App. 4th at 713.

16

152 Cal. App. 4th at 713-14.

17

152 Cal. App. 4th at 718.

18

44 Cal. 4th 937, 942 (2008).

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