California Supreme Court Invalidates Most Noncompetition Agreements But Validates Most General Release Agreements

The California Supreme Court yesterday released its opinion in Edwards v. Arthur Anderson LLP, S147190 (Aug. 7, 2008), in which the Court held that (1) Section 16600 of the California Business and Professions Code prohibits employee noncompetition agreements unless the agreement falls within a specific statutory exception, and (2) a typical provision whereby an employee releases “any and all” claims does not encompass nonwaivable statutory protections, such as the employee indemnity protection of Section 2802 of the California Labor Code.

By way of background, plaintiff Raymond Edwards, prior to accepting a position with Arthur Anderson LLP as a tax manager, signed a noncompetition agreement that prohibited him from working for or soliciting Anderson clients for a specified period of time following his termination. Approximately five years later, when Anderson was selling off parts of its business to other financial entities, Edwards received an offer of employment from HSBC USA, Inc. In connection with the offer, HSBC required Edwards to sign a Termination of Non-Compete Agreement (“TONC”), which, among other things, provided that Edwards release Anderson from: 

“any and all actions, causes of action, claims, demands, debts, damages, costs, losses, penalties, attorney’s fees, obligations, judgments, expenses, compensation or liabilities of any nature whatsoever, in law or equity, whether known or unknown, contingent or otherwise, that Employee now has, may have ever had in the past or may have in the future against any of the Released Parties by reason of any act, omission, transaction, occurrence, conduct, circumstance, condition, harm, matter, cause or thing that has occurred from the beginning of time up to and including the date hereof, including, without limitation, claims that in any way arise from or out of, are based upon or relate to Employee’s employment by, association with or compensation from [Anderson] or any of its affiliated firms, except for claims (i) arising out of [Anderson’s] obligations set forth in this Agreement or (ii) for any accrued and unpaid salary or other employee benefit or compensation owing to Employee as of the date hereof.”  (TONC Section 1(d).) (Emphasis added.)

In exchange, Anderson would release Edwards from the noncompetition agreement. Edwards refused to sign the TONC, in part, because he was afraid of losing his right to indemnification pursuant to Section 2802. Anderson subsequently terminated Edwards’s employment and withheld severance benefits.

The Noncompetition Agreement

The Court of Appeal held that “the noncompetition agreement was invalid under Section 16600, and requiring Edwards to sign the TONC as consideration to be released from it was an independently wrongful act for purposes of the elements of Edwards’s claim for intentional interference with prospective economic advantage.”

The California Supreme Court affirmed this holding, rejecting Anderson’s argument that the Court should apply a “rule of reasonableness” to the noncompetition agreement. Specifically, it affirmed the Court of Appeal’s conclusion that the common law “rule of reasonableness” really just embodied the statutory exceptions to Section 16600, i.e., for dissolution of a partnership, for the sale of goodwill of a business or all the shares of stock in a company, and for the dissolution or sale of a limited liability company.

The California Supreme Court also rejected Andersen’s request to adopt the Ninth Circuit Court’s “narrow-restraint” exception to Section 16600, which would allow noncompetition agreements that bar the pursuit of only a small or limited part of the business, trade or profession:

“We reject Andersen’s contention that we should adopt a narrow-constraint exception to section 16600 and leave it to the Legislature, if it chooses, either to relax the statutory restrictions or adopt additional exceptions to the prohibition-against-restraint rule under section 16600.”

The “Any and All” Language of the TONC

The Court of Appeal held that the “any and all” language quoted above from the TONC contravened public policy because it covered the employee’s statutory indemnification rights, which are not waivable as a matter of law under Labor Code § 2804. The court reasoned that, although the language did not expressly mention indemnification rights, “[t]hey were necessarily encompassed within the clear terms of the broad release. A broadly worded release covers all claims within the scope of its language, even if the particular claim is not expressly listed.” Moreover, requiring an employee to execute such a release is a wrongful act, which can be the basis for tort liability.

The California Supreme Court reversed, holding that, “under Labor Code section 2802, a contract provision releasing ‘any and all’ claims generally does not encompass nonwaivable statutory protections, and in particular does not implicitly apply to an employee’s right to indemnification from the employer.” The Court applied basic tenets of contract interpretation, which (1) required the Court to give the language such an interpretation as will make it “lawful, valid and capable of being carried into effect”; and (2) prohibited the Court from “insert[ing] what has been omitted, or [] omit[ting] what has been inserted. . ..” Accordingly, the Court refused to read the “any and all” language as including an unlawful waiver of Edwards’s indemnity rights, since the TONC did not expressly reference such rights.

The Court also reasoned that, even if it did not apply those principles of contract interpretation, it could presume that Anderson knew Edwards’s indemnity rights were, by statute, not waivable, and, thus, it could treat the TONC as if it expressly included the substance of Section 2804.

The Court refused to require employers to include the phrase “except as otherwise prohibited by law” after the “any and all” language, finding that the phrase was “vague and essentially informs the employee of nothing.” The Court also found it persuasive that “it appears most practitioners already operate with the understanding that the release does not encompass items ‘otherwise prohibited by law.’”

This Court’s decision on the noncompetition provision was expected. It clarifies an area of the law that has been hotly debated and is an unambiguous reminder of California’s strong public policy against restraint of trade. The Court’s ratification of the general release agreement is a significant victory for employers who can rely on the enforceability of existing as well as future general releases. The decision will have application outside the employment context as well, since there are easily dozens of statutory antiwaiver provisions both inside and outside the employment law context, some of which are extremely broad.



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