Issues When Starting a Competing Business in California

Authored by Bryan Springmeyer Bryan Springmeyer is a California corporate attorney who represents startup companies. The information on this page should not be construed as legal advice.

The situation is one I come across fairly frequently. Employees of a company have left or are contemplating leaving a company and want to start a business in the same industry because: (1) they have a better way of doing things; (2) their former employers were jerks; or (3) some combination of (1) and (2).

Starting a competing business with a former employer may touch upon many legal and contractual issues. A few that would-be founders should give some consideration to are anti-compete clauses, intellectual property, trade secrets and anti-solicitation.

1. Non-Compete Clauses

In California, as a function of Business and Professions Code (B&P) §16600, employers generally may not prohibit former employees from working for or starting competing businesses. The exceptions are: (1) when a company is sold, those people who sold the company may agree with the buyer to refrain from carrying on a similar business within a specified geographic area of the business (see B&P §16601); and (2) a partner or member of an LLC who's leaving the company, whether it stays intact or dissolves, may agree that he or she will not carry on a similar business within a specified geographic area (see B&P §16602; 16602.5).

Even if a contract states that the law of another state shall apply, proceedings in California courts will likely apply §16600 as a matter of public policy. See e.g., Application Group, Inc. v. Hunter Group, Inc. (1998) 61 Cal.App.4th 881. As a practical matter, individuals subject to non-compete clauses (or their prospective California employers) may want to proactively file suit in California to seek a determination of their rights.

In other states, anti-compete clauses are generally enforceable if they are reasonable in terms of time and geographical region.

2. Intellectual Property

Employees are often surprised to find out that developments they've made during their employment may belong to their employer. One reason is that employee's intellectual property may often be created without their knowledge that they've developed something that can even be considered property. Even simple ideas and developments can constitute intellectual property. Second, the employee might expect that anything they create belongs solely to them unless they subsequently sell it.

Legal doctrines provide that if an employee is paid to create, their creations are property of the employer. However, employers can also assert ownership contractually, which most employers do in employment documents. The employer's contractual right typically extends far beyond the creations within the scope of employment. California provides public policy statutory protection in this regard also, with Labor Code §2870 which states:

            (a)        Any provision in an employment agreement which provides that an employee shall assign, or offer to assign, any of his or her rights in an invention to his or her employer shall not apply to an invention that the employee developed entirely on his or her own time without using the employer’s equipment, supplies, facilities, or trade secret information except for those inventions that either:
                        (1)        Relate at the time of conception or reduction to practice of the invention to the employer’s business, or actual or demonstrably anticipated research or development of the employer; or
                        (2)        Result from any work performed by the employee for the employer.
            (b)        To the extent a provision in an employment agreement purports to require an employee to assign an invention otherwise excluded from being required to be assigned under subdivision (a), the provision is against the public policy of this state and is unenforceable.

This exception is fairly narrow, but does give employees title to things that employers have no legitimate reason to assert title to.

3. Trade Secrets

Trade Secrets, which are another area that former employees need to be careful with in starting a competing business, are defined as information which derive value by not being generally known to the public AND which are subject to reasonable efforts to maintain secrecy. Cal. Civil Code §3426.1(d). A former employee is usually contractually prohibited from disclosing confidential information, and is also statutorily prohibited from "misappropriating" trade secrets. One common category of trade secrets are customer lists, which generally constitute trade secrets if efforts are made to keep them confidential. If promotional materials identify customers or lists are circulated freely, the list may not constitute a trade secret. Furthermore, simply notifying customers that you are leaving the company to go elsewhere is not a misappropriation. See generally, Thompson v. Impaxx, Inc.(2003) 7 Cal. Rptr. 3d 427.

4. Anti-Solicitation

Customers - Aside from the situation discussed above which involves the misappropriation of trade secrets to solicit customers of the former employer, employees are generally free to solicit their business.

Employees - An employee is subject to liability if, before or after leaving the employment, he causes fellow employees to break their contracts with the employer. On the other hand, it is normally permissible for employees of a firm, or for some of its partners, to agree among themselves, while still employed, that they will engage in competition with the firm at the end of the period specified in their employment contracts. However, a court may find that it is a breach of duty for a number of the key officers or employees to agree to leave their employment simultaneously and without giving the employer an opportunity to hire and train replacements. An employer may prohibit an employee from "raiding" its employees. See Loral Corp. v. Moyes (1985) 174 Cal. App. 3d 268.

California's public policy generally favors free trade over the types of restrictions that may prevent employees of a company from starting a competing business. However, prudence must be given to the types of issues that could result in liability, since a previous employer might sue out of anger and betrayal, or as a business tactic for eliminating competition.

Related Pages:

Can I Start a Startup While Employed?
Intellectual Property Ownership and Assignment