No-Hire and Non-Interference Contract Provisions

Issue

Can a company prevent one of its current clients from hiring away the company's employees?

Short Answer

Possibly. Generally, the company, as an employer, cannot restrict the movement of its employees. However, some California Courts seem to suggest that a narrowly defined contract provision between a company and its client may give the company the ability to prohibit “employee raiding,” or at least make it expensive for a client to steal an employee, which might be a hiring disincentive.

Background

Under common law, contractual restraints on the practice of a profession, business, or trade were once considered valid as long as they were reasonably imposed. In 1872, however, California adopted a public policy that promoted open competition, thus rejecting the common law rule of reasonableness. This public policy is manifested in California Business and Professions Code Section 16600, which states:

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

A key concept in this code section concerns the prohibition of restraining one from engaging in a profession, trade or business. The implications of this concept have been immense in recent years; one of the most important of these implications is the illegality of covenants not to compete.

A covenant not to compete, in a general sense, is an agreement between two or more parties, in which one party agrees not engage in the same or similar business, after some trigger event (like termination of a contract or sale of a business or sale of a majority interest). Some covenants not to compete are valid (Business and Professions Code sections 16601-16602.5); these are not within the scope of this article.

The enforceability of a covenant not to compete gets more difficult in the employment context. (See generally Edwards v. Andersen (2008) 44 Cal.4th 937.) Such a covenant usually reflects an agreement between an employer and an employee in which the employee agrees that if he were to leave the employer, he will not go to work for the employer’s competitors. Often times, these clauses will have time restrictions and geographical limitations imposed upon them. For example, an employee may be prohibited from working for an employer’s competitors, within a particular county, for six months after termination. After that, the employee is free to work with whom he wishes and wherever he wishes. Many employees are even compensated for signing such an agreement.

Despite these clauses being found in many employment contracts, they are illegal in California. 

Historically, California law has protected employees’ right to open competition and mobility (see D'Sa v. Playhut, Inc. (2000) 85 Cal.App.4th 927, 933). In Metro Traffic Control, Inc. v. Shadow Traffic Network (1994) 22 Cal.App.4th 853, 859, the court stated that “every citizen shall retain the right to pursue any lawful employment and enterprise of their choice.” In a similar fashion, the court in Morlife, Inc. v. Perry (1997) 56 Cal.App.4th 1514, 1520 protected “the important legal right of persons to engage in businesses and occupations of their choosing.”

Coincidentally, any contract in which an employer attempts to infringe upon these rights of an employee has been deemed unenforceable. (Edwards, supra.) California courts have extended non-compete invalidity beyond contracts that explicitly restrict an employee’s movements by an employer to also invalidating contracts that implicitly restrict movement. For example, in Muggill v. Reuben H. Donnelley Corp. (1965) 62 Cal.2d 239, 242-243, the California Supreme Court declared a contract unlawful that required a former employee to forfeit his pension rights upon initiating employment with a competitor.

What can a company/employer do?

In light of the foregoing cases and policy against any restraint of trade, how can a California company protect itself from a competitor raiding its employees? In many cases, this is an unavoidable occurrence in the world of business. However, a critical element of California’s attitude towards covenants not to compete revolves around an employer restricting the movement of an employee. What if a company was to restrict a client’s pursuit of one of its employees through a “no-hire” provision?

VL Systems, Inc. v. Unisen, Inc. (2007) 152 Cal.App.4th 708 involved a contract for consulting services between VL Systems and Star Trac in which Star Trac was prohibited from hiring VL Systems’ employees for 12 months after the services contract between the two companies was terminated. VL Systems had a “no hire” provision which stated in part:

“BUYER WILL NOT ATTEMPT TO HIRE SELLER’S PERSONNEL. Any hiring, or offer of employment, entitles, but does not require, VL Systems, Inc. to immediately cancel the performance of this agreement. If, during the term of, or within (12) months after the termination of the performance period of this agreement, buyer hires directly, or indirectly contracts with any of seller’s personnel for the performance of systems engineering and/or related services hereunder, BUYER AGREES TO PAY TO THE SELLER SIXTY PERCENT (60%) OF EITHER THE NEW ANNUAL COMPENSATION PAYABLE TO SUCH PERSONNEL or the fees paid to, or in favor of such personnel for one (1) year after such personnel separates from service with seller, whichever is applicable, as liquidated damages.” (Id. at p. 820.)

The case arose because an employee of VL Systems, who did not provide consulting services to Star Trac, and was not even employed by VL Systems at the time of the Star Trac work, heard about a Star Trac job, via an internet job listing, and was subsequently hired by Star Trac, while still at VL Systems. VL Systems sought to enforce the referenced no hire provision. The court held that the referenced contract was unenforceable. “Such a broad provision is not necessary to protect VLS’s interests and is outweighed by the policy favoring freedom of mobility for employees. It is therefore unenforceable.” (Id. at p. 826.)

However, interestingly, the court’s finding of unenforceability was not necessarily due to the nature of the provision itself but rather due to the scope of the provision. The court stated:

“Thus, the question becomes whether two parties can agree on a no-hire provision as a matter of contract. Freedom of contract is an important principle, and courts should not blithely apply public policy reasons to void contract provisions. [Citation] This type of contractual provision, however, may seriously impact the rights of a broad range of third parties. In this case, those third parties not only included VLS employees who actually performed work for Star Trac under the contract, but all those who did not, including Rohnow, who was not even employed by VLS at the time.” (Emphasis added.) (Id. at p. 822.)

The court further stated, that its “holding, of course, applies only to this case, and we caution against any inference that all such clauses are unenforceable. Perhaps a more narrowly drawn clause limited to soliciting employees who had actually performed work for the client might pass muster.” (Emphasis added.) (Id. at p. 821, fn 4.)

A second case provided such a “narrowly drawn” clause and was found by a court to be enforceable (Webb v. West Side District Hospital (1983) 144 Cal.App.3d 946, overruled on other grounds by Moncharsh v. Heily & Blase (1992) 3 Cal.4th 1.) In Webb, a doctor (Webb) supplied a hospital with contract physicians, much like a temporary agency.

The contract between Webb and the hospital contained the following “non-interference” clause:

“Hospital acknowledges what [Webb] will recruit, train and contract with other physicians for the [emergency room] Department service and that this is a costly and time-consuming endeavor. Should Hospital wish, within two (2) years following the termination of this Agreement—measured from the last extension thereof—to directly or indirectly employ any physician who shall have contracted with [Webb] for Department serviced, Hospital shall first pay [Webb] the sum of $30,000 per physician, which accurately reflects the reasonable valuable of [Webb’s] time and costs.” (Id. at p. 949.)

The hospital eventually hired 4 physicians who were originally recruited by Webb to provide temporary services for the hospital but refused to pay the contract termination fees demanded by Webb, per the referenced “non-interference” clause. The court found this provision to be lawful and enforceable as it went no further than necessary to protect Webb’s legitimate interests and it related only to physicians who had performed work for the hospital. “In the instant case, the physicians were not precluded from working at the hospital’s emergency room facilities, but their employment was merely conditioned upon payment by the hospital of a reasonable fee for services it had already received.” (Id. at pp. 954-55.)

The scope of a no-hire or non-interference provision is paramount to the enforceability of said provision. The all-encompassing provision in VL Systems was simply not necessary to protect its interests because it prevented Star Trac from hiring any employee, regardless of his interaction with Star Trac. In Webb, the provision was within the scope of an allowed restriction not only because it was limited to employees who actually performed work for the client but also because monetary compensation was all that was required to hire the employee. And, importantly, in Webb, the payment required for the hiring bore some reasonable relationship to the loss suffered by Webb (i.e., the employer), to recruit, train and place. Unlike VL Systems’ provision, the provision in Webb allowed for the hire of one of his employees at any time by the other party in the contract provided Webb was compensated for his part in recruiting, training, and contracting the employee. As opposed to focusing on restricting employee mobility, Webb sought reasonable compensation for loss reflected by the costs incurred in providing these employees.

One side note, not fully developed (but mentioned) in the Webb case, was that the no-hire fee was “reasonable.” Any clause drafted should probably recite similar language to Webb and have the parties acknowledge the reasonableness of the no-hire termination fee. This may also raise a “proof” issue and/or there may be a need to address the issue via a liquidated damages clause (See Civil Code section 1671 and cases interpreting same.) Note also, however, that the California Supreme Court said in Edwards:  “Section 16600 is unambiguous, and if the Legislature intended the statute to apply only to restraints that were unreasonable or overbroad, it could have included language to that effect. We reject Andersen's contention that we should adopt a narrow-restraint 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.” (Edwards, at p. 950.)  While one might argue that Edwards, with this language, precludes any reasonableness test in any “restraint” of trade analysis (i.e., non-solicit/no hire or pay to hire cases)—which may bring into question the validity of the Webb and VLS analysis, above—Edwards specifically related to illegal restraints placed on employees, not the narrow and specific limitations placed on competing third party employers.  Moreover, in another context a non-solicit clause was found to be enforceable by a California appellate court and has not been disapproved by the California Supreme Court (see Loral Corp. v. Moyes (1985) 174 Cal.App.3d 268).

A Properly Drafted No-Hire Provision May be Enforceable

In sum, a company who loans or provides an employee to another may be able to craft some level of protection in a contract to prohibit, or lessen the impact of, a client hiring away their employees. A contract provision that models after Webb’s language appears to avoid being void under Business and Professions Code section 16600 and may not be deemed to unduly restrict employee mobility. Of course, this area of the law is not without risk and continues to evolve; your particular situation should be reviewed by a lawyer prior to introducing this or any contract clause in your business.

DISCLAIMER: This entry does not give specific legal advice about your specific legal problem. No text or graphic contained in this entry is to be or should be used or relied upon as legal advice. This entry does not create an attorney-client relationship. If you want specific legal advice about your particular legal issues, or if you want to create an attorney-client relationship, you need to retain the Law Offices of Ron A. Stormoen by a signed written retainer agreement.