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Attorneys

Can A Company Go Too Far In Preventing Its Employees From Being Hired Away By Its Customers?

December 11, 2007

Can A Company Go Too Far In Preventing Its Employees From Being Hired Away By Its Customers?

By Dale C. Campbell

Can a company go too far in preventing its employees from being hired away by its customers? The Fourth District Court of Appeal recently answered, “yes,” but gave some indication where the line of permissible restrictions is crossed. (VL Systems, Inc. v. Unisen, Inc. (June 2007) 152 Cal.App.4th 708.)

The plaintiff VL Systems (“VLS”) was a computer consulting company and defendant Unisen was its client. VLS employed consultants to work with its customers on their particular projects and billed the customer for the consultant’s time on an hourly basis. The contract between VLS and Unisen included a “no-hire provision” in which Unisen agreed that “[b]uyer will not attempt to hire seller’s personnel” for a period of 12 months after the work was completed. The contract further provided for liquidated damages equal to 60 percent of the employee’s compensation in the event Unisen breached the no-hire restriction.

The scope of the consulting contract between VLS and Unisen was rather small. VLS hired a new employee, David Rohnow (“Rohnow”), after the contract with Unisen was completed. Rohnow never worked on the project with Unisen since it was already completed. Rohnow worked for VLS for six months then elected to seek employment elsewhere. Rohnow responded to an advertisement placed by Unisen seeking a director of information technology. Unisen hired Rohnow knowing he had worked for VLS, but Unisen did not believe the no-hire provision applied since Rohnow had not work on the Unisen project. VLS demanded that Unisen pay the liquidated damages provided for under the contract. Unisen refused and VLS brought suit.

The Court balanced two important public policies. The first is the public policy established in Business and Professions Code section 16600 which states: “Except as provided in this chapter, every contract by which anyone is restrained from engaging in a lawful profession, trade or business of any kind is to that extent void.” The second public policy balanced by the Court is the freedom of contract. The Court acknowledged that it should not blithely apply public policy reasons to void contract provisions. (Dunkin v. Boskey (2000) 82 Cal.App.4th 171, 183-84.)

The only case in California that came close to the issues presented in this appeal was Webb v. Westside District Hospital (1983) 144 Cal.App.3d 946 (overturned on other grounds), which upheld a no-hire provision included in a contract between a hospital and temporary employee service. The Court distinguished the Webb case by noting that the no-hire provision in Webb was limited solely to employees who had actually worked for the hospital and that the employment agency had suffered actual damages by the contract being terminated prior to the hospital hiring away its employees.

Without any binding precidence, the Court looked to more general public policies to determine whether VLS’s no-hire provision was enforceable. Narrowly-drawn no-hire provisions that might otherwise limit the employment mobility of individuals if necessary to protect the legitimate business interests of the former employer. Examples include restrictions on a former employee’s right to solicit away other employees and restrictions on former employee’s right to use trade secrets. (See L’Oreal Corp. v. Moyes (1985) 174 Cal.App.3d 268, 279.) Here, the Court found that VLS’s no-hire provision was not so narrowly drawn. It applied to all employees, whether or not they actually worked for the client and whether or not they were actually employed by VLS during the period that VLS worked for the client. The Court found that this broad no-hire provision “is not necessary to protect VL Systems’ interests and is outweighed by the policy favoring freedom of mobility for employees is therefore unenforceable.” (VL Systems, supra, 152 Cal.App.4th at 718.)

VLS attempted to argue that its no-hire provision was not a restraint on employee mobility, noting that the provision did not prohibit a client from hiring away an employee, it only established an agreed-upon price for doing so through the liquidated damages provision. The Court rejected that argument, noting that the liquidated damages provision was sufficiently punitive and would “unfairly narrow the mobility of the employee.”

The Court made it quite clear that its decision was limited to the facts before it and that its decision should not be interpreted to mean that all no-hire provisions were unenforceable under Business and Professions Code section 16600. Conversely, the Court declined to establish a bright line test as to when a no-hire provision goes too far as to become unenforceable. However, some guidance can be gleaned by understanding the factual distinctions the Court noted between the Webb decision and the case before it.

A narrowly-drawn no-hire provision that is reasonable in time and that applies solely to employees who actually work for the client have the best chance of being senforced. The public policy upholding private party contracts should prevail over the public policy favoring employee mobility when necessary to protect the legitimate business interest of the employer. As stated by the VLS Court, “This is not a case where the happy client of a consulting firm attempts to poach an employee.” (Id. at 715.) Contractual no-hire provisions, if narrowly drawn and necessary to protect the business of the company, are quite different than the facts in VL Systems.