Isn't this exactly what non-compete clauses were meant for?
Non-compete clauses prevent you from competing and are largely unenforceable, particularly in California.
Is this true? I'm not doubting, I'm just wondering why. I know a lot of people in the games industry who aren't allowed to work on mods for another company's game and are terrified to even do a little bit, so I always thought they were enforceable.
This wouldn't toggle a non-compete action. The primary company might come after you for beach of confidentiality or for conflict of interest, but not non-compete.
Non-competes in California have to be VERY constrained to be enforceable. Generally they are very time limited (12 months at the longest). The biggest arenas where they do get enforced is for people who are involved at strategic planning levels (like this CTO). The non-compete timeframe allows their knowledge to decay/stagnate/become less relevant/become less damaging.
Your friends probably don't do games on the side because of such an agreement. I couldn't even imagine the issues that might arise from an employee working on mods for a competitor's game, especially since for some games modding isn't explicitly supported by the developer and modders are forced to break EULA's (by reverse engineering) in order to make the mods in the first place.
Is the famous case that I know of and from the articles description the "we own everything you do off the clock" part was treated as valid.
At least have the common decency to spend a period as a government industry regulator in between.