Author: Luis Blanquez
California’s long-standing public policy in favor of employee mobility over an employer’s ability to prohibit any worker from going to work for a competitor is included in California Business & Professions Code Section 16600. So how do employers outside of California try to get around this powerful public policy?
First, employers in states where non-competes are still enforceable have attempted to implement choice-of-law clauses in employment agreements with California employees––requiring disputes between the parties to be governed not by California law, but rather by the law of a state more favorable to the enforcement of non-competes. But, as a general rule, California courts refuse to enforce such clauses. This is because California courts will not apply the law of another state where that law is “contrary to a fundamental public policy of the State of California.” In this case, the fundamental policy is open competition and employment mobility.
Conflict-of-law rules vary from state to state. Most states will not enforce a choice-of-law provision that violates the public policy of a state with a “materially greater interest” in the dispute or where the parties enjoy a “substantial relationship” with such state––i.e. where (i) the employee performs his/her work, (ii) the employee’s residence is, (iii) the contract was negotiated and formed, or (iv) the headquarters of the company is, among other factors.
Second, an employment agreement may also include a forum selection clause. In most cases it’s the employer––who sees one of its key employees leave to work for a competitor––who brings the case in the state court of the choice-of-law clause. When that happens, there is not much an employee can do, unless the case is moved to federal court and then transferred to another state. And even then, unless the case ends up in California federal court, the employee will have to rely on the courts of that other state to apply California choice-of-law principles to find the non-compete provision invalid.
To avoid such a hostile scenario, employees in California try to engage in what is called a “race to the courthouse.” They do so in the hope to effectively void their non-compete agreements under California law, before their former employers outside California enforce the non-compete agreement in a different state. This strategy sometimes works, but not always. For instance, the California Supreme Court has held that while California has a strong public policy against enforcing non-competition agreements, it’s not so strong as to warrant enjoining an employer from seeking relief in another state.
In any event, employers outside California have systematically struggled to enforce non-compete agreements in the past. And now it is even more complicated for them. For agreements entered into after January 1, 2017, California Labor Code Section 925 clarifies that employers may not require employees––who primarily work and reside in California––to agree to forum-selection and choice-of-law clauses that select non-California forums and/or laws, unless such employee is “individually represented by legal counsel in negotiating the terms of an agreement.”
Usually the way employers try to restrict their workers from going to work for a competitor is by including in the employment contract a so-called “restrictive covenant.”
A restrictive covenant is an agreement between an employer and employee that limits an employee’s ability to compete after leaving the employer. The most common and restrictive type of agreement is a non-compete agreement. It prohibits the employee from offering its services within the agreement’s geographic scope for a period of time after leaving the employer. Other types of restrictive covenants may also limit an employee’s ability to solicit the employer’s customers or employees for a period of time.
They are, unquestionably, restraints on trade. But are they unreasonable restraints on trade? In many states outside California that is the issue—if they are reasonable, a court will enforce them. And what does reasonable mean? Again, it depends. But typically, like other restraints on trade, they must usually be narrowly tailored to serve their purpose. They should contain “reasonable” limitations as to time, geographic area, and scope of activity. The laws, of course, vary from state to state. But as a practical matter, most judges are skeptical. Some courts will actually rewrite the agreements to make them reasonable.
In California, however, the law does not allow employers to enforce a restrictive covenant against their former employees, particularly when it takes the form of a non-compete agreement.
These clauses usually have two primary purposes.
The first one is to protect an employer when sharing trade secrets or sensitive financial or customer information with their employees. Nowadays employees rarely stay in the same company for their entire careers. They may leave their employer and start their own firm or join a competitor. What constitutes a trade secret is usually a factually intensive issue subject to extensive litigation. Former employees can’t just forget what they know and are sometimes accused of improperly acquiring company files when they did not do so, did so without knowledge, or did so without the intent to improperly use or disclose trade secrets. In either case, California businesses and employees alike should understand how the California Uniform Trade Secret Act (CUTSA) might affect them.
The second purpose focuses on the training that an employer provides to the employee. The restrictive covenant protects employers that spend time and resources training their employees, only to see them leave later for a competitor.
Courts in states outside California often enforce these agreements, but will usually construe them narrowly, apply a reasonableness requirement, or simply rewrite them so they are, in the court’s view, reasonable. California, by contrast, takes a hard stand against them and will not enforce most forms of restrictive covenants.
California courts may, however, enforce certain non-solicitation clauses, but only when they are narrowly defined.
These are clauses prohibiting a former employee from “soliciting” former employer’s customers. Any enforcement, however, depends, once agai,n on the need to protect the company’s trade secrets. For instance, employee lists may be considered trade secrets, and the courts in California may also enforce a clause prohibiting former employees from raiding the company’s employees if there are legitimate trade secrets involved.
Non-compete and non-solicitation clauses––when narrowly construed––usually define the meaning of the trade secrets concerned for a particular company. This is one of the reasons why we advise clients to define their trade secrets with as much detail as possible, without disclosing them. It’s helpful in case of litigation at a later stage.
APPLICABLE LAW ON NON-COMPETE AGREEMENTS IN CALIFORNIA
Cal. Bus. & Prof. Code § 16600.
Section 16600 states that “every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.” California courts have invoked Section 16600 to void non-competition agreements.
Further, some judges have also held that an employer who violates Section 16600 by entering into a non-compete agreement with a California employee may also violate California’s unfair trade practices law––California Business and Professional Code Section 17200.
Labor Code Section 925 and the new “Represented Employee Exception”
Labor Code Section 925 governs employment contracts entered into after January 1, 2017.
Section 925 states that an employer cannot require an employee residing and working in California to agree to either adjudicate a California-based claim in another state or deprive the employee of the substantive protection of California law.
But Section 925 contains an exception that has recently become the subject of litigation. Section 925 provides that it shall not apply to a contract with an employee who is “individually represented by legal counsel in negotiating the terms of an agreement.”
And this is an important exception because one court has already concluded that even after considering California’s strong public policy against non-compete agreements, a Delaware choice of law and forum selection clause, under the specific circumstances of the case, was valid. NuVasive, Inc. v. Miles (Del. Ch. Sept. 28, 2018). Indeed, the court held that when contracting parties’ rights are protected by representation, freedom of contract trumps California’s prohibition of non-compete agreements.
Consider, however, that this was a state court in Delaware and California courts are not bound by it. Thus, we still need to see what the real impact of this exception is going to be in the future.
SOME EXAMPLES OF RELEVANT CASE LAW IN CALIFORNIA
“Conflict of law” rules allow courts to determine what state’s laws apply when the laws of more than one state might apply to a dispute but would produce different results.
Parties usually include choice-of-law provisions in their contracts to apply a particular state’s law rather than determine what state’s substantive laws apply under a conflict-of-law analysis. Usually, courts accept a choice-of-law provision and apply it as the parties intended. But this is not necessarily the case for a non-compete clause.
Conflict-of-law rules and analysis vary from state to state. For instance, courts will not enforce a choice-of-law provision if it violates the public policy of a state with a “materially greater interest” in the dispute or where the parties do not have a “substantial relationship” with the state concerned.
In California this means that courts will not apply the law of another state where that law is “contrary to a fundamental public policy of the State of California”. This is indeed the case with California Business & Professions Code Section 16600, which favors employee mobility over an employer’s ability to prohibit employees from working for a competitor.
Application Grp., Inc. v. Hunter Grp., Inc., Cal. App. 4th 881, 902 (1998)
California had a “greater interest” in application of its law to the dispute and California’s interests would be seriously impaired if its policy were subordinated to that of Maryland.
Advanced Bionics Corp. v. Medtronic, Inc., Cal. 4th 697 (2002)
While California has a strong public policy against enforcing non-competition agreements, it’s not so strong as to warrant enjoining an employer from seeking relief in another forum.
Edwards v. Arthur Andersen LLP, Cal. 4th 937 (2008)
Holding that noncompetition agreements are invalid unless expressly permitted by statute, such as in connection with the sale of a business.
Ascension Ins. Holdings, LLC v. Underwood, 2015 Del. Ch.
To circumvent California’s strict prohibition on restrictive covenants, out-of-state employers included choice-of-law provisions. But this Delaware court concluded that choice-of-law provisions for a Delaware LLC would violate California’s “fundamental policy” prohibiting restrictive covenants.
Sabol-Krutz v. Quad Elecs., Inc. (E.D. Cal., July 6, 2015)
It is important you also keep in mind that simply relocating to California may not be enough to invoke the protection of California law. And this case is a good example of that.
Here, the court found that Michigan law––and not California law––applied because the employee: (i) entered into the non-compete agreement in Michigan, (ii) worked in Michigan for several years after signing it, and (iii) her business-related contacts with California were minimal, both before and after her relocation.
California’s interest in applying Michigan law was also strong because, according to the Court, companies from states outside of California could hesitate to allow their employees to relocate to California, if they knew that by doing so they could invalidate their non-compete clauses.