February 9, 2024

Client Alert:
Important Change in California Law Regarding Noncompete Provisions and/or Agreements

Authored by:[1] Jeffrey Gersh, Kevin DeBré, Daniel Rozansky, and Jose Meneses

Recent changes in California law require employers’ immediate attention.  The California State Legislature recently passed AB 1076 and SB 699, making post-employment noncompete clauses in the employment context illegal, unenforceable, and void in California.   Both pieces of legislation broaden and strengthen California’s general prohibition on noncompete provisions.  Here are some key takeaways:

  • Post-employment noncompete provisions in an employment context are void and unenforceable in California. This may include noncompete provisions found in employee handbooks, nonsolicitation agreements, or any other agreement that has the same effect of restricting an employee from engaging in a lawful trade, business, or profession.[2]
  • By February 14, 2024, employers must notify their employees and past employees (who were employed by the employer as of January 1, 2022) who have signed agreements with noncompete provisions that such provisions are void and unenforceable.
  • Noncompete provisions during the employment period are still enforceable.
  • Noncompete provisions in commercial contracts are still enforceable.
  • An employee, former employee, or prospective employee may bring a lawsuit against his or her employer for attempting to enforce a noncompete provision, unless a statutory exception applies, or requiring an employee to even sign an agreement containing a noncompete provision. And, in the event of a violation, an employee, former employee, or prospective employee may seek injunctive relief, actual damages, and/or attorneys’ fees and costs.

I. Added/Amended Statutory Language

Section 16600 now provides the following:

(a) 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.

(b)(1) This section shall be read broadly, in accordance with Edwards v. Arthur Andersen LLP (2008) 44 Cal.4th 937, to void the application of any noncompete agreement in an employment context, or any noncompete clause in an employment contract, no matter how narrowly tailored, that does not satisfy an exception in this chapter.

(2) This subdivision does not constitute a change in, but is declaratory of, existing law.

(c) This section shall not be limited to contracts where the person being restrained from engaging in lawful profession, trade, or business is a party to the contract.

Section 16600.1 provides the following:

(a) It shall be unlawful to include a noncompete clause in an employment contract, or to require an employee to enter a noncompete agreement, that does not satisfy an exception in this chapter.

(b)(1) For current employees, and for former employees who were employed after January 1, 2022, whose contracts include a noncompete clause, or who were required to enter a noncompete agreement, that does not satisfy an exception to this chapter, the employer shall, by February 14, 2024, notify the employee that the noncompete clause or noncompete agreement is void.

(2) Notice made under this subdivision shall be in the form of a written individualized communication to the employee or former employee, and shall be delivered to the last known address and the email address of the employee or former employee.

(c) A violation of this section constitutes an action of unfair competition within the meaning of Chapter 5 (commencing with Section 17200).

Section 16600.5 provides the following:

(a) Any contract that is void under this chapter is unenforceable regardless of where and when the contract was signed.

(b) An employer or former employer shall not attempt to enforce a contract that is void under this chapter regardless of whether the contract was signed and the employment was maintained outside of California.

(c) An employer shall not enter into a contract with an employee or prospective employee that includes a provision that is void under this chapter.

(d) An employer that enters into a contract that is void under this chapter or attempts to enforce a contract that is void under this chapter commits a civil violation.

(e)(1) An employee, former employee, or prospective employee may bring a private action to enforce this chapter for injunctive relief or the recovery of actual damages, or both.

(2) In addition to the remedies described in paragraph (1), a prevailing employee, former employee, or prospective employee in an action based on a violation of this chapter shall be entitled to recover reasonable attorneys’ fees and costs.

II. Frequently Asked Questions

What are considered agreements in an employment context?  Such agreements include employment agreements; employee handbooks; and agreements not to solicit an employer’s employees, customers, and/or vendors.

Are there any exceptions to the prohibition against noncompete provisions and/or agreements?  Yes.  Section 16600 states that noncompete agreements are void unless they satisfy “an exception in this chapter.”  These exceptions include noncompete provisions and/or agreements in connection with the sale of a business[3], a partnership dissolution[4], or a dissolution or termination of a membership interest in a limited liability company.[5]

Are noncompete and nonsolicitation provisions enforceable to protect trade secrets?  It is not entirely clear.  As a threshold matter, nonsolicitation provisions may constitute noncompete provisions depending on the specific facts.[6]  Before the adoption of the amended Section 16600, nonsolicitation provisions were in certain instances enforceable to protect an employer’s trade secrets.[7]  The Court in Edwards neither rejected nor adopted this trade secrets exception.[8]   Read in conjunction with the amended Section 16600, and although not entirely clear, the Legislature seems to have adopted a rule that bans the trade secrets exception.  Notably, the California Uniform Trade Secrets Act[9] and the law prohibiting the use of a company’s trade secrets presently remain intact.  Notwithstanding the foregoing, it is likely that nonsolicitation provisions that may be construed to bar employees from engaging in lawful conduct (much like a noncompete agreement or provision in the context of employment) will be unenforceable.

Are noncompete provisions and/or agreements enforceable outside the employment context—i.e., in the context of a business deal between parties?  Yes.[10]  First, Section 16600, subdivision (b)(1), states that noncompete clauses and/or agreements are void in “an employment context” or “an employment contract, no matter how narrowly tailored, that does not satisfy an exception in this chapter.”  A plain reading of Section 16600 demonstrates that the Legislature contemplated that the prohibition of noncompete provisions and/or agreements apply only in an employment context.  If the Legislature wanted to include other types of contracts where the prohibition applied, it would have included that language in the statute.[11]

Second, subject to certain exceptions, “contractual restraints on business operations and commercial dealings” are valid and enforceable.[12]  A court will examine the purpose of the restraint at issue and ask whether that purpose is “to restrain trade by creating a monopoly, restricting supply, or fixing prices.”[13]  If the purpose of the contractual restraint is to create a monopoly, restrict supply, or fix prices, then that contractual provision will be invalidated.[14]  Otherwise, the contractual restraint is enforceable.[15]

Is a contract void, in its entirety, if it contains a noncompete provision?  California courts have routinely voided just the noncompete clauses and not the contract in its entirety.[16]  Despite that, some courts have voided entire agreements when the benefit to the employee (as conferred by the entire contract) was contingent on the enforcement of the noncompete clauses and/or agreement.[17]  

What notice is required under Section 16600.1?  Under Section 16600.1, employers are required to notify current and “former employees who were employed after January 1, 2022, whose contracts include a noncompete clause” that such a clause is void, by February 14, 2024.  The notice must “be in the form of a written individualized communication to the employee or former employee,” and must be delivered to that employee’s or former employee’s “last known address” and “email address.”[18]

What are the penalties for failing to provide notice?  Section 16600.1, subdivision (c), provides that a “violation of this section constitutes an act of unfair competition within the meaning of Chapter 5 (commencing with Section 17200).”  Section 17204 of the California Business and Professions Code vests persons “who [have] suffered injury in fact” to seek relief for violations of unfair competition by way of filing a complaint.  Penalties may include injunctive relief (under Section 17203); civil penalties of up to $2,500 for each violation (under Section 17206); and additional civil penalties of up to $2,500 for each violation perpetrated against one or more senior citizens or disabled persons (under Section 17206.1).

What are the penalties for enforcing a noncompete provision and/or agreement?  Section 16600.5, subdivision (e)(1), provides that “[a]n employee, former employee, or prospective employee may bring a private action to enforce this chapter for injunctive relief or the recovery of actual damages, or both.”  In addition, Section 16600.5, subdivision (e)(2), provides that a prevailing employee, former employee, or prospective employee “shall be entitled to recover reasonable attorney’s fees and costs.”  These provisions are one sided in that they only allow for damages, attorneys’ fees and costs to the prevailing past, present or prospective employee and not to the prevailing employer.

What is the likely effect of AB 1076 and SB 699 on Section 925, subdivision (e), of the California Labor Code?  California law prohibits an employer from requiring an employee “who primarily resides and works in California, as a condition of employer, to agree to” adjudicate his or her claims outside of California (when such claims arose in California), or “[d]eprive the employee the substantive protection of California law with respect to a controversy arising in California.”[19]  Labor Code, Section 925, subdivision (e), is an exception to that rule.  Under this section, the designation of venue or forum where a claim may be adjudicated, or “the choice of law to be applied” are permissible when an employee is represented by counsel in negotiating the terms of the agreement.[20]  Why is this important?  Because noncompete provisions are not enforceable in California, this exception allows employers to include such provisions in employment contracts with venue or forum selection clauses, and/or choice of law provisions in jurisdictions where noncompete provisions and agreements are enforceable.  Without question, this practice conflicts with Section 16600.5, subdivisions (a) through (d).

As a preview of how California courts might adjudicate this issue, Application Group, Inc. v. Hunter Group, Inc. (1998) 61 Cal.App.4th 881, is instructive.  In that case an out-of-state consultant was formerly employed by a privately-held Maryland corporation, and her employment contract which was governed by Maryland law contained a noncompete provision.[21]  Under Maryland law, noncompete clauses are enforceable, while under California law, they are not.[22]  A competing California corporation sought to hire the consultant—to which the Maryland corporation objected pursuant to the consultant’s noncompete.[23]  The Maryland corporation sued the consultant in a Maryland court for breach of the covenant not to compete, but was ultimately unsuccessful as it failed to present any evidence of damages.[24]  Concurrently, the consultant and the California corporation sued the Maryland corporation to seek a declaration that the noncompete clause cannot be enforced in California.[25]  On cross motions for summary judgment and summary adjudication in the California proceeding, the lower court ruled in favor of the California corporation finding the consultant’s noncompete was unenforceable in California.[26]  The Maryland corporation appealed.[27]

On appeal, the main issue was “whether California or Maryland law applies to a dispute over the enforceability of” a Maryland corporation’s “noncompetition clause when a California employer” “seeks to hire one of the nonresident” employees—subject to the noncompete clause—“for employment in California.”[28]  In applying choice-of-law principles[29], the Court of Appeals for the First District ruled that Maryland’s law is contrary to a fundamental policy in California—that “every citizen shall retain the right to pursue any lawful employment and enterprise of their choice”—and that California has a materially greater interest in the determination of the issue.[30]  The court reasoned that “California has a strong interest in protecting the freedom of movement of persons whom California-based employers” “wish to employ to provide services in California, regardless of the person’s state of residence or precise degree of involvement in California projects, and we see no reason why the employees’ interests should not be ‘deemed paramount to the competitive business interests’ of out-of-state as well as in-state employers.”[31]  The court further opined that “California has a correlative interest in protecting its employers and their employees from anti-competitive conduct by out-of-state employers”—“including litigation based on a covenant not to compete to which the California employer is not a party—who would interference with or restrict these freedoms.”[32]  Thus, the out-of-state consultant’s noncompete provision with its former out-of-state employer was not enforceable in California.

Can an employer whose business is incorporated in a different state—i.e., not in California—but operates within California, enforce a noncompete clause or agreement in an employment contract with an employee in a different state?  Assuming, arguendo, that the employee is a California resident, the answer is likely no.[33]  As highlighted in Application Group, Inc. above, while a company that is located in a state where noncompete provisions are enforceable may sue in its home state to enjoin its former employee from working for a California competitor, the former employee and California competitor may also sue the out-of-state company in California to invalidate the noncompete provision.

Is a noncompete clause in an employment contract during the employment period enforceable?  Yes.  The prohibition on noncompete provisions, as codified in Section 16600, should only apply in post-employment situations.[34]  Section 16600 “does not affect limitations on an employee’s conduct or duties while employed.”[35]  “While California law does permit an employee to seek other employment and even to make some preparations to compete before resigning, California law does not authorize an employee to transfer his loyalty to a competitor” because an “employer is entitled to its employees’ undivided loyalty.”[36]

Given the sweeping language of Section 16600, some ambiguities persist.  Namely, it is unclear whether the Legislature intended to apply this broad prohibition to noncompete provisions that restrain current employees from competing with their current employers.  While the statute contemplates that “any noncompete agreement in an employment context, or any noncompete clause in an employment contract” is void, Edwards contemplates the prohibition of noncompete agreements post-employment, not during.[37]  Because the Legislature specifically included Edwards in the body of the amended code section, it is likely that the Legislature also contemplated a general prohibition on noncompete provisions in the post-employment context and not during employment.

III. Next Steps

  1. If any of your employment agreements contain unenforceable noncompete provisions, you must give notice by February 14, 2024 to all current employees and former employees who were employed after January 1, 2022 that the noncompete provision in their agreement is void.
  2. The notice must be sent to your current employee or former employee’s “last known address” AND “email address.”
  3. For employers located in California, it should be your practice not to include post-employment noncompete provisions in your employment agreements (e.g., employee handbooks, and agreements not to solicit an employer’s employees, customers, and/or vendors).
  4. Do not seek to enforce void noncompete provisions or you may be exposed to damages including civil money penalties,

[1] Jeffrey Gersh is a Partner in the Firm’s Business Litigation Practice.  Kevin DeBré is a Partner and Chair of the Firm’s Intellectual Property & Technology Transactions Practice.  Daniel Rozansky is a Partner in the Firm’s Business Litigation, Entertainment and Privacy Practice.  Jose Meneses is an Associate in the Firm’s Business Litigation Practice.

[2] Notwithstanding the fact that noncompete agreements are void and unenforceable, agreements that restrict the employees use of a company’s trade secrets post-employment, may be enforceable under applicable California law, as opposed to enforcement of a noncompete provision.

[3] Cal. Bus. & Prof. Code, § 16601.

[4] Id., § 16602.

[5] Id., § 16602.5.

[6] Latona v. Aetna U.S. Healthcare Inc. (C.D. Cal. 1999) 82 F.Supp.2d 1089, 1095.

[7] Muggill v. Reuben H. Donnelly Corp. (1965) 62 Cal.2d 239, 242 (quoting Gordon v.  Landau (1958) 49 Cal.2d 690, 694).

[8] See Edwards v. Arthur Andersen LLP (2008) 44 Cal. 4th 937, 946 fn. 4 (“We do not here address the applicability of the so-called trade secret exception to section 16600, as Edwards does not dispute that portion of his agreement or contend that the provision of the noncompetition agreement prohibiting him from recruiting Andersen’s employees violated section 16600.”).

[9] See Cal. Civ. Code Section §§ 3426 et seq.

[10] Ixchel Pharma, LLC v. Biogen, Inc. (2020) 9 Cal.5th 1130, 1159.

[11] Edwards, 44 Cal.4th at p. 950.

[12] Ixchel Pharma, LLC, Cal.5th at p. 1159.

[13] Id. at p. 1154.

[14] Id.

[15] See id.; see also Quidel Corp. v. Sup. Ct. of San Diego County (2020) 57 Cal.App.5th 155, 168.

[16] See e.g., Edwards, 44 Cal.4th at p. 948; Dowell v. Biosense Webster, Inc. (2009) 179 Cal.App.4th 564, 575.

[17] See e.g., Muggill, 62 Cal.2d at pp. 242-43.

[18] Cal. Bus. & Prof. Code, § 16600.1(b)(2).

[19] Cal. Lab. Code, § 925(a)-(b).

[20] Id., § 925(e).

[21] Application Group, Inc. at p. 885.

[22] Id. at pp. 899-900.

[23] Id. at p. 887.

[24] Id.

[25] Id. at p. 889.

[26] Id. at pp. 890-91.

[27] Id. at p. 892.

[28] Id. at p. 896.

[29] The court applied the following rule: “(1) whether the chosen state has a substantial relationship to the parties or their transaction, or (2) whether there is any other reasonable basis for the parties’ choice of law.  If neither of these tests is met, that is the end of the inquiry, and the court need not enforce the parties’ choice of law…  If, however, either test is met, the court must next determine whether the chosen state’s law is contrary to fundamental policy of California…  If there is no conflict, the court shall enforce the parties’ choice of law.  If, however, there is fundamental conflict with California law, the court must then determine whether California has a ‘materially greater interest than the chosen state in the determination of the particular issue…’ (citation omitted.)  If California has a materially greater interest than the chosen state, the choice of law shall not be enforced, for the obvious reason that in such circumstances we will decline to enforce a law contrary to this state’s fundamental policy.”  (Id. at p. 897.)

[30] Id. at p. 900.

[31] Id. at p. 900-901.

[32] Id. at p. 901.

[33] Cal. Bus. & Prof. Code, § 16600.5(b).

[34] See Edwards, 44 Cal.4th at pp. 946-47 (“Under the statute’s plain meaning, therefore, an employer cannot by contract restrain a former employee from engaging in his or her profession, trade, or business unless the agreement falls within one of the exceptions to the rule.” (emphasis added)); see also Techno Lite, Inc. v. Emcod, LLC (2020) 44 Cal.App.5th 462, 473 (“Section 16600 is not an invitation to employees to bite the hand that feeds them.”).

[35] Techno Lite, Inc. at p 471 (internal quotations and citation omitted).

[36] Id. (internal quotations and citation omitted).

[37] See Edwards, 44 Cal.4th at pp. 946-47.

 

 

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