United States: California Reaches Across State Lines To Invalidate Employee Non-Compete Agreements – Littler Mendelson

We are in the final stretch of the California legislature’s
first year of a two-year session. One bill that sped through the
legislative process—without any registered
opposition—is Senate Bill 699, which extends the state’s
restrictions on non-compete agreements to contracts signed out of
state. Despite the deadline of September 14, 2023, to pass bills
and send them off to the governor’s desk, this bill leapfrogged
several others and already has been signed into law.

California Business and Professions Code section 16600 provides
that every contract that restrains anyone from engaging in a lawful
profession, trade, or business of any kind is void,
subject to limited exceptions. So “non-compete”
agreements are not enforceable in California. But what if that
“contract” was not signed in California, and the
employment involved occurred outside of the state?

In general terms, SB 699 extends the reach of California’s
restriction on non-competes to such contracts and provides a
private right of action for enforcement, including attorney’s
fees.

More specifically, SB 699 adds a new section to the
Business and Professions Code (B&P Section 16600.5),
implementing the following restrictions:

1. Any contract that is void under B&P Section 16600 is
   unenforceable regardless of where and when the contract was
   signed.




2. An employer or former employer “shall not attempt to
   enforce” a contract that is void regardless of whether the
   contract was signed and the employment was maintained outside of
   California.




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




4. An employer that enters into a contract that is void or
   attempts to enforce a contract that is void commits a civil
   violation. 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 and is entitled to recover
   reasonable attorney’s fees and costs.

A report from the chief counsel of the state Assembly Judiciary
Committee cited a statistic that “non-compete” agreements
(contracts that prohibit someone from engaging in competition
against the employer) affect nearly 20% of workers nationwide, with
30-46%¹ of workers in the private sector subject to such
agreements. With nationwide statistics being cited, why is this a
California problem? The answer: the economy. California’s
economy relies on plucking the best workers nationwide for certain
industries. In the Assembly’s words, “California has
benefitted significantly from this law [the restriction on
non-competes], fueling competition, entrepreneurship, innovation,
job and wage growth, equality, and economic
development…noncompete clauses stifle economic development, limit
firms’ ability to hire and depress innovation and growth.”
The legislature asserts that California’s policy on talent
mobility is necessary to California’s competitive business
interests in the areas of technology, entertainment, biomedicine
and pharma.

Can the California legislature do that? Reach across state lines
to declare that a contract signed in another state is not
enforceable in California?

Consider the following:

1. A California company hires, or wants to hire, an employee to
   work in California.




2. The employee is subject to a non-compete agreement entered into
   at a job they held in another state, say, Texas. The non-compete
   agreement meets all state law requirements to be enforceable in
   Texas.²




3. The lawyer for the Texas company sends a cease and desist
   letter to the California company saying they cannot do this, as the
   former employee has a non-compete, which is enforceable in the Lone
   Star State.




4. The California company can say in response, “too bad, you
   can’t enforce that agreement here in the Golden State, due to
   SB 699.”

The Texas employer just had their lawful contract with a former
employee nullified – by California! The question is, can
California employers take this legal position by relying on SB
699?

The question involves the “extraterritorial
application” of state law. California applies a presumption
against the extraterritorial application of its state laws.
North Alaska Salmon Co. v. Pillsbury, 174 Cal. 1, 4
(1916). The presumption can be rebutted only where a contrary
intent is “clearly expressed or reasonably to be inferred from
the language of the act or from its purpose, subject-matter, or
history.” Here, it now appears that the presumption is subject
to rebuttal, due to the language of the act, and its
stated legislative purpose. The wording of the statute specifically
states that the law is designed to apply to contracts entered into
in another state. And the legislative intent of SB 699 states that
non-competes “stifle economic development.” With such
unambiguous language, this likely is a persuasive rebuttal.

Application of one state’s laws to events occurring in a
different state also raise constitutional concerns, however. States
are limited in their ability to enact laws that impose a
substantial burden on interstate commerce. A state law that places
an undue burden that exceeds the local benefits of the law runs
afoul of the “dormant commerce clause.” Pike v. Bruce
Church, Inc., 397 U.S. 137, 142 (1970). While SB 699 certainly
has extraterritorial application, it can be argued that the law
does not restrain commerce at all, rather, it frees up commerce by
allowing employees to more freely practice their trade or
profession.

One thing is certain. This law will lead to litigation battles
between California-based companies and out-of-state employers
seeking to prevent their former staff from working for competitors
in California. With California’ strong policy on maximizing
innovation and talent through a diverse workforce (as signaled by
not a single “no” vote on this bill), it is no surprise
that Governor Newsom signed this bill into law, notably doing so on
Labor Day weekend.

SB 699 should also concern employers because it creates a
private right of action for employees whose agreements include
restrictive covenants and provides for attorney fees for any
current, former, or even prospective employee who
successfully brings suit against an employer’s use of those
restrictive covenants. Prior to this new law, most courts directly
addressing the issue have held the inclusion of restrictive
covenants did not directly create a right of action against
employers. In particular, California’s Private Attorney General
Act (Cal. Labor Code § 2699) (“PAGA”) did not create
a private right of action for contracts in violation of B&P
Section 16600 because (a) PAGA applies only to Labor Code
violations, (b) Labor Code Section 432.5 prohibits only contracts
“prohibited by law,” and (c) B&P Section 16600
provides that restrictive covenants are void, but not
prohibited by law. That private right of action is now directly
encoded into the new Section 16600.5, as are the remedies of
injunctive relief, damages, and attorney fees for prevailing
employees, former employees, and even prospective employees.

In addition, the statute states that an employer whose contracts
include restrictive covenants has committed a “civil
violation.” The potential impact of this change is uncertain
at this time.

While California employers have known for some time that they
cannot enforce restrictive covenants against California employees,
SB 699 expands the scope of this prohibition and creates serious
liability to employers whose contracts have not been recently
updated to account for the shifting legal landscape. Employers are
advised to consult with counsel when considering seeking to enforce
or oppose a non-compete agreement in California and when asking an
employee to enter into any agreement with restrictive
covenants.

Footnotes

1. This is not a typo, the report from the Chief Counsel of the
California Assembly Judiciary Committee cites the percentages as
“30 – 46%.”

2. The requirements for an enforceable covenant not to
compete are defined by statute in Texas. TEX. BUS. & COM. CODE
ANN. §§ 15.50 to 15.52.

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