You Can't Do 'What' in California? A Summary of California's (Virtually Nonexistent) Restrictive Covenant Laws for Out-of-State Employers

Author:Mr Stephen Tedesco
Profession:Littler Mendelson
 
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As a Littler lawyer based in California, I am often called upon to advise national clients and their in-house counsel on California noncompete laws. Many employers based in other states are vaguely aware that California prohibits noncompetes; many are also shocked at the breadth of that prohibition. Many agreements from out-of-state employers will contain at least one provision that is void under California law. Since the decision by the California Supreme Court in Edwards v. Arthur Anderson, 44 Cal 4th 937 (2008), California law has only become more antagonistic to any type of restrictive covenant. This article will attempt to summarize the recent developments and provide practical examples of how California has become a virtual "killing fields" for restrictive covenants, and suggest ways to navigate through this legal landscape.

Background

In California, since the nineteenth century, with certain limited exceptions, any contract under which a person is prevented from engaging in his or her profession, trade or business is considered void as against public policy. California Business and Professions Code section 16600 states as follows: "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 protection under section 16600 against any restraint on employment presents a strong public policy in California. "The interests of the employee in his own mobility and betterment are deemed paramount to the competitive business interests of employers."1 For years, section 16600 has been held to invalidate agreements that contain provisions that restrain employees from engaging in competitive employment after leaving a former employer.2 Until the decision in Edwards, it was at least debatable whether lesser restrictions were valid. Much of that debate has now been settled. Employers need to be even more careful as the risk of having a restrictive covenant declared void has risen. That risk can be surprising to out-of-state employers with operations in California.

Consequences of a Void Covenant in California

To add insult to injury, the risks to an employer of a restrictive covenant are greater than simply having an unenforceable clause in its agreements. A clause that is void under section 16600 may also violate California's Unfair Practices Act set forth in sections 17200 et seq. of the California Business and Professions Code.3 Thus, an employer who includes restrictive covenants in California agreements not only risks having the clause declared unenforceable, but also risks being found to have committed an unlawful business practice.

The risk posed by restrictive covenants extends beyond the employer's California employees. In Application Group, the court found that section 16600, and by extension section 17200, broadly applied to any "employment in California." The court interpreted "employment in California" to mean: (1) employees living in state; (2) employees living out of state, but hired by California employers; and (3) employees living out of state but performing services in state.4 Thus, the court in Application Group struck down the noncompete of a Maryland employer with a former employee living in Maryland who was hired by a California employer.

The ruling in Application Group has spawned an entirely new set of lawsuits against employers who use restrictive covenants. One of the favored tactics of former employees with unenforceable restrictive covenants, and the California employers who hire them, is to sue the former employer for declaratory relief to declare the clause void and for unfair business practices. In many instances, this can be an effective preemptive attack on restrictive covenants.

In addition to prohibiting the enforcement of restrictive covenants, section 16600 may also permit an employee to sue when he or she is terminated or denied employment for refusing to enter into an unlawful agreement. In Latona v. Aetna U.S. Healthcare, Inc.,5 a federal trial court found that an employee had been fired for refusing to sign a noncompete agreement containing language violating section 16600. Rejecting the employer's argument that section 16600 would not apply unless it attempted to enforce the agreement, the court found that the employee's termination violated the public policy contained in section 16600 and therefore supported an action for wrongful discharge in violation of...

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