Corporate & Transactional
Section 925 and the California Non-Compete Law
California has a well-earned reputation for being one of the most employee-friendly states in the country, when it comes to matters of employment law. One prominent example is the state’s general public policy against employment restrictions in employee contractsSee Business & Professions Code 16600, including noncompete covenants. It is a policy that is not only at odds with the federal public policy favoring freedom of contractCircuit City Stores Inc. v. Adams, 85 FEP Cases 266, 17 IER Cases 545, US SupCt, No. 99-1379, 3/21/01.<, but it is one that is generally despised by employers, particularly those located outside of California, who would like to use standardized noncompete agreements throughout their organizations.
Over the years, employers have attempted some creative strategies, usually unsuccessfully, to try to get around California law in this area. One oft used strategy was to apply choice of law or jurisdiction provisions from another state to non-compete employment agreements for California employees. That is until the California Court of Appeal’s decision in Application Group Inc. v. Hunter Group Inc.Application Group, Inc. v. Hunter Group, Inc., 61 Cal.App.4th 881 (Cal. Ct. App. 1998)., which found a non-compete provision in an employment agreement between a Maryland-based employer and a California-based employee to be unenforceable. The court reasoned that California’s public interest in free competition was greater than Maryland’s interest in enforcing noncompete agreements.
In an attempt to bring some clarity to the issue, the California Legislature, in 2016, added a new Section 925 to the Labor Code.The statute states in full:
(a) An employer shall not require an employee who primarily resides and works in California, as a condition of employment, to agree to a provision that would do either of the following:
(1) Require the employee to adjudicate outside of California a claim arising in California.
(2) Deprive the employee of the substantive protection of California law with respect to a controversy arising in California.
(b) Any provision of a contract that violates subdivision (a) is voidable by the employee, and if a provision is rendered void at the request of the employee, the matter shall be adjudicated in California and California law shall govern the dispute.
(c) In addition to injunctive relief and any other remedies available, a court may award an employee who is enforcing his or her rights under this section reasonable attorney’s fees.
(d) For purposes of this section, adjudication includes litigation and arbitration.
(e) This section shall not apply to a contract with an employee who is in fact individually represented by legal counsel in negotiating the terms of an agreement to designate either the venue or forum in which a controversy arising from the employment contract may be adjudicated or the choice-of-law to be applied.
(f) This section shall apply to a contract entered into, modified, or extended on or after
January 1, 2017. While Section 925 generally bars employers from applying choice of law or jurisdiction provisions from another state to employment agreements for California employees, the plain language of Section 925(e) provides an exception to the general rule, which would seem to permit California employees to voluntarily agree to apply another state’s law to its employment agreement when counsel represents them.
Despite the plain language of Section 925(e), some commentators argue that because Section 925 does not explicitly state that it is an exception to Business and Professions Code Section 16600, it does not weaken California’s public policy against noncompetes.See, e.g., Debra Fischer, Adam Wagmeister, “Does Section 925 Reinforce or Weakern Policy Against Noncompetes,” Daily Journal, Monday, January 7, 2019, Fischer and Wagmeister. This is because Section 16600 states any noncompete is void, whether or not it is negotiated by counsel.
Those who hold this view also note that while Section 925 makes noncompete provisions “voidable” at the employee’s request where the employee was not represented by counsel, one cannot take the logical leap to assume that such provisions are automatically enforceable, merely because the employee was represented by counsel.
Some ambiguous drafting notwithstanding, I believe that the only logical interpretation of Section 925 and the subsequent jurisprudence is that the legislature did in fact intend to allow California employees to contract away the protection of California law and jurisdiction for controversies arising in California, where the employee was represented by counsel in the negotiations. Any other interpretation would render Section 925(e) worthless.
The simplest explanation may seem obvious, but I think it is worth pointing out that where two parties may lawfully agree to apply another state’s laws to a contract that contains a noncompete provision, then California’s general prohibition of noncompete provisions is irrelevant. Since Section 925(e) recognizes that California employees may, in certain circumstances, agree to non-California choice of law and jurisdiction provisions, specifically where they were represented by counsel, then California law could not bar noncompete provisions in those same contracts.
What is the Law on Non-Compete Agreements?
Even if one does apply California law, it is clear that the general prohibition against noncompetes is not absolute, because it is subject to certain statutory exceptions, e.g. the sale of business exception. Although it does not explicitly reference Section 16600 or noncompetes, the California Uniform Trade Secrets Act represents another de facto exception to California’s general public policy.See Civil Code Section 3294 et seq. In fact, there are many more examples of such de facto exceptions can be found in California case law.See, e.g., Jones v Humanscale (2005) 130 Cal. App. 4th 401 (reversing trial court vacating New Jersey arbitration award, because arbitrator’s findings and decisions on enforceability of covenant not to compete was not palpably erroneous under California law, as “a former employee’s right to pursue his or her lawful occupation is not without limitation.”); see also Gordon v. Laundau (1958) 49 Cal.2d 690 (finding a defendant’s agreement not to use plaintiff’s confidential lists to solicit customers for himself for a period of one year following termination of employment valid and enforceable). Section 925 therefore represents but one of several statutory exceptions to Section 16600.
Moreover, one cannot ignore that the legislature, with full knowledge of Section 16600, amended Section 925’s general rule by adding Section 925(e), which states that Section 925
shall not apply to a contract with an employee who is in fact individually represented by legal counsel in negotiating the terms of an agreement to designate either the venue or forum in which a controversy arising from the employment contract may be adjudicated or the choice-of-law to be applied.
The legislative history supports the argument that the legislature carefully considered this issue, and intended to exempt agreements that are knowingly and voluntarily negotiated with the assistance of independent counsel.
Referring to the amendment of Section 925 to add subsection (e), the State Assembly’s June 21, 2016 floor analysis explains:
The opposition raises the concern that this bill would relieve a highly paid employee who has more than sufficient bargaining power in negotiating her employment agreement of honoring the terms of her contract. The author’s recent amendments appear to be aimed at addressing this concern. This bill now exempts employment contracts where an employee is individually represented by legal counsel in negotiating the terms of an agreement that designate venue or the choice-of-law…Californians should only be bound by these potentially one-sided terms if the Californian knowingly and voluntarily wants to leave the state to adjudicate a claim.CA SB 1241 April 25, 2016 Judiciary Report, pp. 7.
At bottom, it is clear that the Legislature intended that employees who freely negotiate their agreements should be bound by their terms.
Finally, in 2019, the emerging case law in this area began to support the foregoing interpretation. In Lyon v. Neustar Inc., the U.S. District Court for the Eastern District of California applied Section 925 and appeared set to enforce it.Lyon v. Neustar, Inc., 2019 US Dist Lexis 75307 (E.D. Cal. 2019). Among the issues considered by the court in that case was whether Section 925 permitted an employer to apply a Virginia choice-of-law provision in an employment agreement to enforce a noncompete against a California-based employee.
Although the employee had referenced “my lawyers” in an email discussing the noncompete agreement, the employee later provided unrebutted testimony that he did not actually have an attorney and that he used this phrase as a negotiation tactic. Based on the court’s presumption that the employee was not represented by counsel, the court ruled that Section 925 was in applicable. However, the court noted in its opinion that
… the plain meaning of the statute’s text controls, if the meaning is plain, and every statute should be read to avoid rendering any provisions superfluous.
This means that if the employee had in fact been represented by counsel, the court would have likely enforced the noncompete agreement.
Taken one step further, I believe that this opinion when read in the context of the foregoing analysis likely indicates that the jurisprudence in this area will continue to develop in the direction of enforcing choice of law provisions when the employee was represented by counsel.
Until that time comes however, employers who would like avail themselves of another state’s law and jurisdiction in contracts with California employees, should take at least the following steps, in order to mitigate the risk of running afoul of California law:
1. Identify Counsel
The employment agreement should state clearly that the employee was represented by counsel in the negotiations. In order to further mitigate risk, the agreement should identify the counsel, attest to the counsel’s independence and provide that the counsel has reviewed the agreement. Finally, if possible, the employer should get the independent counsel to sign off on the fact that the agreement is enforceable.
2. Confirm Independence
Counsel representing the employee should be truly independent. When making the determination of the counsel’s independence above, employers should make sure that the independent counsel is not someone who can be later challenged because they were referred, hired or paid by the employer.
3. Create a Paper Trail
Throughout negotiations, employers should get into the habit of building a record that the agreement, and in particular the choice of law and jurisdiction provisions, were freely and fairly negotiated, with the advice of counsel.