California Expands the Non-Compete Ban on Out-of-State Employment

A new state law expands the geographical reach of California's already broad restrictions on non-competes (and to a certain extent to non-solicitation and NDAs). Except for a handful of narrow exceptions, California makes void all contracts restraining anyone from engaging in a lawful profession, trade, or business of any kind. Bus. & Prof. Code Sec. 16600.

On September 1, 2023, California's governor signed Senate Bill 699 into law, which added Section 16600.5 to the Business and Professions Code, to be effective starting January 1, 2024. This new law will expand this restriction by making the trade-restrictive contracts unenforceable regardless of where and when the contract was signed and regardless of whether the employment was maintained outside of California.

The new law has sharp teeth. It will impose civil penalties on anyone who violates this law, and it will give the employees (even prospective and former employees) the power to bring an action for the penalties, actual damages, or injunctive relief plus reasonable attorney’s fees and costs. This means potentially five, six, or seven-figure amounts.

Which state's law applies?

In today's age of remote cross-state-line work, the non-compete question becomes a question of choice of law. California and D.C. are among the growing number of jurisdictions that have banned contracts restricting trade or business. Other states enforce non-compete agreements only if they are reasonable. Which law applies? Can you shop for pro-competitive or pro-restrictive laws?

The ability to choose certain laws is not always a shopping trip. In some circumstances, you may not be able to avoid California's pro-competitive laws, but in some cases, you may be able to choose a non-California law.

For example, in Application Group v. Hunter Group, 61 Cal.App.4th 881 (1998), the California Appellate court found that a non-California employee who worked for a Maryland corporation could switch to a California company even though his employment contract had a non-compete. The non-compete was valid under Maryland laws, which parties chose to govern the contract. Yet, the court ruled that Maryland non-compete was not enforceable in California against a California corporation because California's public interest was "materially greater" than Maryland's.

Since the Application Group case, California enacted Labor Code Sec. 925 (effective since 2017), which provides that an employer cannot require a California employee to choose a non-California law or a non-California forum in the employment agreement. However, there is an important exception. An employer may put a non-California law in the contract if the employee was individually represented by legal counsel in negotiating the terms of the agreement. One court (non-California court) held that this exception superseded the Application Group case. See Labor Code Sec. 925(e). So, an employer may theoretically avoid California laws if the employee has negotiated the choice of law through his or her legal counsel. And, of course, the chosen law still has to pass the court's choice-of-law balance of each state's interest.

What does this mean?

If your business is in California, and you want to hire out-of-state employees...
You may be able to hire employees from competitors from other states, even if those employees have signed non-compete agreements if the court decides to apply California's strong policies against non-competes. See the Application Group case. The new Section 16600.5 to the Business and Professions Code aims to expand the pool of potential employees for California companies. This is especially convenient for companies that rely on remote workers. And the Labor Code Sec. 925 restrictions on opting out of California law would not apply to out-of-state employees. Hence, the door is open to the expanded pools of out-of-state employees.

If you want to restrict your California employee's ability to work for competitors...
Regardless of where your company is, you should review your current agreement and pay particular attention to the non-compete, non-solicitation, and NDAs. You should remove any non-compete language, and you should narrowly tailor the NDAs. Not only that, but you should be careful choosing non-California law or non-California forum. Remember that Labor Code Sec. 925 makes any attempt to avoid California's laws for California employees potentially invalid. You may still use the exception to this rule, but you still need to consider the choice-of-law test and the balance of interests. See Labor Code Sec. 925(e).

If you are a California company, and you want to limit your non-California employee's ability to work for competitors...
The new law states that you may not do so. However, you may be able to use - with a carefully tailored approach and particular attention - the choice-of-law and forum selection provision. In some very narrow cases, you may be able to enforce a reasonable non-compete, since Labor Code Sec. 925 does not apply to non-California employees.

The question of non-compete, non-solicitation, and non-disclosure agreements is very complex. It depends not only on the applicable law but also on which state's court will decide it. If you leave the forum selection out of the contract, it may turn into a forum shopping competition because different courts may have different opinions about the non-compete and choice of law questions.

Nothing in this blog constitutes legal advice. The blog contains only general information, which may not fit your particular situation.