California Employers Face Feb. 14 Deadline and Tighter Noncompete Prohibitions

SB 699 prohibits an employer from enforcing a noncompete agreement in California that is void under state law, regardless of whether the former employment was outside of California and the agreement was signed outside of the state. The bill also provides that an employer commits a civil violation by having an employee sign a prohibited noncompete agreement, or by trying to enforce one, and allows a lawsuit against the employer. Even more, AB 1076 requires employers to notify current and former employees by February 14 of any void noncompete clause or agreement. Employers must act now to comply with this impending deadline.

A Broad Prohibition, With Few Exceptions

Since 1872, California has restricted employee noncompete agreements. Since the 1940s, Business and Professions Code section 16600 generally has provided that covenants not to compete are invalid in the state, unless an exception within that part of the code applies. Before and now, the statute provides that “every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.” Cal. Bus. & Prof. Code § 16600(a). This broad prohibition has a few, limited exceptions in the law: For the sale of a business (Cal. Bus. & Prof. Code § 16601), dissolution of a partnership or the disassociation of a partner from a partnership (Cal. Bus. & Prof. Code § 16602), and the dissolution of a limited liability corporation or a member’s departure from it. (Cal. Bus. & Prof. Code § 16602.5.)

In Edwards v. Arthur Andersen LLP 44 Cal.4th 937 (2008), the California Supreme Court held that, unless one of these statutory exceptions applies, the state’s prohibition on noncompete agreements is absolute. Under the law’s “plain meaning,” the court held that “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.” It rejected the argument that a noncompete would be permissible as long as it was “reasonably based” or a “narrow restraint,” such as for a limited time or geographic area, as some federal and lower California courts held. The California Supreme Court concluded: “Section 16600 is unambiguous, and if the Legislature intended the statute to apply only to restraints that were unreasonable or overbroad, it could have included language to that effect.”

Subsequently, the California Court of Appeal applied Edwards to bar at least some non-solicitation provisions. See AMN Healthcare, Inc. v. Aya Healthcare Services, Inc., 28 Cal.App.5th 923, 935-939 (2018); Dowell v. Biosense Webster, Inc., 179 Cal.App.4th 564, 574-579 (2009). Thus, California employers should consider carefully whether particular non-solicitation provisions, as well as noncompete terms, would comply with California law in a particular situation. Regardless, these provisions and decisions generally do not prohibit agreements to keep business, proprietary, or trade secret information confidential —although the distinctions between such provisions and prohibited terms may not always be clear.

Stricter Prohibition, Allowing Employees to Sue

In SB 699, the legislature made findings that, despite California’s longstanding general prohibition on noncompetes, employers continue “to subvert this longstanding policy by requiring employees to enter void contracts.” It recognized a recurring issue with employers attempting to rely on noncompete agreements from out of state to restrict people working in California, which California courts have rejected. Thus, in SB 699, the legislature declared the policy 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.”

With respect to out-of-state noncompetes, SB 699 added new Business and Professions Code section 16600.5. This new law now makes expressly clear that a noncompete void under California law “is unenforceable regardless of where and when the contract was signed.” Cal. Bus. & Prof. Code § 16600.5(a). Thus, a noncompete signed outside of California will not be enforceable in the state if California law would not allow it. To further preclude any effort to enforce any void agreement, the new law further provides that an employer or former employer “shall not attempt to enforce a contract that is void” under the law “regardless of whether the contract was signed and the employment was maintained outside of California.” Cal. Bus. & Prof. Code § 16600.5(b). Leaving no doubt, the new law also flatly provides that an employer “shall not enter into a contract with an employee or prospective employee” containing a noncompete provision that California prohibits. Cal. Bus. & Prof. Code § 16600.5(c).

Previously, the law was not entirely clear on what legal claim a California employee might pursue over a noncompete agreement. While an employee might seek a declaratory judgment that a noncompete was void, or assert an unfair business practices claim, the law was unsettled as far as what other claim an employee might have, such as for lost income damages or restitution for not being able to work in a particular job. Otherwise, the issues typically reached a court when an employer sought an order to enforce a noncompete agreement. However, just having a noncompete provision — enforceable or not — could serve as a deterrent to many former employees, regardless of whether an employer took legal action to enforce it.

SB 699 changed matters significantly. It expressly authorized a lawsuit against an employer, as well as potential recovery. Now, an employer who “enters into” or “attempts to enforce” a prohibited noncompete agreement “commits a civil violation.” Cal. Bus. & Prof. Code § 16600.5(d). The new law allows employees, former employees, or prospective employees to sue to enforce California’s noncompete restrictions. They may obtain an injunction and recovery of actual damages, as well as reasonable attorney’s fees and costs. A prevailing employer, on the other hand, cannot recover its attorney’s fees or costs. See Cal. Bus. & Prof. Code § 16600.5(e)(1)-(2). Likely, California employers can expect the creation of this new legal claim and recovery, with attorney’s fees, to spur litigation in this area.

Written Notice Required by February 14

In the same vein, AB 1076 did three things. First, the legislature codified its intent that the law be construed consistently with Edwards. California thus has emphasized that, absent a statutory exception, all noncompete agreements are unenforceable. The law now provides that Business and Professions Code section 16600 “shall be read broadly,” in accordance with Edwards, so that any noncompete is void “no matter how narrowly tailored,” unless a statutory exception applies. Cal. Bus. & Prof. Code § 16600(b)(1). This construction also will apply regardless of whether the person subject to the noncompete is a party to the contract. Cal. Bus. & Prof. Code § 16600(c).

Second, in case there was any doubt about how seriously California restricts noncompetes, AB 1076 expressly declared it “unlawful” for an employer “to include a noncompete clause in an employment contract, or require an employee to enter into a noncompete agreement,” unless it satisfies one of the exceptions in the law. Cal. Bus. & Prof. Code § 16600.1(a).

Third, and extremely significantly, AB 1076 mandates that all employers must notify employees if they are subject to any “void” noncompete clause or agreement (i.e., where none of California’s narrow exceptions allow the noncompete). Employers must give such notice to current employees, as well as to former employees employed after January 1, 2022. The notice must be written and in the form of an “individualized communication.” The employer must send it to the current or former employee’s last known address and email.

Failure to comply with this written notice requirement will constitute “an act of unfair competition” under California’s Unfair Competition Law (Cal. Bus. & Prof. Code § 17200 et seq.), a common basis for other suits against employers, particularly on wage and hour claims. AB 1076 did not specify any penalty, nor authorize employees to seek one. However, the Attorney General or public prosecutors may seek a civil penalty of up to $2,500 per violation.

Employers should work closely with counsel to identify agreements that may be subject to this notice requirement, which employees to notify, and what to communicate.

Trend Against Noncompetes

Although California already severely restricted noncompetes, its recent legislation is part of a broad trend against such agreements. In recent years, several states enacted laws restricting noncompetes. For example, in July 2023, Minnesota joined California, Colorado, North Dakota, and Oklahoma in having a near-total ban on noncompetes. In 2022, Illinois banned, among other things, noncompetes for employees earning less than $75,000 per year and non-solicitation agreements with employees earning less than $45,000 per year. In 2018, Massachusetts prohibited noncompetes with non-exempt employees, interns, and minors, and imposed other restrictions.

New York Governor Kathy Hochul recently vetoed a bill that would have banned noncompete agreements, arguing for a less restrictive measure instead. ArentFox Schiff’s alert on the New York legislation is here.

On the federal level, the Federal Trade Commission (FTC) proposed a new rule banning noncompetes nationwide. It remains pending a possible vote in coming months, with the ultimate outcome uncertain. The National Labor Relations Board’s (NLRB) general counsel also now takes the position that noncompetes violate employees’ right to concerted activity under the National Labor Relations Act (NLRA). The board has not yet ruled on this issue.

Takeaways and Next Steps for California Employers

At least since the California Supreme Court’s Edwards decision in 2008, the legal landscape should have been clear that California broadly prohibits noncompetes, unless one of the limited statutory exceptions applies. SB 699 and AB 1076 should put to rest any remaining doubt. In addition to underscoring California’s broad prohibition on noncompetes, these new laws reinforce them by declaring prohibited noncompetes not only void, but also unlawful, and authorizing employee lawsuits for damages. California employers cannot ignore these issues, and the accompanying risks, any longer.

In addition to providing any required written notices by February 14, employers should review employment agreements, offer letters, confidentiality agreements, or other documents that they use to ensure they comply with California law on noncompetes. Employers should also carefully review non-solicitation and even confidentiality provisions that might run afoul of California’s noncompete provisions, if they can be interpreted as preventing an individual from working in his or her profession, trade, or business, as California noncompete laws have been broadly read.

California employers should also avoid other potential pitfalls, such as attempting to try to include a prohibited noncompete provision, but calling it something else, when the effect actually may be a void noncompete term. After SB 699 and AB 1076, courts likely will scrutinize such attempted workarounds closely. Trying to avoid California law by including a choice of law provision relying on another state’s law most likely would not be successful, as California courts have rejected such arguments and applied California’s more protective noncompete law to California residents and employees instead. Further, as discussed above, California’s protections, as interpreted in Edwards, apply regardless of whether the person subject to the noncompete is a party to the contract. Cal. Bus. & Prof. Code § 16600(c). Thus, two parties cannot avoid California law and apply a prohibited noncompete term to a third-party employee simply by agreeing to a void noncompete in an agreement separate from that employee.

On occasion, while recognizing that a noncompete provision may not comply with the law, California employers still have included a noncompete term in an employee agreement but resolved not to enforce it if challenged. Such terms could have a chilling effect on employees. Now, because of the potential consequences, SB 699 and AB 1076 should put an end to such ideas. As discussed, these new laws declare such provisions unlawful and a civil violation, with an employer subject to a lawsuit and recovery of damages for entering into such terms.

Moreover, as discussed, employers cannot rely on a noncompete agreement entered into outside of California being enforceable in the state. Employers outside of California thus should take these changes into account with respect to former employee who may move to California. Out-of-state employers also should carefully review how these developments may apply to their California employees.

Employers are strongly encouraged to work with employment law counsel experienced in California law to navigate these various issues.

Finally, for those interested in learning more about these bills (as well as other California employment law updates for 2024), ArentFox Schiff hosted a webinar, which can be viewed here.