New Laws Reinforce California’s Hostility to Non-Competes with Notice Obligations and Civil Penalties

Background

California’s strong public policy against non-competes and other contractual restraints on an individual’s ability to practice their trade or profession is well known. Codified in Business & Professions Code Section 16600, the simple (but expansive) prohibition has remained virtually unmodified since its adoption in 1872: “[e]xcept as provided in this chapter, every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.” Only three limited statutory exceptions were recognized: non-competes in the context of a sale of business, the dissolution of a partnership, or the dissolution or termination of interests in a limited liability company. Most non-competes with California employees are thus void under Section 16600. California courts have interpreted Section 16600 to prohibit post-employment non-compete agreements and post-employment customer non-solicitation agreements. Although at least one California appellate court and several California federal courts have interpreted Section 16600 to also prohibit employee non-solicitation provisions, the issue has not been definitively addressed by the California Supreme Court.

Until the enactment of the 2024 amendments, a California resident seeking to challenge a restrictive covenant primarily relied on equitable relief. The resident could file a declaratory relief action and perhaps an unfair business practice claim under Business & Professions Code Section 17200. A California court could invalidate the contract and enjoin the employer from seeking to enforce. The results were mixed when a non-compete governed by a foreign state’s laws was enforced in that foreign state. Issues of comity between sister states, even where the restrained individual resided and worked in California at the time of the suit, often conflicted with California’s strong public policy on this issue.

SB 699

SB 699, codified as new Section 16600.5 to the Business & Professions Code, expands the reach California’s restrictions on non-compete agreements to contracts entered into outside of California. Section 16600.5 provides that “[a]ny contract that is void under [Section 16600] is unenforceable regardless of where and when the contract was signed.” An employer or former employer is prohibited from attempting to enforce a contract that is void under Section 16600 “regardless of whether the contract was signed and the employment was maintained outside of California.” Section 16600.5 therefore prohibits any employer, regardless of location, from attempting to enforce a post-employment non-compete that is unlawful in California, even if such non-compete was initially signed and the employee’s employment was initially maintained outside of California but the employee subsequently moves to California to accept new employment.

An employer who violates the law commits a civil violation. Section 16600.5 authorizes a current, former or prospective employee to bring a lawsuit to enforce the law by seeking injunctive relief and/or actual damages. An employee who prevails in the lawsuit is also entitled to recover reasonable attorneys’ fees and costs. Section 16600.5 provides employees with new remedies in lawsuits against employers who attempt to implement or enforce non-compete agreements that violate Section 16600. It should be noted that there is no counterpart attorneys’ fee provision for employers who prevail in litigation over SB 699.

Some commentary has suggested that California is attempting to impose its will extra-territorially. However, the legislative findings focus on interests within California, stating that SB 699’s added restrictions are intended to preserve California’s “competitive business interests” by “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.” Constitutional challenges to SB 699 relating to the full faith and credit clause of the U.S. Constitution are nevertheless expected.

AB 1076

AB 1076 amends Section 16600 to codify existing caselaw and imposes strict notice requirements on employers with respect to any existing restrictive covenant agreements the employer entered into with current or former employees that are void under Section 16600. First, the amendment codifies the 2008 California Supreme Court decision Edwards v. Arthur Andersen LLP and makes it unlawful to include a non-compete clause in an employment contract that does not satisfy one of the statutory exceptions. Second and importantly for employers, the amendment imposes on employers the following notification requirements with respect to agreements that are void under Section 16600:

• By no later than February 14, 2024, employers must notify any current employees and former employees who were employed after January 1, 2022, who were parties to unlawful post-employment non-compete clauses or agreements, that the noncompete clause or agreement is void.
• The form of notice must be a written individualized communication delivered to the last known address and the email address of the current or former employee.

Any violation of the notification requirement, which may include failure to provide the required notice or providing a defective notice that does not comply with the foregoing requirements, constitutes “an act of unfair competition” and may result in a penalty of $2,500 per violation. The amendment does not specify how the penalty would be calculated, such as whether it is $2,500 for each employee or per clause or agreement.

Next Steps

These new laws do not impact restrictive covenants that fit within statutory exceptions, such as in the sale of business context. Neither SB 699 nor AB 1076 specifically addresses post-employment non-solicitation of employees or customers provisions. AB 1076 does state that Section 16600’s prohibition is “not limited to contracts where the person being restrained from engaging in a lawful profession, trade or business is a party of the contract.” That language reinforces existing case law barring no-hire provisions, but whether it applies to employee non-solicit provisions will need to be determined through litigation.

In light of the foregoing changes in California’s non-compete landscape, employers are encouraged to review their existing restrictive covenant agreements, particularly those with California-based current or former employees, to determine whether any changes should be made to those agreements and whether notification requirements are triggered under the new laws by the February 14, 2024 deadline. Moving forward, employers should consult with counsel before attempting to impose restrictive covenants on individuals based in California.