California Bill Would Impose Penalties on Employers and Attorneys for Attempting to Enforce Restrictive Covenants
In February 2023, new legislation was proposed in the California State Assembly that, if adopted and signed into law by Governor Gavin Newsom, could have a significant impact on employers and their attorneys providing advice regarding the use of restrictive covenants in California.
Assembly Bill (AB) 747, introduced by California Assembly Member Kevin McCarty (D-06), provides, among other things:
The use, or attempted use, of a “covenant not to compete” would constitute a violation resulting in actual damages and an additional penalty of $5,000 per employee or prospective employee who is harmed by the violation.
Attorneys could face suspension, disbarment, or other discipline by the State Bar of California for presenting an employee or prospective employee with a covenant not to compete or attempting to enforce such a covenant not to compete.
The broadly worded definition of “covenant not to compete” includes “any provision of any contract or other agreement that restrains anyone from engaging in a lawful profession, trade, or business of any kind.”
While the bill was just recently proposed and has not yet been voted on by a committee—much less been approved by the full assembly, senate, or governor—if adopted, it could have a significant impact on employers and legal practitioners providing advice in California on restrictive covenants, particularly for employers operating across state lines.
Under section 16600 of the California Business and Professions Code, post-employment noncompete clauses are deemed void in California. California courts, including the Supreme Court of California in Edwards v. Arthur Andersen LLP, have repeatedly reaffirmed the strong public policy in California against such noncompete clauses. With that said, nonsolicitation-of-employee clauses (i.e., clauses providing that employees may not solicit employees from their prior employers) historically had been upheld as enforceable in California. However, in 2018, a lower court of appeal decision, relying on Edwards, held that at least under certain circumstances such nonsolicitation-of-employee clauses were invalid as well. Various federal district court decisions have adopted this same analysis, though the Supreme Court of California has not squarely addressed this issue. As a result, it is still a legally unsettled issue.
If adopted, AB 747 could result in bar discipline or disbarment of attorneys who provide advice or are involved in the drafting of nonsolicitation clauses regarding this unsettled issue. Moreover, while it is perhaps not surprising that the legislature seeks to add teeth to penalties for the prevention of noncompete clauses that are clearly in violation of California state law, this proposed legislation goes beyond just providing for monetary penalties. It also provides for state bar discipline of attorneys involved in drafting employment agreements, even in situations where the law is unsettled or less than clear.
For example, often there are difficult legal nuances regarding when California law may apply to a particular situation, such as when employees frequently travel among a number of states as part of their jobs, or when employees reside in states that allow restrictive covenants but engage in sales or other activity in California. There are also open questions regarding whether certain employment contract provisions, such as provisions requiring lengthy notice before resignation, or (as noted) nonsolicitation-of-employee clauses, would fall under the definition of “covenant not to compete.” Instituting state bar discipline for attorneys involved in drafting provisions intended to comply with current state law in such situations is fairly draconian.
In addition, current California law does not provide any specific monetary penalty for instituting a “covenant not to compete.” Instead, such clauses that violate California law are deemed void, and such clauses could also serve as the basis for an unfair business practice claim under section 17200 of the Business and Professions Code, which then provides potentially for equitable remedies, including injunctive relief and disgorgement. The proposed legislation would provide for a specific $5,000 penalty for each employee or prospective employee harmed by a violation, in addition to any other proven damage. This provision could significantly raise the stakes in any dispute involving a restrictive covenant in California.
AB 747 also addresses an exception to section 925 of the California Labor Code, which allows for an employee who primarily resides and works in California to agree to a forum selection clause or choice-of-law provision of another state if the employee is individually represented by legal counsel in the negotiation of such provisions. This provision is often relied upon by parties to negotiate for the application of law in another state that might uphold a restrictive covenant. This legislation would provide that for any employment contract “entered into, modified, or extended on or after January 1, 2024, an employee is not considered individually represented by legal counsel”—even if there is an arm’s length negotiation—“if the counsel is paid for by, or was selected based upon the suggestion of, the employee’s employer.” (Emphasis added.)
This proposed legislation is a further illustration of the strong legal trend in California (and elsewhere) against the use of restrictive covenants and an indication that employers operating in California may want to reexamine their employment or proprietary and invention agreements.
If the California Legislature adopts the legislation in its current form, legal practitioners in the state will likely tread very carefully when offering advice regarding the enforceability of any restrictive covenants, including nonsolicits.