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The Latest Attack on California’s Ban of Noncompete Agreements
Friday, June 21, 2024

Noncompetes are a widespread and often exploitative practice with which employers limit workers’ ability to ‘compete’ with their former employer during or after employment. Studies have shown that noncompetes suppress wages, hamper innovation, and block entrepreneurs from starting new businesses. The Federal Trade Commission (FTC) has reported on research that shows that one in five workers, or approximately 30 million people in this country, are currently subject to a noncompete. Recently the FTC issued a rule banning noncompetes nationwide, and the District of Columbia barred some noncompetes in 2022. California, in contrast, has effectively banned noncompete agreements for over 150 years.

It is no coincidence that California has seen more than a century of enhanced economic development, wage growth, innovation, entrepreneurship, and competition in the years following its enactment of its broad noncompete ban in 1872. Laws restricting non-competes in California, and across the United States, have evolved substantially since then, but California remains a national leader in thwarting employers’ attempts to restrain their employees’ competition. In spite of California’s longstanding ban on noncompetes, employers in California continue to have their employees sign noncompete clauses that are clearly void and unenforceable under California law. This has a chilling effect on employee mobility.

To address this and other gaps in California’s noncompete legislation, in the fall of 2023, California Governor Gavin Newsom signed two new laws that further extend the state’s ban on non-competes. Shortly after the new provisions took effect, an employee sued his employer for enforcing a noncompete provision, and the employer has defended against his suit by challenging the constitutionality of the new law.

California’s Expansion of its Noncompete Ban

Before the latest wave of amendments, both of which went into effect on January 1, 2024, California Business and Professions Code Section 16600, the statute prohibiting noncompetes, rendered void and unenforceable agreements that restrained California employees from engaging in any lawful profession, trade, or business, subject to very limited exceptions, mostly in the context of sale of a business. Even if one of the narrow exceptions applies, the scope of the restrictive agreement must be reasonable both in geographic scope and duration.

On September 1, 2023, Governor Gavin Newsom signed into law S.B. 699, which adds a new Section 16600.5 stating that “any contract that is void under this chapter is unenforceable regardless of where and when the contract was signed.” More specifically, the new law states that the employer or former employer may not attempt to enforce such void contracts “regardless of whether the contract was signed and the employment was maintained outside of California.” The new law thereby invalidates noncompetition agreements or other restrictive covenants to enforce the agreements – even when employees entered into the agreements outside California in a state where the competition restrictions are lawful.

Likely in response to California employers’ attempts to continue to force employees to sign unenforceable noncompetes, the law also states that an employer that either enters into a contract with a void noncompete agreement or attempts to enforce such a void agreement, “commits a civil violation.” Finally, it provides that employees, former employees, or prospective employees may bring private, civil actions for injunctive relief or actual damages, and be entitled to recover attorney fees and costs. In other words, the new law has teeth: employees can sue their employers for damages if the employer tries to enforce a void noncompete.

In addition to S.B. 699, on October 13, 2023, Governor Newsom signed into law A.B. 1076, which expressly provides that Section 16600, California’s ban on noncompetes, should be “read broadly” to “void the application of any noncompete agreement in the employment context, or any noncompete clause in an employment contract, no matter how narrowly tailored.” In doing this, the law clarifies, it is not expanding existing law, but rather codifying existing law in accordance with Edwards v. Arthur Andersen LLP, 44 Cal. 4th 937, 955 (2008), where the Supreme Court of California stated that “[n]oncompetition agreements are invalid under section 16600 in California, even if narrowly drawn.” A.B. 1076 also includes a notice provision that required employers, by February 14, 2024, to provide written, individualized notice by both mail and email to current and former employees who: (1) were employed after January 1, 2022, and (2) whose employment contracts included a noncompete clause or agreement covered by Section 16600.

Taken together, these two amendments significantly expand California’s ban of noncompetes. As of January 1, 2024, California bans noncompetes for any employee working for a California employer (again, subject to the narrow exceptions in Section 16600), even if the original noncompete was entered into in a state where the noncompete agreement was lawful. Employers may not attempt to enforce such void contracts, and furthermore, employees may bring civil actions for damages and attorney fees if an employer tries to enforce a void noncompete.

The Latest Attack on California’s Noncompete Ban Expansion

Unsurprisingly, California’s expansion of its noncompete ban has met resistance. Just over a month after the new laws went into effect, a former DraftKings executive filed a lawsuit against his former employer to challenge his noncompete agreement under the new Section 16600 amendments. Hermalyn et al. v. DraftKings Inc., No. 24-stcv-02694 (Cal. Super. Ct.). Mr. Hermalyn alleged that his former employer, DraftKings, sought to enforce its noncompete agreement with Mr. Hermalyn, which Mr. Hermalyn had signed in New Jersey. DraftKings sought to prevent Mr. Hermalyn from working for Fanatics, a California employer. Mr. Hermalyn alleged that, because the noncompete agreement is void and unenforceable under California law thanks to the S.B. 699 amendment, DraftKings cannot seek to enforce its noncompete, even though he entered into the agreement in another state where noncompetes are lawful.

For its part, DraftKings has argued that, because it is headquartered in Massachusetts, and the noncompete invoked Massachusetts as its choice of law, Massachusetts law should apply – and Massachusetts does permit noncompetes, with some restrictions. DraftKings further argued that the California law is unconstitutional thus raising the first major challenge to these California amendments. Mr. Hermalyn has requested a bench trial on the enforceability of the DraftKings noncompete this summer.

It is not yet clear how California courts will rule on the constitutionality of the California law. Because the law invalidates contracts agreed to in other states, defendants may argue, as DraftKings has done, that California’s new law violates the full faith and credit clause of the United States Constitution, which requires that states must respect the “public acts, records, and judicial proceedings of every other state.” Courts have generally applied this clause to prevent conflict among states and to ensure the dependability of judgments across the country.

Other Open Questions about the California Amendments

In addition to a lack of clarity about whether California’s new laws will be deemed unconstitutional due to their intrusion upon contracts agreed to in other states, there are several other open questions flowing from the new laws. For example: it is not clear whether S.B. 699 and A.B. 1076 restrict California employers from enforcing noncompete agreements with employees who are located outside of California, but employed by California employers. Especially in this post-Covid era where many workers continue to work remotely, it is likely that many California employers employ people who work remotely from states across the country. Given the new law’s codified instruction to interpret restrictive covenants broadly, it will likely prevent even out-of-state employees from being constrained by noncompetes issued by California employers.

Another consideration is the potential impact of the Federal Trade Commission’s new nationwide noncompete ban barring employers from imposing noncompetes with their employees. The nationwide ban goes into effect on September 4, 2024, and is a bit narrower than California’s, as described in more detail here. Even if portions of California’s latest expansion to its noncompete laws are found unconstitutional, the FTC’s new rule would retroactively invalidate noncompetes for all employees except senior executives (as defined in the new rule).

Finally, the amendments do not address California Labor Code Section 925, which courts have found on occasion to support enforcement of noncompetes entered into by a California employee if the agreement was governed by another state’s laws and the employee was represented by counsel during contract negotiations. For example, in Nuvasive, Inc. v. Patrick Miles, C.A., No. 2017-0720-SG (Del. Ch. Sept. 28, 2018), the Delaware Court of Chancery ruled that a Delaware choice-of-law provision and noncompete between a California resident and his former Delaware-based employer were enforceable, in spite of California’s Section 16600. That court relied on California Labor Code Section 925 and concluded that the noncompete would not violate California fundamental public policy given the passage of that section. However, the relevant noncompete was signed prior to the passage of Section 925, and the law was not retroactive. Further, there is nothing in Section 925’s legislative history indicating that the California legislature intended to authorize choice-of-law provisions that would operate to undermine its 150-year public policy in favor of free competition. And the California legislature’s new laws now make it clear that it invalidates even noncompetes signed in other states. It is possible that a court may interpret the amendments, read alongside Labor Code Section 925, to further establish California’s codified preference for the supremacy of California law over California employees and employers.

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