Employers who sign employees up to noncompetition agreements or other restrictive covenants or seek to enforce the agreements — even when employees enter into the agreements outside California in a state where the restrictions are lawful — risk liability under a new California law taking effect January 1, 2024.  Senate Bill 699, signed by Governor Newsom this month, also authorizes employees and former employees who sue to invalidate such restrictions to recover damage awards and attorney’s fees against their employer.  The new law is some of the most consequential legislation for employers to come from the 2023 legislative session.

SB 699 Voids Restrictive Covenants Entered into Within and Outside of California.

For more than 80 years, California law has declared void “every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind.”  (Business & Professions Code section 16600.)  Consequently, restrictive covenants – employer-drafted contracts that bar employees, once their employment ends, from competing with their former employer or from soliciting customers or employees to leave the employer – have long been subject to challenge in California.  Section 16600 has been most effective in invalidating restrictive covenants entered into by employees when they are living and working in California. 

However, where employees entered into such restrictions outside of California and in a state where the restrictions are enforceable, California courts have shied away from ruling them invalid.  Those circumstances arise, for example, when an employee signs an employer’s restrictive covenants while working in, say, Texas, then quits and moves to California to work for a competitor, and sues in California to invalidate the former employer’s restrictions.  In such situations, courts in the Golden State have in instances declined to invalidate restrictions out of respect for the laws of another state (the legal principle of comity) or when the court finds the other state’s interest in the matter to be greater than California’s interest (conflict of laws principles).

Under newly enacted SB 699, respect for the law of other states is apparently out the window!  The bill, which enacts Business & Professions Code section 16600.5, declares that restrictive covenants are “unenforceable regardless of where and when the contract was signed,” unless the agreement is within one of a few exceptions already in California law.  Taking aim at employers, the law prohibits employers entering into, and from attempting to enforce, such agreements “regardless of whether the contract was signed and the employment was maintained outside of California.”

Have no doubt: Section 16600.5 is a bold broadside assault on restrictive covenants regardless of where they are entered into.  That said, questions remain.  Do California courts have authority to rule void in all circumstances such restrictions that were lawfully entered into in other states?  Does the Full Faith and Credit clause set out in Article IV, Section 1, of the U.S. Constitution limit the reach of section 16600.5?  Where the court of another state has already ruled the parties’ restrictive covenants to be enforceable, does a California court have authority to then rule otherwise? 

Answering those questions and gaining greater clarity on the scope and impact of Section 16600.5 will require litigation and appellate decisions.

SB 699 Exposes Employers to Damage and Attorney’s Fees Awards.

This being California, Section 16600.5 authorizes employees, former employees, and applicants to recover damage awards, injunctive relief, and attorney’s fees and costs against their employers when they prevail in invalidating restrictive covenants!  Employers who prevail in litigation over restrictive covenants are not entitled under the new law to recover their fees against the losing individuals. 

Before the adoption of section 16600.5, individuals suing in California to invalidate restrictive covenants had no basis to recover damage awards or attorney’s fees.  While individuals could seek restitution, that dollar figure is different than a damages award and often less than a damages award.

Importantly, the new law authorizes prevailing employees, former employees, and applicants to win damages and attorney’s fees in cases, regardless of whether the restrictive covenants were entered into within or outside California.   

Quick Take Aways!

While appellate courts will need to answer questions concerning the limits of the new statute, we can say this much now:

1. With the potential the new law brings to recover damages and fees awards, Section 16600.5 boosts the motivation of employees, former employees, applicants, and plaintiffs’ attorneys to sue over restrictive covenants and increases the exposure in dollars for employers who are sued.

2. The new law will not end the familiar race between the employee rushing into court in California to invalidate restrictive covenants and the employer sprinting to court in its home state for a ruling enforcing the covenants.  If anything, the out-of-state employer will now hurtle more quickly than before in the hopes of obtaining a favorable ruling before the employee — now waving section 16600.5 on a flagpole — reaches court in California.

3. In addition to recognizing the greater reward individuals will have if they sue over unlawful restrictions, also take note that the new law does not require potential plaintiffs, before suing, to ask employers to withdraw restrictive covenants.  Given those facts, consider giving notice in a proactive manner to at least some current or former employees now located in California that your organization will not enforce the restrictive covenants within the Golden State.  That step may have value in pulling the rug out from beneath potentially litigious individuals before they file suit.

The law governing restrictive covenants is in flux in states across the U.S. and on a federal level.  As you reevaluate your organization’s approach to restrictive covenants, it will be key to include California’s new Business & Professions Code section 16600.5 in the mix.

If you have questions or we may assist with this or other employment law challenges, please contact your Fox Rothschild LLP attorney or the author.

This post provides general information and does not constitute legal advice to any person with respect to any circumstance.  This post does not create an attorney-client relationship with any person.