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The Golden State’s New Golden Rule: Section 925 Adds Another Hurdle To Protecting Business Information

An employer that wants to protect confidential information from walking out the door with former employees knows to avoid California, a place notoriously hostile to agreements that limit former employees’ mobility. Alas, California has just made it harder to avoid California.    

Suppose you are a nationwide employer that, say, designs and makes digital technology or services the specialty chemical needs of your business partners—either of which would involve highly confidential, proprietary information. Let’s also say that, if your technical information or customer lists fell into the hands of competitors, or walked out the front door with a departing employee, that loss could cause irreparable competitive harm. And finally, let’s say that you’re a smart employer, and you use various forms of restrictive covenants—noncompetes, non-solicitation agreements, and nondisclosure agreements—to protect your competitive lifeblood.  Good work: every state—even California, which is viewed in popular mythology as a restrictive-covenant-free land—recognizes that some employer information deserves protection.

But savvy employers know that California isn’t so nice in practice. The ways in which the California legislature will allow an employer to protect trade secrets and similar information from poaching and disclosure by employees are extremely limited. First, you can’t have an agreement that prevents an employee from competing—at all.  Second, you might be able to have a nondisclosure agreement (with respect to information) or a nonsolicitation agreement (with respect to business partners, customers, employees, etc.), but only if the information rises to the level of a real trade secret. Other information you might care about—admittedly confidential and competitively important—may not be protectable at all under California law.

In contrast to California, many states take a blunderbuss approach: I’ll just prevent you from working altogether, and then I don’t have to worry about you disclosing my confidential information or poaching my customers, as presumably you won’t have an employer to disclose to or a target to poach. Extreme, but effective.

The problem with the narrow approach taken by California, however, is that while some level of non-solicitation or nondisclosure protection is helpful, it’s very difficult to police. An employer knows, or generally can find out, if an employee is working for a competitor; nowadays, just take a look at LinkedIn. What’s harder to know is whether a former employee who is permitted to work for a competitor is disclosing, say, sensitive sales and pricing information to your competitor. Often, employers find out only after the damage has been done, when what the employer really needed was an injunction to prevent the damage in the first place.

So back to avoiding California: smart employers learned that where an employee and an employer both had a meaningful connection to a jurisdiction that would actually enforce a noncompete, a court would enforce choice of law and forum selection provisions in favor of that jurisdiction—even where the employee in question lived and worked in Los Angeles. Hello, New Jersey (and most other states); so long, California.

Alas, the California legislature got wise to this strategy and just erected its newest hurdle to the enforcement of noncompetes in jurisdictions that allow them:  California Labor Code § 925.  Section 925 seeks to restrict choice of law and venue clauses in certain employment agreements.  This article will address these new challenges and some ways employers can still protect their confidential business information and customer relationships.


 

Non-Competition Clauses in California: Forget About It

            It’s only a mild overstatement to say that California’s public policy views noncompetition agreements as about as fair and reasonable as paying the mob for “protection” or beating up little kids for their lunch money.  California’s employee-friendly reputation stems largely from its legislative bar prohibiting employers from utilizing non-competition agreements with their employees, absent certain very narrow exceptions.  The Supreme Court of California has wholeheartedly endorsed this wide-reaching prohibition, holding that even narrowly-drawn non-competition agreements are invalid unless they meet one of the specific statutory exceptions.

Soon thereafter, the California Courts of Appeal reminded employers that non-compete provisions aren’t the only form of unlawful restraint—non-solicitation provisions are just as bad, and just as unenforceable.  Employers are thus prohibited from using non-solicitation provisions to stop former employees from soliciting the employer’s customers (unless, as noted, the employee utilizes trade secrets in doing so).  With these prohibitions in place, California employees enjoy more freedom in pursuing their own professional ambitions. That seems like a good thing. They are also freer to use information and customer relationships developed at a former employer’s expense and time to compete with their former employer. That seems like a bad thing, and the laws of most U.S. states say so.

Leveling the Playing Field: Choice of Law and Venue Provisions

            Given these strict legislative prohibitions, what is an employer to do if they want to protect their business interests by non-compete and non-solicitation provisions?  The answer is simple: ensure that these disputes never see the inside of a California court room. Bring the dispute into a court in a state and under laws that recognize that, at least sometimes, a noncompete (or a non-solicitation agreement founded by something short of a true trade secret) is necessary and enforceable.

            Employers that are successful in enforcing these choice of law and venue provisions do so by shifting the focus of the of the employer-employee relationship.  Instead of focusing on where the employee was or is working (in California), the employer shifts the focus to the employer’s established protectable interests in another state. For example, my hypothetical chemical company might be headquartered in New Jersey and do business worldwide. Its Los Angeles employee goes to work in a Los Angeles office and lives in a house I can’t afford near the Pacific. But she also travels worldwide for her employer, whose interests are not just in California, but everywhere. Courts in New Jersey—and even courts in California—would enforce an employment agreement choosing New Jersey law to govern it and requiring that any dispute under the agreement be litigated in New Jersey.

In a choice of law analysis, California courts will generally look to see if there is a substantial relationship between the state law the parties agreed to use and, if so, will determine if applying that state law violate a strong public policy of California.  If you start your litigation in California and assert that New Jersey law should apply, you’re facing an uphill battle: you are before an overworked California judge who knows about the whole noncompete-like-stealing-lunch money thing, and technical arguments aside, you will lose virtually every time.

The brilliance of a good forum selection provision (in my example, requiring litigation in New Jersey) is this: now, you just commence the action there, and a New Jersey court has no problem with the choice of New Jersey law or forum unless there’s just no connection to the state at all. And even if your former employee races to a California courthouse before you, now you’ve got that same overworked judge looking at an agreement that says the litigation should be somewhere else. Dismiss for lack of jurisdiction under the agreement? Kick one case off the docket? You bet!

For example, a federal court in California upheld a forum selection clause in an employment agreement between a California-based employee and a Washington-based corporation providing for disputes to be litigated in the state of Washington, despite the inclusion of a non-compete provision in the employment agreement. The court in Meras explained that federal courts normally consider three factors in a choice of venue analysis: (1) whether the provision was obtained by fraud or duress; (2) if the party seeking to avoid the clause would be deprived of its day in court should the clause be enforced; and (3) if enforcing the clause would contravene a strong public policy of the state in which the suit is filed. 

The court rejected the employees’ argument in Meras that enforcing the choice of venue clause would violate California’s public policy against non-compete provisions. In doing so, the court cautioned against conflating choice of law and choice of venue provisions, explaining that the two are separate and distinct issues to be decided independently. To that end, just because a court enforces a contractual choice of venue provision does not mean that the parties will ultimately litigate according to that venue’s law; rather, the venue itself must conduct a choice of law analysis. It’s encouraging, however, that the court did not allow California’s non-compete prohibition to win the day to invalidate the choice of venue provision.  This gives some level of hope for employers seeking to enforce these clauses.

California Strikes Back: Section 925

            As a response to the very real possibility that courts will enforce an employer’s preferred choice of law and choice of venue provisions, California signed into law Section 925, which went into effect on January 1, 2017.  Section 925 applies to employees who “primarily reside and work in California.” If you’re following all this, in other words, California just shifted the focus away from the employer’s otherwise protectable interests and back onto the employee—who, as we know, lives in California, drives a Prius, enjoys yoga, and intends to compete against you.

The new California law is simple in its approach:  it prohibits employers from requiring these employees, as a condition of employment, from agreeing to a contractual provision that either: (1) “require[s] the employee to adjudicate outside of California a claim arising in California”; or (2) “deprive[s] the employee the substantive protection of California law with respect to a controversy arising in California.”  If the parties do agree to such a provision, the employee has the statutory option of voiding the provision, requiring the dispute to be heard in California pursuant to California law.  Importantly, however, if the employee is represented by counsel during the negotiation of the employment agreement, the parties can legally stipulate that Section 925 does not apply and the choice of law or choice of venue provisions can be enforced as written.

            Regardless of any number of questions that Section 925 leaves to be clarified by future litigation, the intent of the statute is clear: California employees will enjoy their statutory prohibition against non-compete (and non-solicitation) clauses, the California court system will be there to enforce the prohibition, and employers are now almost powerless to stop that reality.  For employers facing the uphill battle of protecting their interests and mitigating risk against employee mobility, the slope just became steeper.  But, as the old saying goes, where there is a will, there is a way, and creative employers still have a number of options to best protect themselves and their confidential information in California.


 

Employer Options in Light of Section 925  

 

        The simplest options are usually the best ones. One simple way to protect your protectable interests is to do what smart employers always do: tailor restrictive covenants to protect what you really care about, and leave the rest alone. You don’t need a full-blown noncompete if a promise not to disclose confidential information is enough, for example.

            The fact is that most employers who use real noncompetes overuse them. Everybody from the CEO to the copy room guy signs one. This one-size-fits-all approach is foolish for a couple of reasons. First, good luck ever convincing any court anywhere that your copy center guy shouldn’t work in the copy center of your competitor for 12 months. Second, if you have to enforce an agreement against a senior executive trying to flaunt it, you can be sure that she will point out in any litigation that you can’t, of course, be all that serious about narrowly protecting your interest because he knows for a fact that the copy center guy was forced to sign one, too.

This kind of solution—creating narrow protections focused on what’s really important—is only as good as your employment policies and procedures. For a nondisclosure agreement to be of any use, you had better be sure to limit employees’ access to that information on a need-to-know basis even during employment. And, if an employee indeed needs access, you had better be sure to understand and control where the information “lives.” A decent IT person can help you understand what has been downloaded to USB drives or emailed to personal accounts; an even better approach is to technically block downloading to USB drives and the emailing of sensitive business information to personal email accounts. And if employees use personal devices to receive, send or store confidential business information, an employer get an agreement in place that gives it the right to inspect personal devices and accounts to ensure that all company property and information has been “returned” (meaning, deleted forever).

A second suggestion piggybacks on the idea of using restrictive covenants only to the extent an employer really needs them for protection. Assuming that your employment lawyer got you to back off on having the copy center guy sign a nondisclosure agreement, and assuming that it’s still important to you to have the CEO sign, you’re probably talking about an employee who is either already represented by counsel or for whom you may be willing to provide counsel. The sense of this approach (and even of the California legislature, I will grudgingly admit) is that it is the ultimate way to level the playing field. If my theoretical chemical company really is a worldwide concern, the CEO at the helm (and her lawyer) would have to acknowledge that a narrowly-tailored noncompete is fair, that the agreement should be governed by the laws of a state that permits one, and that any disputes about the noncompete should play out in courts that actually have experience enforcing them (read: almost anywhere but California, and possibly Colorado).

In the end, employers can protect their legitimate interest in confidential information and important customer or client relationships, but let the employer beware in California. No longer can employers simply assume that an agreement to litigate outside of California will be enforceable. That leaves the smart employer with only two meaningful choices: either use restrictive covenants that will hold up under California law, or make sure that an employee gets legal advice in agreeing to litigate elsewhere.

Partner Mark Konkel and Associate Steven R. Nevolis are with Kelley Drye & Warren. They represent clients in all aspects of labor & employment matters. Mark can be reached at 212-808-7959 or mkonkel@kelleydrye.com. Steven can be reached at 212-808-7962 or snevolis@kelleydrye.com.

Contributing Author

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Mark A. Konkel

Mark Konkel is a Labor and Employment partner in Kelley Drye’s New York office. He guides and protects employers in all aspects of...

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Contributing Author

Steven R. Nevolis

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