How Employers Can Avoid California Labor Code Section 925

Many non-California employers view the enactment of California Labor Code Section 925 as destroying any possibility of avoiding the state’s restrictive covenants laws for California-based employees. But there is hope! With creative legal counsel, employers can draft agreements that do not implicate the statute and avoid its application in litigation. Below are several approaches to consider.

What is Section 925?

Labor Code Section 925, which came into effect this year, attempts to prevent an employer from requiring an employee who resides and works primarily in California to agree to any provision that would mandate the employee engage in litigation outside the state, or litigate under another state’s laws, on a claim that arose in California.

Approach 1:  Employers should challenge Section 925 as an unconstitutional violation of the dormant Commerce Clause.

The dormant Commerce Clause is a court-created doctrine, inferred from the Commerce Clause in Article I of the U.S. Constitution, which restricts states from enacting legislation that discriminates or inappropriately burdens interstate commerce.  Under the dormant Commerce Clause, a state law will be stricken if its burden on interstate commerce is clearly excessive compared to the local benefit. California Labor Code Section 925 is just that sort of law – California appears to have enacted it to favor California residents over the valid economic interests of out-of-state employers.

When looked at under the lens of the dormant Commerce Clause, Section 925 burdens out-of-state employers because it prevents them from litigating disputes with California employees near the employer’s non-California headquarters. Being forced to litigate in California is less efficient and predictable, wastes time and costs, and results in less money spent on employee compensation, investment, and profits. California employers, however, do not face these burdens because they can litigate disputes in their home state. The statute also inhibits the use of non-compete agreements, which reasonably protect the investments companies make in their employees, confidential information, and customer goodwill, and thus, one could argue, stifling innovation and investment by entrepreneurs in the state.

Though the dormant Commerce Clause has not been used as a defense against Section 925 claims, a few employers have tried similar arguments without success so far. But those situations differ significantly from the application of Section 925 and should not dissuade future attempts.

  • Medtronic made the dormant Commerce Clause argument in Waguespack v. Medtronic, Inc., regarding a Louisiana protectionist statute similar to California Labor Code Section 925. Language specific to the Louisiana law (and not appearing in Section 925) defeated the argument. The decision includes some unfortunate language about the burdens these sorts of laws put on out-of-state employers, simplistically stating that a company that conducts business in multiple states is not unduly burdened by having to litigate employment disputes in each of those disparate and far-flung locations. Given the differences between the Louisiana and California statutes, employers should not consider this decision as closing the door on a dormant Commerce Clause argument.
  • In Yoder v. W. Express, Inc., an interstate trucking company argued California’s onerous wage-and-hour laws impose such excessive burdens on interstate commerce that they violate the dormant Commerce Clause. The court could not rule in the company’s favor because it did not have “evidence of the increased costs [the company] would incur by complying with California wage and hour laws.” This certainly suggests an out-of-state employer that presents the higher costs of litigating in California may persuade a court to strike down Section 925.

Approach 2:  If applicable, argue the employee did not reside and work in California when the agreement was signed.

A narrower attack on Section 925 might be that it simply does not apply. In Mechanix Wear, Inc. v. Performance Fabrics, Inc., a Michigan company sought to enforce a non-compete, which contained Michigan choice-of-forum and choice-of-law clauses, against a former employee, who had been living and working in Michigan but moved to California to join a competitor. The court held Section 925 did not apply because the individual agreed to the forum-selection provision at the time he worked in Michigan, not after he moved to work in California. The court held the forum-selection clause was not unreasonable, notwithstanding California’s strong public policy against non-compete agreements, because the relevant issue was whether the forum clause itself was improper, not the accompanying restrictive covenant. The decision suggests courts will take a close look at the specific language of Section 925 and appropriately limit its application when the circumstances warrant.

Approach 3:  Draft around Section 925 by using permissive, rather than mandatory, choice-of-forum and choice-of-law clauses.

Challenges to Section 925 are still in their infancy, but the few courts that have addressed the statute provide potentially helpful insights on ways to draft around it, including Farrar v. Cupcake Digital, Inc. The court distinguished mandatory forum-selection clauses from permissive forum-selection clauses, concluding that Section 925 did not apply to the latter. In Farrar, several California individuals sued their former employer, a New York company, for various claims after the company allegedly failed to pay their salaries. The company moved to transfer the case to New York under the federal venue transfer statute, arguing, among other things, that venue was proper in New York under the individuals’ employment agreements. The court concluded that the individuals “expressly consented in their employment agreements to potential venue in the Southern District of New York.” Those agreements all contained this provision:

This Agreement shall be governed by and construed in accordance with the internal laws of the State of New York without reference to principles of conflicts of laws and each of the parties hereto irrevocably consents to the jurisdiction and venue of the federal and state courts located in the State of New York.

The court concluded Section 925 did not apply, stating: “[P]laintiffs incorrectly conflate mandatory forum selection clauses and permissive clauses. The forum selection clause at issue here is permissive. Thus plaintiffs appear to have consented to New York as a potential forum but are not contractually limited to bringing claims in New York as the exclusive forum for disputes.” Id. at *3 n.1 (citation omitted). In other words, the individuals were not required to litigate in New York, but they agreed not to object if they were sued in New York. The same analysis could be applied to a choice-of-law provision that does not mandate another state’s law (or “deprive” the employee of California law), but instead merely has the employee consenting to that law if the suit occurs in the selected forum.

The Farrar court’s conclusion, if followed by other courts, provides some key insights into how to draft around the restrictions in Labor Code Section 925, and how to litigate when these disputes arise.

  • Regarding drafting, the distinction between mandatory and permissive forum-selection and choice-of-law clauses suggests that employers closely review their agreements to ensure the language fits into this carve-out. The Farrar employer’s forum-selection language is a good start. With counsel’s guidance, employers should add language that claims arising out of the agreement that are litigated in the chosen forum are governed by the chosen state’s law.
  • Regarding litigation strategy, employers also should be vigilant in quickly taking legal action to enforce restrictive covenants in a court of their choice, because the race to the courthouse has become even more important. If the employer files first in the out-of-state forum for enforcement of the restrictive covenant, that out-of-state court can comfortably ignore Section 925 because the permissive clauses do not “require” out-of-state litigation or “deprive” the employee of California law.

Approach 4: Include a savings clause and a limited time period for the employee to void the forum-selection clause.

Section 925(b) permits an employee to void a contract provision that violates the statute, after which a litigated matter must be adjudicated in California and under California law. The statute does not place any time limits or triggering events on when the employee must exercise the right to void. Thus, there is no statutory reason why the employee’s right to void must wait until a controversy over the forum-selection clause has arisen, or why the employer’s behavior after notice of the right to void could not be used as evidence of an intent to waive that right.

One option to avoid Section 925 is to include in the contract:

  • forum-selection and choice-of-law clauses,
  • an unambiguous statement by the employer disclaiming any intent to deny the employee rights under California law,
  • clear notice to the employee of the ability to void the clause, and
  • notice that continued employment acts as a voluntary and knowing waiver of the right to void the forum-selection and choice-of-law clauses.

Failure to exercise that ability to void within a defined narrow period of time, followed by continued employment under the agreement as written, could be used to argue the employee has unambiguously waived the right to void.

Approach 5:  Condition the forum-selection provision on receipt of optional compensation or benefits, not on employment.

Labor Code Section 925 applies only when an employee is required to sign a contract “as a condition of employment.” One employer strategy, therefore, is to tie the agreement to something other than commencing or continuing employment. Examples might include conditioning the contract on the employee’s ability to participate in an optional benefits program or receipt of stock options. While not tied to employment, this sort of agreement could still be offered at commencement of employment, ensuring the restrictive covenant would be in effect as soon as the specified consideration was paid. Another option is to tie the contract to a later event, like receipt of a bonus, salary increase, or promotion. In either case, employers should understand they risk the employee choosing not to sign the contract and simply continuing employment.

On the surface, Labor Code Section 925 seems like a death knell for out-of-state employers who wish to avoid the tough restrictive covenant laws. But with creativity – and time to test Section 925 – employers can hold onto hope.