United States: New California Law May Preclude Use Of Forum-Selection Clauses To Enforce Non-Compete Agreements In Employment Contracts

On September 25, California Governor Jerry Brown signed into law Senate Bill 1241. SB 1241, effective January 1, 2017, adds Section 925 to the Labor Code to restrain the ability of employers to require employees to litigate or arbitrate employment disputes (1) outside of California or (2) under the laws of another state. The only exception is where the employee was individually represented by a lawyer in negotiating an employment contract.

For companies with headquarters outside of California and employees who work and reside in California, this assault on the freedom of contract is not welcome news. Particularly affected are companies that include forum-selection clauses in contracts with California employees that include non-competition or customer non-solicit provisions. Once SB 1241 becomes effective, it may foreclose—in all but the most unusual circumstances—the sometimes successful strategy of enforcing a non-competition agreement against a California resident through litigation in another state.

The Genesis of SB 1241—The Recent Rise of Forum Selection and Choice-of-Law Clauses

Companies have long used forum-selection clauses and choice-of-law provisions in an effort to avoid California courts applying California law to employment disputes, especially those concerning attempts to enforce non-competition provisions. There often are legitimate reasons to have employment disputes decided where the company primarily does its business. Companies often prefer a court in their own state to decide which law (California's or some other state's) will govern a dispute. SB 1241 generally invalidates these provisions.

Courts have long held that the freedom to contract favors the enforcement of forum-selection clauses. The U.S. Supreme Court in 2013 reinforced this rule in Atlantic Marine Constr. Co. Although not an employment case, Atlantic Marine broadly endorsed forum-selection clauses, stating that "courts should not unnecessarily disrupt the parties' settled expectations" and that usually " 'the interest of justice' is served by holding parties to their bargain." Since that time, federal district courts in California have increasingly given more weight to forum-selection clause, including those in employment contracts, leaving the decision on which law to apply to the dispute—that of California or the foreign state—to a court outside of California.

What SB 1241 Provides

SB 1241 was among a bevy of employment-related bills that were sent to Governor Brown at the end of August 2016. SB 1241, the full text of which appears here, will be enacted as Labor Code section 925. It applies to employment contracts entered into, modified, or extended on or after January 1, 2017.

The key provision of Section 925 is its first section:

(a) An employer shall not require an employee who primarily resides and works in California, as a condition of employment, to agree to a provision that would do either of the following:

(1) Require the employee to adjudicate outside of California a claim arising in California.

(2) Deprive the employee of the substantive protection of California law with respect to a controversy arising in California.

A key exception to the application of Section 925 appears in subdivision (e):

(e) This section shall not apply to a contract with an employee who is in fact individually represented by legal counsel in negotiating the terms of an agreement to designate either the venue or forum in which a controversy arising from the employment contract may be adjudicated or the choice of law to be applied.

Thus, Section 925 generally forbids employers to require California employees to adjudicate claims outside of California or to submit to the laws of another state. An employee who successfully sues to void such offending provisions can recover reasonable attorney's fees. (Lab. Code § 925(e).)

A Shift in Codified Public Policy that Will Likely Impact How Federal Courts in California Analyze Forum Selection Clauses in Employment Agreements

Under California state law, a party seeking to enforce a forum-selection clause in an employment agreement already faced an uphill battle: it had to "prove that enforcement of the forum-selection clause would not result in a significant diminution of rights." What is more, even though the party seeking to avoid a forum-selection clause generally bears the burden of showing it is unreasonable or unfair, that burden is reversed when, like in the employment context, the claims at issue are based on unwaivable rights. It is therefore unsurprising that California Courts of Appeal regularly refuse to enforce an employer's forum-selection clause and related choice-of-law provision when they violate California public policy. For cases brought in California state court, then, some might say that Section 925 changes the employer's battle from difficult to hopeless: clauses that once were simply presumptively unenforceable may now be categorically unenforceable, except for clauses negotiated with an employee "individually represented by legal counsel."

But Section 925 will almost certainly change the analysis of forum-selection enforceability in federal courts, too. Federal Courts apply federal law when determining the enforceability of forum-selection clauses. And the Supreme Court has held that forum-selection clauses are "prima facie valid and should be enforced unless enforcement is shown by the resisting party to be 'unreasonable' under the circumstances." Federal courts' generally find forum-selections clauses unreasonable only if they are (1) the product of fraud or overreaching, (2) would serve to deprive a party of its day in court, or (3) contravene public policy.

Employees whose employment agreements contained non-competition clauses have tried to avoid enforcement of their forum-selection clauses by arguing that their enforcement would contravene Business and Professions Code section 16600. However, some federal courts have rejected such attempts to conflate forum-selection clauses with choice-of-law provisions, stating that the problem with such an argument "is that it does not challenge the reasonableness of the forum-selection clause itself, only the reasonableness of its effect."

Section 925 may make such a distinction less tenable. It serves to make the reasonableness of a forum-selection clause itself a contravention of public policy. To this extent, it brings employment agreements into line with franchise agreements. As the Ninth Circuit has held when evaluating forum-selection clauses in franchise agreements, Business and Professions Code section 20040.5 establishes a public policy "to protect California franchisees from the expense, inconvenience, and possible prejudice of litigating in a non-California venue." Because that provision itself, rather than its effect, contravenes California public policy, the Court affirmed the district court's order denying the motion to transfer venue from California to Pennsylvania.

Labor Code section 925 may serve the same function in federal courts' analyses of forum-selection provisions in employment agreements as Business and Professions Code section 20040.5 serves now in the context of franchise agreements.

It remains to be seen how Labor Code section 925 and Business and Professions Code section 16600 may operate where an California employee individually represented by legal counsel in negotiating the terms of her employment contract agrees to forum selection and choice-of-law provisions that are later used to enforce a non-compete against such an employee.

Employer Takeaways

  • Employers with California employees should continue to use caution when using forum-selection clauses to provide the potential option of enforcing non-compete agreements. After January 1, 2017, attempting to enforce such provisions may not only result in litigation, but now may also result in the employer being on the hook for the employee's attorneys' fees.
  • Use of forum-selection provisions may also increase litigation over questions such as what "primarily resides and works" in Section 925 actually means and whether attempts to enforce non-competition provisions in this context may be argued to be unfair competition in violation of Business and Professions Code section 17200.
  • Although the law takes effect January 1, 2017, it only applies prospectively to employment contracts "entered into, modified, or extended on or after January 1, 2017." The law will not apply retroactively (which would violate the Contract Clause) to employment contracts effective before the new year.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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