SB1421 – Limiting The Use Of Non-California Choice Of Law And Forum Provisions in Employment Agreements: What The New Law Will And Will Not Do

Many companies have a love/hate relationship with California. In addition to the State’s beauty and diversity, they love the large markets, the strong industry sectors, and the skilled pool of applicants from which to hire. But the love does not always extend to the decidedly employee-friendly laws and juries who resolve the disputes arising under those laws. Some out-of-state companies have used choice of law, forum selection and venue provisions to avoid California’s prohibition on non-competes and other employee protective laws, to avoid litigating or arbitrating in California, and – some would argue – to prevent such claims altogether by making them prohibitively difficult and expensive to pursue. In an effort to end the mandatory acceptance of employment agreements including these provisions, California’s governor signed into law in September of 2016 a bill that allows an employee to invalidate these provisions in some circumstances. The new law may make it easier for California employees who signed agreements with choice of law, forum selection and venue provisions to avoid the effect of these provisions in most cases, although it may have a unique effect on arbitration agreements.

The Background

Often at the forefront in passing laws governing the employment relationship, California deservedly has a reputation as an employee-protective state. Unlike other states, for example, California strictly prohibits non-compete agreements in the employment context and likewise bans customer non-solicitation agreements. This prohibition has broad reach and no exception for limited restraints that do not entirely preclude the person from working for a competitor. Edwards v. Arthur Andersen LLP, 44 Cal.4th 937 (2008). California allows pre-dispute employment arbitration agreements but imposes stringent requirements on their enforcement, Armendariz v. Foundation Health Psychcare Services, Inc., 24 Cal.4th 83, 113 (2000), and employees often successfully challenge these agreements and thereby try their claims to a jury rather than an arbitrator.

With little room to avoid these strict laws, some out-of-state companies use another approach that may enable the company to bind its California employees to the same agreements used in other states in which the company operates. These companies ask or perhaps require that employees sign agreements with a choice of law provision making the law of another state govern the agreement and a forum selection/venue provision obligating the parties to litigate or arbitrate disputes in a designated forum in that other state.1 While these provisions do not allow an employer to avoid non-waivable substantive rights such as California’s wage & hour laws and equal employment laws,2 they may enable an employer to avoid some of California’s laws regarding arbitration agreements, non-compete agreements, and other restrictive covenants, and to avoid litigating disputes in California.

The New Law

SB 1241 adds a new provision to the California Labor Code – Labor Code section 925 – which took effect on January 1, 2017. The new Statute reads as follows:

(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.

(b) Any provision of a contract that violates subdivision (a) is voidable by the employee, and if a provision is rendered void at the request of the employee, the matter shall be adjudicated in California and California law shall govern the dispute.

(c) In addition to injunctive relief and any other remedies available, a court may award an employee who is enforcing his or her rights under this section reasonable attorney’s fees.

(d) For purposes of this section, adjudication includes litigation and arbitration.

(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.

(f) This section shall apply to a contract entered into, modified, or extended on or after January 1, 2017.

Although perhaps prompted by the use of choice of law, venue and forum selection (collectively referred to as “Covered Provisions” for this article) clauses to avoid California law governing non-compete and arbitration agreements, SB1421 broadly applies to any agreement between an employer and employee. Notably, the new law does not entirely prohibit Covered Provisions, but instead only prohibits an employer requiring employees to sign agreements containing these provisions. How big an impact will SB1421 have on the use of Covered Provisions? This inquiry raises a number of underlying questions.

Will employers stop asking employees who work in California to sign agreements with Covered Provisions?

Probably not, at least in the context of non-compete agreements, for several reasons. First and foremost, Section 925 does not prohibit an employer from doing so. It only prohibits an employer from requiring that a person accept an agreement with such provisions “as a condition of employment.” So employers may continue to use these provisions and remove them if an employee covered by Section 925 refuses to sign (which, as discussed below, may not happen often).

Also, Section 925 does not apply to all California employees. It applies only to those who “primarily” reside and work in California. Assuming “primarily” means more than half the time – the Statute does not define the term – Section 925 will not apply to many employees who work in California.3 Most obviously, the Statute does not apply to an employee who resides and works primarily outside of California; for example, it likely would not apply to non-residents. It also may not cover an employee who lives in California but who spends most of his/her time working outside the State on business travel or working at another office.

Finally, while potentially raising the costs of including Covered Provisions, the availability of attorneys’ fees under Section 925 may not deter their use because the determination of rights under the Statute will generally not involve protracted litigation and, in most cases, may not involve any litigation at all. Section 925 notes in its attorneys’ fees provision the potential recovery of injunctive and other relief, but it does not expressly require the filing of any legal action to void a Covered Provision or explain what steps a person must take to do so. The process may involve no more than notifying the employer of the person’s exercise of his/her right to void the provision. Even if the employee does file an action seeking injunctive or other relief, however, the employer might elect not to oppose the action and thereby limit or entirely avoid payment of attorneys’ fees. For these reasons, employers may not consider the possibility of having to pay the individual’s attorneys’ fees and costs enough of a risk to discontinue the use of Covered Provisions.4

Although Section 925 may not deter employers from including Covered Provisions in non-compete agreements and other restrictive covenants, it will likely have that effect on arbitration agreements. The ability to avoid California’s strict requirements for pre-dispute arbitration agreements may make attractive a choice of law provision imposing the law of another state; the less restrictive the law of that state in regards to arbitration agreements, the greater the attraction. An employer perceiving this as an advantage may include Covered Provisions in its arbitration agreement, draft the agreement in accordance with the laws of the designated state, and require employees to sign that agreement. But Section 925 makes it likely that this employer will not only find itself bound by California law and defending claims in California, but doing so in court rather than in arbitration.

If an individual bound by an arbitration agreement with Covered Provisions exercises his or her right to void those provisions, California law will govern and the parties will have to adjudicate the dispute in California. (Cal. Lab. Code §925(b).) If the arbitration agreement does not comply with California’s stringent requirements – a strong likelihood since the employer may have included the Covered Provisions, in part, to avoid those requirements and instead drafted it in accordance with the law of the designated forum–the employer may end up with an unenforceable agreement. From an agreement through which the employer sought to avoid California law, a California forum, and a jury, the employer may face all three. To avoid this result, an employer set on including Covered Provisions may draft the arbitration agreement to comply with California law (assuming it can do consistent with the law of the designated state). Although this deprives the employer of one significant advantage of using a choice of law provision in the first instance (i.e., avoiding California’s stringent requirements), it may enable the employer to avoid a losing its right to compel arbitration.

For non-competes and other restrictive covenants, employers may see little downside in using Covered Provisions. If the individual later voids the provisions, the employer ends up in the same place as it would have stood if it had not included them at all; in California and subject to California law. For arbitration agreements, the same may not hold true. An employer may have to choose between an enforceable California arbitration agreement or one that risks losing altogether the right to arbitrate if the individual exercises the right to void the Covered Provisions. For this reason, Section 925 may have a greater deterrent effect on arbitration agreements than it does on other employment agreements.

Will California employees refuse to sign an agreement with a Covered Provision?

Probably not, even though the new law allows them to do so. Many employees pay little attention to the specific provisions of an agreement and sign with no more than a cursory review. Not many employees understand (or even read) choice of law or venue provisions, particularly if buried within a lengthy agreement of the “standard” type that they have signed at each company for which they have worked. Even those who do notice and find objectionable the provisions covered by Section 925, however, may say nothing because they fear the consequences of refusing to do so. The fact that Section 925 allows an employee to refuse to sign does not mean that an employee will understand or exercise that right. Employees who understand the Statute’s protections may opt to sign rather than make waves by pushing back or refusing to sign, doing so with the understanding that they can void the provisions down the road if and when a dispute arises.
Section 925 may for some employees actually increase the use of Covered Provisions in their individual employment agreements. Although it varies by company and position, employers often view the post-termination risk of competitive injury as correlating to the level of the position the person held within the company; the higher the level, the greater the risk in that individual working for a competitor. So the employer may consider it especially important that these key individuals sign non-compete agreements with the Covered Provisions necessary to make the restrictive covenant enforceable against a California employee. For these higher level employees, the employment terms to which they ultimately agree may result from actual negotiation and the involvement of legal counsel in the process. This, in turn, may ensure the enforceability of Covered Provisions included within the final agreements. The outcome of a negotiation standoff between a represented person and an entrenched employer will, of course, come down to which side has the greater leverage. But the certainty that Section 925 provides regarding the enforceability of Covered Provisions in circumstances such as this may prompt the employer to dig in its heels.

Can an employer refuse to hire or terminate an individual who refuses to sign an agreement with a Covered Provision?

No. Section 925 makes it unlawful for an employer to “require an employee who primarily resides and works in California, as a condition of employment, to agree to” a covered choice of law, forum selection or venue provision. Declining to hire an employee or terminating an employee because he/she refuses to agree to such a provision would likely support a claim for wrongful termination in violation of fundamental public policy. See, D’sa v. Playhut, Inc., 85 Cal.App.4th 927 (2000)(Terminating employee for refusing to sign an unlawful non-compete violates fundamental California public policy). Although an employer may refuse to hire or may terminate a person who refuses to sign if he/she does not reside and work primarily in California, the ambiguity of the Statute’s language regarding this requirement makes it risky for an employer to rely on it as a basis for refusing to hire an applicant or terminating an employee.

What level of involvement must an individual’s attorney have to make an agreement with an Out-of-California provision enforceable?

Here, too, Section 925 provides no clear answer, and its uncertainty may lead to litigation. The new Statute excludes any agreement “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.” The language of this provision raises several questions. Does the exclusion apply only where the parties actually negotiated an agreement and, if so, what qualifies as a negotiation? Must the attorney have participated in the negotiation, or will it suffice if the attorney only advises the individual behind the scenes? While Section 925(e) does not directly answer these questions, read as a whole the Statute and its legislative history provide guidance.

The legislative history of SB1241 makes clear the legislature’s focus on procedurally unconscionable agreements presented to employees on a take-it-or-leave-it basis and agreements signed by individuals without an understanding of the Covered Provisions. (See SB1241 Bill Analysis, August 19, 2016, p.7) (“Californians should only be bound by these potentially one-sided terms if the Californian knowingly and voluntarily wants to leave the state to adjudicate a legal claim.”) The Legislature did not intend to ban entirely choice of law, venue, and forum selection provisions. It instead sought only to prohibit employers from mandating their acceptance. In interpreting Section 925(e), therefore, a focus on whether the individual had an opportunity to negotiate the terms (regardless of whether he/she actually did so), freely chose to sign the agreement, and made an informed decision with an understanding of both the effect of the Covered Provisions and the protections of Section 925 would seem consistent with the overall purpose of the Statute.

Courts must often determine whether an individual had an opportunity to negotiate the terms of an agreement or whether the employer instead presented it on a “take it or leave it” basis; for example, when considering a claim of procedural unconscionability in a challenge to an arbitration agreement. See, Armendariz v. Foundation Health Psychcare Services, Inc., 24 Cal.4th 83, 113 (2000)(“Unconscionability analysis begins with an inquiry into whether the contract is one of adhesion.”). As for the involvement of counsel, it would seem sufficient if the individual consulted with counsel—regardless of whether counsel actively participated in the negotiation—as this would generally suggest the person made an informed decision. Requiring a showing that counsel participated to some extent in the actual negotiation would go beyond the goals of the SB1421 because a showing that counsel stepped out from his/her advisory role into a more active negotiation role does not in itself demonstrate that the represented individual had a greater understanding of the protections of Section 925 or that any actual negotiation occurred. Likewise, the absence of any direct involvement by counsel does not mean that the employee did not make an informed decision or that he/she could not and did not negotiate the terms of the agreement.

Interpreting Section 925(e) to require only a showing that the person had an opportunity to negotiate the terms and that the person signed with the benefit of legal advice would seem consistent with the purpose of SB1421, but it raises a practical problem that may effectively require the active involvement of legal counsel for the exception to apply. If counsel actively participated in the negotiations, it seems clear that the exception applies. But if counsel worked solely behind the scenes in an advisory role (as attorneys often do), the employer may never learn whether the individual received legal advice regarding the agreement because the person could assert the attorney-client communications privilege as a basis for refusing to disclose this information. With no evidence to show the involvement of counsel and the provision of legal advice regarding the Covered Provisions and Section 925, the employer would have no ability to demonstrate the applicability of the exception. So regardless of the intended scope of Section 925(e), employers may find that they can rely on this exception in defending a challenge to Covered Provisions only if counsel actively participated in the negotiations.5

Where will Section 925 have its greatest impact?

As discussed above, Section 925 may deter employers from including Covered Provisions in their arbitration agreements with California employees because of the risk of losing altogether the ability to compel arbitration if the employee voids those provisions. On the other hand, the Statute will probably not have this effect on non-compete agreements. For these agreements, the Statute may have its greatest impact on the way in which post-termination challenges involving restrictive covenants unfold and play out.

A person bound by a restrictive covenant with a non-California choice of law and venue provision faces a tactical dilemma when considering potential employment with a competitor in California that might violate the covenant. Should the person preemptively challenge the agreement by filing a declaratory relief action in a California court, or should he/she hold tight to see whether the former employer learns of the competitive employment and, if so, moves to enforce the agreement?

Moving preemptively has some benefits. It may allow the individual to have a California court rule on the enforceability of a covenant that directly violates California law and this improves the chances of success. Moreover, failure to strike first may make it more difficult to invalidate the agreement if the former employer gets a jump on the employee by filing in the designated forum. Having filed first, the employer gets a lead in the race to final judgment. If the employer files in federal court and the employee separately files a case challenging the agreement, the employer may effectively freeze that case if filed in or removed to federal court by availing itself of the “first to file” rule. See, e.g., Wallerstein v. Dole Fresh Vegetables, Inc., 967 F.Supp.2d 1289, 1292-93 (2013) (“First to file” rule permits federal district court to dismiss, stay, or transfer a case to another district court to alleviate burden placed on the federal judiciary by duplicative litigation and to prevent the possibility of conflicting judgments; in applying rule, courts look at (1) chronology of actions; (2) similarity of parties; and (3) similarity of issues). If the former employer ultimately prevails in another state it can then enforce the judgment in California under the full faith and credit clause of the United States Constitution even if the employer could not have directly obtained such a judgment in a California court. For all of these reasons, a person anticipating employment in California that might violate a restrictive covenant may decide to proactively challenge that agreement.

But moving proactively has downsides. Most significant, proactively filing a declaratory relief action involves cost—a consideration for most people, and especially for those recently out of work. It might also raise an issue where none would have arisen if the company would not have learned of the competitive employment (a possibility that seems less likely today than in the recent past given the widespread use of LinkedIn and other social media) or if it did not intend to enforce the restrictive covenant (a possibility given that employers often choose not to enforce restrictive covenants because of the cost, the position the person held, the position he/she will hold with the competitor, or the perceived threat of competitive injury). So the proactive route not only entails potentially unnecessary cost, it also creates the risk of attracting attention where inaction might have allowed the former employee to fly under the radar.6

SB1241 changes the field on which a person bound by a restrictive covenant and the former employer do battle. If covered by Section 925, an individual bound by a non-compete agreement with Covered Provisions need only notify the former employer of his/her intent to void the Covered Provisions. This should end the matter if the former employer has not yet filed any action to enforce the agreement, as the employer would seemingly face a difficult task in trying to enforce an agreement in the designated state given the plain language of Section 925 requiring adjudication in California pursuant to California law. It should, but it may not.

Even where an employee has exercised his/her rights to void the Covered Provisions, the former employer may not so easily give up on the agreement as worded. The employer may argue in the designated forum and under that forum state’s laws that the court should enforce the agreement of the parties and should disregard both Section 925 and the employee’s attempt to void the provision; an argument perhaps made stronger to the extent that the agreement includes within the choice of law provision an additional provision rendering inapplicable principles of conflicts of law. Section 925 will undoubtedly make it more difficult and more costly for an employer to move forward in enforcing an agreement after the individual exercises his/her right to void the Covered Provisions, but it does not entirely foreclose the possibility that the employer will succeed. So while the new law may reduce the amount of litigation challenging or seeking to enforce restrictive covenants covering California employees through Covered Provisions, it probably will not end it entirely.

For the above reasons, Section 925 may have an interesting effect on the choice of law and venue provisions that fall within its scope. Dependent on the type of agreement, the level of the person signing the agreement, and the needs of the particular employer, the new law may deter employers form including these provisions, incentivize them to do include them, or have little effect either way.

[1] Choice of law provisions alone generally will not work because California courts refuse to apply such provisions if doing so would contravene California public policy.  Application Group, Inc. v. Hunter Group, Inc., 61 Cal. App. 4th 881, 902 (1998).

[2] See, e.g., Armendariz, 24 Cal.4th 83, 100 (Individuals may waive protections of a law intended solely for his or her benefit but cannot waive by private agreement a law established for the public benefit, including the protections of the California Fair Employment & Housing Act);  Gentry v. Superior Court, 42 Cal.4th 443, 456 (2007)(“In short, the statutory right to receive overtime pay embodied in section 1194 is unwaivable.”);.

[3] The Statute not only fails to define “primarily,” but creates additional ambiguity about its reach through its placement of the adverb.  Does the Statute apply to employees who primarily reside and primarily work in California, or does it apply more broadly to those who primarily reside in the California and perform any work within the State?  Given the broad protections provided even non-residents who perform any work in California under other Labor Code sections, a court might broadly interpret this provision to cover any residents performing any work in the State.  See, Sullivan v. Oracle Corp., 51 Cal.4th 1191, 1206 (2012)(California Labor Code governs overtime worked in California for a California-based employer by out-of-state employees).

[4] To deter an individual from immediately pursuing litigation without first notifying the employer of the intent to void the provision, an employer could include in the agreement a term obligating the employee to first submit a request to void the provision directly to the employer before filing an action (i.e., before the fees begin to mount).  Upon receipt, the employer would have the option to stipulate and thereby end the matter, capping the employee’s right to fees.  If the individual failed to comply with this notice requirement, the provision might serve to limit or preclude an award of fees because the employer could convincingly argue that the individual would have avoided most or all of those fees by first raising the issue with the employer before filing an action.

[5] Including a provision within the agreement through which the person affirms that he/she consulted counsel, understands the provisions of the agreement (including the Covered Provisions), and understands the protections of Section 925 may solve this problem, but it remains to be seen how courts will interpret Section 925(e), whether the burden will fall on employers to show the involvement of counsel, and whether such a provision alone will suffice.

[6] Even if the former employer would not have moved to enforce the restrictive covenant against this person, it may nevertheless step up to defend the case.  Because the company may have the same agreement in place with numerous other people, it may feel compelled to aggressively defend both to avoid an adverse ruling that might affect future challenges and to send a message to others bound by that form of agreement.