Wednesday, August 22, 2018

Legislative Reform, Non-Compete Agreements, and the Contracts Clause

With increasing frequency, we see state legislatures wade into the hot topic of non-compete reform. Over the past several years, we've seen the States enact laws that govern employee non-compete arrangements in myriad ways.

Below is just a sampling:

  • Illinois enacted the Freedom to Work Act, which banned non-competes for employees below a salary threshold;
  • New Mexico and California established laws that restrict the use of choice-of-law and choice-of-forum clauses;
  • Idaho repealed a statutory rule that created a rebuttable presumption of irreparable harm for certain employees who were subject to non-compete clauses;
  • Colorado limited remedies for certain physician non-compete arrangements;
  • Hawaii banned non-competes for technology workers; and
  • Massachusetts totally revamped its entire law on non-competes at the end of July.
One inevitable feature of these legislative reforms is the prospective application of the new law. For instance, California's amendment to its Labor Code specifically provides that the bar on foreign choice-of-law/choice-of-forum clauses do not apply to any contract entered into before January 1, 2017. The new Massachusetts non-compete bill is basically the same, as it only impacts contracts signed on or after October 1, 2018.

This "prospective application only" obviously requires lawyers to evaluate potentially two different sets of non-compete law, depending on the breadth of the legislative reform. But why do have to worry about this at all? I have had several clients, for instance, who live in California but have Illinois choice-of-law and -forum clauses perplexed at why the legislative reform would just target new contracts, instead of existing ones.\

The answer lies in the U.S. Constitution's Contracts Clause (Art. I, § 10, cl. 1), which provides that no State shall pass any law impairing the obligation of contracts.

Relatively simple language has spawned an impairment test that is anything but easy to apply, however. Not all laws that affect pre-existing contracts violate the Contracts Clause. Instead, courts must look first at whether the state law has "operated a substantial impairment of a contractual relationship." To answer that question, courts consider the extent to which a law undermines a contractual bargain, interferes with a party's reasonable expectations, and prevents a party from safeguarding its rights. Assuming a party can demonstrate this substantial impairment, courts then ask whether the state law is drawn in a reasonable way to advance a significant and legitimate public purpose.

The recent rash of non-compete reform, both big and small, raises the question of just how far States could go to alter contractual rights retroactively if they so choose. For instance, Alabama enacted its Restrictive Covenants Act effective January 1, 2016, but nothing in the Act says anything about prospective application. Indeed, the language of the Act suggests it applies to everything.

Alabama actually serves as a good starting point for analysis. The new law changed some stuff, but perhaps not in a way that impaired existing non-competes in a constitutional sense. For instance, it now lists presumptive periods of reasonableness, but it does not say for instance that a three-year non-compete is void against public policy. Alabama also puts the burden on an employee to prove that a covenant will impose an undue hardship on her, a deviation from prior law that is somewhat significant. But the statute still allows for presentation of the defense (as distinguished from Florida law, which does not).

On the other side of the equation, Hawaii's law banning non-competes for technology workers would constitute the sort of substantial impairment that the Contracts Clause prohibits. So too, Massachusetts now bans non-competes unless they meet a rash of substantive and procedural requirements (including garden-leave pay). No doubt, that law could not be given retroactive application.

But we can imagine tougher calls. Laws that address choice-of-law and choice-of-forum clauses do not necessarily impact contractual rights, but could place a burden on obtaining a contractual remedy. A law that allocates burdens of proof similarly would not constitute a substantial impairment. By the same token, a law that shortened the statute of limitations for enforcement or even for asserting damages claims still would preserve the underlying right. But those that establish a maximum non-compete period, categorically, likely would be unconstitutional because they would invalidate a whole class of agreements.

Prospective application of the law is sort of a bedrock principle of statutory construction. The Contracts Clause was supposed to harden that into a rigid mandate. Like much of constitutional law, the contours of the clause are now a bit fuzzy. Non-compete law, in most states, suffers from the same problem.

Wednesday, August 1, 2018

Ninth Circuit Expands Reach of Section 16600 in Golden II

Three years ago, I wrote a lengthy blog post on the case of Golden v. California Emergency Physicians, a Ninth Circuit case that I felt was a bit of an oddity. It addressed California's well-known statute, Section 16600 of the Business and Professions Code, which generally bars non-compete agreements.

The problem in Golden I was that the provisions at issue weren't really non-compete covenants at all, and so the application of Section 16600 was a little confusing. Though I punt to my 2015 post for a factual run-down of Golden I, summarized briefly the case involved this scenario. Am emergency physician had an employment dispute with a staffing company. As part of a settlement, the company required him to agree not to work at any facility where the company had a staffing contract. It further provided that if the company later acquired a staffing contract at another facility, it could and would terminate the physician.

So how does this implicate Section 16600? Golden I didn't necessarily address that question and remanded for fact-finding about how this covenant impacted Dr. Golden. I wrote three years ago that I didn't understand the fact-finding rationale at all. I still don't. But the Ninth Circuit now has addressed the application of Section 16600 and what the district court did on remand.

To start with, the Ninth Circuit says Section 16600 covers all contractual provisions that impose "a restraint of a substantial character." That means, the provision cannot "significantly or materially" impede a person's lawful profession, trade, or business. According to the California decisions summarized in Golden II, restraints that meet this definition include:

  1. Restrictions on working for a competitor;
  2. Restrictions on soliciting customers;
  3. Clauses that impose a monetary penalty for engaging in competitive conduct.
What won't meet the definition? A limited provision allowing for a company to recoup training program costs when an employee leaves.

The no-employment clauses at issue in Golden I and Golden II don't fit neatly into any of these boxes. Instead, they make clear that Dr. Golden won't work where CEP is contracted to provide services, now or in the future. The Ninth Circuit concluded that a clause pertaining only to Dr. Golden's employment at CEP wasn't problematic and was so limited that it didn't meet the "significantly or materially" impeding test it created.

The other provisions in the draft settlement agreement, however, were void under Section 16600. Those prohibited his current and future employment at CEP-contracted facilities. The court's analysis suggested that it was focused more on results and less on methodology. For instance, it emphasized CEP's expansive reach into California medical facilities. But it also downplayed Dr. Golden's admissions concerning his medical specialties, which suggested that the restraint in practice might not be that onerous.

To be sure, it's hard to make much of this case. I suspect that it's so factually goofy that any other case that deals with obliquely limited clauses having some peripheral impact on employment will easily be able to navigate around the court's rationale. About all the case may do for practitioners is reinforce the reach of Section 16600 and solidify that true covenants against competition are almost certain to fail, even if those covenants are very specific and narrow.