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New Teeth in the Prohibition Against Non-Competition Clauses
By Steven J. Pynes and Lee Burdick Austin

Sophisticated business people know that California law generally prohibits non-competition provisions in employment contracts. Despite that knowledge, some bold companies have continued to include non-competition clauses in their California agreements hoping that they might deter employees from seeking jobs in the future that compete with their current employer. However, employers should be aware that changes in California law effective this year make including non-competition provisions in employment contracts riskier than ever.

First, it must be pointed out that non-competition provisions in employment agreements are generally prohibited by law. California's Business and Professions Code section 16600 clearly provides that "every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void," with certain limited exceptions (such as the sale of a business). In reviewing non-competition provisions, California courts have declared them to be prohibited by California public policy which favors competition in the marketplace. Specifically, the courts have found that citizens retain the right to pursue any lawful employment of their choice. Thus, even though an employer may propose and an employee may enter into an agreement with a non-competition clause, such a clause is void and will not be enforced by California courts.

Every violation of a Cal/OSHA standard, order, special order, or Health and Safety Code provision in which there is a death or serious injury to five or more employees must be investigated by a State agency. As part of such an investigation, a decision will be made whether to impose criminal liability. Cal/OSHA provided for criminal penalties on any employer or employee having direct management, control or custody of any employment, place of employment, or other employee who willfully violates a Cal/OSHA or Health and Safety Code standard.

Second, State law prohibits the inclusion of an "illegal" term in an employment agreement. Section 432.5 of the California Labor Code provides that no "employer . . . shall require any employee or applicant . . . to agree, in writing, to any term or condition which is known by such employer . . . to be prohibited by law." Therefore, an employer's inclusion of a prohibited non-competition provision within a written employment contract constitutes a violation of § 432.5.

A person who makes a false statement in any record, report or plan that the State agency requires an employer to file or maintain may be subject to criminal liability. This would include the Injury and Illness Prevention Plans required of all California employers. Violation of this requirement could result in a fine of up to $70,000 or imprisonment of up to 6 months, or both.

Before January 1, 2004, there was no penalty specifically provided for violation of Labor Code § 432.5. However, the passage of SB 796 that added sections 2698 and 2699 to the Labor Code provides for imposition of civil penalties that can be enforced by employees. Section 2699(e) imposes a civil penalty for every section of the Labor Code that does not already have one imposed. This new penalty (for employers of one or more employee) is $100 for each aggrieved employee per pay period for the initial violation. So, for instance, if an employer included a non-competition clause in the employment contracts of 100 employees for a year (paying wages weekly - 52 pay periods) the penalty might be calculated at $520,000 (100 employees x 52 pay periods x $100 each).

Not only is the potential liability great, but it is also easier for the violation to be uncovered and enforced. In the past, only the State agency could bring an action against an employer to collect such a penalty; however § 2699(f) now permits an aggrieved employee to bring the action on behalf of himself or herself and all current and former employees against whom the violations were committed. When an employee brings such an action the employee gets to keep a "commission" of 25 percent of the penalty. In addition, the employee can also recover costs and reasonable attorney's fees. Thus, employees are provided an incentive under the new law to become "bounty hunters," and to find and prosecute every employer violation of the Labor Code.

For these reasons, under the new California law, the simple inclusion of an unenforceable non-competition clause in a written employment agreement could easily generate significant liability exposure for the employer that can be readily discovered and enforced by any one of its affected employees.