Why Assuming Out of State Non-Compete Agreements are Unenforceable Against California Employees is High Risk Behavior

A recent case holding that a Washington employer’s non-compete agreement is enforceable against California employees reinforces a continuing trend in the California judiciary to allow non-compete agreements to be decided in the forum and under the case law originally designated in a non-compete agreement.  This means that assuming that an out of state non-compete agreement signed by a California employee is unenforceable could be high risk behavior for departing employees and their new employers.

It is well known that non-compete agreements are not enforceable in California with narrow exceptions under California Business and Professions Code Section 16600 et seq.  However, reasonable non-compete agreements are enforceable in most other states.  As a result, multi-state companies frequently require their California employees to sign a non-compete agreement that designates that the agreement is to be interpreted under the law of another state (“choice of law”) and adjudicated in the courts of that other state (“choice of forum”).

In the past, it was commonly believed that out of state non-compete agreements may be unenforceable if the employee is first to file an action in a California court asking that the court declare the non-compete agreement unenforceable.  This strategy was based on federal precedent known as the “first to file rule.”  Under the first to file rule if two or more cases are filed in different federal courts which concern similar facts, issues and parties, the second case filed is dismissed or stayed in order to promote efficiency and consistency in rulings.  Therefore it was assumed that filing an action first in California seeking a declaration that an out of state non-compete agreement was not enforceable would de facto result in a choice of California law, which in turn would result in the California court ruling that the non-compete agreement was  unenforceable.  However, a recent ruling from the Northern District of California court in Meras Engineering, Inc. v. CH20, Inc,  indicates that forum shopping in the hope of having out of state non-compete agreements declared unenforceable may no longer work.

In Meras,  a Washington state employer , CH20, required two California employees to sign employment agreements that included a three year post termination non-compete clause,  a Washington State choice of law clause, and a Washington State  choice of forum clause.  The two California employees resigned from CH20, went to work for a competitor, Meras Engineering, and, along with Meras, immediately filed a lawsuit in the Northern District of California seeking a declaration that the non-compete provision was unenforceable. CH20 then filed an action in Washington federal court to enforce the non-compete agreement.  The Washington federal court ruled that it was appropriate for the non-compete agreement to be interpreted under Washington law, which enforces reasonable non-compete agreements.

CH20 also filed a motion to dismiss the declaratory relief action filed by Meras and the employees in California on the basis of the choice of forum clause.  In deciding whether the forum selection clause should be enforced, the California court considered whether the enforcement would result in violating California’s public policy disfavoring non-compete agreements.  The employees and Meras argued that enforcing the forum selection clause would violate California public policy because the Washington court had already ruled that Washington law applied, and if the California case was dismissed, the Washington court was likely to find that the non-compete agreement was enforceable.  Thus the employees and Meras argued that the enforcement of the forum selection clause would violate California’s policy of not enforcing non-compete clauses.  The California court disagreed, noting that to find the forum selection clause unenforceable because it would result in a choice of law that the plaintiffs found distasteful would “conflate” or confuse the analysis of the enforceability of choice of forum with the choice of law analysis.  Therefore the California court dismissed the California declaratory relief case, and in doing so compelled the parties to litigate the enforceability of the non-compete in Washington federal court and under Washington law.

Based on the holding in the Meras case, and similar California case precedent, former employees and their new employers should not assume that California courts will not enforce out of state non-compete agreements.

Topics:  Employer Liability Issues, First-to-File, Hiring & Firing, Non-Compete Agreements

Published In: Civil Procedure Updates, General Business Updates, Labor & Employment Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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