Your business is growing and fortune is shining. Out-of-state opportunities are increasing. Perhaps you are considering expanding operations. If you haven’t already, you’re likely to end up serving the world’s sixth largest economy[i]—California. And who wouldn’t want to be in California? It has nearly 40 million consumers.
Before heading out with your sunscreen and order book, there are a few intricacies of California law that any out-of-state business—as well as any business already operating in California—should keep in mind when doing business involving California-based employees or parties.[ii]
1. Contract Law.
a. Restrictive Covenants. Employers would do well to take Section 16600 of the California Business and Professions Code seriously when it says:
. . . every contract by which anyone is restrained from engaging in a lawful profession, trade or business of any kind is to that extent void.[iii]
Section 16600 is the cornerstone of California’s strong public policy favoring worker mobility over employers’ restrictive covenant protections. It prohibits non-compete and employee non-solicitation restrictions in employment agreements, and probably most customer non-solicitation restrictions.[iv] The law covers:
- employees living in California working for out-of-state employers;
- out-of-state workers of California companies; and
- out-of-state workers working in California for out-of-state companies.
Naturally, over the years employers have attempted various tactics to avoid Section 16600. One popular approach is for out-of-state employers to have their employment agreements with California-based employees governed by out-of-state laws and decided in out-of-state forums that are willing to enforce such restrictive covenants. California recently responded to these tactics with a legislative counterpunch. Effective for agreements entered into or renewed in or after 2017, employment agreements that deprive a California resident working in-state from the protections of California’s laws by use of out-of-state choice of law, out-of-state litigation forums, or arbitration provisions are now voidable, unless the employee was represented by counsel in negotiating the agreement.[v] Out-of-state employers now face a dilemma. Do they include out-of-state governing law and dispute resolution provisions for their in terrorem effect (knowing that they are likely unenforceable) or do they make sure the employee has his or her own legal counsel, and risk educating the employee about the valuable protections of California law that he or she may be giving up in signing the agreement? Stay tuned.
Employers still thinking they can get around Section 16600 would be wise to consider Section 17200 of the Business and Professions Code. Section 17200 makes it an unfair trade practice to attempt to enforce a provision prohibited by Section 16600.
b. Trade Secrets. So, in the face of California’s strong public policy favoring employee mobility over employers’ restrictive covenant protections, what can an employer do? Answer: protect its trade secrets and confidential information.
California protects trade secrets,[vi] including perhaps the most valuable item for many employers—customer lists.[vii] In fact, some restrictions in employment agreements that operate very much like non-competes and customer non-solicitations have been enforced by California courts under the so-called “trade secrets exception” to Section 16600, where those provisions were deemed to protect against unfair competition by misappropriation of the employer’s trade secrets and confidential information.[viii] So, employers should take note: they might get a second bite at the restrictive covenant “apple” if they word their agreements appropriately.
c. Commission Plan Agreements. California requires employers to provide employees receiving commissions and performing services in California with written commission plan agreements.[ix] Such agreements must describe how commissions are computed and paid. Employers must also collect signed acknowledgments of receipt from employees for such agreements. Failure to comply bears penalties of $100 for the first violation and $200 for subsequent violations, per employee per pay period.[x] That adds up.
2. Community Property. California is a community property state.[xi] In California, community property is any property (other than a gift or inheritance) acquired or debt incurred by either spouse, between marriage and permanent separation. Further, quasi-community property is property that would have been community property, had it been acquired while either spouse was domiciled in California. At the time a divorce is filed in California, each spouse has a one-half interest in each separate item of community property and each item of quasi-community property.
Why should a business located outside of California be concerned about California’s community property law? Consider the situation of a married entrepreneur living outside of California who incorporates his 100%-owned, closely-held business outside of California. Things are going so well that he decides to temporarily relocate to California to oversee a West Coast expansion. During the relocation, his spouse files for divorce—in California. Even though the company was formed outside of California, all of its stock is held in the name of the entrepreneur and all of the stock was issued when the entrepreneur was not a California resident; at divorce in California his spouse owns a one-half community property interest in all the stock of the out-of-state corporation. It matters not that the couple had no intention to move to California when the business was started or during its growth. Now, consider that the corporation receives an unsolicited offer to purchase the business. The entrepreneur wishes to accept the offer. The spouse does not. What happens?
In the absence of an agreement, there is a stalemate. The entrepreneur cannot obtain the approval of a majority of the company’s outstanding stock to approve any merger or asset sale, or a direct sale of a majority of the outstanding stock. Moreover, the company would be deadlocked in any shareholder vote where the two spouses cannot agree.
To avoid a situation like this, companies (even those incorporated outside of community property jurisdictions like California) should consider having the spouses of all shareholders sign carefully-drafted shareholder agreements, even when those spouses do not hold shares and do not live in community property states. Such agreements should certainly be put in place before any shareholder or their spouse moves to California, even temporarily.
3. Employment Law. California’s public policy protecting workers has caused it to adopt numerous laws that are outside of the mainstream of most other states. Here are just a few examples.
a. Independent Contractors vs. Employees. For employers, independent contractors hold several advantages over employees. In California, for independent contractors, employers do not have to: (a) pay payroll taxes; (b) comply with minimum wage, overtime, meal periods, and rest breaks; (c) comply with vacation rules; (d) provide workers’ compensation insurance; or (e) make unemployment or disability insurance payments or social security contributions. These advantages provide a strong incentive for employers to categorize workers as independent contractors instead of employees—even if they may not be.
California counterbalances this incentive in several ways. First, California law establishes various rebuttable presumptions that workers are employees and not independent contractors.[xii] In such cases, the burden is on the employer to rebut the presumption that the worker is an employee and to prove that he or she is an independent contractor. Adding to an employer’s difficulty in establishing that a particular worker is an “independent contractor,” is the fact that there is no single definition of, or test for, the term in California. Different tests apply for different situations.[xiii] Second, California law makes persons vicariously and individually liable for advising employers to willfully misclassify workers as independent contractors, rather than employees.[xiv] Third, the burden of proving that a particular worker is an independent contractor shifts to the employer once the worker shows he performed any service for the employer.[xv] These and other principles should make any employer, and its executives, very careful when attempting to classify California workers as independent contractors, rather than employees.
b. Minimum Wage. California’s minimum wages (note the plural) are higher than the current $7.25 federal rate. In California, the state’s minimum is $10 for employers with less than 25 employees and $10.50 for employers with 25 or more employees. (It will increase to $15 by 2022.) Cities, however, can set their own minimums that are above the state’s. Examples include: San Francisco ($14 effective July 1, 2017); Oakland ($12.86); and San Jose ($10.50).
c. Vacation. While California does not require mandatory paid vacation, employers offering vacation are prohibited from adopting policies requiring employees to “use or lose” accrued vacation days.
d. California Leave Laws. Under certain conditions, California provides up to six months of paid leave for the birth or adoption of a child. Separate from paid family leave, California also provides numerous grounds for employees to demand unpaid leave, including participation in a child’s school activities and meeting with the child’s teachers. Leave time can be up to 40 hours in a 12-month period. Employers must, therefore, be careful before terminating employees for absence, lest such absences be protected under leave laws. They should always check the law before disciplining or terminating any employee for absences.
e. The California Family Rights Act (“CFRA”) and the federal Family and Medical Leave Act (“FMLA”). California affords greater rights than the FMLA for pregnancy, pregnancy disabilities, and bonding leave time. The FMLA requires allowing up to 12 weeks to be taken in the first year, but such leave must be taken all at one time. CFRA allows 12 weeks to be taken in the first year in as many as five two-week chunks, plus two additional one-week chunks of time.
f. Non-Exempt (Hourly) Employees. Hourly employees are entitled to these privileges in California.
- Meal periods. Employers must provide an unpaid meal break of not less than 30 minutes for each six-hour shift, and must provide a second 30 minute unpaid meal period if the employee works more than 10 hours per day.[xvi] During the meal break an employer cannot exercise control over the employee’s activities, nor can an employer require that the meal break be spent on the employer’s premises.
- Rest breaks. Employers must provide paid rest breaks of: (a) ten minutes for every shift lasting between 3.5 and six hours; (b) 20 minutes for shifts lasting between 6 and 10 hours; and (c) 30 minutes for shifts between 10 and 14 hours.
- Day of Rest. Workers cannot be forced to work for seven consecutive days in the same work week.
- Overtime. Overtime in Calfornia is calculated on a daily and weekly basis. Overtime rates kick in after the 8th hour in any day and 40 hours in the week.[xvii] Out-of-state workers temporarily working in California are covered by the same rule.[xviii]
g. Paid Sick Leave. Employers are required to provide paid sick leave for exempt and non-exempt employees.[xix] Sick days accrue at the rate of one hour per 30 days worked, but not less than 24 hours (three work days) for any 12-month period. An employer’s comparable paid time off policy can satisfy the paid sick leave obligation.
h. Final Pay. Employers are required to immediately pay all wages due to an employee who is discharged or quits.[xx] Willful failure to pay such wages timely incurs a daily penalty of one day’s wages for each day such payment is late.
Conclusion: Employers incorporated or located outside of California need to be aware of California’s laws, particularly when they employ workers based in or temporarily assigned to California. Knowing these laws can prevent a host of unwelcome surprises, as well as the loss of valuable corporate assets.
If you have questions regarding doing business in California or California law, contact Scott Harris at SHarris@fh2.com or (770-399-9500) for more guidance.
[i] Chris Nichols, Does California really have the ‘6th largest economy on planet Earth?’ PolitiFact (July 26, 2016), available at http://www.politifact.com/california/statements/2016/jul/26/kevin-de-leon/does-california-really-have-sixth-largest-economy-/
[ii] This article is only a limited sampling of California law and does not include every issue warranting consideration.
[iii] The statute contains three exceptions involving: a sale of goodwill of a business; partners in advance of dissolving or dissolution of a partnership; and agreements among members of a limited liability company.
[iv] See Edwards v. Arthur Anderson LLP, 44 Cal.4th 937 (Cal.2008) (striking down a non-compete, customer non-solicitation, and employee non-solicitation in an employment agreement). But see Loral Corp. v. Moyes, 174 Cal.App.3d 268, 219 Cal.Rptr. 836 (1985) (enforcing a covenant prohibiting a former employee from “raiding” the former employer’s employees).
[v] California Labor Code Section 925.
[vi] California Uniform Trade Secrets Act at California Civil Code Section 3426 et seq. A recently publicized example of the extent to which California protects trade secrets is the partial injunction won by Waymo (a Google affiliate) in its lawsuit against Uber involving self-driving car technology. See Waymo LLC v. Uber Technologies, Inc., No. C 17-00939 WHA, 2017 WL 2123560 (N.D. Cal. May 15, 2017).
[vii] Brocade Communications Systems, Inc. v. A10 Networks, Inc., 873 F.Supp.2d 1192, 1214 (N.D. Cal. 2012) (under CUTSA, “confidential customer-related information including customer lists and contact information, pricing guidelines, historical purchasing information, and customers’ business needs/preferences … is routinely given trade secret protection.”).
[viii] See Kindt v. Trango Systems, Inc., No. D062404, 2014 WL 4911796 (Cal. Ct. App. Oct. 1, 2014) (enjoining former employee’s use of former employer’s customers’ identities under unfair competition theory); see also StrikePoint Trading, LLC v. Sabolyk, No. SACV071073DOCMLGX, 2008 WL 11334084 (C.D. Cal. Dec. 22, 2008) (enforcing restrictive covenants preventing employee from undertaking “any employment or activity competitive with Employer’s business wherein the loyal and complete fulfillment of the duties of the competitive employment or activity would call upon Employee to reveal, to make judgment on or otherwise to use, any confidential information or trade secrets of Employer.”).
[ix] California Labor Code Section 2751.
[x] California Labor Code Section 2699(f)(2).
[xi] The eight contiguous-states girding the United States’ southern and western perimeter in the “Community Property Belt” are: Louisiana, Texas, New Mexico, Arizona, California, Nevada, Idaho, and Washington. The ninth is outlier Wisconsin. A tenth, Alaska, applies community property if both spouses opt-in.
[xii] When determining whether a worker is an employee or independent contractor for issues including wage & hour, meal periods, rest breaks, and workers’ compensation insurance, the California Department of Labor Standards Enforcement presumes that a worker is an employee. California Labor Code Section 3357. Where a worker performs services requiring a license or provides services for another who is required to have a license, that worker is presumed to be an employee. California Labor Code Section 2750.5 and California Business and Professions Code Section 7000 et seq., respectively.
[xiii] For example, the three-factor test for when a worker performing licensed services is an independent contractor is at California Labor Code Section 2750.5.
[xiv] California Labor Code Sections 226.8 and 2753.
[xv] See Bowerman v. Field Asset Services, Inc., No. 3:13-CV-00057-WHO, 2017 WL 1036645 (N.D. Cal. March 17, 2017).
[xvi] California Labor Code Section 512.
[xvii] California Labor Code Section 510.
[xviii] Sullivan v. Oracle Corp., 254 P.3d 237 (Cal. 2011).
[xix] California Labor Code Section 246.
[xx] California Labor Code Section 203.