As a matter of fundamental public policy, California values employee mobility over the right to enforce restrictive covenants. Consistent with this well-delineated policy, California courts regularly void non-compete and non-solicitation agreements.
In 2023, California doubled down on this stance by amending the Business & Professions Code to add Section 16600.5 which voids any non-compete agreement “regardless of where and when the contract is signed.” Effective as of January 1, 2024, the amendment projects California’s policy outside its own borders – making clear that California courts will not even enforce non-compete agreements executed by non-residents in another state.
The new law, however, raises a plethora of constitutional and jurisdictional issues. Most notably: to what extent can a California resident void a non-compete agreement executed in a different state and governed by that state’s laws? The answer remains unclear. A former Draftkings employee (and newly settled California resident), however, challenged his Massachusetts non-compete provision and provided some early insight into the practical implications of applying the new statute. As the employee and Draftkings litigated on parallel tracks in California and Massachusetts, the courts’ findings shed (at least some) light on how these types of cases may shake out in the future.
I. California’s Ban On Employee Non-Compete Agreements
Over 150 years ago, California broke from the common-law tradition observed in most states and took a firm stance against non-compete and non-solicitation agreements. It rendered them, by and large, unenforceable. See Edwards v. Arthur Andersen LLP, 44 Cal.4th 937, 945 (2008).
California has held firm in that position ever since, settling on a “deeply rooted public policy favoring competition.” Blue Mountain Enterprises, LLC v. Owen, 74 Cal.App.5th 551-52 (2022); see Hill Medical Corp. v. Wycoff, 86 Cal.App.4th 895, 901 (2001) (California public policy is “to ensure that every citizen shall retain the right to pursue any lawful employment enterprise of their choice.”). Employee mobility fosters that spirit of open competition and is “deemed paramount to the competitive business interests of the employers …” Diodes, Inc. v. Franzen, 260 Cal.App.2d 244, 255 (1968).
The California Legislature codified this public policy in the California Business & Professions Code, Section 16600(a):
Except as provided in this chapter, every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.
This language provides little wiggle room. Restraints on trade, which include non-compete and non-solicitations agreements, are void. In Edwards, supra, 44 Cal.4th at 945 the California Supreme further sharpened the statute’s contours by declining to adopt the Ninth Circuit’s “narrow-restraint” exception – confirming that even narrowly drafted employee non-compete provisions are void as against public policy. Id.; see also Muggill v. Reuben H. Donnelley Corp., 62 Cal.2d 239, 242-43 (1965). Employee non-compete agreements, no matter how “reasonable” or narrowly drawn, cannot be enforced unless one of three statutory exceptions applies.[1]
II. Choice-of-Law Provisions And Non-Compete Agreements Under California Law
Under California law, employee non-compete agreements are generally unenforceable. But what happens when an employment agreement concerning a California employee includes a choice-of-law provision requiring application of another state’s laws? Employers have tried it. But even though contractual choice-of-law provisions are generally enforceable, a crucial exception allows California courts to disregard a choice-of-law provision that is contrary to fundamental public policy. 1-800-Got Junk? LLC v. Sup. Ct. (Minimum Asset Recovery, Inc.), 189 Cal.App.4th 500, 512-13 (2013).
In assessing contractual choice-of-law provisions, California courts engage in a two-step process. First, the party enforcing the choice-of-law provision must establish that either: (1) the chosen state has a substantial relationship to the parties or their transaction; or (2) there was a reasonable basis for the selection. Washington Mutual Bank v. Sup. Ct. (Briseno), 24 Cal.4th 906, 916 (2001).
If established, the burden shifts to the party challenging the provision to show “that the chosen law is contrary to a fundamental policy of California and that California has a materially greater interest in the determination of the issue.” Id. (emphasis in original).
The California Court of Appeal grappled with this question in Application Group, Inc. v. Hunter Group, Inc., 61 Cal.App.4th 881 (1998), wherein a California company (Hunter) recruited a Maryland-based employee from one of its competitors (AGI). The employee’s contract with Hunter included a one-year non-compete provision and a Maryland choice-of-law provision. Id. at 886-888. When AGI and the employee filed suit in California state court to void the out-of-state noncompete agreement, the California Court of Appeal had to determine whether a California employer’s out-of-state recruiting efforts for an in-state position are governed by California law. Id. at 896-897 (“Thus, we must decide whether California or Maryland law applies to a dispute over the enforceability of Hunter’s noncompetition clause when a California employer … seeks to hire one of Hunter’s nonresident consultants for employment in California.”).
Applying California choice-of-law principles, the Court weighed California’s interest in “protecting the freedom of movement of persons whom California-based employers … wish to employ to provide services in California” against Maryland’s self-proclaimed interest in “preventing recruitment of employees who provide ‘unique services,’ and the misuse of trade secrets …” Id. at 901. Because the employee in that case was not providing “unique” services, the Court discounted the Maryland’s relative interest in the dispute and declined to apply Maryland law.
In short, employers can try to utilize choice-of-law provisions in their employment contracts to sidestep California’s ban on non-compete agreements. But the inevitable balancing test, combined with California’s fundamental public policy against non-compete agreements, makes this an uphill climb.
III: Recent Amendments to Bus. & Prof. Code § 16600, et seq.
Effective January 1, 2024, the California Legislature passed two significant amendments to Section 16600.
First, Assembly Bill 699 added Section 16600.5, which in turn expanded the scope and geographical reach of California’s non-compete ban:
(a) Any contract that is void under this chapter is unenforceable regardless of where and when the contract was signed.
(b) An employer or former employer shall not attempt to enforce a contract that is void under this chapter regardless of whether the contract was signed and the employment was maintained outside of California.
Id. This amendment injects an extraterritorial dimension to California’s ban on employee non-compete agreements. Under the plain language of the statute, non-compete agreements signed entirely out-of-state, between an out-of-state employer and non-California resident, cannot be enforced in California.
Section 16600.5 raises new questions about just how far the Legislature can go in voiding contractual agreements signed outside California’s own borders by non-California residents. Does the new statute render the traditional choice-of-law analysis moot? Are there any circumstances in which a California court may apply another state’s law, and enforce a non-compete provision, based on a contractual choice-of-law agreement? By its plain language, Section 16600.5 would seem to suggest that the Legislature has taken this decision out of the Court’s hands. Exactly how Section 16600.5 will be applied, however, is still up in the air.
Second, Assembly Bill 700 also amends Section 16600 by adding subpart (b)(1):
This section shall be read broadly, in accordance with Edwards v. Arthur Andersen LLP, 44 Cal.4th 937 (2008), to void the application of any noncompete agreement in an employment context, or any noncompete clause in an employment contract, no matter how narrowly tailored, that does not satisfy an exception in this chapter.
This simply codified the holding in Edwards and reaffirmed that even narrowly tailored restrictive covenants are unenforceable in California.
IV. Early Test Case: Hermalyn v. Draftkings
The new statutory amendments raised significant questions about whether California can reach into other states to void non-compete agreements between non-residents and foreign companies. Within months of the amendments going into effect, the first high-profile test case worked its way through the courts. Mark Hermalyn left his job in New Jersey, took a new job in California, and immediately sued to void his non-compete agreement with his former Massachusetts employer. It set up a show-down between a California state court and a Massachusetts federal court over the California Legislature’s ability to project its policy preferences beyond its own borders.
Factual Background
Prior to 2024, Hermalyn worked for DraftKings, Inc. (“DraftKings”) as a Senior Vice President of Growth, tasked with growing and cultivating DraftKings’ online gaming vertical’s stable of high-net-worth customers. Although DraftKings is based in Massachusetts, Hermalyn lived and worked in New Jersey.
As a condition of his employment, Hermalyn signed a number of employment and stock grants – nearly all of which included non-compete, non-solicitation, and Massachusetts choice-of-law provisions. The non-compete agreement, specifically, prohibited Hermalyn from working for any competitor, worldwide, for twelve (12) months.
In early 2024, Hermalyn accepted an offer with Fanatics, Inc. (“Fanatics”), a California corporation, to run its Los Angeles office. He took immediate steps to establish California residency, including securing an apartment, getting a driver’s license, and applying to schools for his children. The day after he accepted his offer, Hermalyn filed suit in Los Angeles Superior Court to void his non-compete and non-solicitation agreements with DraftKings pursuant to Bus. & Prof. Code § 16600.5.[2]
DraftKings responded by claiming that not only did Hermalyn breach his non-compete and non-solicitation agreements, but he also accessed, downloaded, and absconded with a trove of confidential information and trade secrets before his departure. Within days, DraftKings filed its own lawsuit in Massachusetts federal court to enjoin Hermalyn from working for Fanatics in breach of his non-compete agreement.[3]
Procedural History
The California and Massachusetts Actions proceeded on parallel tracks. As both sides raced to obtain judgment in their chosen forum, this procedural jockeying (outlined below) played a critical role in the outcome and can provide strategic lessons moving forward for similarly situated parties.
- February 1, 2024: One day after formally accepting DraftKings’ offer, Hermalyn filed the California Action seeking a declaration that his non-compete and non-solicitation agreements with DraftKings are unenforceable under California law, specifically Bus. & Prof. Code §§ 16600, 16600.1, 16600.5, and 17200.
- February 5, 2024: DraftKings filed its own lawsuit in the Massachusetts Action. In it, DraftKings accused Hermalyn of misappropriating trade secrets, breaching his non-compete, non-solicitation, and confidentiality agreements, and conversion.
- March 14, 2024: After receiving a TRO, DraftKings moved for a preliminary injunction in the Massachusetts Action. Specifically, DraftKings sought to enjoin Hermalyn from working at Fanatics (in a role similar to the he held at DraftKings) for the full twelve months.
- April 30, 2024: The federal court granted DraftKings’ preliminary injunction in the Massachusetts Action.[4]
- May 3, 2024: Hermalyn appealed the District Court’s ruling to the First Circuit Court of Appeal.
- May 13, 2024: In the California Action, Hermalyn filed an ex parte application asking for its own TRO enjoining DraftKings from enforcing the non-compete agreement and an OSC re: preliminary injunction.
- May 14, 2024: The Superior Court denied Hermalyn’s TRO request but set a July 17, 2024 hearing on his request for a preliminary injunction.
- July 23, 2024: The Los Angeles Superior Court denied Hermalyn’s Motion for Preliminary Injunction
- Sept. 26, 2024: The First Circuit Court of Appeal affirmed the District Court’s Order granting Draftkings’ preliminary injunction.
The District Court Granted DraftKings’ Motion for Preliminary Injunction
The District Court’s 60-page opinion included two critical findings.
First, it applied Massachusetts choice-of-law principles and determined that Massachusetts law – not California law – governed any dispute over the employment agreements.[5] In doing so, the District Court concluded that California does not have a materially greater interest in the litigation than does Massachusetts. It relied largely on Hermalyn’s contacts with Massachusetts in finding that “[a]ny harms flowing from Hermalyn’s likely violation of his noncompetition, non-solicitation, and non-disclosure agreements will be felt by DraftKings in Massachusetts, not California.”[6]
At the same time, the District Court minimized California’s interest in the litigation. It acknowledged California’s unquestioned, “settled legislative policy in favor of open competition and employee mobility” but it gave equal weight to Massachusetts’ own considered legislative policy, which allows non-compete agreements that are “reasonable” and meet certain “minimum requirements.” In the District Court’s view, California’s public policy was no greater than Massachusetts’- California’s professed interest in voiding out-of-state non-compete agreements notwithstanding.
Notably, the District Court also distinguished a case relied on by Hermalyn, Oxford Global Resources, LLC v. Hernandez, 480 Mass. 462, 468 (2018), in which a Massachusetts state court refused to enforce a non-compete agreement in deference to California’s public policy interests. In Oxford – unlike the case at bar – the employee signed the agreement in California, trained in California, and performed his job duties in California. Without expressly saying so, the District Court seemingly dismissed California’s attempt, through its recent amendments, to apply its non-compete ban to out-of-state agreements.
The First Circuit Affirmed The District Court’s Ruling
On appeal, the First Circuit affirmed the District Court – finding that under Massachusetts’ choice-of-law principles, California did not have a materially greater interest in the litigation than did Massachusetts.
In doing so, it distinguished Oxford by focusing on Hermalyn’s relative lack of California contacts when he executed his employment contract and during his subsequent employment. Because Hermalyn’s relationship with California was minimal, Massachusetts (where Draftkings is headquartered) had a greater interest in the litigation.
Meanwhile, the Los Angeles Superior Court Denied Hermalyn’s Motion for Preliminary Injunction In Deference To The Parallel Federal Court Proceedings
While the parties pled their case to the Federal District Court of Massachusetts (and the First Circuit Court of Appeal), Hermalyn forged ahead in his parallel California state court proceeding in seeking a preliminary injunction against DraftKings. Ultimately, the Los Angeles Superior Court determined that although Hermalyn was likely to prevail on the merits, i.e. the non-compete was unenforceable under California law, its hands were tied with respect to issuing an injunction. The court reasoned that Hermalyn was asking the Court to, in effect, enjoin a federal court proceeding in another state – something it could not do under well established principles of comity and judicial restraint.
The Result?
For now, the U.S. District Court of Massachusetts and the First Circuit have defanged California’s recent statutory amendments and cast doubt on California residents’ ability to void out-of-state non-compete agreements. Draftkings has also provided a roadmap to out-of-state employers; by obtaining an early, out-of-state injunction, they can enforce their non-compete and/or non-solicitation agreements against California residents.
And although the Los Angeles Superior Court acknowledged that the underlying non-compete and non-solicitation agreements are unenforceable under California law, it declined to issue a preliminary injunction preventing Draftkings from enforcing it. Merits aside, it determined that it could not enjoin federal court proceedings in another state.
Ultimately, we will have to wait and see how future litigation involving Section 16600.5(a) plays out to assess how effectively it can be wielded (or blunted) depending on the circumstances. We will continue to provide updates as courts grapple with these issues moving forward.
[1] These three narrow, statutory exceptions allow for non-compete agreements in connection with the sale of a business.
[2] Los Angeles Superior Court Case No. 24STCV02694 (the “California Action”).
[3] Civil Action No. 1:24-cv-10299 (D. Mass. 2024) (the “Massachusetts Action”).
[4] Although the District Court enforced the non-compete agreement, it limited its geographic scope to the United States.
[5] Massachusetts choice-of-law principles largely mirror California’s.
[6] Draftkings, Inc. v. Hermalyn, 732 F.Supp.3d 84 (D. Mass. 2024).
For more information on California non-competes, please contact Benjamin Kussman, Esq. at ben@annagueymccann.com.
