New Law Imposes Penalty for Non-Competition Provisions in Employment Contracts
By Stuart J. Yasgoor, Esq.
California courts have consistently held that employees have the unfettered right to compete against an employer following termination of employment and, with only a few exceptions, any provision in an employment contract prohibiting competition is generally found to be illegal and unenforceable. Despite this, there is a widely held belief by many California veterinary practice owners that the inclusion of a non-competition provision1 contained in an associate/employee's written employment contract is enforceable if the restricted geographical area is reasonable and the length of time prohibiting competition is not excessive. Still other employers, fully aware that non-competition provisions are illegal and unenforceable, nevertheless choose to include such provisions in their associates' employment contracts anyway hoping that it may deter the employees from seeking employment with a nearby competitor or opening a new practice in the community. However, in light of recent changes in California law, any employer who elects to include a prohibited non-competition provision in the associate/employee's employment contract, for whatever reason, will do so at his or her own peril.
By way of background, California Labor Code section 432.5 provides that an illegal term may not be included in an employment contract. The inclusion of a prohibited non-competition provision in the employment contract is an illegal term and, therefore, constitutes a violation of section 432.5. Under prior law, California did not impose any monetary penalties for a violation of Labor Code section 432.5. However, effective January 1, 2004, the enactment of Senate Bill 796 created Labor Code sections 2698 and 2699, which now provide for an effective enforcement mechanism for a violation of Labor Code sections like 432.5 that do not have their own penalty provisions. The new law imposes a penalty of $100 for each aggrieved employee per pay period for the initial violation and $200 per pay period per violation for each subsequent violation. For example, if an employer includes a prohibited non-competition provision in an employment contract and the employee is paid bi-weekly (i.e., 26 pay periods per year) the penalty would be $2,600.00 for the first year computed as follows: 1 employee x 26 pay periods x $100.2 However, if the employer employs several employees and each employment contract contains the prohibited non-competition provision, the penalty could become very expensive.
The new law now provides two factors that will make it easier to uncover and enforce violations of Labor Code section 432.5. First, the aggrieved employee may bring an action against the employer on his or her own behalf as well as on behalf of all current and former employees who have or may have had an employment contract containing a prohibited non-competition provision. Second, there is a strong economic incentive to turn in the employer because the employee will receive a "finder's fee" equal to 25% of the penalty imposed against the employer, in addition to reimbursement of the employee's reasonable attorney's fees and costs incurred in bringing an action against the employer.
In view of the new law, California employers should carefully review their employment contracts to make sure that a prohibited non-competition provision has not been included. For those California employers whose employment contracts contain such a provision, the employer should immediately contact his or her attorney so that the contracts may be amended to delete the illegal provision, thereby avoiding the possible imposition of civil penalties in the future. 3
- The following is a typical prohibited non-competition provision found in an employment contract: "The employee agrees that during the term of the contract and continuing for a period of 5 years after termination of employment, the employee will not, either directly or indirectly, engage in as an owner, employee, independent contractor, agent, consultant or otherwise, the practice of veterinary medicine or any other services similar to or competitive with the veterinary practice conducted by employer within a 10-mile radius of employer's veterinary hospital facility."
- Arguably, the renewal of the associate's employment contract would constitute a subsequent violation doubling the penalty from $100 to $200 per pay period per violation. Thus, if the associate's contract is renewed annually, the $200 per pay period penalty would begin in the second year of the contract term and continue until the contract is either amended or terminated.
- Although non-competition provisions may not be included in the written employment contract, all employment contracts should include provisions that protect the employer's proprietary information and trade secrets (e.g., client lists, brochures, logos, and the like). In addition, all employment contracts should contain specific language providing that, either during the employee's employment or at any time following termination of his or her employment, the employee shall be prohibited from (i) disclosing names, addresses and other personal information about the owners of the employer's patients, (ii) soliciting the employer's patients, and (iii) soliciting the employer's personnel.