Employers who settle discrimination or other claims of wrongdoing brought by former employees commonly include a provision in the settlement agreement providing that the former employee will never reapply or be eligible for rehire. Such provisions, which are known as “no-employment” or “no-rehire” provisions, are intended to protect the employer against claims by the former employee that they were not rehired in retaliation for their prior claims against the employer. However, a recent Ninth Circuit case suggests that in certain circumstances, these provisions may be void and could render an entire settlement agreement unenforceable.
On April 8, 2015, in Golden v. California Emergency Physicians Medical Group, 782 F.3d 1083 (9th Cir. 2015), the Ninth Circuit held that a district court erred in enforcing a settlement agreement containing a no-employment provision. The Ninth Circuit held that California Business and Professions Code Section 16600, which 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,” may apply outside of the context of covenants not to compete if the contract provision constitutes a “restraint of substantial character” and remanded the case for further consideration of the issue.
Importance of No-Employment Provisions in Employee Settlement Agreements
The rationale for no-employment provisions is simple—to avoid claims of retaliation. Nearly every state or federal discrimination statute contains a prohibition against retaliation, meaning that an employer may not fire, refuse to hire, demote, harass or otherwise “retaliate” against anyone for filing a charge of discrimination or participating in a discrimination proceeding.1 Therefore, if a former employee sues an employer and enters into a settlement agreement which does not include a no-employment provision, the former employee could potentially reapply for a job and bring another round of litigation against the employer alleging for retaliation if the former employee is not rehired.
Given the risk of retaliation claims, it has become common practice for employers to include no-employment provisions in settlement agreements with former employees. The recent decision in Golden now calls into question the enforceability of these types of covenants in California.
California Business & Professions Code Section 16600
Section 16600 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.” Most often, Section 16600 is invoked by employees to invalidate covenants not to compete. There are three narrow statutory exceptions to California’s prohibition on restraints of trade. Covenants not to compete are permissible in connection with (1) the sale of the goodwill of a business, (2) the dissolution of a partnership, and (3) limited liability companies. Cal. Bus. & Prof. Code §§ 16601-2.5. In Edwards v. Arthur Andersen LLP, 189 P.3d 285 (Cal. 2008), the California Supreme Court refused to recognize a “narrow restraint exception” to Section 16600 beyond the three enumerated statutory exceptions. Accordingly, California’s prohibition against restrictive covenants is considered, at least to some, shockingly broad.
Golden v. California Emergency Physicians Medical Group
In Golden, the Ninth Circuit noted the considerable breadth of Section 16600, emphasizing that while the courts of California have not clearly delineated the boundaries of Section 16600, there is no reason to believe that Section 16600 simply prohibits “covenants not to compete” and not other contractual restraints on professional practice.
Golden involved a settlement agreement between a physician, Donald Golden (“Dr. Golden”), and his former employer, the California Emergency Physicians Medical Group (“CEP”). The CEP was an association of over one thousand physicians that staffed many of the emergency rooms and clinics throughout California. Dr. Golden sued CEP after it terminated his staff position alleging several causes of actions including race discrimination under federal and California law. The parties reached an oral agreement in open court to settle the case. In return for payment, Dr. Golden agreed to drop the suit and agreed to a no-employment provision pursuant to which he agreed to waive all rights to employment with CEP or at any facility that CEP may own or with which it may contract in the future.
After the terms of the agreement were reduced to writing, Dr. Golden refused to accept the conditions of the settlement and moved to have it set aside. Dr. Golden argued that the court could not enforce the agreement because the no-employment provision, a material term of the settlement, violated Section 16600. The district court rejected Dr. Golden’s Section 16600 argument, denied the motion to set aside the settlement, and ordered him to sign the agreement. According to the trial court, Section 16600 did not bar the no-employment provision because it “is not a covenant not to compete,” and “does not . . . preclude Dr. Golden from working for one of [CEP’s] competitors or at a hospital or other facility not operated by [CEP].”
The Ninth Circuit’s Holding That 16600 Applies to Settlement Agreement
In a 2-1 panel decision,2 the Ninth Circuit ruled that the district court erred in categorically excluding the no-employment provisions from Section 16600’s prohibition against restraints on trade.
First, the court acknowledged that the issue turned entirely on an interpretation of California state law and that the California Supreme Court had yet to rule on whether Section 16600 applies beyond covenants not to compete. Therefore, the Ninth Circuit, in deciding this issue of state law, would “apply what it finds to be the state law after giving proper regard to relevant rulings of the other courts of the state.” In other words, the Ninth Circuit attempted to predict how the California Supreme Court would rule after giving proper regard to relevant rulings of other state court decisions.
Looking at the statutory language, the Court noted that Section 16600 did not support a narrow interpretation: “every contract by which anyone is restrained from engaging in a lawful profession, profession, trade, or business of any kind is to that extent void.” The Court emphasized that the text of the statute does not include any reference to “compete” or “competition” and there is no textual evidence that Section 16600 is limited to employment contracts.
The majority also noted that prior California Supreme Court decisions, in particular Chamberlain v. Augustine, 156 P. 479 (Cal. 1916), supported a broader reading of 16600 than that adopted by the district court. Chamberlain involved a provision in a stock purchase agreement that required the parties to pay liquidated damages in the event that they start working in a certain geographical area. The Chamberlain court rejected the argument that 16600 did not apply to the liquidated damages clause simply because it did not prohibit the party from competing. Rather, the California Supreme Court held the heart of the Section 16600 analysis was not whether the provision in question was a covenant not to compete, but whether the provision imposes “a restraint of substantial character,” no matter its form or scope, on the ability of the individual to practice their trade or profession.
Accordingly, the court reversed and remanded, holding that the district court relied on a faulty premise—that only covenants not to compete fall within the ambit Section 16600. Rather, the majority emphasized that based on the statutory language and previous California Supreme Court decisions, other restraints on professional practice, including no-employment provisions, may impose “a restraint of a substantial character” which would render such provisions void under the California statute. Importantly, however, the court declined to rule on the validity of the no- employment provision at issue and instead remanded to the district court to determine “whether the no- employment provision constitutes a restraint of substantial character to Dr. Golden’s medical practice.”
Practical Implications for Employers and Best Practices
The Ninth Circuit’s decision in Golden raises new questions for employers who have entered or may enter into settlement agreements with former employees. Employers should now expect courts and counsel for employees to approach no-employment provisions with much greater scrutiny. Accordingly, it may be prudent to tailor the scope of any no- employment provision to fall within the “substantial character” standard discussed in Golden.
While it is unclear how lower courts will apply Golden’s “substantial character” standard, heightened scrutiny is more likely where a no-employment clause applies beyond an employee’s prior employer or if that prior employer controls a large portion of the relevant labor market. The Golden court suggested that the no-employment provision at issue was problematic because it prohibited employment not only with CEP, but employment with any facility that CEP may own or with which it may contract in the future. Accordingly the parties to a broad no-rehire clause that applies to an employer’s subsidiaries, affiliates or related entities should assume that such a provision may be at increased risk of being considered a substantial restraint in violation of Section 16600.
The potential unenforceability of a settlement agreement containing a no-employment provision is also not the only risk to consider. The inclusion of a no-employment provision could expose an employer to claims of unfair competition. California courts have held that an employer’s use of an illegal non- compete agreement may violate California Business & Professions Code Section 17200, California’s Unfair Competition Law. See Dowell v. Biosense Webster, Inc., 179 Cal. App. 4th 564, 575 (2009). Therefore, while the state of the law is certainly not settled—the Ninth Circuit was only predicting how the California Supreme Court would decide the issue—by including a no-employment provision in a settlement agreement, an employer could be at risk of defending a Section 17200 claim.
Finally, it would be unwise for out-of-state employers to ignore Golden on the assumption that California law would not apply. Choice-of-law determinations are case-by-case and California courts have applied Section 16600 despite out-of-state choice of law provisions. See, e.g., Application Group, Inc. v. Hunter Grp., Inc., 61 Cal. App. 4th 881 (applying Section 16600 to invalidate an agreement drafted and entered into in Maryland by a Maryland employee and requiring application of Maryland law). Accordingly, employers with former employees in California could be impacted by the ruling in Golden and should likewise consider this impact in drafting, reviewing and entering into settlements with former employees.
In closing, it is important to remember that the California Supreme Court is the final arbiter regarding the scope of section 16600, not the federal district courts or Ninth Circuit. In the meantime, while lawyers and clients wait for the California Supreme Court to weigh in, we will continue to monitor Golden on remand to the district court.