Non-Applicability of California Law in California Contract Disputes

By Conner D. Johnston

Determining which state law applies is one of the first steps in any corporate contract dispute. This is especially important in California as the state has several unique laws that affect the rights of corporations and the individuals that work for them. For instance, California generally prohibits non-compete provisions in employment agreements and has strong minority shareholder rights. Yet, a contract dispute in a California court does not automatically mean California law will apply. Instead, the existence and application of two contractual provisions will usually dictate whether California law is applied.

The first term is a choice-of-law provision. As the name implies, these provisions declare what state law will apply if there is a dispute over the contract. Yet, even if another state’s law is provided in this provision, California law may still be applicable. When deciding whether to apply another state’s law, California courts perform a two-step analysis. Here, courts first determine

(1) whether the chosen state has a substantial relationship to the parties or their transaction, or (2) whether there is any other reasonable basis for the parties' choice of law. If neither of these tests is met, that is the end of the inquiry, and the court need not enforce the parties' choice of law. If, however, either test is met, the court must next determine whether the chosen state's law is contrary to a fundamental policy of California.

Nedlloyd Lines B.V. v. Superior Court, 3 Cal. 4th 459, 465 (1992). Enforcement of non-compete clauses are an example of a policy contrary to a fundamental policy of California. Under this analysis, California courts will apply California law and invalidate non-compete clauses imposed on California employees, even if there is a choice-of-law provision for another state. See Application Grp., Inc. v. Hunter Grp., Inc., 61 Cal. App. 4th 881 (1998) (“[T]he trial court did not err when it declined to enforce the contractual conflict of law provision in Hunter's employment agreements. To have done so would have been to allow an out-of-state employer/competitor to limit employment and business opportunities in California.”).

An important exception to this rule is if there is a previously-file action pending in another state. Google, Inc. v. Microsoft Corp., 415 F.Supp.2d 1018 (N.D. Cal. 2005) is instructive on this issue. There, a former Microsoft employee went to work for Google in violation of his noncompete agreement with Microsoft that designated Washington law. Microsoft sued in Washington to enforce the agreement and Google sued in the Northern District of California to invalidate the agreement based on California’s policy against non-competes. Though, the District Court noted California’s strong policy in favor of competition, it stayed the action because Google “filed to try to secure a California forum. In addition, the Washington state court has already held an evidentiary hearing, issued a preliminary injunction, and set a January 2006 trial date.” The court acknowledged Google’s argument that “California and Washington view covenants not to compete differently,” and a stay will only be issued if “’the same state issues [are] ... pending’ in both state and federal court.” Yet, “[t]he flaw in this argument is that Google and [and the employee] fail to explain why they cannot ask the Washington state court to apply California law.” Thus, even if California law would apply, another pending action may justify dismissal.

The second contractual term to analyze is a choice-of-venue provision, also known as a forum selection clause. These specify the precise location where a suit may be brought. California courts will often dismiss a suit on a contract with a non-California choice-of-venue clause without analyzing which state’s law applies. Another Northern District of California case is helpful here. In the unreported case Besag v. Custom Decorators, Inc., 2009 WL 330934 (N.D. Cal. 2009), a California-based independent contractor sued her Oregon-based employer in a California Superior Court. The employer then removed the case to federal court and filed a motion “seeking transfer to the District of Oregon pursuant to a forum selection clause in the parties' Independent Contractor Agreement.” The contractor challenged the transfer largely on the basis that Oregon law would not afford equivalent damages as are available under California law for her wage claims. The court first noted that “[f]orum selection clauses are presumptively valid unless the party challenging enforcement can demonstrate that the clause is invalid or that its enforcement would be unreasonable. [Citation]. The party challenging the clause bears a heavy burden and ‘must clearly show that enforcement would be unreasonable or unjust, or that the clause was invalid for reasons such as fraud or over-reaching.’” Though the contractor’s public policy arguments “may be relevant in the context of challenging the validity of a choice of law provision,” there is “no evidence that the public policy underlying her claim expressly relates to venue.” Further, “a party challenging enforcement of a forum selection clause may not base its challenge on choice of law analysis.” Thus, the contractor “failed to demonstrate how transfer of this case would contravene an express California public policy underlying the Labor Code as it relates specifically to venue.” The court also stated that the contractor could still challenge the choice-of-law provision once in Oregon, where it can still apply California law if appropriate.

In short, California law can apply even if there is a choice-of-law provision for another state, depending on the two-step analysis. Yet, California law is unlikely to apply if there is a choice-of-venue provision in favor of an out-of-state venue. Though it is possible to overcome this provision, it is a “heavy burden” and policy arguments will not be considered. For additional information about California contract disputes, feel free to contact: Conner D. Johnston, cjohnston@diepenbrock.com or (916) 492-5095.