Significant 2006 Employment Law Cases

As of September, 2006 has been a banner year for decisions impacting California employment law. Here are notes on just a few of the most important developments:

CALIFORNIA COURT OF APPEALS REAFFIRMS UNENFORCEABILITY OF POST-EMPLOYMENT NON-COMPETE AGREEMENTS

Sophisticated California employees and employers know that in California, alone among the 50 states, agreements precluding post-employment competition by a former employee are contrary to statute (and public policy) and not enforceable (with specific and limited exceptions). [Business & Professions Code Section. 16600]. For decades, however, the federal courts in the Ninth Circuit have interpreted Section . 16600 less stringently than state courts, holding that “narrow restraints” – i.e.., provisions barring the former employee from competing for the former employer’s specific customers but not precluding all competition in the relevant market – would not violate the statute. See, e.g., the oft-criticized opinion in IBM v. Bajorek (1999), in which the Ninth Circuit permitted enforcement of an agreement calling for the forfeiture of post-employment stock option profits where a former employee joined a competitor within six months of termination.

At the end of August, the California Court of Appeal (2d District) emphatically rejected the Ninth Circuit’s “narrow restraint” exception to sec. 16600. In Edwards v. Arthur Andersen LLP (PDF, 119KB) (August 30, 2006), the Court of Appeal held “the narrow restraint doctrine” to be a “misapplication of California law,” and affirmed that “noncompetition agreements are invalid under section 16600 even if narrowly drawn.” (Emphasis added.) Edwards (assuming the California Supreme Court does not overrule it or “unpublish” it) has significance beyond facial “non-competition” agreements. The restriction at issue in Edwards was a restriction on working with or for the former employer’s clients post-employment. The Edwards holding will thus be no less applicable to “non-solicitation” agreements which bar post-employment “solicitation” of a former employer’s customers – unless the existence or requirements of such customer can be proved to be a “trade secret.” Proving that the existence or requirements of a client is a “trade secret” (i.e., that it is not generally known, that it is subject to reasonable efforts to preserve confidentiality, and that its quality of being not known among competitors has real value for the former employer) is a very difficult task.

Edwards is not so much a change in California law, as a direction to the federal courts to apply that law in the same fashion the state courts do (which is, after all, the job of the federal courts on matters of state substantive law). Thus, wise employers should not rely on customer “non-solicit” agreements to prevent competition from former employers where such customers are in fact known to be part of the market for goods and services offered by the employer – whether they can get the case into federal court or not. And employees may feel a bit freer to engage in such competition (again, assuming that the California Supreme Court does not intervene), notwithstanding customer “non-solicit” provisions in their agreements with their former employers.


A CHANGE IN LAW REGARDING TAXABILITY OF EMOTIONAL DISTRESS DAMAGES IN EMPLOYMENT CASES.

Among the “tort reform” (anti-“trial lawyer”) provisions pushed through by the post-1994 “Contract with America” Congress was an amendment to Section 104 of the Internal Revenue Code (the section that governs taxability of compensation for injuries or sickness). Section 104(a)(2) was amended in 1996 to provide that emotional distress damages arising from an employment tort claim (other than those rare employment claims arising from a physical injury) are, unlike emotional distress damages in other tort claims, treated as taxable income. This change had an immediate impact on the settlement of discrimination, harassment and public policy wrongful termination cases. The prior practice of attributing some part of the settlement proceeds to “emotional distress and/or personal injuries” – thereby enabling defendant employers to pay part of a settlement in non-taxable dollars (thus getting more net dollars to employee plaintiffs at a lower cost to employer defendants) – became largely impossible. The United States Court of Appeals for the D.C. Circuit, a court which is widely respected for its expertise in tax-related issues, has now held the amendment unconstitutional.

In Murphy v. United States (PDF, 140KB) (August 22, 2006), the United States Court of Appeals for the District of Columbia, relying on a 1955 U.S. Supreme Court case (Glenshaw Glass Co., 348 US 426), held that emotional distress damages, like physical injuries, do not constitute a “gain” or an “accession to wealth.” Rather, such damages are a recompense for a quality or asset (such as peace of mind), not constitutionally subject to taxation. If Murphy remains the law (that is, if other circuits adopt it and/or the U.S. Supreme Court affirms it), we will be back to the good old days of employers settling portions of employment law tort claims with non-taxable dollars – a benefit to employers and employees, but not to the taxman. Stay tuned.

ACTIONABLE RETALIATION NEED NOT BE MEASURABLE JOB DETRIMENT.

The United States Supreme Court has resolved a split in the circuits in holding that a Title VII retaliation claim may be premised upon any action that would dissuade a reasonable worker from making or supporting a charge of discrimination. Prior to the Court’s decision in Burlington Northern Santa Fe Railway v. White (PDF, 244KB) (June 22, 2006), different Courts of Appeals had articulated different standards for determining whether an alleged retaliation was actionable: Did the alleged retaliation have a “materially adverse effect on the terms, conditions or benefits of employment?” Did it concern an “ultimate” employment decision such has hiring, granting leave, discharging, promoting or compensation. Or, in the more liberal jurisdictions, was the challenged employer action one which would dissuade a “reasonable” worker from making or supporting a charge of discrimination?

In an opinion by Justice Breyer, the Court adopted the latter, more liberal, standard. In so doing, the Court made it clear that the appropriate test had both “objective” and “subjective” elements; i.e., the “reasonable worker” is a reasonable worker in the actual position of the plaintiff. Thus, as Justice Breyer explained, a schedule change might not matter to one worker, but might “matter enormously” for a young parent with child care requirements. In effect, the Court’s White decision puts retaliation claims on the same footing as discrimination claims: If the negative employer action is minimally “material” (i.e., it would matter to the employee), it will be sufficient. Interesting, the Court’s decision (though not its reasoning) was unanimous. The White case should be a reminder for employers (and employees) that retaliation is no less a legitimate employment claim than, e.g., discrimination or harassment, and a successful plaintiff is entitled to the same panoply of damages (including emotional distress and attorney’s fees). And, since retaliation is a separate and independent basis for liability, a plaintiff may prevail regardless of the merit (or lack of merit) of the foundational charge of discrimination or harassment. Thus, even if the employee’s prior claim of discrimination or harassment fails, employers must take care not to engage in actions (and, since White, not just “ultimate” actions like termination, suspension, demotion, etc.) that could provide the employee with an independent retaliation claim.