Welcome to California: A Very Short Introduction to Several California Laws that Affect Out-of-State and Foreign Businesses

California is a leader in new trends and lifestyles, and a world leader in developing and commercializing new technologies. Also, however, California often “goes its own way” when developing laws and regulations.

Here are just a few of the quirks of California law that I raise most often with my clients both outside (and inside) of California. This list is not intended to be all-inclusive.

1. Non-competition provisions are void (with exceptions). Business and Professions Code Sections 16600 to 16602.5 make most non-competition provisions illegal, with limited exceptions for certain sales of businesses and dissolutions of partnerships and limited liability companies (LLC’s). Section 16600 frequently arises when one party to a business transaction wants to prevent the other party from competing with it, or a hiring party desires to stop its subcontractor from competing with it. Other legal tools, such as restrictive licenses or covenants restricting the use or disclosure of confidential information or the solicitation of employees or customers, often may be used instead.

2. Web sites that collect personally identifiable information from California residents must include a privacy policy. The California Online Privacy Protection Act of 2003 requires operators of commercial web sites and online services that collect “personally identifiable information” from individual consumers residing in California to post conspicuously a privacy policy on specified pages of their sites (including the home page). (An operator is in violation if it fails to post a privacy policy within 30 days after being notified of non-compliance.) Separately, the California security breach information act, also known as SB 1386, codified at California Civil Code Sections 1798.29, 1798.82 and 1798.84, requires businesses to disclose certain security breaches of personal information.

3. Employees in California own their inventions created with their own facilities and on their own time. California Labor Code Sections 2870-2872 provide that an employee’s inventions are not assigned to the employer if: (a) they are developed entirely on the employee’s own time, and (b) without using the employer’s equipment, supplies, facilities, or trade secret information. This does not apply, however, to inventions that either: (1) relate at the time of conception or reduction to practice of the invention to the employer’s business, or actual or demonstrably anticipated research or development of the employer; or (2) result from any work performed by the employee “as employee” of the employer. Provisions in employment agreements that attempt to modify this scheme are unenforceable. Also, if an employment agreement with a California employee requires the employee to assign any invention, then the employer must also — at the time the agreement is made — provide a written notification to the employee that the agreement does not apply to an invention which qualifies fully under the provisions of Section 2870. As a result, this notice generally appears in California employee invention assignment agreements.

4. A broad “private attorney general” law enables lawsuits for virtually any violation of law by a company. The California Unfair Competition Law, also known as Business & Professions Code Section 17200 (and following sections), permits the California Attorney General, as well as private parties acting as “private attorney generals,” to recover for “any unlawful, unfair or fraudulent business act or practice” and any “unfair, deceptive, untrue or misleading advertising,” among other things. Although the statute creates significant liability for deceptive or misleading advertising (such as incorrect marketing claims about technology products), the courts have interpreted it broadly to permit recoveries for virtually any violation of law.

5. Corporations formed outside of California may nevertheless be subject to California corporate law. Private “foreign corporations” that have significant contacts in California must comply with many California corporate legal requirements as if they were formed in California. (For California law purposes, a “foreign corporation” is a corporation formed outside of the United States, or within the United States but outside of California, such as in Nevada, Delaware or New York. “Significant contacts” means having substantial operations and a majority of shareholders in California.) These requirements include corporate governance, the directors’ standard of care, limitations of liability and indemnification of directors and officers, and provisions limiting takeovers and dividends. For this reason, corporations with significant contacts in California often are incorporated in California, and then reincorporate in Delaware only if and when they pursue an initial public offering (IPO). See California Corporations Code Section 2115 and the Handbook for Incorporating a Business in California by the Corporations Committee of the State Bar of California (2006).

6. California prohibits unreasonably high interest rates on certain loans (usury) — as written in its Constitution! Article 15 of the California Constitution prohibits charging an interest rate of over 7 to 10% on many loans. However, financial institutions such as banks and credit unions are excluded from this limitation, and Article 15 contains other exclusions.

7. Releases of claims should include a statutory waiver. Businesses often need to release legal claims when settling a lawsuit or even voluntarily ending a contract. Such releases of claims are of course best made in writing. However, California Civil Code Section 1542 provides that “A general release does not extend to claims which the creditor [in other words, the releasing party] does not know or suspect to exist in his or her favor at the time of executing the release, which if known by him or her must have materially affected his or her settlement with the debtor [i.e., the party being released].” Properly prepared California releases include a written waiver of the Section 1542 rights.

The author would like to thank attorneys Scott D. Gattey, Fran Smallson and Scott Edward Walker for their comments in the preparation of this article.

This article was originally written on October 30, 2007 and transferred to www.boadweelaw.com/blog on January 3, 2012.

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