California is not known as the “Golden State” just because of its resource wealth and picturesque sunsets. It is the largest state economy within the United States, and, standing by itself, the sixth-largest economy in the world. The state offers immense opportunity and access to markets, customers, clients, suppliers, and potential business partners. That means that if you do business, you probably have dealings relating to California.
However, actually doing business in California also presents unique challenges and pitfalls for the unwary out-of-state actor. Navigating the complex and idiosyncratic legal landscape can be difficult. Below is a discussion of a few common traps that businesspeople unfamiliar with California’s business regulations can find themselves ensnared by. There are others, but this article is intended to give you an idea of the types of issues that might arise. The statutory and regulatory burdens imposed by California are second only to those of the federal government, are much less well-known, and in many cases are completely unique to the state.
Meissner Tierney Fisher & Nichols has experienced professionals to help you with these and other difficult issues. Additionally, as a Wisconsin-based California-licensed attorney with many years of representing businesses and individuals there, I and the firm are in a unique position to assist Wisconsin businesses with California-related issues. Please contact us if you find yourself in need of help doing business in or with legal matters related to the Golden State.
Registering to Do Business in California
Business entities, including S-corps and LLCs formed under the laws of other states such as Wisconsin or Delaware, are required to register as foreign entities in California when they are “transacting intrastate business” there. The definition of what qualifies as “transacting intrastate business” is not fixed, and is subject to judicial interpretation, but is generally defined as “entering into repeated and successive transaction of its business in [California], other than interstate or foreign commerce” for purposes of having to generally register in the state to do business. However, the tax and other regulatory regimes have their own “nexus” rules. A few examples of what could trigger jurisdiction under these various rules can include the following:
- Maintaining an office, warehouse, or sales personnel in California.
- Maintaining physical store locations within California.
- Sales within California for a taxable year exceed the lesser of $500,000 OR 25% of the business’ total sales, including sales by an agent or independent contractor.
- Holding real estate or tangible property within California that exceed the lesser of $50,000 OR 25% of the business’ total real estate or tangible property holdings.
- Payroll compensation paid by the business within California exceeds the lesser of $50,000 OR 25% of the total compensation paid by the business.
- Even if the business does not maintain any offices or personnel in the state, the business maintains consistent and pervasive commercial contacts within California.
The above is far from an exhaustive list of what qualifies as “transacting intrastate business.” Every business and every situation is different, but the point is that there are many ways to become ensnared in California’s regulatory regime.
There are various civil and criminal penalties for failing to file as a foreign corporation in California, but perhaps the biggest issue for the unregistered foreign entity is the inability to maintain a lawsuit in California courts. To be clear, any entity, even unregistered foreign entities, are entitled to defend lawsuits brought against them in California. However, unregistered foreign corporations cannot initiate lawsuits, or, more consequentially, file counterclaims in lawsuits they are defending.
To illustrate the seriousness of this, in a contract dispute involving a Wisconsin company and a California company, if the California company sues for breach of contract in California courts, the Wisconsin company could defend itself regardless of its registration status. However, the Wisconsin company may have legitimate claims against the California company, regardless of the California company’s claims against it. That fact notwithstanding, if the Wisconsin company is “transacting intrastate business” and fails to register, the Wisconsin company would be precluded from asserting its counterclaims, losing an effective tool to limit downside or gain leverage in the litigation.
This is just one example and does not discuss other civil and criminal implications of failing to register. Accordingly, if you do business in California, it is necessary to carefully evaluate whether your business needs to register to do business in the state. Not all businesses will need to register, and there are many exemptions, but many businesses will. Contact the professionals at MTFN to discuss your options.
Non-Compete Agreements (“NCA”) have become a nearly ubiquitous tool that many businesses use to protect their interests against employees leaving and using knowledge or relationships gained at the expense of a past employer for the benefit of a competitor. While they take many forms, NCA’s can prevent employees from accepting certain jobs or with certain competitors, soliciting customers and employees of the former employer to work with a competitor, or prohibit the use of confidential information, usually for a set period of time. In Wisconsin and many other states, within certain strictures, these types of agreements are enforceable.
Not so in California. Cal. Bus. & Prof. Code § 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.” Thus, it is public policy of the state that virtually no restriction on future employment, no matter how necessary or reasonable, will be enforced by a California court. Non-solicitation clauses and confidential information restrictions may be enforceable when narrowly tailored, but even these are heavily disfavored and can be very difficult to enforce.
The implications for an out-of-state business that employs people or contractors in California should be apparent. You may believe that you have a valid NCA that protects your business’s interests, but it is not worth the paper it is written on when it comes to enforcement time.
However, careful drafting of agreements, as well as structuring and management of relationships, can help to manage risk. Every business and every situation is different. Contact the professionals at MTFN to discuss your options.
Forum Selection Clauses in Employment Agreements
For many reasons, including those discussed in the NCA section above, many employers may seek to protect themselves by mandating in an employment agreement that, if a dispute arises between the employer and the employee (i.e., the enforceability of an NCA), the dispute must be litigated or arbitrated in the employer’s home state. Such a provision could read: “In the event of a dispute related to this Employment Agreement, the Parties agree that the dispute will be submitted to the American Arbitration Association for binding arbitration to take place in Milwaukee, WI. The Parties further agree that such dispute will be governed by the laws of the State of Wisconsin.” In many states, this provision would be enforceable.
Again, not so in California. Cal. Lab. Code § 925(a) provides that, for all employment contracts entered into, modified, or extended after January 1, 2017, for an “employee who primarily resides and works in California” the employer may not, as a condition of employment, “[r]equire the employee to adjudicate outside of California a claim arising in California”, or “[d]eprive the employee of the substantive protection of California law with respect to a controversy arising in California.” Further, Section 925(c) provides that the employee can recover attorneys’ fees to enforce this provision of the Labor Code.
The practical effect of Section 925(a) means that, if you have a dispute with a California employee, you must litigate it in California, and California law applies. To not do so would expose you to a separate suit by the employee in California court, and could result in you paying for employee’s attorneys’ fees for your trouble. Once you lost that, your only option would then be to adjudicate the matter in California, a forum not known for its friendliness to business in general, and outsiders in particular.
Businesses that employ California residents need to be aware of this reality. Further, businesses considering employing California residents must carefully consider the risks and options available to them. Contact the professionals at MTFN to discuss your options.
Attorneys’ Fees Provisions
Following the so-called American Rule, the general principle is that everyone in litigation pays their own costs, win or lose, unless a statute or contract provides otherwise. For this reason, many contracts provide for the award of attorneys’ fees. This takes many forms, but, as a general matter, attorneys’ fees provisions can take two basic forms: one-way and two-way. A two-way attorneys’ fee provision simply provides that, in the event of a dispute, the loser pays the winner’s attorneys’ fees. The risks of two-way provisions are easy to understand: you lose, you pay.
However, many contracts, especially employment contracts, include one-way attorneys’ fees provisions, which provide that only one party is entitled to its fees if it wins. An example in the employment context would be: “Employee agrees to pay all of the actual costs and expenses (including attorneys’ fees) incurred by Company to enforce this Agreement.” An example in the supply contract context would be: “Supplier shall be entitled to recover its expenses (including attorneys’ fees) for the collection of amounts not paid by Purchaser when due under this Agreement.” These are just examples, and these provisions can take many forms, but one-way attorneys’ fee provisions are generally enforceable and can provide the parties in whose favor they run with an effective tool to keep other parties in line.
But not in California. Civil Code §1717(a) provides that “[i]n any action on a contract, where the contract specifically provides that attorneys’ fees and costs . . . shall be awarded to one of the parties . . ., then the party who is determined to be the party prevailing on the contract, whether he or she is the party specified in the contract or not, shall be entitled to reasonable attorney’s fees in addition to other costs.” That is, your one-way attorneys’ fee provision just became two-way.
Further, Section 1717 can expand the scope of an attorneys’ fee provision. Section 1717 provides that “[w]here a contract provides for attorneys’ fees, . . . that provision shall be construed as applying to the entire contract,” unless the contract was negotiated by lawyers, all parties were represented in the negotiation, and the contract specifically states that all parties were represented.
In the supply example above, the attorneys’ fee provision applies by its express terms only to “collection of amounts not paid” but conceivably not to other parts of the contract. However, if, for example, a dispute arose about the quality of the products supplied and a lawsuit was filed in California by the purchaser, and this exact provision was in the contract, a California court will apply the attorneys’ fee provision globally (unless the above exception applies). So, where the supplier thought it had a narrow, one-way provision for attorneys’ fees that only applied to collections, now there is a broad, two-way provision that applies to all parties and all parts of the contract, including the claims being brought by the purchaser in our hypothetical.
This can be a major trap for the unwary. The contractual protections that you thought you bargained for evaporate as soon as you’re in court in California. Further, being in court in California may not be up to you if the other party files first and there are no additional protections in the contract. For this reason, careful drafting of agreements, being proactive about managing risk, and assessing whether, when, and where to initiate a lawsuit involving a California party can make all the difference between winning, losing, and paying unanticipated costs. Contact the professionals at MTFN to discuss your options.
Due to the cost and uncertainty of litigation, many parties will agree in their contract to submit disputes to arbitration rather than going to court. In many cases, arbitration provisions hide in plain sight, overlooked by one party to the contract when it is drafted by the other. An example could be where a California company’s contract includes the following provision that a Wisconsin company may agree to without much thought: “The Parties agree that all disputes related to the Agreement shall be resolved by binding arbitration before the American Arbitration Association located in Los Angeles County, California; the Parties further agree that any arbitration award shall be enforced by the Superior Court of Los Angeles County, California.”
Two things are happening in the above example. The first and most obvious is that, if there is a dispute, you have already agreed to go to Los Angeles to have it heard by an arbitrator, and cannot simply go to court. That can be time-consuming and costly by itself. However, the second part is the enforcement mechanism calling in California courts, which creates its own set of issues.
When an arbitrator issues an award, a notice of the award will be sent to the parties by the prescribed method (mail, courier, etc.). However, that award only has the force of a contract, and can only be enforced via the court system.
In California, sending the notice of award starts a critical clock for the losing party. The losing party only has 100 days after the award is issued to challenge it. Civil Code § 1288. Failure to challenge the award within those 100 days effectively waives most of the arguments the losing party has against enforcement, even if the award is entered without their knowledge, or even if it is a gross miscarriage of justice.
By contrast, the winner of the arbitration has four years to petition the court to enforce the award. Thus, the winner can simply wait out the 100 days, and petition the court to enforce the award on the 101st day, leaving the losing party with little to do but pay.
For that reason, it is critical to analyze any arbitration provision (or any other provision) in a contract before you agree. If you are involved in an arbitration where the award could be enforced in California, or if you have received notice that an award has been made and have reason to believe it could be enforced in California, time is of the essence. Contact the professionals at MTFN to discuss your options.