Limits on stay-or-pay contracts in California

Newly enacted AB 692 adds section 16608 to the California Business and Professions Code. Beginning Jan. 1, California employers generally will not be allowed to include in an employment contract, or condition employment on, a term: 

• requiring a worker to repay a debt to the employer, training provider, or debt collector if the worker’s “employment or work relationship with a specific employer” ends; 
• authorizing the employer, training provider, or debt collector to resume, initiate collection of, or end forbearance on a debt if the worker’s “employment or work relationship with a specific employer” the specific “employment ends;” or
• imposing a penalty or fee on the worker if the worker’s “employment or work relationship with a specific employer” ends.

The term “worker” under the statute “includes, but is not limited to, an employee or prospective employee.”  Combined with the statute’s references to “employment or work relationship,” it is unclear whom besides employees and prospective employees the statute protects. An earlier version of the measure defined “worker” to include “independent contractor, freelance worker, extern, intern, apprentice, or sole proprietor.” That language was dropped, but an orphaned definition of “freelance worker” remains.

Reason for statute

These agreements are pejoratively called TRAPs: Training Repayment Agreement Provisions. The new law is part of the California Labor Code restricting non-compete agreements. Detractors consider these repayment agreements undue restraints on employees leaving jobs for better opportunities, whether with a competitor or otherwise.     

The Student Borrower Protection Center explains in a fact sheet: “Whereas traditional non-compete clauses directly prohibit employees from working for competing firms, stay-or-pay provisions — often presented as a precondition to employment — obligate employees who quit or are fired within a certain period of time, typically years, to pay their employer potentially huge sums of money. Because they create such large financial burdens for switching jobs, stay-or-pay contracts are sometimes called de facto non-compete clauses.”

Exceptions

Two of the five types of agreements excluded from the statute’s prohibitions apply only if specific conditions are met.

First, the law does not apply to repayment of employer tuition payments for a “transferable credential,” defined as “a degree that is offered by a third-party institution that is accredited and authorized to operate in the state, is not required for a worker’s current employment, and is transferable and useful for employment beyond the worker’s current employer.”  This exception applies only if the contract: 

• Is offered apart from the employment contract;
• Does not condition employment on obtaining the credential;
• Specifies the repayment amount before the worker agrees to the contract, and the repayment amount does not exceed what the employer paid out;
• Prorates repayment during the required employment period proportional to the total repayment amount and does not require accelerated repayment if the worker’s employment ends early; and 
• Excuses repayment of the balance if the worker is terminated, unless the worker is terminated for “misconduct” that would disqualify the worker from receiving unemployment insurance benefits. Under court rulings, ”misconduct”  means the employee’s intentional violation of employer rules or standards, dereliction of duty, or repeated or gross negligence. Misconduct does not include the employee’s mere inefficiency, unsatisfactory conduct, ordinary negligence, or good faith lapses in judgment. 

The second notable exception allows contracts requiring repayment of a discretionary or unearned monetary payment at the outset of employment, such as a signing bonus, “not tied to specific job performance.”  This exception applies only if:

• The repayment terms are in a contract separate from the main employment agreement;
• The employee is notified they have at least five business days to consult an attorney before signing the agreement;
• No interest is accrued on the repayment obligation for early separation from employment and such repayment obligation is prorated based on the remaining term of the retention period, which retention period cannot be more than two years after the employee has received the payment;
• The worker may elect to defer receipt of the payment until “the end of a fully served retention period without any repayment obligation;” and
• The employee alone decides to leave, unless the employee is discharged for misconduct. 

Remedies

AB 692 adds section 926 to the Labor Code to make an employer liable for each injured plaintiff’s actual damages or $5,000, whichever is greater, for each violation of section 16608, plus their reasonable costs and attorney’s fees. Consequently, employers should have repayment agreements reviewed by counsel. 

Eaton is a partner with the San Diego law firm of Seltzer Caplan McMahon Vitek where his practice focuses on defending and advising employers. He also is an instructor at the San Diego State University Fowler College of Business where he teaches classes in business ethics and employment law. He may be reached at eaton@scmv.com.