A Deeper Dive Into California’s New Limitations on “Stay or Pay” Clauses as of January 1, 2026

Many jurisdictions have recently enacted, or are considering enacting, legislation limiting “stay-or-pay” compensation structures, which require employees to repay their employers certain amounts either upon or as a result of a termination of their employment relationship. California has implemented one of the most comprehensive bills in this regard, which represents a significant expansion of California’s restrictions on contractual restraints affecting worker mobility. Assembly Bill (AB) 692 prohibits most employment‑related repayment and “exit‑fee” provisions in agreements that are entered into on or after January 1, 2026. Codified as Section 16608 of the California Business and Professions Code and Section 926 of the California Labor Code, the law declares such provisions unlawful restraints on trade, rendering them void and exposing employers to civil liability. This Legal Update provides a comprehensive analysis of the statute, its exemptions, and practical guidance for employers seeking to structure compensation and training arrangements in compliance with the new law.

Overview of AB 692

AB 692 targets what are commonly referred to as “stay-or-pay” provisions—i.e., contractual terms that require workers to pay money to an employer, training provider, or debt collector as a result of or upon termination of employment. The statute is meant to further California’s longstanding public policy, expressed in Business and Professions Code Section 16600 et seq., that contracts restraining workers from engaging in a lawful profession, trade, or business (such as non-competes) are void.

The law applies prospectively to agreements (whether written or oral) entered into on or after January 1, 2026. Contracts entered into before that date are not affected, though employers should exercise caution when renewing, amending, or extending pre-existing agreements, as such modifications may be deemed new contracts subject to the statute’s prohibitions.

The statute broadly defines “employer” to include any parent company, subsidiary, division, affiliate, contractor, hiring party, and third‑party agent of the worker’s direct employer. The statute also broadly applies not just to employees, but to “worker[s]”, which includes any “person who is permitted to work for or on behalf of an employer or business entity, or who is permitted to participate in any other work relationship, job training program, or skills training program,” such as employees, prospective employees, and independent contractors.

Prohibited Contract Terms

AB 692 makes it unlawful to include in any “employment contract,” or to require a worker to execute “as a condition of employment or a work relationship”, three categories of contract terms:

• Debt Repayment Upon Termination. Contract terms that require a worker to pay an employer, training provider, or debt collector for a “debt” if the worker’s employment or work relationship with a specific employer terminates. The definition of “debt” is expansive, encompassing “money, personal property, or their equivalent.” The definition reaches debts that are “alleged to be due or owing,” and those that are “certain or contingent” or “voluntarily incurred.”
• Collection or Forbearance Provisions. Contract terms that authorize an employer, training provider, or debt collector to resume or initiate collection of a debt, or end forbearance on a debt, upon termination of employment or a work relationship. This provision targets arrangements where a debt exists, but is held in abeyance during the employment or work relationship, with collection triggered by the worker’s departure.
• Penalties, Fees, or Costs. Contract terms that “impose[] any penalty, fee, or cost on a worker” upon termination. The statute provides a non-exhaustive list of covered penalties, fees, or costs, including “replacement hire fees, retraining fees, replacement fees, quit fees, reimbursement for immigration or visa costs, liquidated damages, lost goodwill, and lost profit.” The use of non-exhaustive language in the statutory definition suggests that other financial impositions not specifically enumerated may also be prohibited, though the examples focus on the imposition of out-of-pocket payments on workers that are triggered by termination.

Statutory Exemptions: What Remains Permissible

AB 692 provides five targeted exemptions from the statutory prohibitions. Employers seeking to rely on these exemptions should ensure strict compliance with their requirements.

Exemption #1: Government Loan Repayment and Forgiveness Programs. The statute does not apply to contracts “entered into under any loan repayment assistance program or loan forgiveness program provided by a federal, state, or local governmental agency.”

Exemption #2: Repayment of Tuition for Transferable Credentials. The statute does not apply to contracts related to the repayment of the cost of tuition for a “transferable credential,” provided the following conditions are satisfied:

• The contract must be “offered separately” from any employment contract;
• Obtaining the credential is not required as a condition of employment;
• The contract must specify the repayment amount before the worker agrees to the contract;
• The repayment amount does not exceed the tuition cost actually incurred by the employer for the transferrable credit;
• The repayment amount is prorated over the applicable service period;
• The contract does not require an accelerated payment schedule if the worker separates from employment; and
• The contract does not require repayment by the worker to the employer if the worker is terminated, except upon termination by the employer for “misconduct.” “Misconduct” is defined by reference to Unemployment Insurance Code Section 1256, which generally requires a substantial breach of duty or disregard of the employer’s interests. Accordingly, a worker’s voluntary resignation or involuntary termination for performance reasons or due to layoffs cannot trigger repayment obligations.

Notably, not all credentials qualify for the exception. “Transferable credential” is defined as a “degree from an accredited, authorized third‑party institution that is not required for the worker’s current job and is useful beyond the current employer.” Examples of credentials that likely qualify include the following, as long as they are offered by an accredited institution, are not required for the worker’s current role, and are valuable to other employers:

• Graduate degrees (e.g., MBS, JD, or master’s degrees in various fields);
• Professional certifications (e.g., CPA preparation programs offered through universities);
• Undergraduate degrees (e.g., Bachelor’s degree); and
• Technical degrees (e.g., Associate’s degrees in Information Technology, healthcare, or skilled trades from community colleges);

By contrast, internal employer-specific certification programs, professional certifications not offered by accredited institutions, and required credentials would not qualify.

Exemption #3: Apprenticeship Programs. The statute does not apply to contracts for repayment of enrollment costs associated with enrollment in apprenticeship programs approved by the California Division of Apprenticeship Standards.

Exemption #4: Discretionary Upfront Monetary Payments. The statute provides an exemption for certain discretionary or unearned monetary payments that are paid by the employer to the worker at the outset of employment and are not tied to specific job performance (such as sign-on bonuses). This exemption is narrowly drawn and subject to five mandatory conditions:

• The repayment terms must be set forth in a “separate agreement from the primary employment contract”;
• The worker must be notified of the right to consult an attorney, and must be provided at least five business days to obtain legal advice before signing the agreement;
• The worker must have the option to defer receipt of the payment to the end of a fully served retention period without any repayment obligation (e.g., instead of receiving the payment as an up-front sign-on bonus with a two-year clawback period, the bonus would be paid after two years);
• Any repayment obligation for early separation may not be subject to interest and must be prorated based on the remaining retention period, not to exceed two years from the receipt of the payment; and
• Early separation may trigger repayment only if the separation was at the worker’s sole election (e.g., due to a voluntary resignation) or if the employer terminated the worker for “misconduct” (as defined above).

Notably, AB 692’s sign-on bonus exception is expressly tied to unearned payments made “at the outset of employment.” Accordingly, mid‑stream retention bonuses with exit‑triggered clawback obligations are not expressly exempt and carry heightened risk.

Exemption #5: Residential Property Transactions. The statute does not apply to contracts related to the lease, financing, or purchase of residential property governed by the California Residential Mortgage Lending Act. This exemption preserves employer-assisted housing programs and relocation benefits involving real property transactions.

Penalties and Remedies Under AB 692

Contracts with non-compliant terms are deemed unlawful restraints on trade, and therefore void as contrary to public policy. Violations may also constitute unfair competition under California’s unfair competition law. The new law creates a private right of action authorizing workers to bring a civil action on behalf of themselves and similarly situated workers against an employer for the inclusion of unlawful contract terms. Available remedies include statutory damages for the greater of the worker’s actual damages or $5,000 per impacted worker, plus injunctive relief and recovery of reasonable attorneys’ fees and costs. 

Application to Other Arrangements Between Employers and Employees

Workers and employers often enter a myriad of arrangements with various structures that may implicate worker repayment obligations upon termination. Employers should consider whether AB 692’s provisions apply in circumstances where workers agree to repay certain amounts to employers that are not entered into as a condition of employment (e.g., repayment of loans made to employees experiencing emergency hardship or who require immediate cash infusion for needs such as equity purchases). The applicability of AB 692 may ultimately hinge on how broadly the term “employment contract” is interpreted and applied, as the term is not defined in the statute and these types of arrangements would not typically be viewed as “employment contracts”. Similarly, it does not appear that AB 692 was intended to prohibit forfeiture of unpaid compensation at termination. Rather, the statute appears to target arrangements that require workers to pay (or repay) money upon termination, including the collection of debts upon termination. As noted above, the definition of “penalty, fee, or cost” in the statute includes a non-exhaustive list of enumerated examples that all involve affirmative payment obligations, such as replacement fees, quit fees, liquidated damages, and similar charges. Forfeiture of unpaid compensation that has not yet been earned arguably is conceptually distinct from a clawback provision because the worker is not required to pay (or repay) anything, and no incentive compensation is owed or has been “earned” because the compensation was contingent on conditions that remain unsatisfied (i.e., continued employment through the payment date).

Tax and Deferred‑Compensation Considerations

AB 692’s restrictions on stay-or-pay provisions have significant implications for the tax treatment of deferred compensation and bonus arrangements.

Section 409A Implications

Internal Revenue Code Section 409A governs nonqualified deferred compensation arrangements and imposes strict rules on the timing of deferral elections, permissible payment events, and prohibition on acceleration of payments. Arrangements that violate Section 409A (whether in form or in operation) generally subject the worker to immediate income inclusion, a 20% penalty tax, and interest charges. Employers restructuring bonus arrangements to comply with AB 692 must ensure continued compliance with, or exemption from, Section 409A. This is a particular focus where an employer converts a sign-on bonus with a clawback provision into a deferred payment arrangement. Employers need to carefully consider Section 409A prior to giving employees a choice in an effort to comply with AB 692 if that choice impacts the timing of income inclusion for the employee to ensure that any such choice does not violate Section 409A.

Constructive Receipt

The constructive receipt doctrine provides that income is taxable when it is made available to a taxpayer without substantial limitations, even if not actually received. AB 692’s requirement that workers be given the option to defer receipt of sign-on bonuses to the end of the retention period—thereby avoiding repayment obligations—creates potential constructive receipt issues.
If a worker has the unrestricted ability to receive a sign-on bonus immediately, the worker may be in constructive receipt of the full amount at the time of the election, even if deferral is chosen. Employers should consider structuring these arrangements so that the deferral election is made before the bonus amount becomes unconditionally available (and again also ensuring that any such choice does not violate Section 409A).

Practical Recommendations for California Employers

• Review and revise standard form templates that may contain repayment or clawback provisions triggered by termination of employment (e.g., offer letters, employment agreements, training agreements, tuition assistance programs, sign‑on and retention bonus agreements, relocation agreements, immigration/visa cost provisions, equity plans, and award terms).
• When relying on exceptions, use separate agreements and document all statutory prerequisites (e.g., five‑day attorney review window, interest‑free prorated schedules, optional deferral, and misconduct‑only termination triggers where applicable).
• Review and consider restructuring mid‑employment retention arrangements.
• Review any restructuring of compensation arrangements for compliance with Section 409A and other applicable tax rules.
• Train Human Resources, recruiting, and compensation professionals on AB 692’s requirements and the conditions for applicable exemptions.
• Monitor any updates, Labor Commissioner guidance, legislative amendments, and case law.

Conclusion

AB 692 represents a significant expansion of California’s restrictions on contractual restraints affecting worker mobility. Employers should carefully review their compensation, loan, and training arrangements to ensure compliance and should restructure agreements entered into on or after January 1, 2026, to avoid liability. While the statute provides exemptions for certain arrangements, these exemptions are narrowly drawn and require strict compliance with multiple conditions. Employers are encouraged to consult with legal counsel to evaluate specific arrangements and develop compliant alternatives that continue to serve legitimate business objectives.