Alerts and Updates
Beware Multiple Non-Compete Agreements Given in Connection with Corporate Deals in California
September 14, 2012
In short, this decision of the California Fourth District Court of Appeal suggests that the only non-compete agreements that will be enforced in a deal context are those which are clearly and directly tethered to the divestiture of equity and goodwill.
In California, non-compete agreements are generally unenforceable pursuant to Business and Professions Code § 16600, which provides "[E]xcept as provided in this chapter, every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void." When evaluating enforceability of non-compete provisions in contracts, California courts routinely refuse to follow choice-of-law provisions that specify that laws of another state will govern the agreement. Companies acquiring operations with California employees need to be aware of this and should assume that in interpreting any restrictive covenants, California law will apply in determining the rights of California employees.
An exception to the general rule is Business and Professions Code § 16601, which states:
"Any person who sells the goodwill of a business, or any owner of a business entity selling or otherwise disposing of all of his or her ownership interest in the business entity, or any owner of a business entity that sells (a) all or substantially all of its operating assets together with the goodwill of the business entity, (b) all or substantially all of the operating assets of a division or a subsidiary of the business entity together with the goodwill of that division or subsidiary, or (c) all of the ownership interest of any subsidiary, may agree with the buyer to refrain from carrying on a similar business within a specified geographic area in which the business so sold, or that of the business entity, division, or subsidiary has been carried on, so long as the buyer, or any person deriving title to the goodwill or ownership interest from the buyer, carries on a like business therein."
In a wide range of deal structures, it is not uncommon for executives to sell their interests in their companies, to enter into non-compete agreements, and to enter into employment agreements that also have non-compete provisions. Many parties to deals have assumed that the non-compete agreements in the stock purchase agreements and the ancillary employment agreements are both enforceable, since both were given in connection with the executive's sale of his or her interest in the company being acquired or whose assets are being sold.
On August 24, 2012, California’s Fourth District Court of Appeal decided FillPoint, LLC v. Maas (Case No. G045057). There, Maas sold his interest in a company and entered into a stock purchase agreement that restricted him from competing with the company for a period of three years. As part of the deal, Maas also entered into an employment agreement. That agreement had a non-compete provision that would be triggered upon Maas' departure from the company, and would restrict him for one year following the end of his employment. Maas remained with the company for more than three years, but then resigned and went to work for a competitor. At issue was the enforceability of the one-year "tail" non-compete contained in the employment agreement.
Although the deal documents and the employment agreement cross-referenced one another, and both were clearly entered into as part of the same transaction, the Court of Appeal held that the non-compete contained in the employment agreement violated Business and Professions Code Section 16600 and was void and unenforceable.
What This Means for Employers
This case highlights the fact that California courts are likely to limit enforcement of non-compete agreements to those which clearly are given in connection with the sale of the business or its stock and its associated goodwill, and are unlikely to support enforcement of ancillary non-compete agreements that expand the scope of the non-competes given in connection with the sale of equity. It may be prudent to review all non-compete promises given in connection with a deal, and to identify any that are different from those given in connection with the divestiture of equity, goodwill or interest, as such non-competes may not be enforced. In short, this decision suggests that the only non-compete agreements that will be enforced in a deal context are those which are clearly and directly tethered to the divestiture of equity and goodwill.
Businesses contemplating acquisitions in which they expect to obtain enforceable non-competes should also be aware that even enforceable non-competes must be reasonable in duration and geographic reach. Because California's enforcement of non-competes is limited, and because circumstances under which non-competes are enforceable are very narrowly construed, businesses may want to have a California employment attorney review deal documents containing any discussion of restrictive covenants. Additionally, companies should be aware that key California decisions have held that restrictions on solicitation of customers or clients are unenforceable under Section 16600 as well, so cloaking a "non-compete" in "nonsolicitation" clothing is likely to be unsuccessful.
For Further Information
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