Court of Appeal Strikes Down Non-Compete Related to Sale of Business

Maas sold his company, Crave, to Handleman.  As part of the sale transaction, Maas signed a stock purchase agreement that prohibited Maas from competing with Handleman for three years from the sale.

Maas became a Handleman employee. He also signed an employment agreement with Handleman that contained another non-compete, barring him from competing for one year from the termination of his new employment with Handleman or from the expiration of the three-year non-compete, whichever came first.  That employment agreement also contained a non-solicitation clause.

Maas stayed with Handleman three years, thereby satisfying the non-compete in the purchase agreement.  But then he went to work for a new company, violating the non-compete in his employment contract. Handleman sued, claiming that the one-year non-compete was part of the sale transaction and was in consideration for the "good will" value of Crave.

Fillpoint bought the Crave assets from Handleman and sued Maas and others for violating the non-compete agreement.

Most people who read this blog know that most non-competition agreements are unenforceable under California law. But there are exceptions.  One exception applies to the sale of a business to protect the buyer.  See Business and Prof. Code Section 16601.

The court of appeal noted that the three-year covenant in the purchase agreement satisfied the exception contained in Section 16601, as it protected Handleman's purchase of Crave.  Fillpoint, however, argued that the employment agreement's further non-compete was part of the same transaction.   The court agreed that the purchase agreement and employment agreement must be read together.  But the court struck down the employment agreement's non-competition provision.

For one thing, Fillpoint argued that the employment agreement's non-compete served a different purpose from the purchase agreement's non-compete.  The latter applied to Maas as a shareholder and the former as a Handleman employee.  The court viewed that argument as a concession that brought the non-compete outside Section 16601.  Moreover, the court decided that the employment agreement non-compete was way too broad and precluded Maas from pursuing a profession regardless of Crave's goodwill.

So, according to the court's decision in Fillpoint v. Maas, non-competes associated with the sale of a business cannot have a "latent tail" that becomes effective years after the sale.   The opinion is here.

No More Non-Solicits?

Looks that way. Mostly. The Court of Appeal held in The Retirement Group v. Galante, opinion here, that contractual agreements not to solicit customers are not enforceable because of California's unfair competition statute, Bus. and Prof. Code section 16600.

TRG sued a bunch of ex-employees for stealing trade secrets and violating a non-solicitation agreement. TRG obtained a preliminary injunction and the employees appealed. The Court of Appeal in essence held that if a former employer proves misuse of trade secrets under the Trade Secrets Act or Unfair Competition Law, the former employee may be enjoined from misusing those trade secrets. But no court can enjoin a non-solicitation clause merely because it appears in an agreement. Here is the money quote:

We distill from the foregoing cases that section 16600 bars a court from specifically enforcing (by way of injunctive relief) a contractual clause purporting to ban a former employee from soliciting former customers to transfer their business away from the former employer to the employee's new business, but a court may enjoin tortious conduct (as violative of either the Uniform Trade Secrets Act and/or the Unfair Competition Law) by banning the former employee from using trade secret information to identify existing customers, to facilitate the solicitation of such customers, or to otherwise unfairly compete with the former employer. Viewed in this light, therefore, the conduct is enjoinable not because it falls within a judicially-created "exception" to section 16600's ban on contractual nonsolicitation clauses, but is instead enjoinable because it is wrongful independent of any contractual undertaking.

Recent decisions have said as much, albeit less concisely. The point is that a non-solicitation agreement is now legally unnecessary to create substantive rights because the Trade Secret Act does not require such an agreement for an employer to come within its provisions. However, a non-solicitation clause, which is usually found in a confidentiality agreement, may be part of the evidence showing that the employer takes reasonable measures to maintain the secrecy of trade secrets. Therefore, it may not be a good idea to abandon such contractual provisions.
At the same time, it remains to be seen whether such clauses will be attacked as "overreaching" and, therefore, unfair competition.