A California Court of Appeal recently ruled that a non-compete given in connection with the sale of a business was unenforceable. Fillpoint, LLC v. Maas, 2012 Cal. App. LEXIS 904. Specifically, the Court held that because the non-compete period began on the date of the employee’s termination from the successor company — rather than on date of the closing of the underlying transaction — the entire non-compete agreement was overboard and not designed to protect the buyer’s interest in the goodwill of the business.
The Facts of the Case
Maas was a “key employee” and “major shareholder” of Crave Entertainment Group, which was acquired by Handleman Company. As part of the transaction, and as consideration for Maas’ sale of his stock in Crave, Maas signed a stock purchase agreement containing a covenant not to compete. The non-compete prohibited Maas from engaging in a competitive business for 36 months following the closing date of the transaction. The stock purchase agreement also contained a provision requiring certain key employees of the seller, including Maas, to execute employment agreements following the acquisition.
After the closing of the acquisition, Maas entered into an employment agreement with the acquiring company. That agreement contained not only a covenant not to compete, but also certain non-solicitation restrictions. Specifically, for a period of one year following Maas’s termination, he was prohibited from: (1) making contacts or sales to any customer or potential customer; (2) working for or owning any competitive business; and/or (3) employing or soliciting for employment any current employees or consultants.
More than three years later, Maas resigned his employment. Shortly thereafter, Maas began working for a competitor as its president and CEO. The successor to the acquiring company, Fillpoint, LLC, then sued Maas for breaching the employment agreement’s one-year non-compete that was triggered upon Maas’ resignation. Fillpoint, LLC also sued the company Maas joined.
Covenants not to compete are generally void and unenforceable under California law. See Bus. & Prof. Code §16600. However, a limited exception is permitted in connection with the sale of a business under Bus. & Prof. Code §16601. The purpose of this exception is to protect the goodwill or ownership interest acquired by the buyer. As one Court explained, Bus. & Prof. Code §16601 “serves an important commercial purpose by protecting the value of the business acquired by the buyer…[I]t is ‘unfair’ for the seller to engage in competition which diminishes the value of the asset he sold.” Strategix, Ltd. v. Infocrossing West, Inc., 142 Cal. App. 4th 1068 (2006).
The Court’s Analysis
Given that Maas had remained employed for more than three years following the acquisition, the non-compete in the stock purchase agreement was not at issue in the case. The only issue was whether the non-compete contained in the employment agreement — which had a one-year trigger from the date of his resignation — was valid and unenforceable under Bus. & Prof. Code §16601.
After noting that the non-compete contained in the purchase agreement was clearly created to protect the goodwill acquired by the buyer, the Court held that the non-compete and non-solicitation covenants in the employment agreement served a different purpose: to limit Maas’ right to be employed in the future. By starting the non-compete obligation not at the close of the underlying transaction but, instead, at Maas’ termination, the non-compete “targeted [Maas’] fundamental right to pursue his or her profession.” Thus, the Court ruled that the non-compete was void and unenforceable under California law.
On the issue of the non-solicitation provisions, the Court concluded that they too depended “entirely on Section 16601 for [their] survival.” In analyzing whether the non-solicitation provisions furthered the purpose of the exception, the Court concluded that they did not. The Court ruled that the non-solicitation provisions went too far because they sought to prevent Maas from soliciting and contacting not only actual customers but potential customers as well.
Impact on California Employers
There are several important take-aways from the Fillpoint decision:
- Non-compete agreements remain generally unenforceable under California law.
- Only those non-compete agreements that clearly fall within a statutory exception — such as Bus. & Prof. Code §16601 — will be enforced in California.
- Bus. & Prof. Code §16601 serves a legitimate public policy purpose in California, so it remains a vital exception that allows a properly drafted non-compete to be enforceable.
- However, even Bus. & Prof. Code §16601 cannot save a non-compete that does not advance the purposes of the exception (to protect the value of the business acquired or the goodwill transferred).
- Non-solicitation agreements are also likely unenforceable under California law unless they fit within a statutory exception. This answers a question that was technically left open in Edwards v. Arthur Anderson LLP, 44 Cal. 4th 937, 946 n.4 (2008).