In California, contractual provisions that prevent a person from engaging in a profession, trade or business are generally void. See California Business and Professions Code §16600. As the California Supreme Court has noted, “section 16600 evinces a settled legislative policy in favor of open competition and employee mobility.” Thus, for example, employers cannot require their employees to enter a contract that prohibits the employees from competing with the employers’ business after termination.
There are, however, a few exceptions to the prohibition of §16600. Business and Professions Code §16601 provides that: “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 . . . 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 . . . carries on a like business therein.” The idea here is that having just purchased a business from someone, it is reasonable to bar them from competing with that business, which would otherwise diminish the value of the purchase. This is known as the “sale-of-business” exception to California’s ban on non-compete agreements.
In a recent (albeit unpublished) case, California courts expansively applied this sale-of business exception. The defendant was an individual who had entered into a joint venture agreement with a few companies. The parties had signed a customer non-solicitation agreement binding the individual, but it was in a document different than the one where the individual sold his shares in the venture. In addition, while the sale of shares was indeed a transfer to a different entity, the individual initially owned the transferee entity.
After departing the joint venture, the individual sent letters to the joint venture’s customers, addressing them as “past and potential future clients” and introducing two former joint venture employees as those of his new, competing entity. This prompted a company in the joint venture to sue for breach of the non-solicitation agreement. It obtained a TRO and injunction against the individual, barring him from soliciting their clients or poaching their employees, and ultimately obtained summary adjudication against him.
The Court of Appeal upheld the trial court orders. Notably, in doing so, it read the joint venture documents together, and so it did not matter that the non-solicitation agreement was contained in a document separate from the contract transferring the individual’s ownership. Also, it found it irrelevant that the individual transferred his ownership shares to an entity in which he held the ownership interest; all that mattered was that he was disposing of all his business interests. This was sufficient to trigger the sale-of-business exception.
The court also held that the individual’s letter constituted a breach of the non-solicitation agreement, as it was a “solicitation” for business. This was because the letter was targeted at potential clients, and boasted that the new venture was a superior alternative to the joint venture.
Also, the court upheld the lower’s court’s award of approximately $600,000 in contractual attorneys’ fees to the plaintiff for the cost of enforcing the non-solicitation agreement. While this was substantially lower than the amount requested, it is still a substantial sum and highlights the risk of violating non-compete agreements.