California Court of Appeal Reads Employment Agreement in Conjunction with a Sale of Business Transaction Yet Refuses to Apply “Sale of Business” Exception to its Non-Compete Clause

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On August 24, 2012, a California Court of Appeal clarified when an employment agreement can satisfy the “sale of business” exception to California’s general ban on post-employment non-compete provisions. The Court held that when a stock purchase agreement’s non-compete clause already adequately protects the goodwill of the sold business, any inconsistent and additional non-compete protection in a related employment agreement with the purchasing company may not be enforceable. The holding signals that an employment agreement’s non-compete covenant does not automatically qualify for the “sale of business” exception  simply because it is part of the same transaction as a stock purchase agreement.

In Fillpoint v. Michael Maas, Maas sold his stock in a corporation to Handleman (which was later acquired by Fillpoint). In consideration for the sale, Maas signed a stock purchase agreement prohibiting him from competing for three years from the purchase date. Around the same time, Maas became an employee of Handleman and signed a separate employment agreement. This employment agreement contained an additional non-compete provision effective for one year after termination of employment or one year after expiration of the stock purchase covenant, whichever came first.

At the end of the three-year period, Maas’s employment ended and he took a job with a competitor about six months later. Fillpoint sued, claiming that the additional one year non-compete in Maas’ employment agreement was part of the business purchase transaction, and thus was additional “good will” consideration qualifying for the Business and Professions Code §16601 exception.

The Court of Appeal held that the trial court erred by reading the stock purchase and employment agreements separately. Rather, when these types of agreements are entered into at or around the same time, they should be treated as one transaction. Nevertheless, reading these two agreements as part of the same transaction did not automatically render both covenants enforceable and subject to the Section 16601 business purchase exception. Because the non-compete in Maas’ stock purchase agreement sufficiently protected the goodwill consideration of the business purchase, the employment agreement’s additional and different protection was overly broad and unenforceable. In dictum, the Court postulated that a covenant not to compete in an employment agreement, even when absent from the parallel stock purchase agreement, could fall within the exception if it was, in fact, entered into as consideration for the sale of business.

The Court of Appeal carefully distinguished the facts and legal principles from several prior cases, and this decision is essential reading for structuring non-compete provisions as part of a business sale.