Non-Compete Agreements

The California Supreme Court Clarifies Section 16600 as Applied to Business Contracts and Holds That an Independently Wrongful Act Is Necessary to Prove Interference With At-Will Contracts

The most powerful tool capable of invalidating competitive restraints under California law is Business and Professions Code section 16600.  That statute states that “[e]very contract by which anyone is restrained from engaging in a lawful profession, trade or business of any kind is to that extent void.”  California courts have historically used that statute to void non-compete and non-solicit provisions in agreements between employees and employers or buyers and sellers of a business.

The question presented to the California Supreme Court in Ixchel Pharma, LLC v. Biogen, Inc., was whether section 16600 voids restraints on business operations and commercial dealings between businesses in the same manner that it voids restraints on competition following the termination of employment or the sale of a business. The Court held that section 16600 does indeed apply to contractual restraints on businesses, but not in the same way as it applies to employment or sale-of-business agreements.  Instead, contractual restraints on business operations and commercial dealings between businesses should be evaluated using the same “rule of reason” standard that courts use to analyze alleged antitrust violations under the Cartwright Act.  In so holding, the Court harmonized section 16600’s application to commercial agreements with long-standing antitrust laws.

In a separate part of its opinion, the Court also held that a claim for tortious interference with an at-will business contract (i.e., one that can be terminated at any time) requires pleading and proving an independently wrongful act.  This brings the standard for interference with an at-will business contract more in line with a cause of action for tortious interference with prospective economic relations.

Case Background.  TSW initially reported on this case in August 2019, when the Ninth Circuit certified these issues to the California Supreme Court for consideration. The case arises from a unique set of circumstances in which the plaintiff (Ixchel) challenges a contractual restraint on business contained in a contract between the defendant (Biogen) and a third party (Forward).

The facts of this case are described in TSW’s earlier post.  As a brief recap, Plaintiff Ixchel filed a claim against Defendant Biogen alleging, among other things, interference with contract.  Ixchel alleged that it had a “collaboration agreement” with Forward to jointly develop a new drug.  That collaboration agreement stated that it could be terminated at any time by either party, i.e., it was essentially an “at-will” contract.  Ixchel further alleged that Biogen subsequently convinced Forward to enter into a separate agreement with Biogen in which Forward agreed to (1) terminate the collaboration agreement with Ixchel—which it had a right to do—and (2) refrain from entering into any other contracts for the development of the drug.

At the district court level, the court dismissed Ixchel’s interference with contract claim, holding that interference with an at-will contract required pleading an independently wrongful act.  Ixchel argued that the non-compete provision in Biogen’s contract with Forward violated section 16600 and, thus, constituted an independently wrongful act.  The court rejected this argument, finding that section 16600 did not apply to business agreements outside the employment context.

After the district court dismissed Ixchel’s claims, it appealed, and the Ninth Circuit certified two questions to the California Supreme Court:  (1) Is a plaintiff required to plead an independently wrongful act in order to state a claim for tortious interference with a contract that is terminable at will? (2) Does section 16600 of the California Business and Professions Code void a contract by which a business is restrained from engaging in a lawful trade or business with another business?

Tortious Interference with At-Will Contracts.  In answering the first question, the Court held that interference with an at-will contract requires more than interference with other contracts and, specifically, requires pleading and proving that the defendant engaged in an independently wrongful act.  The Court explained that a cause of action for tortious interference with contractual relations generally does not require the defendant’s conduct to be independently wrongful “apart from the interference with the contract itself.”  It noted, however, that in Reeves v. Hanlon, it held that interference with at-will employment contracts should require independent wrongfulness because (a) California public policy favors employee rights to compete with former employers, and (b) “at-will contracts do not involve the same ‘cemented economic relationship[s]’ as contracts of a definite term” since there is no legal assurance of future relations.

In its holding, the Court declined to limit Reeves to the employment context, reasoning that the “broader logic underlying [Reeves] is persuasive with respect to other spheres of economic relations” and that because parties to at-will contracts—like parties to a prospective economic relationship—have “no legal assurance of future economic relations,” the same interests are implicated even though parties to at-will contracts may have more concrete “expectations of a continued relationship.”  It therefore held that stating a cause of action for interference with an at-will contract requires an independently wrongful act, just like a cause of action for interference with prospective economic advantage.

Section 16600 as Applied to Business Contracts.  In answering the second question, the Court started by observing that the parties did not appear to dispute that section 16600 applies to “business contracts” or that none of the statutory exceptions to section 16600 (e.g., sale of a business or dissolution of a partnership or LLC) applied to the facts of the case.  Rather, the true dispute was about the standard a court should apply when analyzing a contractual restraint on business operations and commercial dealings between businesses.

After examining the legislative and judicial history surrounding section 16600 and its Civil Code predecessor, the Court distinguished two categories of agreements that may contain restraints on trade:  (1) contractual restraints in employment or sale of business agreements, and (2) contractual restraints on business operations and commercial dealings between businesses.  With respect to the latter, the Court held that section 16600 should be read in accordance with the Cartwright Act to incorporate the same “rule of reason” that applies in an antitrust analysis.  Accordingly, courts evaluating such business restraints under section 16600 must ask whether the restraint “promotes or suppresses competition” considering the “circumstances, details, and logic of a restraint.”  With respect to the former category of agreements (employment and sale-of-business), the Court reaffirmed its decision in Edwards and other existing opinions that do not apply a reasonableness standard and instead strictly construe section 16600 in the employment or sale-of-business context to void any restriction on an individual’s ability to engage in a lawful profession, trade, or business if that restriction does not otherwise meet a recognized exception.

FTC Holds Workshop Examining Potential for Regulation of Non-Compete Agreements

After a busy year for non-compete regulation at the state level, the Federal Trade Commission (FTC) held a public workshop last Thursday in Washington D.C. to examine the legal basis and economic support for a contemplated FTC rule restricting the use of non-compete clauses in employment agreements. A link to the FTC’s webpage with details about the workshop is located here: https://www.ftc.gov/news-events/events-calendar/.

The workshop brought together experts from academia, organized labor and the private sector to discuss the impact of non-competes on the American workforce and overall economy. Multiple panels involved presentations of academic studies taking the position that non-competes negatively impact workers and the labor market. In particular, there appeared to be broad consensus among panel presenters that non-competes restrict worker mobility, limit the exchange of information, and cause a suppression of wages. One study estimated that an outright ban on non-competes clauses would cause wages of workers in the U.S. to increase, on average, by approximately 7%.

There was also discussion about the potentially positive impact of non-compete agreements for certain categories of employees, such as physicians and CEOS. In particular, one study found that physician groups that utilized non-competes saw doctors make significantly more patient referrals within the physician group and led to higher overall earnings. Moreover, the study found CEOs bound by non-compete clauses tend to be more accountable and typically receive higher compensation.

There was also significant discussion regarding the FTC’s authority to promulgate a rule regulating the use of non-compete agreements. Several participants noted that the FTC has broad statutory authority to regulate unfair competition. Non-competes could theoretically fall within the FTC’s authority pursuant to the FTC’s view that non-compete agreements are anti-competitive and an unfair restraint on the ability of employers to compete for labor.

Overall, workshop participants agreed that more empirical evidence is needed before there can be meaningful discussion about an outright ban of non-compete agreements. Other proposals for an FTC rule included setting a nationwide minimum earnings threshold for workers against whom a non-compete may be enforced and requiring employers to disclose the terms of a non-compete with an offer of employment (not after an offer has been accepted).

To aid its continuing analysis of non-competes, the FTC is seeking public comments on several questions aimed to determine how the Commission should focus its rulemaking efforts. Public comments are due by February 20, 2020. More information about submitting a public comment to the FTC can be found at the link above. Trade Secrets Watch will continue to monitor developments from the FTC.