NHEH Publications

New Guidance Related to Non-Compete Restrictions in Business-to-Business Contexts

By Danny Little

Attorney, Noland, Hamerly, Etienne & Hoss

                                   As published in the Salinas Valley Business Journal, December 2020

Non-compete agreements, or contracts that prevent individuals or entities from working with one another, typically show up in three different contexts: business-to-business agreements (for example, as part of a cooperative working arrangement), employer-employee relationships, or as part of an agreement to sell or purchase a business or its assets.

Except as specifically provided for in the California Business and Professions Code, “every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.” (Bus. & Prof. Code section 16600.)  In other words, non-compete agreements are invalid and unenforceable unless a statutory exception applies to the particular circumstances.  Examples of exceptions to this broad prohibition are when a company sells its assets and goodwill to another company or upon the dissolution of a partnership or LLC.  However, an opinion recently issued by the California Supreme Court (Ixchel Pharma, LLC v. Biogen Inc.), has broadened the circumstances when a non-compete can be enforced. 

In 2016, two pharmaceutical development companies, Ixchel Pharma, LLC and Forward Pharma, entered into a Collaboration Agreement under which they were to jointly produce a drug to treat a rare genetic disease.  In 2017, as part of an entirely unrelated dispute, a third biotech company (and competitor of Ixchel), Biogen Inc., and Forward Pharma entered a settlement agreement pursuant to which Forward was required to stop all existing business relationships with Ixchel.  As was its right under the Collaboration Agreement, Forward Pharma immediately terminated its relationship with Ixchel, causing Ixchel to sue Biogen, challenging the settlement agreement as an unenforceable non-compete covenant under California law.  Eventually, the question of how to evaluate business-to-business non-compete agreements made its way to the California Supreme Court.  

After considering the potential impacts of strictly prohibiting all contractual restrictions on competition between business, the Court held that section 16600 “is best read not to render void per se all contractual restraints on business dealings, but rather to subject such restraints to a rule of reason.”  The Court stated that the rule of reason asks “whether an agreement harms competition more than it helps by considering the facts peculiar to the business in which the restraint is applied, the nature of the restraint and its effects, and the history of the restraint and the reasons for its adoption.”  In other words, in business-to-business contexts, a non-compete restriction will be per se invalid only if it is unreasonable.  

The Ixchel holding was particularly significant because historically, California courts strictly interpreted section 16600 to prohibit enforcement of any agreement which restricted trade between businesses. Now, after Ixchel, it appears that if a non-compete restriction between businesses is “reasonable” under the law, it will likely be enforced.    

Moving forward, the Ixchel case will likely have a two-fold effect. First, it opens the door for business owners to impose reasonable non-compete restrictions in their business-to-business relationships, which previously was understood not to be permissible.  Second, the Court’s ruling has the potential to significantly reduce the risk of costly litigation for businesses that may already have reasonable non-compete restrictions in their business-to-business contracts, such as an exclusive dealing agreement.  

In summary, the California Supreme Court held that contractual restrictions on competition between businesses are not per se invalid, but rather will be evaluated by “the rule of reason,” or whether an agreement harms competition more than it helps.
 

This article is intended to address topics of general interest and should not be construed as legal advice.  © 2020 Noland, Hamerly, Etienne & Hoss