IS YOUR NON-COMPETE GOING TO WORK FOR YOU?

Purchasers of businesses frequently require sellers to agree or covenant not to compete for a period of time with the business that they have sold. Such a covenant is designed to protect the goodwill of the business acquired by the purchaser. Employers often seek to insert covenants not to compete in employment agreements with their employees in a similar effort to protect the value of their businesses. Unfortunately for employers in California, not all covenants not to compete are created equal.

The general rule in California (set forth in Business and Professions Code section 16600) is that covenants not to compete are unenforceable. The primary exception (set forth in Business and Professions Code section 16601) to that rule permits covenants not to compete in connection with the sale of a business. In connection with the sale of a business, a seller and/or the owner of a business entity selling the goodwill of a business may agree to refrain from carrying on a similar business within a geographic area in which the business was conducted. When a selling owner also accepts employment with the purchaser and thus may have continuing contact with the customers, suppliers and confidential information of the business, the purchaser needs to exercise particular care in drafting an enforceable covenant not to compete.

In Fillpoint, LLC v. Maas, 2012 DJDAR 11800, the California Court of Appeals recently held that a seller's three-year covenant not to compete included in a stock purchase agreement was enforceable, but that a covenant not to compete for one year following the termination of the seller's employment with the purchaser, that was contained is a separate employment agreement, was not enforceable. While the Court agreed that the stock purchase agreement and the employment agreement were part of a single transaction and should be read together, it concluded that the covenant in the employment agreement was broader and, among other things, sought to restrict sales to customer or potential customers during the two years preceding termination. The restrictions on such solicitations extended beyond the business sold and thus were held to fall outside the exception set forth in section 16601.

However, this ruling should not be read to reject the enforceability of all covenants not to compete that are tied to a period of time after the termination of employment of a seller by the purchased business. In Hilb, Rogal and Hamilton Insurance Services of Orange County, Inc. v. Robb, (1995) 33 Cal. App. 4th 1812, a case cited with approval in Fillpoint, the Court of Appeal upheld a covenant not to compete for three years after termination of the seller's employment that was contained in an employment agreement between the seller and the purchaser and that provided for the payment of a separate consideration for this covenant.

The California public policy of not restricting a person's right to work is a strong one and the California courts will continue to scrutinize covenants not to compete to assure that they fit within the purpose of the section 16601 exception. Thoughtful structuring of the purchase transaction and careful drafting of the documents must be employed in order to assure that the covenant is targeted at the protection of the acquired goodwill for the purchaser and thus will be enforced. So, the question remains, if Fillpoint had merely allocated a portion of the purchase consideration to the non-compete in the employment agreement, would the Court have come to a different conclusion?