A limited exception to California's general prohibition against non-competition restrictions is Bus. & Prof. Code § 16601, which permits enforcement of reasonable covenants not to compete entered into in connection with the sale of a business. The rationale behind this exception is to protect the value of the purchaser's acquisition, by reasonably preventing competition from the seller which would have the effect of reducing the value and goodwill of the acquired business.
A recent California Court of Appeal decision, Fillpoint, LLC v. Maas, reminds us that employers may not use the so-called "sale of business" exception to restrict competition beyond the scope of the acquired entity's business. Such a restriction will be unenforceable in violation of Bus. & Prof. Code § 16600.
The Fillpoint plaintiff purchased the assets of a video game company, Crave Entertainment Group, Inc., that was previously acquired by another entity through a purchase agreement dated October 18, 2005. As part of the 2005 purchase agreement, defendant Michael Maas sold all of his stock in Crave and agreed to a three year noncompete restriction after the closing date, and also agreed to execute a new employment agreement with Crave. In this regard, on November 22, 2005, Maas executed a 3-year employment agreement with Crave that also broadly prohibited Maas from competition and solicitation for one year following the termination of his employment.
After working for Crave for three years, Maas resigned on November 22, 2008 and six months later, began working for a competitor to Crave. The plaintiff, which had acquired Crave's assets several months prior, sued Maas and his new employer for breach and tortious interference. The trial court dismissed the case, and the plaintiff appealed.
On appeal, the Court of Appeal initially agreed with the plaintiff's contention that the employment agreement must be read together as part of the purchase agreement because both agreements referenced each other and were part of the same transaction. However, even though the two agreements were read together, the court disagreed that the plaintiff could obtain the benefit of the "sale of business" exception to California's prohibition against non-competition restrictions. The court noted that the three year covenant not to compete that Maas entered into in connection with the sale of his stock protected the goodwill of Crave and satisfied the purpose of the "sale of business" exception. In contrast, the one year post-employment covenant not to compete was much different: it was broader in scope, improperly prohibited Maas from soliciting both existing and potential customers of Crave (a similar type of restriction was held unlawful by an earlier case), was not focused on protecting the acquired goodwill, and appeared to target the employee's fundamental right to pursue his profession. Accordingly, the Court of Appeal held that the one year post-employment restriction was unenforceable and affirmed judgment for Maas and his new employer.
Businesses looking to apply the sale of business exception in California should review Fillpoint and draft their post closing restrictions on competition accordingly.