Will the ban on restrictive covenants get even broader?

California courts have broadly enforced the state of California's long-standing public policy against non-competition and non-solicitation restrictive covenants in the employment context, as codified in California Business and Professions Code Section 16600. As the California Supreme Court made clear in its 2008 decision in Edwards v. Arthur Andersen, LLP, Section 16600's protections are broad and absolute. 44 Cal. 4th 937 (2008). Traditionally, these protections have been applied to prevent former employers from restraining a former employee's right to work in their chosen profession, even when a former employee seeks to compete directly with a former employer.

Now, in what could be an important first step to further expand the already broad reach of Section 16600, the 9th U.S. Circuit Court of Appeals has asked the California Supreme Court to answer the question: "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?" Ixchel Pharma, LLC v. Biogen, Inc., 2019 DJDAR 6613 (9th Cir. July 16, 2019). In its request to the California Supreme Court, the 9th Circuit states that Section 16600 -- on its face -- is not limited to the employment setting, and in fact, the plain language suggests that the California Legislature did not intend to impose any limitation. Section 16600 applies to "every contract by which anyone is restrained from engaging in a lawful profession, trade or business of any kind."

The Ixchel Dispute. The dispute before the 9th Circuit, in which this certified question arose, relates to a contract provision in which defendant-appellee Biogen Inc. required third party Forward Pharma to cut all ties with plaintiff-appellant Ixchel, Pharma, LLC. Pursuant to that contract provision, Forward cut all ties with Ixchcel. The contract provision at issue in Ixchel related to a collaboration agreement that Ixchel and Forward previously entered into for the development of a drug. Shortly thereafter, Forward and Biogen began negotiating the settlement of an unrelated dispute, and Ixchel alleges that in the course of those negotiations, Forward provided Biogen with a copy of the collaboration agreement it had entered into with Ixchel.

Ixchel further alleges that the drug development contemplated by its collaboration agreement with Forward threatened a drug Biogen had designed, and the contract provision was intended to ameliorate that threat. Ixchel sued, in part, to invalidate this contract provision as void and unenforceable under Section 16600. Ixchel argues that Section 16600 is not limited to employment agreements; Biogen argues that it is limited.

Restrictive Covenants Outside the Traditional Employment Context Section 16601: The Sale of the Goodwill of a Business Exception. Although Section 16600 has been broadly enforced to prohibit employment restraints, California courts have enforced, with equal strength, the "sale of goodwill of business" exception to Section 16600, as codified in California Business and Professions Code Section 16601. Under Section 16601, a restrictive covenant is enforceable if entered into in conjunction with the sale of a business. See, e.g., Monogram Indus., Inc. v. Sar Indus., Inc., 64 Cal. App. 3d 692, 701 (1976); Alliant Ins. Servs., Inc. v. Gaddy, 159 Cal. App. 4th 1292, 1301 (2008); Hilb, Rogal & Hamilton Ins. Servs. v. Robb, 33 Cal. App. 4th 1812, 1817, 1825-26 (1995).

Why does this matter here? It demonstrates that the state of California recognizes the importance of noncompetes in certain business to business agreements and, in fact, has already determined that, at least when business goodwill is exchanged, restrictions on competition should be enforced.

Golden v. California Emergency Physicians Medical Group. In June 2018, the 9th Circuit held that a provision in a settlement agreement that was not a traditional noncompete, but still restricted a doctor's ability to compete with his former employer (i.e., the doctor could freely seek employment with a competitor but could be prohibited from working at certain facilities which his former employer provides services or has an interest in), was a de facto noncompete and void under Section 16600. The provision at issue provided that "if CEP contracts to provide services to, or acquires rights in, a facility that is an emergency room ... at which [the doctor] is employed or rendering services, CEP has the right to and will terminate [the doctor] from any work in the emergency room without any liability whatsoever." Golden v. California Emergency Physicians Med. Grp., 896 F.3d 1018 (9th Cir. 2018), reh'g denied (Aug. 13, 2018).

The Golden court held that any provision which "imposes a restraint of a substantial character [] that significantly or materially impedes a person's lawful profession, trade, or business" is void and unenforceable under Section 16600. Defining this standard, the 9th Circuit stated: "To meet this standard, a provision need not completely prohibit the business or professional activity at issue, nor does it need to be sufficient to dissuade a reasonable person from engaging in that activity. [Citation omitted]. But its restraining effect must be significant enough that its enforcement would implicate the policies of open competition and employee mobility that animate section 16600." (Emphasis added.) The Golden court further confirmed the broad reach of Section 16600: "We stress, however, that it will be the rare contractual restraint whose effect is so insubstantial that it escapes scrutiny under section 16600. California's Legislature has clearly expressed its disapproval of contracts that restrain lawful business and professional activities, and we are bound to heed that policy judgment wherever its logic applies."

While the Golden court's decision clearly stands for the proposition that a restriction (no matter how it is labeled or phrased) that impedes a person's lawful profession, trade or business is void under Section 16600, it left the door open to the precise issue raised in Ixchel: Does a restriction aimed at another business (versus an individual employee) which "implicates policies of open competition" run afoul of Section 16600?

What Is at Stake? In short, the certified question puts two strong California public policies directly at odds: the interest in protecting California employees from competitive restraints and the interest in promoting a free and fair marketplace and upholding business contracts. It also implicates antitrust laws and California Unfair Competition Law. If the California Supreme Court determines that Section 16600 applies to business agreements, it could open the door for businesses to stifle competition. While it is a virtual certainty that a California court would likely void any restrictive covenant provision related to employment under Section 16600, applying those protections to agreements between businesses would seemingly give rise to a situation where the policy codified in Section 16600 should arguably not apply. This would be especially true if counsel, presumably providing an even playing field, represents the parties. If the California Supreme Court follows Ixchel's argument, it could forever change the way that business in this State is conducted and business agreements are made. 