Buyers of all or parts of another business often seek to protect the value of their investments by entering into non-compete agreements with their sellers. Courts typically favor enforcement of such sale-of-business non-compete agreements in order to protect buyers from unfair competition from sellers, and to protect the business's goodwill for which the seller has paid as part of the purchase price. Courts regularly enforce sale-of-business non-compete agreements, either as an exception to a general legal prohibition on agreements restraining trade or by applying a more lenient standard for enforceability. The public policy favoring enforcement of sale-of-business non-compete agreements stands in stark contrast to non-competes between employers and their employees triggered by termination of employment. Courts in most states generally will enforce narrowly drafted and reasonable post-employment non-competes in accordance with a patchwork of state laws. However, courts in several states, notably California, North Dakota and Oklahoma, broadly refuse to enforce post-employment non-competes.

Although California law prohibits post-employment non-compete agreements, California law allows parties to enter into non-compete agreements in the context of a sale of business in accordance with certain detailed statutory requirements. Because of the size of the California economy, and the willingness of California courts to enforce appropriate sale-of-business non-compete agreements, buyers of businesses both inside and outside of California frequently seek to maximize compliance with California law. One of the key issues such buyers need to consider in drafting sale-of-business non-compete agreements is whether the ownership interest being sold will suffice to trigger California's sale-of-business exception. In this month's column, we discuss California law governing sale-of-business non-competes and the case law addressing the nature of the ownership interest that the seller must transfer for the sale-of-business rules to apply. We also analyze the Federal Trade Commission's (FTC) recently published proposed rule banning post-employment non-competes. Like the California prohibition on employment non-compete agreements, the FTC's proposed rule also includes a sale-of-business exception which buyers should consider in structuring their transactions.

California's Sale-of-Business Exception

California generally invalidates non-compete agreements by making "void" "every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind." Cal. Bus. & Prof. Code §16600. However, §16601 of the Business and Professions Code carves out a limited exception for buyers and sellers of businesses.¹ Under §16601, any of the following persons "may agree with the buyer to refrain from carrying on a similar business within a specified geographical area in which the business is sold, or that of the business entity, division, or subsidiary has been carried on, so long as the buyer, or any person deriving title to the goodwill or ownership interest from the buyer carries on a like business therein": (1) "any person who sells the goodwill of a business"; (2) "any owner of a business entity selling or otherwise disposing of all of his or her ownership interest in the business entity"; or (3) "any owner of a business entity that sells (a) all or substantially all of its operating assets together with the goodwill of the business entity, (b) all or substantially all of the operating assets of a division or a subsidiary of the business entity together with the goodwill of that division or subsidiary, or (c) all of the ownership interest of any subsidiary." Cal. Bus. & Prof. Code §16601.