In Noncompetes, Substance Matters

In Edwards v. Arthur Andersen, 44 Cal.4th 937 (2008), the California Supreme Court held that covenants not to compete, even if narrowly drawn, are invalid and unenforceable under California Business & Professions Code §16600 unless the covenant falls within one of three statutory exceptions. One of those exceptions is found in §16601, which permits such restrictive covenants in connection with the sale of a business. In Fillpoint v. Maas, 208 Cal.App.4th 1170 (2012), California’s Fourth District Court of Appeal reaffirmed that noncompete agreements, even if generally associated with the sale of a business, are not enforceable in California unless they are specifically tailored to protect the value of the acquired business. Fillpoint helps define the boundary between enforceable restrictive covenants which legitimately protect the goodwill of a business and unenforceable covenants which restrict employee mobility beyond the narrow exception permitted under §16601. Although the opinion does not create new law, it should be required reading for those drafting such covenants in anticipation of a merger or acquisition of a business.

In Fillpoint, Michael Maas owned stock in his employer’s parent company and signed a securities purchase agreement upon the sale of that company. The purchase agreement contained a three-year covenant not to compete in the relevant business of distributing and publishing video games. The term was three years from the close of the transaction. About one month later, Maas signed a three-year employment agreement, which restricted competing conduct (contacting customers, working for a direct competitor or soliciting workers) for one year post-employment. Three years after signing the agreements, thus satisfying the noncompete term in the purchase agreement and employment term in the employment agreement, Maas resigned and became the president, chief executive officer and major shareholder of a competing company. Fillpoint (an assignee of rights in the employment agreement) then sued Maas for breach of the employment agreement and Maas asserted a defense that the covenant was an unenforceable restraint of trade under §16600. Following plaintiff’s opening statement and briefing on the issue, the trial court granted Maas’ motion for nonsuit on the grounds that the employment agreement and purchase agreement were “separate” and the noncompete in the employment agreement was unenforceable under §16600.