©2024 Seyfarth Shaw LLP www.seyfarth.com 2024 Cal-Peculiarities | 347 12.1.5 The ban on noncompete covenants as applied to buy-sell contracts Section 16600’s ban on noncompete covenants is subject to a statutory exception applying upon the sale of all or substantially all of a business, including its goodwill.20 But the Court of Appeal has held that when the sale involves two separate agreements—a stock purchase agreement and an employment agreement—the agreements must be read together. The Court of Appeal concluded that the employment agreement’s covenant not to compete or solicit, which was not designed to protect the acquired company’s goodwill, failed to qualify under the “sale of business” exception.21 In 2022, the California Court of Appeal enforced a non-solicitation-of-customers provision.22 The defendant had founded several real estate development firms. In a complex series of transactions, he consolidated these firms into a new entity—that he owned—sold fifty percent of his ownership interest to a third party, and was hired as the CEO. Four years later, he was terminated for cause. He formed a new company and solicited his “past and potential future customers.”23 The Court of Appeal focused on the consolidation phase of the transaction to find that the defendant had transferred all or substantially all of his businesses. Further, the defendant owned the new entity when he consolidated his businesses, but the Court of Appeal held that this was immaterial. The court focused on whether he sold or otherwise disposed of all of his business interests when he conveyed his entire ownership stake in his various companies.24 Because he did, the sale of business exception applied and the non-solicitation provision was properly enforced. 12.1.6 The ban as applied to settlement agreements Settlement agreements, like contracts generally, are enforceable, notwithstanding California’s ban on noncompete covenants, to the extent that the settlement agreement protects trade secrets. In a settlement of a trade secret lawsuit, the parties agreed to a stipulated injunction by which defendants would refrain from contacting customers on plaintiff’s customer list (allegedly including trade secrets). When a dispute arose about compliance with this stipulated injunction, the plaintiff successfully moved for an order of contempt. The Court of Appeal held that the stipulated injunction was facially valid, as it existed to protect trade secrets.25 12.1.7 The ban as applied to third-party contracts The ban on noncompete covenants extends even to contracts to which an employee is not a party, which the California legislature confirmed as part of its updates effective in 2024.26 Before this legislative change, both federal and state courts had recognized that certain business-to-business non-competes are permissible to further legitimate business interests. At issue in one case was a provision in a contract between a consulting firm and its customer that the customer would not hire the consulting firm’s employees for 12 months following the contract’s termination. This provision aimed to protect the consulting firm’s key asset—the expertise of its consultants—by discouraging the firm’s customers from hiring away the firm’s consultants. When the customer breached this provision, the consulting firm successfully sued its customer to recover damages. But the Court of Appeal reversed, reasoning that because “the interests of the employee trump the interests of the employers as a matter of public policy,” “it logically follows that a broad-ranging contractual provision such as the one at issue here cannot stand.”27 The Court of Appeal concluded in 2007 that “enforcing this clause would present many of the same problems as covenants not to compete and unfairly limit the mobility of an employee who actively sought an opportunity with [the customer].”28 The Court of Appeal allowed that a “more narrowly drawn and limited no-hire provision” might be permissible under California law, but noted that the provision in question covered all hiring (not just solicitation by the customer) and covered all of the consultant firm’s employees (not just those who worked for the customer or
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