NON-COMPETITION AGREEMENTS UNDER CALIFORNIA LAW: Further Issues

 

IVAN HOFFMAN, B.A., J.D.

 


In a prior article (read “NonCompetition Agreements Under California Law.”  http://ivanhoffman.com/noncompete.html), I explored the issues surrounding the non-enforceability of these clauses in agreements entered into or governed by in California law.  You should read that article before this one so you have the context of the California statute and related cases. 

In the context of a California divorce case, the issue was whether a court had the right to issue a court order (as opposed to an “agreement” which is what is mentioned in the statute) that had the effect of restraining a party to the divorce from competing.   In In re Marriage of Gréaux and Mermin, the trial court, after examining the evidence, awarded control over a community property business including its goodwill to a husband (I will not discuss the community property issues in this regard.  You may wish to read “Divorce and Copyright” on my site.  The Court adopted a proposed order prepared by the husband to this effect:

Husband prepared a proposed statement of decision and a proposed judgment, to which wife filed objections. The proposed judgment included far more detailed language than that contained in the intended statement of decision concerning the restraints to be imposed upon wife post-dissolution. Specifically, husband proposed that wife be restrained and enjoined from: (1) contacting or communicating with “any person or entity in the SBSC/Batiste infrastructure” including its growers, distillers, shippers, bottlers, distributors, attorneys, employees, consultants, customers “or other persons doing business with SBSC[;]” (2) holding herself out as a representative of SBSC or of the brand Batiste; (3) holding herself out as having any connection or involvement with SBSC or Batiste rum; and (4) entering the premises of SBSC or dealing with the books, bank accounts and records of SBSC.

Husband also proposed that wife be “restrained and enjoined from competing with [husband] or SBSC for a period [of] five years from entry of judgment herein. She shall not . . . [set] up a company of her own or with other investors, or persons or entities engaged in the production, bottling, marketing or selling [of] Rhum Agricole or rum of any kind, wherever produced or grown. Further, [Wife] shall not consult with any person or entity that is in competition with or could be in competition with SBSC’s rum product or who proposes to offer a competing product. She shall not work for a competitive Rhum Agricole product or other rum product during the five year period.” {Slip Opn. Page 6}

The appellate court stated:

Section 16600 provides, “[e]xcept as provided in this chapter, every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.” This has not always been the rule. “Under the common law . . . contractual restraints on the practice of a profession, business, or trade, were considered valid, as long as they were reasonably imposed. [Citation.] . . . However, in 1872 California settled public policy in favor of open competition, and rejected the common law ‘rule of reasonableness,’ when the Legislature enacted the Civil Code. [Citations; fn. omitted.] Today in California, covenants not to compete are void, subject to several exceptions. . . .” (Edwards v. Arthur Andersen LLP (2008) 44 Cal.4th 937, 945 (Edwards).) Those exceptions include noncompetition agreements made in connection with the sale of a business (§§ 16601, 16602.5) or the dissolution of a partnership (§16602). The code does not address the issuance of noncompetition orders.

The Court went on to say that the prohibition against noncompetition agreements is not based merely on the statute but is a reflection of a strong state public policy against restraint of trade.  It stated in part:

But this statutory prohibition on noncompetition agreements reflects not just a prohibition on contracts restricting one’s business or employment but a “settled policy in favor of {Slip Opn. Page 8} open competition.” (Howard v. Babcock (1993) 6 Cal.4th 409; 416; Kelton v. Stravinski (2006) 138 Cal.App.4th 941, 946; Hill Medical Corp. v. Wycoff (2001) 86 Cal.App.4th 895, 900 (Hill).) “ ‘The rule making void contracts in restraint of trade is not based upon any consideration for the party against whom the relief is sought, but upon considerations of sound public policy.’ [Citation.]” (Pacific Wharf Etc. Co. v. Dredging Co. (1920) 184 Cal. 21, 24--25.) “California courts have consistently declared [section 16600] an expression of public policy to ensure that every citizen shall retain the right to pursue any lawful employment and enterprise of their choice.” (Metro Traffic Control, Inc. v. Shadow Traffic Network (1994) 22 Cal.App.4th 853, 859; Strategix, Ltd. v. Infocrossing West, Inc. (2006) 142 Cal.App.4th 1068, 1072 [“California’s public policy affirms a person’s right to pursue the lawful occupation of his or her choice.”].)

However, the Court also acknowledged that, within the context of a divorce, a court has the power to issue orders that are designed to reflect a “fair and equal distribution of marital property.”  (citing cases and Family Code section 2553)

We must therefore determine whether the public policy affirming an individual’s right to engage in a trade or business of his or her choosing trumps the family court’s authority to issue any orders--and specifically a noncompetition order--to achieve an equal division of marital property. We conclude it does not.

So as a general rule, freedom to compete takes second place to a court’s ability to fairly and equitably divide marital property.

The Court went on and stated in part:

“Where a covenant not to compete is executed as an adjunct of a sale of a business there is an inference that the business had a ‘goodwill’ and that it was transferred.” (Monogram Industries, Inc. v. Sar Industries, Inc. (1976) 64 Cal.App.3d 692, 701.) Indeed, noncompetition agreements will not be enforced if a close examination of the purchase and sale agreement demonstrates that no goodwill was included in the sale. “In order to restrain the seller’s profession, trade, or business, there must be a clear indication that in the sales transaction, the parties valued or considered goodwill as a component of the sales price, and thus the . . . purchasers were entitled to protect themselves from ‘competition from the seller which competition would have the effect of reducing the value of the property right that was acquired.’ “ (Hill, supra, 86 Cal.App.4th at p. 903.) Goodwill is often referred to as the expectation of continued patronage that has become an asset of the business. (Id. at p. 902, fn. 6.)

In connection with the valuation of a business in a dissolution action, the court must decide whether the business has any goodwill, and if so, what is its value. (In re Marriage of Lopez (1974) 38 Cal.App.3d 93, 109, disapproved on other grounds in In re Marriage of Morrison (1978) 20 Cal.3d 437, 453.) “Essentially, goodwill in a dissolution context is a portion of the value of the [business] as a going concern. {Slip Opn. Page 10} [Citation.]” (In re Marriage of Rives (1982) 130 Cal.App.3d 138, 149 (Rives).) A family court’s discretion in dividing marital property includes the authority to award a marital business to one spouse as a means to achieve equity in the division of property. (In re Marriage of Kozen (1986) 185 Cal.App.3d 1258, 1262; In re Marriage of Burlini (1983) 143 Cal.App.3d 65, 70.) It therefore follows that, if an ongoing marital business is being awarded to one spouse, and if the value of that business includes goodwill, a family court should have the power, pursuant to Family Code section 2553, to issue a noncompetition order so that the value of that asset is preserved, just as a noncompetition clause in a business purchase and sale agreement is designed to protect the value of the asset purchased. Decisions from our sister states are largely in accord. fn. 5 (In re Marriage of Fischer (Colo.Ct.App. 1992) 834 P.2d 270 (Fischer); Lord v. Lord (Me. 1983) 454 A.2d 830 (Lord); Holland v. Holland (Wyo. 2001) 35 P.3d 409; Cesar v. Sundelin (2012) 81 Mass.App.Ct. 721 [967 N.E.2d 171] (Cesar); Carr v. Carr (1985) 108 Idaho 684 [701 P.2d 304] (Carr).) [emphasis added]

  

This reasoning supports our conclusion that, as a general proposition, a party to a marital dissolution may be ordered not to compete where it is necessary to protect the value of a marital asset. fn. 6 We believe this rationale applies whether the business is sold to a third party or assigned to one of the spouses as an ongoing concern.

However, within the context of the case before the Court, the Court concluded that the trial court did not properly evaluate the worth of the goodwill of the business being transferred to the husband and as to which the non-competition order applied.  The Court stated:

…In keeping with our state’s policy of freedom to choose one’s trade or business, noncompetition orders must be “reasonable and not broader than necessary to protect the good will included in the valuation and transfer.” (Cesar, supra, 967 N.E.2d at p. 173.) Looking, again, at the statutes allowing noncompetition clauses in connection with certain commercial transactions, we observe that a transferor may agree to refrain from carrying on “a similar business within a specified geographic area” where the prior business has been carried on, so long as the person recieving ownership of the business or the goodwill “carries on {Slip Opn. Page 14} a like business therein.” (§§ 16601, 16602, 16602.5.) Thus, “[t]he geographic scope of a noncompetition covenant must be limited to the area where the sold company carried on business because ‘[o]therwise, a seller could be barred from engaging in its business in places where it poses little threat of undercutting the company it sold to the buyer.’ [Citation].” (Alliant Ins. Services, Inc. v. Gaddy (2008) 159 Cal.App.4th 1292, 1301.)

Using the statutes and the cases construing them for guidance, we conclude that, if a family court’s noncompetition order is not restricted to the geographic area where the parties carried on the marital business, there must be evidence to support the need for a broader order. Additionally, just as a court’s valuation of property must be based on findings supported by substantial evidence (In re Marriage of Micalizio (1988) 199 Cal.App.3d 662, 672--673), so, too, must the terms of a noncompetition order--i.e., the scope of prohibited activities and the length of the prohibition--be based on findings supported by substantial evidence that they are reasonably necessary to protect the value of the asset awarded in the dissolution.

Here, wife was restrained from working in a Rhum Agricole business or other rum product business, or any other business that “could be in competition with SBSC’s rum product” for a period of five years, without geographical limitation. The family court’s statement of decision, however, contains nothing about the geographic market of SBSC at the time of the dissolution, nor does it contain any findings to support the unlimited geographic reach of the order. The court therefore abused its discretion, and the noncompetition order must be vacated. fn. 7

Conclusion

As with much in the law, the “devil is in the details.”  So while there is often a “general rule,” nearly equally as often there are exceptions to the general rule.

That’s the reason lawyers “get the big bucks.”

 

Copyright © 2014 Ivan Hoffman.  All Rights Reserved.

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This article is not legal advice and is not intended as legal advice.  This article is intended to provide only general, non-specific legal information.  This article is not intended to cover all the issues related to the topic discussed.  The specific facts that apply to your matter may make the outcome different than would be anticipated by you.  This article is based on United States law.  You should consult with an attorney familiar with the issues and the laws of your country.  This article does not create any attorney client relationship and is not a solicitation.

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